"Going Dark" - The Simple Path to Exiting the U.S. Public Company Reporting System - Delisting and Deregistration under the U.S. Securities Exchange Act of 1934 Update

The beginning of the 2013 calendar year is an excellent time for China-based companies to consider their eligibility to exit the U.S. public company reporting system. There is often a significant opportunity for China-based companies that are unhappy with their U.S. stock exchange listing and the burdens of being a publicly reporting company in the United States to promptly delist and deregister their shares under the U.S. Securities Exchange Act of 1934 (the “Exchange Act”) at the beginning of the fiscal year. This is because an automatic suspension of reporting obligations under Exchange Act Section 15(d) occurs when a calendar year company has less than 300 shareholders of record as of the first day of its fiscal year.¹ As only record holders (and not beneficial owners) are generally counted under this provision, some companies may be able to exit the U.S. reporting system even though they have thousands of beneficial owners.² This path to exiting the U.S. Exchange Act reporting system through the statutory suspension under Section 15(d) and related Rules 15d-6 and 12g-4 may be available even if a company does not have an alternative non-U.S. listing and is currently delinquent in its Securities and Exchange Commission (“SEC”) filings. We believe that many China-based companies that have compelling reasons to consider Exchange Act deregistration are not fully aware of this possibility.³

In the SEC’s October 15, 2012 report to Congress on its authority to enforce the numerical thresholds that require registration under the Exchange Act, the SEC noted that there were approximately 2,500 publicly reporting companies on which the SEC had available shareholder of record data. Of these companies, only 318 had more than 2,000 shareholders of record, the new threshold for registration under Section 12(g) of the Exchange Act. That is actually less than the number of publicly reporting Chinabased companies trading in the United States. While we do not have data on the number of China-based companies with more than 300 shareholders of record, it is likely that a very large number of publicly reporting China-based companies are below the 300 shareholders of record threshold. Those companies may have an opportunity to promptly relieve themselves of their U.S. public reporting company obligations by taking a few simple steps explained in this memorandum. And those companies that are not so eligible may wish to consider a possible going private transaction to eliminate their public shareholders.

Many China-based issuers currently have very good reasons to consider whether to “go dark” and/or undertake a going private transaction. Going dark and going private both involve a voluntarily delisting from U.S. stock exchanges and an exit from the SEC reporting system under the Exchange Act. Among the most common incentives for leaving the system and to consider a subsequent or concurrent going private transaction are: (1) depressed share valuations which are often well below the company’s intrinsic value and low trading volumes resulting from limited interest in the company’s shares or negative market perception, (2) limited or no analyst coverage, (3) negative publicity and in some cases accusations of accounting or other irregularities, (4) short seller attacks, (5) the existence or threat of SEC investigations or shareholder litigation, (6) the continuing management distractions and high costs that arise from U.S. disclosure and reporting rules and the above regulatory burdens, (7) cumbersome and expensive Sarbanes-Oxley governance and reporting requirements and potential securities law liabilities, (9) the inability to raise further capital in the United States, or (10) in some cases, the availability of a stock exchange listing outside the United States and alternative opportunities for raising capital overseas and in the private market.

This memorandum briefly summarizes the steps necessary for a China-based issuer to delist and deregister under the Exchange Act for issuers that may wish to consider leaving the U.S. reporting system voluntarily. To effectively terminate its SEC reporting obligations, a China-based company potentially must deregister under any and all of three separate Exchange Act statutory provisions which may be applicable to them: Section 12(b) (for listed companies), Section 12(g) (for companies that have total assets exceeding $10 million and have a class of securities held of record by either 2,000 persons or 500 persons who are not accredited investors⁴) and Section 15(d) (for companies that have filed a registration statement under the U.S. Securities Act of 1933). These statutes—each of which is a separate and distinct predicate for Exchange Act registration and reporting obligations⁵—apply to U.S. SEC reporting companies whether they are U.S. companies or foreign private issuers.⁶

Delisting from a U.S. Stock Exchange and Deregistration under Section 12(b) of the Exchange Act

