A Primer on Public Company De-Registration

These are tough times for small public companies. Despite the recent uptick, the extended bear market has continued to result in low stock prices, making it difficult for small companies to attract the attention of institutional investors and analysts. Many small companies are not able to meet stock market listing standards for share prices or market capitalization. Over 60 companies were delisted from Nasdaq for failure to maintain a sufficiently high stock price or market cap in the first quarter of 2003 alone.

To make matters worse, the Sarbanes-Oxley Act of 2002 and concurrent stock market rule changes have imposed tough new burdens on public companies, many of which were already struggling under the weight of Securities and Exchange Commission and stock market regulation. Independent directors, already difficult to come by for struggling companies, must soon make up a majority of a listed company's board. Companies are scurrying to find board members qualified as financial experts under demanding new regulations. Audit fees, D&O insurance premiums, legal fees, and internal time and expenses attributable to keeping up with a dizzying array of new rules are all going up. And CEOs and CFOs of many public companies are reconsidering their roles in light of the new requirement that they personally certify the accuracy of their companies' financial statements.

For companies that have been unable to establish and maintain investor appeal and analyst coverage, or that have struggled in vain to overcome what they see as temporary business difficulties or market aversions to their industry group, there may be a better way. These "market orphans" are subject to all of the liabilities and expenses of being a public company, while reaping little of the benefit associated with being public. Often, the market value of their shares is too low for such companies to use the public markets to raise capital or for them to use their stock as a currency for acquisitions. Such companies may be well-advised to assess whether they are eligible to voluntarily deregister their securities under the Securities Exchange Act of 1934 and cease being a reporting company. Eligible companies should carefully consider the pluses and minuses of such a strategy.

Eligibility

Companies having a class of securities registered under the Exchange Act that has less than 300 record holders, or less than 500 record holders if the company's total assets have not exceeded $10 million as of the end of the company's three most recent fiscal years, may terminate the registration of any such class of securities. The common stock of many market orphans, which frequently does not trade with any significant volume, will often fit in one of these two categories regardless of the number of beneficial owners of the stock, because often the vast majority of beneficial owners hold their stock in street name through a broker. Such companies are able to deregister at any time, generally without stockholder approval, if their boards of directors find such a course to be in the company's best interest.

Companies that wish to deregister but have too many record holders to immediately deregister will have to undertake some form of "going-private transaction." These transactions commonly take the form of tender offers, exchange offers, reverse stock splits, or mergers, in each case targeted at reducing the number of security holders or concentrating the ownership of a class of registered securities.

Deregistration

Like all companies with stock traded on the Nasdaq, most market orphans will have a class of securities (generally their common stock) registered under Section 12(g) of the Exchange Act, which triggers the duty to file periodic reports with the SEC and to comply with the SEC's proxy rules. Filing of a Form 15 terminates registration of a Section 12(g) registration 90 days after filing, or such shorter period after the filing as may be determined by the SEC. Rule 12g-4 further provides that a company's duty to file periodic reports under Section 13(a) of the Exchange Act (which include Forms 10-K, 10-Q and 8-K, but not proxy statements or Forms 3, 4, and 5) is suspended immediately upon filing the Form 15. The substance of Form 15 is simple; the issuer must simply certify that the class of securities has less than 300 record holders, or less than 500 record holders if the issuer's total assets did not exceed $10 million during the issuer's last three fiscal years. However, if the SEC denies the termination (generally because it believes the issuer's certification is incorrect or improper), or if the Form 15 is subsequently withdrawn, the issuer must file, within 60 days, all reports that would have been required had the Form 15 not been filed.

The stock of an issuer trading on the NYSE or AMEX will be registered under Section 12(b) of the Exchange Act. To deregister its stock under Section 12(b), the issuer must first comply with the rules of the stock exchange regarding voluntary removal from the exchange's list. Once the issuer is removed from the exchange listing, it must file an application with the SEC to complete the deregistration under Section 12(b).

In addition to SEC filing obligations that arise under Section 12 of the Exchange Act, Section 15(d) independently requires that a company that has filed a registration statement that has been declared effective pursuant to the Securities Act file periodic reports with the SEC. Thus, where an issuer terminates its registration under Section 12 but has previously filed a Securities Act registration statement that was declared effective, the issuer's duty to file periodic reports may continue under Section 15(d). Rule 12h-3 provides that any reporting obligations arising under Section 15(d) are immediately suspended upon the issuer's filing of a certification on Form 15.

Form 15 allows issuers to specify the rule(s) under which the form is being filed. Because filing obligations may arise under more than one section of the Exchange Act, issuers must take care to deregister under all applicable sections thereof. To ensure that there are no continuing duties to file SEC reports following the filing of a Form 15, issuers must carefully consider each provision of the Exchange Act that may trigger such a duty. In some cases deregistration will require checking appropriate boxes for subsections of both Rules 12g-4 and 12h-3 on the Form 15 filed with the SEC, in order to properly terminate all of an issuer's filing obligations.

Delisting

Most market orphans are traded on Nasdaq or the OTC Bulletin Board (soon to be moved to the new "BBX" or "Bulletin Board Exchange" system), each of which require that issuers remain current with their periodic filings under the Exchange Act. An issuer that ceases filing its periodic reports will be subject to delisting by Nasdaq or the bulletin board system. However, issuers may elect to voluntarily initiate the delisting process by contacting Nasdaq or the bulletin board in writing and communicating the issuer's reasons for delisting. Neither Nasdaq nor the bulletin boards specify any substantive criteria that must be met to delist, so ordinarily a request for a voluntary delisting would be granted.

As noted above, the procedure for delisting from a national securities exchange – that is, NYSE or AMEX – is integrated with the deregistration of a class of securities under Section 12(b). The national exchanges do have substantive requirements that must be met by an issuer seeking voluntary delisting.

After delisting, if a market maker is willing to provide quotations on an issuer's stock the stock may be listed in the "Pink Sheets," an Internet-based real-time quotation service for over-the-counter securities. Securities that trade only on the Pink Sheets typically have much lower trading volumes than securities trading on other markets, and therefore Pink Sheets stocks are often considerably less liquid than stocks trading on Nasdaq, the NYSE or AMEX.

Additional Considerations

Companies considering deregistration must consider factors other than SEC and stock exchange rules. For instance, such a company needs to be comfortable that the benefits of being public are truly outweighed by the burdens. Although operating as a private company may decrease costs and offer company management increased flexibility in running the business, it also forecloses the access to capital that can be available for public companies. For a company seeking to acquire competitors or strategic partners, publicly-traded stock can be an important deal currency. Publicly-traded stock may also make it easier for a company to structure attractive compensation packages for employees and directors.

Moreover, legal considerations may require an issuer to keep its stock publicly-trading. A company may have agreed to grant registration rights to investors or vendors that require the company to continue filing reports with the SEC. Credit agreements or indentures may require that the company file its SEC reports, or provide its lenders with the type of reports it would otherwise have to file if its securities continued to be registered under the Exchange Act. Public companies will frequently have existing stock option or other benefit plans pursuant to which the company is obligated to issue securities to its employees. If the subject class of securities is no longer registered, the company must find an exemption from Securities Act registration requirements that may not be available. Further, the value of such options will be adversely impacted by the lack of an active trading market.

Conclusion

In struggling with today's difficult business climate, the directors and managers of small public companies may wonder how they can get out from under the heavy burdens of being public. Many such companies may be able to deregister their securities and cease public trading without undertaking an expensive and cumbersome going-private transaction. With the guidance and advice of experienced counsel, going private may simply be a few steps away.