More frequently, public companies are considering the prospect of “going dark” to reduce the economic and managerial burden of continued regulatory compliance with the reporting and disclosure requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and the Sarbanes-Oxley Act of 2002. Given the ever mounting cost of regulatory compliance, “going dark” is no longer accompanied by the negative connotations of past years. Rather, “going dark” can be a prudent business decision aimed at improving a company’s bottom line to the benefit of shareholders, particularly where a company is not otherwise enjoying the advantages of being a public company. Nevertheless, “going dark” also comes with material disadvantages, including decreased liquidity, lack of access to the capital markets, decreased alternatives for incentive programs and acquisition currency, and trading restrictions.
I. “Going Dark”
The term “going dark” refers to the process of voluntarily terminating and/or suspending a public reporting company’s statutory obligations to file periodic reports (i.e., Forms 10-K, 10-Q and 8-K) imposed by Sections 13(a) and 15(d) of the Exchange Act, potentially leading to a lack of publically available information for the company – a “dark” company. Section 13(a) of the Exchange Act imposes periodic reporting requirements on any issuer with a class of securities registered under Section 12 of the Exchange Act.1 Section 15(d) of the Exchange Act imposes the same periodic reporting requirements as Section 13(a) on any issuer having a registration statement declared effective under the Securities Act of 1933, as amended (the “Securities Act”), although the Section 15(d) obligations are suspended during any period that an issuer is subject to Section 13(a).
II. Turning Off the Lights
The “going dark” process requires compliance with numerous technical SEC rules and regulations, which, in turn, are dependent on the basis of the issuer’s underlying statutory reporting obligation.
Section 12(b) – Form 25, Delisting and Deregistration
Often, public companies considering “going dark” have already been delisted from the national securities exchanges (which is one of the reasons such issuers may not be realizing the benefits of being a public company). However, for those issuers that are still listed and wish to “go dark,” the issuer must first delist its securities and terminate registration of those securities under Section 12(b) of the Exchange Act.2 To do so, the issuer must notify the Securities Exchange Commission (the “SEC”) of its intention by filing a Form 25 with the SEC for each exchange on which the issuer’s securities are listed. Rule 12d-2 dictates that, at least ten days before filing its Form 25 with the SEC, a delisting issuer must also provide written notice to such national securities exchange(s) of the issuer’s intent to delist and deregister, issue a press release publicly announcing the issuer’s intent and post the release on the issuer’s website. The issuer’s Section 13(a) periodic reporting obligations triggered by its Section 12(b) registration are suspended upon filing of the Form 25, although termination of the Section 12(b) registration is not effective until 90 days after filing the Form 25 during which time other reporting obligations under applicable proxy rules and beneficial ownership rules continue. Delisting of the issuer’s securities is automatically effective 10 days after filing of the Form 25 at which time trading of the issuer’s securities on the subject national securities exchange(s) terminates.3 Filing of the Form 25 has no effect on the issuer’s Section 13(a) periodic reporting obligations arising out of a Section 12(g) registration or under Section 15(d) of the Exchange Act, which continue until otherwise terminated or suspended as discussed below.
Section 12(g) – Form 15 and Deregistration
For an issuer with a class of equity securities registered under Section 12(g) of the Exchange Act to “go dark,” the issuer must also file, pursuant to Section 12(g)(4) of and Rule 12g-4 under the Exchange Act, a Form 15 with the SEC certifying that:
- For an issuer other than a bank, bank holding company and savings and loan holding company, the issuer has fewer than (i) 300 “holders of record” or (ii) 500 “holders of record” and that the issuer’s total assets have not exceeded $10 million on the last day of each of the issuer’s three most recent fiscal years, or
- For a bank, bank holding company and savings and loan holding company, the issuer has fewer than 1,200 “holders of record.”
