Following the run-away success of Strategy, Inc. (formerly MicroStrategy, Inc.), Metaplanet, Inc., MARA Holdings, Inc. and several others, a new model for public company activity emerged – a DatCo. DatCo is shorthand for a company whose primary value proposition is centered on data, technology platforms, analytics, or proprietary information, rather than a traditional operating business with established revenues. A DatCo generally buys, holds and trades in cryptocurrencies.
While the DatCo label may be new, the regulatory issues raised by these transactions are not. In fact, many DatCo formations follow a familiar playbook that squarely implicates Nasdaq and NYSE American shareholder approval rules — rules that issuers sometimes attempt to structure around, and that regulators are increasingly scrutinizing.
How DatCos Are Typically Formed
Many DatCos are formed when an existing public company — often a microcap issuer or a company whose original business has stalled — pivots to a data-driven business model. The pivot is frequently accomplished through a combination of:
- A secondary sale of a controlling interest by one or more substantial shareholders to a new control group;
- A change in management and board composition;
- A significant equity investment, often structured as a PIPE or private placement; and
- The acquisition or internal build-out of a data or technology platform.
Where an IPO or standard reverse merger/de-SPAC transaction are relatively straight forward transactions, secondary acquisitions of majority interests are not. In that structure, generally one or more significant shareholders sell to a new control group but maintain an existing business for a time period. The company then engages in one or more PIPE transactions priced at market to avoid triggering shareholder approval requirements with the new money all going toward the new DatCo business model Although the company may technically remain the same legal issuer, the economic reality is often a new business with new control and new capital.
Nasdaq and NYSE Shareholder Approval Requirements
One of the most significant — and frequently underestimated — regulatory hurdles for DatCos is compliance with Nasdaq and the NYSE’s shareholder approval requirements. Because DatCos often have small market capitalizations, limited public float, and a need to issue equity to fund growth or acquire a business, these rules are triggered far more often than expected. Where a PIPE is in close proximity to other changes such as new board members, in-kind contributions, secondary shareholder transactions and the start of a crypto focused business model, the Exchange may take a more wholistic approach and require shareholder approval.
The 20% Rule
Nasdaq and the NYSE American both have rules requiring listed companies to receive shareholder approval prior to issuing twenty percent (20%) or more of the outstanding securities in a transaction other than a public offering at a price less than the Minimum Price, as defined in the rule (see HERE). Although many DatCo’s – or DatCo’s in the making – structure their PIPE transactions to avoid the 20% rule, the Exchanges are taking a closer look at the deals overall.
Change of Control Transactions
Nasdaq and the NYSE also require shareholder prior to the issuance of securities when the issuance or potential issuance will result in a change of control of the company (see HERE). The change of control rule only applies where the change is as a result of the issuance of securities and accordingly, where a change of control occurs without the issuance of securities (such as through the appointment of new board members or the private sale of a control block), no shareholder approval is required. Again however, the Exchanges are scrutinizing change of control transactions that technically avoid the shareholder approval requirements but are in close proximity to other transactions signaling the formation of a DatCo.
Acquisitions Using Stock
Nasdaq and the NYSE require approval prior to the issuance of securities in connection with the acquisition of the stock or assets of another company: (1) where, due to the present or potential issuance of common stock, including shares issued pursuant to an earn-out provision or similar type of provision, or securities convertible into or exercisable for common stock, other than a public offering for cash: (a) the common stock has or will have upon issuance voting power equal to or in excess of 20% of the voting power outstanding before the issuance of stock or securities convertible into or exercisable for common stock; or (b) the number of shares of common stock to be issued is or will be equal to or in excess of 20% of the number of shares of common stock outstanding before the issuance of the stock or securities; or (2) any director, officer or substantial shareholder of the company has a 5% or greater interest (or such persons collectively have a 10% or greater interest), directly or indirectly, in the company or assets to be acquired or in the consideration to be paid in the transaction or series of related transactions and the present or potential issuance of common stock, or securities convertible into or exercisable for common stock, could result in an increase in outstanding common shares or voting power of 5% or more (see HERE).
The rules apply to strategic partnerships, joint ventures and similar transactions between companies as well.
Change of Control Plus a New Business: Re-Listing Required
Where a DatCo transaction results in both a change of control and the introduction of a new operating business, Nasdaq/NYSE will often treat the transaction as a back-door IPO. In those circumstances, the company must:
- Re-apply for listing, and
- Meet the Exchange’s initial listing requirements, not just the continued listing standards.
Initial listing requirements are significantly more onerous, with higher thresholds for stockholders’ equity or market value, bid price, public float, round-lot holders, and governance standards.
Trading Activity, FINRA Scrutiny, and Market Conduct Risk
Another emerging issue for DatCos is heavy or unusual trading activity, particularly in low-float stocks. Sudden price spikes or speculative trading can draw the attention of regulators, including FINRA’s Market Watch and lead to inquiries or investigations into market conduct, communications, and supervisory controls. FINRA has reportedly reached out to at least 200 public companies to request information regarding trading activity preceding public announcements of crypto strategies.
DatCos Are on the SEC’s Radar
Regulators are not blind to the DatCo phenomenon. Senior SEC staff have publicly acknowledged concerns regarding companies that undergo significant business pivots accompanied by changes in control and capital structure.
In an October speech, Acting Director of the Division of Corporation Finance Cicely LaMothe emphasized the SEC’s focus on transactions that effectively result in a new business or new control being introduced into an existing public company. Her remarks made clear that Corp Fin is attentive to disclosure quality, transaction structure, and whether investors are being asked — or improperly denied — a voice in transformative transactions.
The Author
Laura Anthony, Esq.
Founding Partner
Anthony, Linder & Cacomanolis
A Corporate and Securities Law Firm
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony, Linder & Cacomanolis, PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALC legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
Ms. Anthony is a member of various professional organizations including the Crowdfunding Professional Association (CfPA), Palm Beach County Bar Association, the Florida Bar Association, the American Bar Association and the ABA committees on Federal Securities Regulations and Private Equity and Venture Capital. She is a supporter of several community charities including the American Red Cross for Palm Beach and Martin Counties, Susan Komen Foundation, Opportunity, Inc., New Hope Charities, the Society of the Four Arts, the Norton Museum of Art, Palm Beach County Zoo Society, the Kravis Center for the Performing Arts and several others.
Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.
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