Nasdaq and the NYSE American both have rules requiring listed companies to receive shareholder approval prior to issuing securities when a stock option or purchase plan is to be established or materially amended or other equity compensation arrangement made or materially amended, pursuant to which stock may be acquired by officers, directors, employees, or consultants. Nasdaq Rule 5635 sets forth the circumstances under which shareholder approval is required prior to an issuance of securities in connection with: (i) the acquisition of the stock or assets of another company (see HERE); (ii) equity-based compensation of officers, directors, employees or consultants; (iii) a change of control (see HERE); and (iv) transactions other than public offerings (see HERE). NYSE American Company Guide Sections 711, 712 and 713 have substantially similar provisions.
In this blog I am detailing the shareholder approval requirements related to equity-based compensation of officers, directors, employees or consultants. Other Exchange Rules interplay with the rules requiring shareholder approval for equity issuances and for equity compensation issuances in general. For example, the Exchanges generally require a Listing of Additional Securities (LAS) form submittal at least 15 days prior to establishing or materially amending a stock option plan, purchase plan or other equity compensation arrangement pursuant to which stock may be acquired by officers, directors, employees, or consultants without shareholder approval.
Nasdaq Rule 5635(c)
Nasdaq Rule 5635(c) requires shareholder approval prior to the issuance of securities when a stock option or purchase plan is to be established or materially amended or other equity compensation arrangement made or materially amended, pursuant to which stock may be acquired by officers, directors, employees, or consultants, except for: (1) warrants or rights issued generally to all security holders of the company or stock purchase plans available on equal terms to all security holders of the company (such as a typical dividend reinvestment plan); (2) tax qualified, non-discriminatory employee benefit plans (e.g., plans that meet the requirements of Section 401(a) or 423 of the Internal Revenue Code) or parallel nonqualified plans (including foreign plans complying with applicable foreign tax law), provided such plans are approved by the company’s independent compensation committee or a majority of the company’s Independent Directors; or plans that merely provide a convenient way to purchase shares on the open market or from the company at market value; (3) plans or arrangements relating to an acquisition or merger as permitted under IM-5635-1; or (4) issuances to a person not previously an employee or director of the company, or following a bona fide period of non-employment, as an inducement material to the individual’s entering into employment with the company, provided such issuances are approved by either the company’s independent compensation committee or a majority of the company’s Independent Directors. Promptly following an issuance of any employment inducement grant in reliance on this exception, a company must disclose in a press release the material terms of the grant, including the recipient(s) of the grant and the number of shares involved.
NYSE American Company Guide Section 711
Substantially similar to Nasdaq, the NYSE American Company Guide Section 711 requires shareholder approval with respect to the establishment or material amendments to a stock option or purchase plan or other equity compensation arrangement pursuant to which options or stock may be acquired by officers, directors, employees, or consultants, except for: (1) Â issuances to an individual, not previously an employee or director of the company, or following a bona fide period of non-employment, as an inducement material to entering into employment with the company provided that such issuances are approved by the company’s independent compensation committee or a majority of the company’s independent directors, and, promptly following an issuance of any employment inducement grant in reliance on this exception, the company discloses in a press release the material terms of the grant, including the recipient(s) of the grant and the number of shares involved; or (2) tax-qualified, non-discriminatory employee benefit plans (e.g., plans that meet the requirements of Section 401(a) or 423 of the Internal Revenue Code) or parallel nonqualified plans, provided such plans are approved by the company’s independent compensation committee or a majority of the company’s independent directors; or plans that merely provide a convenient way to purchase shares in the open market or from the issuer at fair market value; or (3) a plan or arrangement relating to an acquisition or merger; or (4) warrants or rights issued generally to all security holders of the company or stock purchase plans available on equal terms to all security holders of the company (such as a typical dividend reinvestment plan).
The NYSE American requires a listed company to notify the exchange in writing if it intends to rely on any of the exemptions.
