Notice To Members 87-32

Request for Comments on Shareholder Voting Rights Proposal For NASDAQ Companies

Published Date:

TO: All NASD Members and Other Interested Persons

LAST DATE FOR COMMENT: JUNE 30, 1987.

EXECUTIVE SUMMARY

The NASD requests comments on a proposed amendment to Schedule D to the NASD By-Laws that would make an issuer ineligible for initial or continued inclusion in the NASDAQ System if it issues securities or takes corporate action that would have the effect of nullifying, restricting, or disparately reducing voting rights of holders of an outstanding class or classes of common stock.

The text of the proposed amendment is attached.

BACKGROUND

During the fall of 1984 and the spring of 1985, the NASD Corporate Advisory Board, which is currently composed of chief executives of 16 NASDAQ issuers, and the NASD Board of Governors developed an initial set of corporate governance criteria to be applicable to NASDAQ National Market System issuers. This process included a survey of issuers 1/ and publication for comment of proposed rules. 2/ The criteria developed by the Board of Governors are currently on file with the Securities and Exchange Commission3/ and approval is anticipated in the near future.

One area in which the Corporate Advisory Board and the Board of Governors determined not to impose requirements during their initial consideration of the corporate governance issue had to do with allowing issuers to create either multiple classes of stock having unequal voting rights or voting and non-voting stock.

In July 1985, the NASD Board of Governors authorized the solicitation of public comment on the voting rights issue. 4/ At that time, the NASD proposed for consideration two possible concepts for limiting issuers' ability to create disparate voting rights. The NASD received approximately 100 comment letters. The NASD Board reviewed the comment letters at its September 1985 meeting and concluded that the issue of shareholder voting rights required further study. The Board retained an independent outside consultant to study a number of issues raised during the comment process. The NASD selected Professor Daniel R. Fischel of the University of Chicago's Center for Law and Economics to undertake the study.

In that study, 5/ Professor Fischel analyzed the status of multiple classes of common stock in the context of the "race to the bottom" thesis, the economics of shareholder voting, and the evidence developed by other studies of shareholder voting rights. In addition, the study analyzed the costs and the benefits inherent in the imposition of a prohibition on dual-class common stock. Among other conclusions, the Fischel study found that the vast majority of companies opt for a one-share, one-vote structure, but that in appropriate cases, multiple classes may fulfill legitimate business and economic functions.

The issue of voting rights was again brought to the fore by the filing of a proposed rule change by the New York Stock Exchange in September 19866/ which would have eliminated the exchange's long-standing one-share, one-vote requirement. Using a procedure reserved for only the most critical of policy issues, in December 1986, the SEC held two days of public hearings on the proposal. Approximately 50 witnesses, including representatives of the NASD, testified. A common theme in those hearings was that some uniformity among the marketplaces is appropriate in this area, with some witnesses suggesting that there may be a need for federal legislation.

In March 1987, at the request of the NASD Corporate Advisory Board and the Board of Governors, the NASD suggested, in a letter to SEC Chairman John S. R. Shad, 7/ the framework of an approach to voting rights that would allow the creation of disparate voting or non-voting stock if it would be accomplished in a manner which would not disenfranchise existing securities holders. NASD President Gordon S. Macklin also stated in that letter that "the Association would like to suggest that all equity securities markets should have a uniform rule for domestic securities which would emphasize the principle of equal voting rights but allow for legitimate variations."

As a result of this initiative, the SEC convened several meetings among representatives of the New York and American stock exchanges and the NASD. Based upon discussions at these meetings, the Corporate Advisory Board recommended and the NASD Board of Governors authorized solicitation of comments on the rule proposal which accompanies this notice to members.

PROPOSED AMENDMENT

The rule proposal takes the form of an amendment to the provisions of Schedule D to the NASD By-Laws that sets qualification standards for domestic NASDAQ securities. The general premise of the proposal is to prohibit issuers of NASDAQ securities from issuing any class of securities or taking any other corporate action that would nullify, restrict, or disparately reduce the voting rights of holders of an outstanding class or classes of publicly traded securities of the issuer.

The proposed rule creates two sets of presumptions as to transactions which do, or do not, have the effect of restricting, nullifying, or disparately reducing voting rights. These are, however, only presumptions and the ultimate decision as to whether the issuance of a class of greater, lesser, or non-voting securities violates the rule must be based upon a determination of whether the action restricts, nullifies, or disparately reduces voting rights.