The first step towards Exchange Act deregistration for a U.S.-listed issuer is to delist from any U.S. stock exchange on which its shares or ADRs may be traded. U.S.-listed issuers have an absolute right to delist their securities voluntarily and to deregister them under Section 12(b) of the Exchange Act by filing a Form 25 with the SEC. The issuer must give notice of its intention to file a Form 25 and issue a press release announcing that intention ten days prior to filing the Form 25. The delisting will become effective ten days after filing the Form 25. However, SEC reporting obligations are not suspended on the Form 25 filing date, except in the rare case where the company has no Section 12(g) or Section 15(d) reporting obligations which would be revived by filing the Form 25. The actual termination of registration under Section 12(b) does not occur until 90 days after effectiveness of the delisting.⁷

Deregistration under Section 12(g)

Once a company has delisted and deregistered under Section 12(b) (even if it was never a listed company), it must also generally deregister under Section 12(g). Section 12(g) obligations (which are suspended while Section 12(b) obligations are in effect) are revived once Section 12(b) obligations are suspended by filing a Form 25.⁸ In order to deregister its shares under Section 12(g), the company must file a Form 15 pursuant to Rule 12g-4 based on its having less than 300 holders of record within the meaning of Rule 12g5-1 as of a current date.⁹ Besides the 300 shareholder of record numerical requirement, Rule 12g-4 does not have any other substantive requirements. However, once the company’s Section 12(g) registration is terminated, the company’s reporting obligations under Exchange Act Section 15(d) would be revived if the company has ever filed a registration statement under the Securities Act of 1933. Those Section 15(d) obligations can also be suspended (usually on the same Form 15 filed to terminate Section 12(g) obligations under Rule 12g-4) as explained below.

Suspension of Reporting Obligations under Section 15(d)

Statutory suspension at beginning of fiscal year. A company that has filed a registration statement under the Securities Act also has reporting obligations under Section 15(d) of the Exchange Act in addition to any obligations it may have under Section 12. A calendar year company’s Section 15(d) obligations are automatically suspended by statute as of January 1, 2013, provided that the company had less than 300 holders of record on such date. Companies taking advantage of this automatic statutory suspension under Section 15(d) are required by Rule 15d-6 to file a notice on Form 15 informing the Securities and Exchange Commission (“SEC”) of such suspension within 30 days.¹⁰ However, even if the company does not make that filing by within the 30 day period (i.e., by January 31, 2013 for calendar year filers, that Form 15 filing is not a condition of the automatic reporting suspension set forth in
Section 15(d).¹¹ Therefore, we believe that a company can suspend its obligations under Section 15(d) by filing a Form 15 at the same time and on the same Form 15 that it files under Rule 12g-4 described above.¹²

Rule 12h-3 suspension during the fiscal year. There is another Exchange Act rule, Rule 12h-3, which allows a company to suspend its Section 15(d) obligations based on its having less than 300 shareholders of record on any day other than the first day of its fiscal year, provided that it has less than 300 shareholders of record within the meaning of Rule 12g5-1, is current on all SEC filing obligations, and has not had a registration statement declared effective or updated pursuant to Section 10(a)(3) of the Securities Act. Such updating occurs automatically by means of the incorporation by reference of an annual report on Form 10-K (or Form 20-F) into a company registration statement prior to filing the Form 15. Thus to be eligible to use Rule 12h-3 in 2013 a calendar year filer must not yet have filed its Form 10-K or Form 20-F for the year ended December 31, 2012 if it has any registration statements that would incorporate that filing by reference. If a company that is current on its SEC filings, did not have any registration statements declared effective in fiscal 2013 and has not yet filed its 2012 Form 10-K or Form 20-F, it would be eligible to suspend its Section 15(d) reporting obligations under Rule 12h-3 as well as under the statutory suspension set forth in Section 15(d). If a company does not meet these requirements, it can only use the automatic statutory suspension contained in Section 15(d) discussed above, unless it already has a primary non-U.S. trading market and meets the requirements of Rule 12h-6, discussed in Note 12 below.

Obligations in the 90 day period prior to effectiveness of deregistration. Obligations to file Form 10-Ks, 20-Fs, 10-Qs, 8-Ks and 6-Ks, as applicable to a particular issuer, are suspended immediately upon filing of the Form 15. However, other Exchange Act filing obligations continue during the 90 day period following the filing of the Form 15 (or Form 25 to deregister under Section 12(b)). Foreign private issuers that were previously registered under Section 12(b) or 12(g) will continue to be subject to Section 13(d) and Section 13(e) requirements, which includes the very onerous going private Rule (Rule 13e-3) during the 90 day period. U.S. issuers (or non-U.S. issuers that fail to qualify as foreign private issuers) will also continue to be subject to the proxy rules and Section 16 reporting and short swing profit requirements. Issuers that were reporting only under Section 15(d)—because they have had an effective registration statement (e.g., covering debt securities)—would not be subject to these additional requirements during the 90 day period.