Interpretation and Guidance
               Definition of Consultant
For purposes of this rule, a “consultant” is anyone for whom the company is eligible to use a Form S-8. Accordingly, shareholder approval would be required for stock awards, plans or arrangements for the issuance of equity to: (i) natural persons; (ii) that provide bona fide services to the company; and (iii) whose services are not in connection with the offer or sale of securities in a capital-raising transaction, and who does not directly or indirectly promote or maintain a market for the company’s securities.
Adoption of Plans
A company may adopt an equity plan or arrangement, and grant options (but not shares of stock) thereunder, prior to obtaining shareholder approval provided that: (i) no options can be exercised prior to obtaining shareholder approval, and (ii) the plan can be unwound, and the outstanding options cancelled, if shareholder approval is not obtained. Companies should be aware of any accounting issues that may arise under these circumstances.
A company that has a plan in place at the time of listing on an Exchange would not be required to obtain shareholder approval for that plan, but would be required to obtain approval for future amendments.
               Material Amendments
For purposes of the rule, both Exchanges specifically indicate that a material amendment would include, but not be limited to: (i) any material increase in the number of shares to be issued under the plan, including sublimits (other than as a result of a reorganization, stock split, merger or spin-off); (ii) a material increase in benefits including repricing (such as lowering the strike price of an option) or extensions of duration (though a change in a vesting schedule without more is not material); (iii) a material expansion of the class of participants eligible for the plan; or (iv) an expansion of the types of options or awards under the plan, including value for value exchanges.
If a plan allows for the issuance of stock options, adding stock appreciation rights (SARs) to a plan would not be material as SARs are substantially similar to options. Similarly, if a plan allows for the issuance of restricted stock, adding restricted stock units (RSUs) would not be material.
An amendment to increase tax withholding associated with awards to satisfy tax obligations is not considered a material amendment. Likewise, allowing a recipient to surrender unissued shares to satisfy a tax obligation would not be considered a material amendment. Adding a cashless exercise feature is also not a material amendment.
Neither Exchange will require shareholder approval if the plan, by its own terms, allows for specific actions without further approval, including, for example, the re-pricing of options. In order to rely on the ability to amend, the plan must be specific in the terms and actions that are allowed. A general authority to amend will not obviate the need for shareholder approval for what would otherwise be considered a material amendment. Moreover, some pricing changes, such as changing the exercise price from the closing bid price on the day of grant to the average of the high and low market price on the same day, would not require a new approval.
However, if a plan has a formula that allows for automatic increases of the shares available under the plan (“evergreen plan”) or a formula for automatic grants, the plan cannot have a term in excess of ten years unless shareholder approval is obtained every ten years. Plans that do not contain a formula and do not impose a limit on the number of shares available for grant would require shareholder approval of each grant under the plan.
As the rule specifically only applies to equity grants, awards or compensation and not cash, a company could buy back outstanding awards for cash without first seeking shareholder approval.
               Mergers
Plans or arrangements involving a merger or acquisition do not require shareholder approval in two situations. First, shareholder approval will not be required to convert, replace or adjust outstanding options or other equity compensation awards to reflect the merger transaction. Second, shares available under certain plans acquired in acquisitions and mergers may be used for certain post-transaction grants without further shareholder approval provided the plan had originally been approved by shareholders.
In particular, where a non-listed company is acquired by or merged with a listed company, the listed company may use shares for post-transaction grants of options and other equity awards without further shareholder approval, provided: (i) the time during which those shares are available for grants is not extended beyond the period when they would have been available under the pre-existing plan, absent the transaction, and (ii) such options and other awards are not granted to individuals who were employed by the granting company or its subsidiaries at the time the merger or acquisition was consummated.
Plans adopted in contemplation of a merger or acquisition will not be considered pre-existing for purposes of this exception. Where an evergreen plan is assumed in a merger, the ten-year period for shareholder approval is measured from the date the target company established the plan.