The following transactions are presumed not to restrict, nullify, or disparately reduce voting rights:

(1) Issuance of securities in an initial public offering. When securities with reduced or no voting rights are issued as part of an issuer's first public offering of securities, purchasers are aware of what they are purchasing and are able to factor the nature of the securities into their investment decisions. Nothing is being forced upon shareholders and pre-existing rights are in no way impacted.
(2) Issuance of securities in a public offering with voting rights not greater than those of any outstanding class of the issuer's common stock. This provision allows investors in a new class of securities to make the same investment decisions as investors in an initial public offering, but protects against the disenfranchisement of existing shareholders.
(3) Issuance of securities as approved by a shareholder vote pursuant to a proxy statement in a merger or acquisition or in a stock dividend transaction where the voting rights of the securities would not be greater than those of any outstanding class of the issuer's common stock. This provision allows the issuance of securities that would "participate" in the earnings or operations of the merged or acquired entity but still protects the voting rights of existing shareholders against a dilution of their voting power.
(4) Issuance of securities of a class which protect the relative voting rights of existing shareholders, which are freely transferable and whose issuance is not coupled with other present or future corporate actions designed to adversely impact or dilute the rights of existing shareholders. This provision would allow the declaration of stock dividends and other issuances of securities carrying differing (greater or lesser) voting rights than existing shares so long as no restrictions on transferability or other impediments are attached to the new shares. Some impediments could, for example, have the effect of inducing a certain group of shareholders to convert the new shares into a class of lesser voting securities, thereby disparately reducing the per-share voting rights of that group. To qualify for this presumption of compliance, the issuance of securities must not be coupled with any other corporate action which is designed to, or has the effect of, adversely impacting or diluting the per-share rights of existing shareholders. Such corporate action could include a determination to purchase, through an employee stock ownership plan or other corporate-controlled plan, large amounts of greater voting securities.

This provision (Subsection (2)(D)) is intended to clarify that companies are permitted to issue new classes of securities with greater or lesser voting rights so long as such issuance is not contrary to the prohibition of Section 3.o., but that any such issuance must meet the requirements of Subsection (2)(D) in order to enjoy a presumption of compliance. Any company deviating from the criteria of Subsection (2) would bear the burden of demonstrating compliance with Section 3.o.

The following transactions are presumed to restrict, nullify, or disparately reduce voting rights:

(1) Restrictions on voting power based upon the number of shares held which, for example, result in diminished voting power as the amount of shares held by any one shareholder increases.
(2) Restrictions on voting power based upon the length of time such shares have been held, such as voting structures that require securities to have been held for a stated period of time before full voting power accrues.
(3) Issuance of securities pursuant to an exchange offer where the securities being issued result in a nullification, restriction, or disparate reduction of voting rights of outstanding common stock.

The proposed rule would be prospective in its application and would "grandfather" issuers that currently have outstanding multiple classes of stock with disparate voting rights or that are in the process of implementing such a structure for which proxy materials have been filed with the SEC on or before May 15, 1987. Issuers that have had multiple class capitalizations authorized but that have not issued securities pursuant thereto before May 15, 1987 would not be grandfathered. However, if the issuer had on file with the SEC before May 15, 1987 a registration statement or offering circular for the issuance of securities of a previously authorized class, authorized securities of that class would be grandfathered. Subsequent offerings of new classes of securities of grandfathered issuers would have to comply with the rule.

REQUEST FOR COMMENTS

The NASD is requesting comments on the foregoing proposal, as well as other constructive alternatives and suggestions which commentators may offer. In particular, the NASD requests comments on the effect the proposal would have on the ability of issuers to adopt so-called "fair price" and other charter amendments that would operate in the context of a two-tier tender offer. An example is an amendment to a corporate charter that requires that shareholders in the second phase of a tender offer receive substantially the same form and amount of consideration as those in the first. These provisions are frequently adopted in conjunction with a super-majority provision requiring a vote of a higher percentage of shareholders to approve the second step of a tender offer where equivalent compensation is not going to be paid. The NASD understands that there are several variations of such provisions. Commentators are requested to identify and address these variations in the context of the proposed rule and its impact, if any, upon them.

The NASD also requests comments with respect to any areas of the voting rights issue which have not been addressed in this notice, but which commentators feel are pertinent.

