Deregistration of Securities: A Permanent Solution?

by Seth I. Rubin

Since the passage of the Sarbanes-Oxley Act of 2002 and related stock market rule changes, many smaller public companies have decided to deregister their securities in order to avoid the tough new burdens imposed on publicly traded entities.  Deregistration, coupled with delisting of a company’s securities, involves a termination of a class of securities whereby a company ceases to be a publicly traded entity.  Since 2002, hundreds of publicly traded companies have deregistered their securities.  The reasons for this movement to deregistration are many, with most resulting from the substantially increased cost and expense of Sarbanes-Oxley compliance coupled with ever-greater liability for violations of the new, more stringent rules.  While there are clearly benefits to deregistration, especially for companies that are having difficulty reaping the benefits typically associated with being public, deregistration is not a cure-all and is not necessarily a permanent solution, regardless of the issuer’s intentions.

Deregistration of securities is accomplished by the filing of a Form 15 with the Securities and Exchange Commission.  Such filing results in the automatic suspension (but not termination) of the issuer’s obligation to file periodic reports with the SEC and terminates the registration of the class of securities to which it relates under the Securities Exchange Act of 1934 (the “1934 Act”).  A Form 15 becomes effective 90 days following its filing, or such earlier date as determined by the SEC and the issuer.

A company that meets the following criteria may choose to voluntarily deregister its securities:  (a) it has fewer than 300 shareholders; or (b) it has fewer than 500 shareholders and has had total assets of less than $10 million in each of the last three fiscal years.  The benefits of deregistration for struggling companies are many.  A company that deregisters its securities will be able to avoid the cost and expense of public filings – everything from the time and energy expended by company officers to prepare the requisite public reports to accounting expenses, attorney’s fees and the cost of financial printers.  Other benefits include the avoidance of Sarbanes-Oxley liability and the struggle to find directors who meet the requirements of the exchange on which the company’s shares are traded.  In addition, if a company is unable to truly take advantage of the public markets by raising capital or using the market value of its shares for acquisitions and other transactions, there may be little advantage to being publicly traded.  Similarly, a company may have believed that public markets were the key to success only to find that it was unable to overcome analyst aversion to its industry, or it was unable to establish and maintain analyst coverage.

Deregistration should not be confused with a going private transaction, which typically involves an infusion of capital and where a company usually has too many shareholders to deregister, causing it to undertake a transaction which results in a reduction of the number of its shareholders.  Possible going private transactions include: (a) a merger with, or sale of assets to, another company; or (b) acceptance of a tender offer from another company to buy all or most of the company’s publicly held shares; or (c) declaration of a reverse stock split that not only reduces the number of outstanding shares but also reduces the number of shareholders. In this type of reverse stock split, the company typically gives shareholders a single new share in exchange for a block of the old shares. If a shareholder does not have a sufficient number of old shares to exchange for new shares, the company will usually pay the shareholder cash based on the current market price of the company’s stock.

For all its benefits, the process of deregistration and delisting is not for every company and is not necessarily a permanent solution.  For starters, a company that found it difficult to raise money as a public entity may find it impossible to raise money as a private entity.  Additionally, private entities have significantly greater difficulty using their stock as currency to finance acquisitions and other transactions.  A company that deregisters its securities may also hurt employees who have been granted options in a publicly traded entity only to find that the value of such options has be adversely impacted by a lack of trading market in the company’s securities.  Finally, a company may incur unexpected costs and expenses as a result of having to renegotiate agreements with investors and creditors pursuant to which the company was required to continue filing period reports with the SEC.

For those companies that choose to deregister, there is one final pitfall to watch out for: despite the filing of the Form 15 and the desire to avoid periodic filings with the SEC, a company may still be required to make public filings.  This unfortunate possibility stems from the fact that a company that offered its shares under Section 12 of the 1934 Act is subject to periodic reporting obligations that are suspended under Section 15 of the Act only so long as the company has fewer than the minimum number of shareholders of record on the first day of each fiscal year following the filing of the Form 15.  Oddly enough, due to the way in which the mechanics of deregistration operate, the very act of deregistration may result in the requirement to continue filing periodic reports.  For example, following a company’s deregistration, a large shareholder may decide to break up a large bloc of shares into many smaller ones, or institutional investors may be required to sell securities that are no longer traded on a national exchange or which are no longer required to file periodic reports with the SEC.  Another possibility is that large numbers of securities held by companies like Depository Trust Company (“DTC”) and others, may be returned to brokers and individual shareholders upon the filing of a Form 15 by a company.  As a result, where there had previously been one holder of record (DTC), there may now be hundreds.  If any of these examples were to occur, and the number of shareholders increased beyond 300 or 500 (depending on the company’s assets), an issuer would be required to file periodic reports on the first day of the next fiscal year until the beginning of the following fiscal year when the company could once again examine its obligations to file.  So, despite the seeming finality of the deregistration process, the filing and effectiveness of a Form 15 does not eliminate the possibility that an issuer will be required to comply with the 1934 Act’s reporting requirements at some future date.

For companies that have suffered the severe impact of the revised regulations, and which can no longer incur the cost and expense (in both money and time) of public company compliance, deregistration of securities offers a ray of hope.  Handled properly, deregistration can be accomplished relatively quickly and without an expensive going private transaction.  The key is understanding and avoiding the potential pitfalls of deregistration while alleviating the burdens of being public.

 

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