“Record holders” are defined as (i) shareholders identified on an issuer’s records of security holders as typically maintained by the issuer’s transfer agent, or (ii) in cases of institutional custodians such as Cede & Co.4 and other commercial depositories identified in an issuer’s records of security holders, the nominees named on the accounts of those institutional custodians and commercial depositories (such as banks, brokers or other third parties holding shares in “street name” for beneficial owners).5 “Record holders” do not include (i) the underlying beneficial owners holding shares in “street name” through such a nominee, as most holders of publicly traded shares do, or (ii) those holding securities received pursuant to, or in substitute for securities received, pursuant to an “employee compensation plan” in transactions exempt from registration under Section 5 of the Securities Act.6 As a result, an issuer will typically have significantly more than 300 or even 500 beneficial shareholders, and yet still be eligible to use Form 15 and to “go dark.”7
Upon the filing of a Form 15, an issuer’s obligations to file periodic reports required by Sections 13(a) of the Exchange Act (i.e., Forms 10-K, 10-Q and 8-K) are immediately suspended.8 Effective 90 days after filing, an issuer’s shares are deregistered under Section 12(g) of the Exchange Act, and the issuer’s corresponding obligations to file periodic reports required by Section 13(a) of the Exchange Act terminate.9 The issuer’s obligation to comply with applicable proxy rules and shareholders’ obligations to comply with applicable Section 16 reporting requirements and Schedule 13D and 13G filing requirements continue between the filing of the Form 15 and the effective deregistration of the shares.10
Section 15(d) – Form 15, Suspension and No Action Relief
Section 15(d) of the Exchange Act imposes the same periodic reporting requirements as Section 13(a) of the Exchange Act on any issuer having a registration statement declared effective under the Securities Act, although the Section 15(d) obligations are suspended during any period that an issuer is subject to Section 13(a). With the suspension or termination of an issuer’s Section 13(a) reporting obligations as discussed above, an issuer’s reporting obligations under Section 15(d) of the Exchange Act become effective.
As with Section 13(a) of the Exchange Act, an issuer’s reporting obligations under Section 15(d) of the Exchange Act are not absolute. An issuer’s Section 15(d) reporting obligations may be suspended in two ways.
First, an issuer’s reporting obligations under Section 15(d) are automatically suspended as to any fiscal year, other than in which a registration statement becomes effective, if the issuer had fewer than 300 “record holders,” or 1,200 in the case of banks, bank holding companies and savings and loan holding companies, on the first day of that fiscal year.11 While it is recommended that the issuer files a Form 15 within 30 days of the start of such fiscal year notifying the SEC of the suspension pursuant to Section 15(d)(1) of and Rule 15d-6 under the Exchange Act, the SEC Interpretations provide that the suspension is not contingent on filing the Form 15 since the suspension is statutory.12
Second, in a corollary to Rule 12g-4, Rule 12h-3 similarly suspends an issuer’s Section 15(d) periodic reporting requirements, upon the filing of the Form 15, at any time during the issuer’s fiscal year where the issuer:
- has fewer than (i) 300 “holders of record,” or 1,200 in the case of banks, bank holding companies, and savings and loan holding companies, or (ii) 500 “holders of record” and that the issuer’s total assets have not exceeded $10 million on the last day of each of the issuer’s three most recent fiscal years;
- has not had a registration statement declared effective under the Securities Act or that is “required to be updated” pursuant to Section 10(a)(3) of the Securities Act in the fiscal year for which suspension is sought (and for two next preceding years for issuers relying on clause (ii) above); and
- is otherwise current is its periodic reporting obligations.