Board Considerations

In order to cease its Exchange Act reporting obligations, a company’s board of directors would generally need to conclude, in the exercise of its fiduciary obligations under the law of its jurisdiction of organization, that such termination would be in the best interests of the company and its shareholders. If the issuer is incorporated in Delaware, the business judgment rule would apply to this decision unless a board member had a particular conflict of interest or an affiliate transaction were involved with the decision (such as a purchase of minority shareholder interests) that might make a higher standard of review applicable. If there is an interested director transaction or other special circumstances affecting the independence of board members, a special committee of independent directors is sometimes appointed to consider the question of deregistration and its fairness to, and effects upon, unaffiliated shareholders. In any case, it is critical for the company and its counsel to review all outstanding debt agreement, investor agreements, registration rights agreements, preferred stock and warrant agreements and other material contracts to make sure that going dark or going private will not violate those agreements.

The decision to deregister involves balancing the costs and benefits of going dark to the company and its shareholders. The benefits to the company of terminating its reporting obligations would normally include significantly lower accounting, legal, insurance and compliance costs related to Exchange Act and Sarbanes-Oxley requirements and public disclosure obligations. The company should make an effort to estimate and document these savings. The company would normally also benefit through the reduced public scrutiny and disclosure requirements following deregistration and the time saved and the reduction of burdens and distractions on its management and staff.

A “dark” period could, if needed, also give a troubled company an opportunity to develop a revised operating plan or a new financing plan to reinvigorate its business without the distractions and costs of being a public company. The company could also benefit from lower ongoing securities law liability risks, although Rule 10b-5 and other Federal and State antifraud statues would still be applicable to U.S. domestic transactions in its shares.

Negative effects of a “going dark” decision, on the other hand, would include reduced visibility of the company to its public shareholders after it ceases public reporting. However, if the market for a company’s stock is already relatively illiquid and is trading at a low price per share, public shareholders may not be greatly injured or even surprised by a decision to deregister. Following filing of a Form 15, shares would typically trade in the over-the-counter market operated by OTC Markets Group, Inc. known as the “Pink OTC Market” and would have the abbreviation “PK” added to the trading symbol.

In computing the number of record holders for purposes of Rule 12g5-1, an issuer need not look through the holdings of brokers, dealers, banks or other nominees to count the beneficial owners of its common shares. As a result, the company may have many hundreds of beneficial owners of its common stock while still having less than 300 holders of record for purposes of Rule 12g5-1.¹³ 

To determine whether the company has less than 300 holders of record, the company should obtain a shareholder list (including for employees who hold shares or others who directly own share certificates, other than any employees who acquired shares privately in exempt transactions, as such holders need not be counted) as of the beginning of the company’s most recent fiscal year and as of a subsequent date (nearer the date on which it intends to file a Form 15) as well as DTC security position listings dated the same dates in order to count the total number of record holders shown in the manner required by Rule 12g5-1.

The impact of any decision to deregister on a company’s minority shareholders must be carefully considered by the Board of Directors and/or a special committee. Public shareholders often view deregistration in a negative manner due to diminished available information about the company and the resulting potentially adverse impact on liquidity in the trading for the shares. However, the market for the company’s common stock is often already extremely illiquid when a company is considering whether to “go dark”.

A board of directors may also wish to consider whether it may be possible to mitigate the effect on the company’s public shareholders of the deregistration process by having the board of directors establish a policy of continuing to regularly report unaudited earnings information (and perhaps annual audited information) in a manner similar to the company’s past reporting practices for some further period. If desired this would help provide some additional liquidity to the company’s shareholders while saving the expense of complying with full SEC, Sarbanes-Oxley governance requirements.