Any additional shares available for issuance under a plan or arrangement acquired in connection with a merger or acquisition would be counted in determining whether the transaction involved the issuance of 20% or more of the company’s outstanding common stock, thus triggering the shareholder approval requirements under Rule 5635(a) related to mergers and acquisitions.
Source of Shares
A requirement that grants be made out of treasury shares or repurchased shares will not alleviate shareholder approval requirements.
Inducement Exemption
The inducement exemption can only be used for employment, and not consulting, arrangements. However, in some circumstances the exemption may be relied upon to induce a consultant to enter into an employment arrangement. An exchange would consider all facts and circumstances related to the relationship. This exemption can only relied upon in connection with the initial inducement for employment. Accordingly, if an inducement award is materially amended, the amendment would require shareholder approval notwithstanding that the initial award did not.
Likewise, the determination of a “bona fide period of non-employment” requires a facts and circumstances analysis. Generally an exchange will consider: (i) whether there was a relationship between the company and former employee during the time of non-employment; (ii) whether the former employee received payments from the company during the period of non-employment; (iii) the reasons for ending the employment relationship; (iv) whether the former employee was employed elsewhere after leaving the company; and (v) whether there was an agreement or understanding that the employee would return to the company.
For purposes of the required press release disclosure, four days will generally satisfy the “promptly” requirement. A company can aggregate the disclosure of inducements where the inducements were made in connection with a merger or acquisition, or a company regularly offers such awards. In that regard, a company can adopt a plan that will be used solely for inducements, without the necessity of shareholder approval. However, inducement grants made to executive officers must always be individually disclosed.
Parallel Nonqualified Plan
A parallel nonqualified plan means a plan that is a “pension plan” within the meaning of the ERISA Act that is designed to work in parallel with a qualified tax plan to provide benefits that exceed IRS compensation limitations. A plan will not be considered a parallel nonqualified plan unless: (i) it covers all or substantially all employees of an employer who are participants in the related qualified plan whose annual compensation is in excess the compensation limits; (ii) its terms are substantially the same as the qualified plan that it parallels except for the elimination of the limitations; and, (iii) no participant receives employer equity contributions under the plan in excess of 25% of the participant’s cash compensation.
Below Market Sales
The private sale of securities to officers, directors, employees or consultants at a price less than market value is considered a form of “equity compensation” and, as such, requires shareholder approval. For purposes of this rule, market value is the consolidated closing bid price immediately preceding the time the company enters into a binding agreement to issue the securities. Shareholder approval would not be required if the officer, director, employee or consultant was purchasing securities from the company in a public offering.
Issuances to an entity controlled by an officer, director, employee, or consultant of the a company may also be considered equity compensation under certain circumstances, such as where the issuance would be accounted for under GAAP as equity compensation or result in the disclosure of compensation under Regulation S-K.
Broker Votes
Broker-dealers may not vote client proxies on equity compensation plans unless the beneficial owner of the shares has given voting instructions. That is, equity compensation plans are considered “non-routine” items prohibiting broker votes on behalf of their clients.
Foreign Private Issuers
Although the rule applies to foreign private issuers, if such issuer is otherwise following its home country practices in accordance with the Exchange rules, it can do so related to this shareholder approval requirement as well.
Consequences for Violation
This rule is strictly construed and, as such, all plans or material amendments to a plan, regardless of the number of shares under the plan or arrangement, require shareholder approval. Consequences for the violation of any of the Exchange’s rules, including shareholder approval rules, can be severe, including delisting from the Exchange. Companies that are delisted from an Exchange as a result of a violation of these rules are rarely ever re-listed.
The Author
The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded 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 L.G., 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 ALG 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 sitting on the board of directors of the American Red Cross for Palm Beach and Martin Counties, and providing financial support to the 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. She is also a financial and hands-on supporter of Palm Beach Day Academy, one of Palm Beach’s oldest and most respected educational institutions. She currently resides in Palm Beach with her husband and daughter.
Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.
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