Unlike the automatic suspension the periodic reporting obligations under Section 15(d)(1), the filing of a Form 15 is a condition to the suspension available under Rule 12h-3.13
Nevertheless, even issuers with relatively few “record holders” may still be unable to avoid the periodic reporting obligations under Section 15(d) of the Exchange Act. The automatic suspension under Section 15(d)(1) is unavailable to issuers for the fiscal year in which its registration statement was declared effective. As a result, the issuer must still file an Annual Report on Form 10-K (“Form 10-K”) as to the fiscal year in which the registration was declared effective.14
The suspension under Rule 12h-3 is similarly unavailable to an issuer in any fiscal year in which it had a registration statement declared effective under the Securities Act or that is “required to be updated” pursuant to Section 10(a)(3) of the Securities Act.15 In the proposing release for Rule 12h-3, the SEC stated that the purpose of periodic reporting under Section 15(d) is “to assure a stream of current information about an issuer for the benefit of purchasers in the registered offering, and for the public, in situations where Section 13 of the Exchange Act would not otherwise apply,” and that “this [Rule 12h-3(c)] limitation is in keeping with the philosophy reflected in Section 15(d) of the Exchange Act that generally the investing public should have available complete information about the issuer’s activities at least through the end of the year in which it makes a registered offering.”16
Note that certain registration statements, such as Form S-3 for resale offerings and Form S-8 for employee benefit and incentive plans, incorporate by reference and are automatically “updated” with the meaning of Section 10(a)(3) of the Securities Act by an issuer’s periodic reports, including Form 10-K’s, where such “updating” constitutes a post-effective amendment to and a new effective date for the registration statement. For example, consider a Form S-3 or Form S-8 registration statement originally effective in fiscal year 2014 and the filing of an issuer’s 2015 Form 10-K in early fiscal year 2016. Because the 2015 Form 10-K acted to “update” that Form S-3 or Form S-8 during fiscal year 2016, which constitutes any new effective date for purpose of that registration statement(s), the issuer may not suspend its reporting obligations for fiscal year 2016. Without proper planning by terminating any existing Form S-3’s and Form S-8’s prior to filing a Form 10-K, this waterfall effect may effectively eliminate the availability of an issuer “going dark” under Rule 12h-3.17
However, the SEC has also repeatedly indicated that a literal reading of Rule 12h-3 is not always justified by public policy reasons, particularly when an issuer’s securities are held by a small number of persons. In its proposing release, SEC acknowledged that “Congress recognized, with respect to Section 15(d), that the benefits of periodic reporting by an issuer might not always be commensurate with the burdens imposed . . . .”18 For issuers in this situation where Rule 12h-3 or Rule 15d-6 are technically unavailable, no action relief from the SEC will be necessary to “go dark.”
Fortunately, the SEC has indicated and granted no action letters to the effect that issuers with effective Form S-3 and Form S-8 registration statements can still “go dark” in a fiscal year (notwithstanding that such issuers had effective registration statements that had been automatically updated during the current fiscal year) where those registration statements are withdrawn and, by post-effective amendments, any unsold and unissued securities thereunder are deregistered. In fact, the SEC has granted no-action relief in a range of circumstances where the literal application of Rule 12h-3(c) would yield relatively little public benefit in light of the burdens on the issuer of compliance with reporting requirements under the Exchange Act.19
Unlike termination of Section 13(a) reporting obligations, an issuer’s reporting obligations under Section 15(d) of the Exchange Act are not terminated but only suspended so long as the issuer’s “holders of record” number fewer than the 300/1,200 thresholds under Rule 12h-3 or Section 15(d). Should an issuer’s number of “holders of record” creep back above the applicable thresholds on the first day of the issuer’s fiscal year, the periodic reporting obligations imposed by Section 15(d) of the Exchange Act may be retriggered effectively requiring the issuer to turn the “lights” back on.20
III. Who Turns Off the Lights?
No shareholder approval is necessary to “go dark” or file the requisite Form 15. The Board of Directors may elect to file the Form 15 and “go dark” provided the issuer meets the requirements discussed above. However, often there are actual or perceived conflicts of interest on a Board of Directors or among shareholders regarding “going dark.” “Going dark” may benefit a large shareholder to the detriment of smaller or minority shareholders by way of reduced liquidity or trading opportunities and reduced disclosure requirements. Where a controlling shareholder is also represented on the Board of Directors, the Board of Directors should be careful to avoid any appearance of self-dealing or self-interest in “going dark.” For this reason, it is best that any decision regarding “going dark” be delegated to a Special Committee of disinterested directors.