The company may also wish to consider providing an alternative market such as the Hong Kong stock exchange for its shareholders. Providing an alternative listing or relisting in connection with a U.S. reporting system exit can be a time consuming and expensive process (particularly where an overseas corporate structure may need to be unwound), but provides a more attractive result for public shareholders. If a company which is a foreign private issuer is already listed outside the United States and the non-U.S. market is its primary trading market, the company may also wish to consider its eligibility to use Exchange Act Rule 12h-6 which can provide some dual listed foreign private issuers with an ability to exit the U.S. reporting system where a substantial majority of the company’s trading volume is outside the United States and various other technical requirements are met.¹⁴

Going Private Requirements

If the company is interested in cashing out unaffiliated shareholders in a going private transaction either before or after an Exchange Act delisting and/or deregistration more complex U.S. legal issues are involved. The U.S. going private regulations such as Rule 13e-3 under Exchange Act Section 13 involve intrusive and difficult disclosure requirements and generally result in a detailed SEC review process. A reverse stock split, affiliate cash out merger, tender offer or open market purchases by the issuer or any affiliate designed to reduce the number of shareholders (or U.S. resident shareholders) of record or to reduce U.S. trading volume below the benchmark for deregistration in Rule 12h-6 undertaken prior to a company’s Exchange Act deregistration, would most likely trigger the extensive going private requirements for filing and disclosure mandated by Exchange Act Rule 13e-3 and Schedule 13E-3. While a discussion of these requirements is beyond the scope of this memorandum, it is important to note that the going private rules continue to apply to an issuer registered under Section 12(b) or 12(g) for 90 days after the company files a Form 15 to deregister under Section 12.

The SEC’s going private rule, Rule 13e-3, is intended to give security holders being cashed out in a going private transaction one last chance to get detailed information about an issuer before it deregisters under the Exchange Act and takes action in connection therewith. Rule 13e-3 requires, among many other things, extensive disclosures regarding the substantive and procedural fairness of the going private transaction, the reasons for the transaction and the alternatives considered to the transaction, and requires the issuer and any other participant in the Rule 13e-3 transaction to take a public position on the fairness of the transaction. It is expensive and time consuming to make a Schedule 13e-3 filing and such filings are almost always reviewed by the SEC. A special committee process is generally used in these transactions and fairness opinions are also customarily obtained. However, for an issuer determined to escape the U.S. reporting regime, the burdens of a Rule 13e-3 filing may be well worth the additional
effort and expense. 

If the company is listed on a U.S. stock exchange it must first delist before deregistering as described above.  Delisting involves issuing an announcement at least 10 days before filing a Form 25 as well as the filing of a Form 25 at least 10 days before the Form 15 is filed.  Delisting thus adds at least 20 days to the deregistration time schedule.

Conclusion

In conclusion, assuming it has less than 300 holders of record at January 1, 2013 and/or currently, a China-based company that is a calendar year filer may have a quick path now to exit the U.S. Exchange Act reporting system promptly and at minimal cost. This would allow the company to cease making filing SEC reports with respect to its current calendar year and would free it from future Exchange Act compliance obligations going forward¹⁵ which should result in substantial cost savings for the company in the future and also eliminate the management distractions and burdens of SEC compliance matters.

It is possible that minority shareholders of the company may object to the decision to exit the Exchange Act reporting system. The Board should consider any proposal to delist and/or exit the U.S. reporting system in light of its fiduciary duties under applicable law. The possibility of relisting in Hong Kong, on a Mainland stock exchange or elsewhere outside the United States may also be considered for eligible companies.

¹ The issuer must also previously or concurrently have delisted and deregistered under Section 12(b) and Section 12(g) of the Exchange Act, as applicable. But such deregistration need not have occurred prior to the first day of a company’s fiscal year, and such deregistration can typically be accomplished on the same basis as the Section 15(d) automatic suspension, namely having less than 300 shareholders of record. Additionally, any bank or bank holding company is permitted to deregister if it has less than 1,200 holders of record on a worldwide basis.

² The JOBS Act, signed into law on April 5, 2012, requires the SEC to examine whether the determination of record holders under Rule12g5-1 should be revised to prevent evasion of registration requirements. The SEC must submit its recommendations to Congress by August 3, 2012. Further, the SEC is required to revise the definition of “held of record” to exclude any persons who received securities pursuant to an employee compensation plan in transactions exempt from registration under the Securities Act. As a result, employees who acquire shares upon exercise of options need no longer be counted.

³ Many U.S.-trained lawyers are not familiar with the difficult and technical rules that govern deregistration under the Exchange Act.

⁴ The JOBS Act also created an exemption for issuers that are banks or bank holding companies with not more than 2,000 record holders of a class of equity security, regardless of the number of accredited investors.

⁵ Section 12(g) obligations are suspended while Section 12(b) obligations are in effect. Section 15(d) obligations are suspended while Section 12(g) obligations are in effect.