All comments received will be reviewed by the NASD Corporate Advisory Board and the Board of Governors. Comments should be addressed to:

Mr. Lynn Nellius
Secretary
National Association of Securities Dealers, Inc.
1735 K Street, N.W.
Washington,D.C. 20006-1506

All comments must be received by June 30, 1987. Questions regarding this notice should be directed to either the undersigned, at (202) 728-8319, or John F. Guion, Senior Vice President, NASDAQ Company Services, at (202) 728-8379.

Sincerely,

Frank J. Wilson
Executive Vice President and General Counsel

Attachment

PROPOSED AMENDMENT TO PART IIB, SCHEDULE D OF THE NASD BY-LAWS*

II

QUALIFICATIONS FOR AUTHORIZED SECURITIES

* * * *

B. Rules for Authorized Domestic Securities

* * * *

3. An eligible security shall not be authorized, and an authorized security shall be subject to suspension or termination of authorization, if:

* * * *

o. on or after May 15, 1987, the issuer of such security issues any class of securities or takes other corporate action that would have the effect of nullifying, restricting, or disparately reducing the per-share voting rights of holders of an outstanding class or classes of common stock of such issuer registered pursuant to Section 12 of the Securities Exchange Act of 1934; provided, however, that this subsection (o) shall not apply to the issuance of any securities pursuant to a registration statement or offering circular, or the issuance of any security authorized by a shareholder vote solicited by proxy material, filed with the Commission on or before May 15, 1987.
(1) For purposes of this Subsection (o):
(A) the term "security" shall not include any class of securities, other than common stock, having a preference over the issuer's common stock as to dividends, interest payments, redemption, or payments in liquidation if the voting rights of such securities only become effective as a result of specified events, which reasonably can be expected to jeopardize the issuer's financial ability to meet its payment obligations to the holders of that class of securities not relating to an acquisition of the issuer's common stock; and
(B) the term "common stock" shall include any security of an issuer designated as common stock and any security of an issuer, however designated, which by its terms is a common stock (e.g., a security that entitles the holders thereof to vote on matters submitted to the issuer's security holders for a vote); however, nothing herein shall be construed to prevent a company from obtaining financing by issuing a class of securities (other than common stock) to institutional investors under an indenture or purchase agreement containing security arrangements (such as covenants not to merge, consolidate, or sell substantially all the company's assets without the consent of a percentage of the holders of the class of securities) reasonably related to the financing.
(2) For purposes of this Subsection (o), the following shall be presumed not to have the effect of "nullifying, restricting, or disparately reducing" voting rights:
(A) the issuance of securities pursuant to an initial public offering;
(B) the issuance of any class of securities, through a public offering, with voting rights not greater than the per-share voting rights of any outstanding class of the issuer's common stock;
(C) the issuance of any class of securities for which proxies were solicited to effect a merger or acquisition, or by way of a stock dividend to all holders of an outstanding class of the issuer's common stock, where the voting rights of these securities would not be greater than the per-share voting rights of any outstanding class of the issuer's common stock; or
(D) the issuance of a class of securities which protect the relative per-share voting rights of existing shareholders, are freely saleable and transferable without any impact upon or dilution of the voting rights or other property rights inherent in the ownership of the newly issued shares, and which issuance is not coupled with other present or future corporate action which is designed to, or has the effect of, adversely impacting or diluting the rights of existing shareholders.
(3) For purposes of Subsection (o), the following shall be presumed to have the effect of "restricting, nullifying, or disparately reducing" voting rights:
(A) any restriction on the voting power of shares of the issuer's common stock held by a beneficial or record holder based on the number of shares held by such beneficial or record holder;
(B) any restriction on the voting power of shares of the issuer's common stock held by a beneficial or record holder based on the length of time such shares have been held by such beneficial or record holder; or
(C) any issuance of securities through an exchange offer by the issuer for shares of an outstanding class of the issuer's common stock where the securities issued have voting rights, whether greater than or lesser than the per-share voting rights of any outstanding class of the issuer's common stock, that have the effect of nullifying, restricting, or disparately reducing the per-share voting rights of holders of an outstanding class of the issuer's common stock.

1/ This survey was mailed to all NASDAQ companies on May 13, 1985.

2/ Notice to Members 85-20 (March 28, 1985).

3/ SEC File Nos. SR-NASD-85-20 and 86-27.

4/ Notice to Members 85-49 (July 19, 1985).

5/ D. Fischel, Organized Exchanges and the Regulation of Dual Class Common Stock (March 1986).

6/ SEC File No. SR-N YSE-86-17.

7/ Letter from NASD President Gordon S. Macklin to Chairman John S. R. Shad, dated March 13, 1987.

* New language is underlined