In cases where the issuer does not initially meet the requisite requirements discussed above, “going dark” may also require the issuer first to “go private” by engaging in a corporate transaction in accordance with Rule 13e-3 of the Exchange Act with the goal of reducing an issuer’s number of “record holders” below 300 or 1,200 as applicable, where such transaction will require shareholder approval.
IV. Once “Dark”
Once “dark,” an issuer will experience both the advantages and disadvantages of being a non-reporting company.
Reduction in Regulatory Burdens – A deregistered issuer can operate relatively free of many of the burdensome and costly regulatory obligations of a public reporting company. Just a few of these include regulatory compliance with and potential liability of officers and directors under the Exchange Act and Sarbanes Oxley Act, certain public disclosure obligations which can have adverse competitive effects, strict corporate governance requirements and other costly accounting and legal needs.
Available Information – Despite the lack of public reporting obligations, an issuer may voluntarily make available such level of information as it deems necessary and appropriate, provided, however, that the issuer will still be subject to state and federal anti-fraud laws. “Dark” companies are still required to hold annual shareholder meetings.
Trading and Liquidity – An issuer’s stock, despite deregistration, may continue to trade in the “over the counter” markets, although the level of available information varies with market tier on which the stock is traded. Similarly, it can be expected that trading volumes, analyst coverage and market interest in an issuer will decrease once it is deregistered, in part, because the level of available information typically decreases. These effects can reduce the liquidity of an issuer’s shares, particularly for non-controlling shareholders who rely on the trading markets alone for liquidity.
Reregistration – An issuer must continue to monitor the number of its “holders of record.” Its periodic reporting obligations under Section 15(d) of the Exchange Act are triggered by its “holders of record” increasing to the applicable 300/1,200 threshold. It must also reregister as a public reporting company under Section 12 of the Exchange Act if its shareholders of record exceed the applicable 2,000/500, which also triggers the periodic reporting obligations under Section 13(a) of the Exchange Act. Such increases in “holders of record” can occur in a several ways, including ordinary trading and, hypothetically, broker “kick outs” where the broker distributes street name shares to the beneficial owners because it doesn’t want to hold private company shares.
Management Incentive Plans – Use of shares registered on Form S-8 with stock-based management incentive, benefit and compensation plans will no longer be available. Rather, shares issued under such plans will be restricted, although other types of incentive plans not requiring the actual issuance of issuer stock are also available.
Capital Markets and Acquisitions – A “dark” issuer will have restricted access to future funding and capital markets. In addition, it may be difficult to use its stock as currency for future acquisitions.
Shell Companies – Any stock issued by an issuer after becoming a “shell company”21 is restricted and not tradable (including under Rule 144 of the Securities Act) until the issuer acquires an operating business and files a Form 8-K or Form 10 disclosing such information about the acquired business as typically required in a registration statement. This is particularly relevant to many shell companies as a significant motivation for “going dark” may be to avoid the cost of preparing the ‘jumbo” Form 8-K in the event the shell company acquires an operating business.
Although the process of “going dark” can be complicated, time consuming and often expensive, “going dark” can be an economical long term solution for those issuers not benefitting from the typical advantages of being a public company but still facing crippling SEC compliance costs.
* Andrew H. Pontious is a partner with Dudnick, Detwiler, Rivin & Stikker in San Francisco, California.
Copyright © 2017 by Andrew H. Pontious. All Rights Reserved.
1 Registration is required under Section 12(b) of the Exchange Act for any company with shares listed on a national securities exchange. Registration is also required under Section 12(g) for (A) any issuer (other than banks, bank holding companies, and savings and loan holding companies) which, on the last day of its fiscal year, has total assets of more than $10 million and a class of equity securities (other than exempt securities) “held of record” by either (i) 2,000 persons, or (ii) 500 persons who are not accredited investors, and (B) any bank, bank holding company and savings and loan holding company which, on the last day of its fiscal year, has total assets of more than $10 million and a class of equity securities (other than exempt securities) “held of record” by either 2,000 persons.