⁶ “Foreign private issuers” are defined in Exchange Act Rule 3b-4.

⁷ Exchange Act Rule 12d2-2.

⁸ Section 12(g) obligations are triggered by a company having more than 500 shareholders of record.

⁹ Deregistration is effective 90 days after filing the Form 15. The SEC has the option to reject a Form 15 during the 90 day period prior to effectiveness but almost never does so.

¹⁰ Rule 15d-6 provides that “If the duty of an issuer to file reports pursuant to section 15(d) of the Act as to any fiscal year is suspended as provided in section 15(d) of the Act, such issuer shall, within 30 days after the beginning of the first fiscal year, file a notice on Form 15 informing the Commission of such suspension unless Form 15 has already been filed pursuant to Rule 12h-3. If the suspension resulted from the issuer's merger into, or consolidation with, another issuer or issuers, the notice shall be filed by the successor issuer.”

¹¹ See SEC compliance and disclosure interpretation No. 153.01. “[U]nder Rule 15d-6, if an issuer has fewer than 300 security holders of record at the beginning of the fiscal year, a Form 15 should be filed to notify the Commission of such suspension, but the suspension is granted by statute and is not contingent on filing the Form 15.”

¹² Note that to take advantage of the statutory suspension under Section 15(d), a company must first deregister under both Section 12(b) and Section 12(g).

¹³ Rule 12g5-1 currently reads as follows:

(a) For the purpose of determining whether an issuer is subject to the provisions of Sections 12(g) and 15(d) of the Act, securities shall be deemed to be “held of record” by each person who is identified as the owner of such securities on records of security holders maintained by or on behalf of the issuer, subject to the following: (1) In any case where the records of security holders have not been maintained in accordance with accepted practice, any additional person who would be identified as such an owner on such records if they had been maintained in accordance with accepted practice shall be included as a holder of record; (2) Securities identified as held of record by a corporation, a partnership, a trust whether or not the trustees are named, or other organization shall be included as so held by one person; (3) Securities identified as held of record by one or more persons as trustees, executors, guardians, custodians or in other fiduciary capacities with respect to a single trust, estate or account shall be included as held of record by one person; (4) Securities held by two or more persons as co-owners shall be included as held by one person; (5) Each outstanding unregistered or bearer certificate shall be included as held of record by a separate person, except to the extent that the issuer can establish that, if such securities were registered, they would be held of record, under the provisions of this rule, by a lesser number of persons; and (6) Securities registered in substantially similar names where the issuer has reason to believe because of the address or other indications that such names represent the same person, may be included as held of record by one person. Rule 12g5-1 will be amended pursuant to the JOBS Act to exclude from those counted as record holders any employees who receive securities under an employee compensation plan in transactions exempt from registration under the Securities Act.

(b) Notwithstanding paragraph (a) of this section: (1) Securities held, to the knowledge of the issuer, subject to a voting trust, deposit agreement or similar arrangement shall be included as held of record by the record holders of the voting trust certificates, certificates of deposit, receipts or similar evidences of interest in such securities; provided however, that the issuer may rely in good faith on such information as is received in response to its request from a non-affiliated issuer of the certificates or evidences of interest; (2) Whole or fractional securities issued by a savings and loan association, building and loan association, cooperative bank, homestead association, or similar institution for the sole purpose of qualifying a borrower for membership in the issuer, and which are to be redeemed or repurchased by the issuer when the borrower’s loan is terminated, shall not be included as held of record by any person; and (3) If the issuer knows or has reason to know that the form of holding securities of record is used primarily to circumvent the provisions of Section 12(g) or 15(d) of the Act, the beneficial owners of such securities shall be deemed to be the record owners thereof.

¹⁴ Rule 12h-6 requires that (i) the issuer be current in all SEC filings, (ii) the issuer not have made a registered offering in the United States for the past 12 months, (iii) the company must have maintained a non-U.S. listing that constituted at least 55% of trading in a recent 12 month period, (iv) (A) the average daily trading volume (“ADTV”) of the issuer’s shares in the United States must be no more than 5% of worldwide ADTV, or (B) the company must have had less than 300 holders of record using a modified look through to beneficial owners that is stricter than the Rule 12g5-1 test, and (v) there is a 12 month further waiting period if the company did not meet the 5% ADTV test when it delisted. Most U.S. listed China-based companies would be unlikely to meet these requirements.

¹⁵ Delinquent filings from prior periods would still be required to be made.