2 Section 12(b) of and Rule 12d2-2(c) under the Exchange Act.
3 Trading will then typically commence on the OTC Markets. It is recommended that the issuer contact the OTC Markets in advance of filing the Form 25 to assure a smooth transition from the national securities exchange to the OTC Markets.
4 Cede & Co. is the nominee of the Depository Trust and Clearing Corporation, a securities clearing house and depository responsible for settling the vast majority of securities transactions in the United States.
5 Rule 12g5-1 under the Exchange Act; SEC’s Compliance and Disclosure Interpretations, December 8, 2016, Question 152.01. See http://www.sec.gov/divisions/corpfin/guidance/exchangeactrules-interps.htm (“SEC Interpretations”).
6 The Jumpstart Our Business Startups Act (the “JOBS Act”) amended the Exchange Act to exclude from the definition of “held of record,” for purposes of determining whether an issuer is required to register a class of equity securities, securities that are held by persons who received them pursuant to an “employee compensation plan” in transactions exempted from the registration requirements of Section 5 of the Securities Act. Although the term “employee compensation plan” is not defined in the JOBS Act, the SEC adopted a non-exclusive safe harbor in the amended Rule 12g5-1 relying on the current definition of “compensatory benefit plan” in Rule 701 and the conditions in Rule 701(c).
7 Confirmation from the issuer’s transfer agent verifying that the issuer has, in fact, fewer than the threshold level of “holders of record” before proceeding with a Form 15 filing is highly recommended.
8 Rule 12g-4(b) under the Exchange Act.
9 Rule 12g-4(a) under the Exchange Act.
10 Rule 12d2-2(d)(5) under the Exchange Act.
11 Section 15(d)(1) of the Exchange Act.
12 See SEC Interpretations, Question 171.01.
13 See SEC Interpretations, Question 153.01.
14 See SEC Interpretations, Question 153.03.
15 Rule 12h-3(c) under the Exchange Act.
16 Exchange Act Release No. 34-20263 (October 5, 1983).
17 Rule 12h-3(c) under the Exchange Act.
19 See e.g., Maxygen, Inc. (available October 30, 2013); Environmental Tectonics Corporation (available March 22, 2013); China Shenghuo Pharmaceutical Holdings, Inc. (available July 19, 2012); Intraop Medical Corporation (available May 12, 2010); GrandSouth Bancorporation (available March 24, 2010); PureDepth, Inc. (available March 8, 2010); Craftmade International, Inc. (available January 27, 2010); International Wire Group, Inc. (available November 6, 2009); Neuro-Hitech, Inc. (available July 30, 2009); Silverstar Holdings, Ltd. (available May 14, 2009); Mountain Valley Bancshares, Inc. (available March 30, 2009); Metro One Telecommunications (available March 4, 2009); I.C. Isaacs & Company, Inc. (available August 13, 2008); Questar Assessment, Inc. (available June 13, 2008); SunCom Wireless Holdings, Inc. (available February 29, 2008); Planet Technologies, Inc. (available February 7, 2008); and Bausch & Lomb Incorporated (available November 6, 2007), which can be found at https://www.sec.gov/divisions/corpfin/cf-noaction.shtml.
20 Rule 12h-3(e) under the Exchange Act. Similarly, should an issuer’s number of “holders of record” creep back above applicable 2,000/500 record holder thresholds, the issuer may also be required to reregister its shares under Section 12(g) of the Exchange Act, thereby similarly retriggering the periodic reporting obligations imposed by Section 13(a) of the Exchange Act.
21 A “shell company” is defined by Rule 12b-2 under the Exchange Act as an issuer with “no or nominal operations and either no or nominal assets, assets consisting solely of cash and cash equivalents, or assets consisting of any amount of cash and cash equivalents and nominal other assets.”