A Survey of Delisting in the United States

The United States has the largest securities market in the world, with thousands of publicly traded firms (issuers) whose composition constantly changes. Both voluntary and involuntary delisting are a natural part of its evolution. Our paper, which will be published as a book chapter, surveys both types of delisting in the United States. We cover corporate law, securities law, and listing rules.

1. Voluntary delisting and going private

Voluntary delisting usually involves two steps, namely ‘going private’ under corporate law and ‘delisting’ following a securities law process. The going private transaction eliminates minority shareholders from the firm so that (ideally) the number of security holders falls under the thresholds established in the Securities Exchange Act.  

The corporate going private transaction is typically structured either as a one-step merger or a two-step transaction consisting of a tender offer followed by a merger. In a one-step merger transaction, the target corporation (ie the entity going private) is merged with a wholly-owned subsidiary of the acquirer (ie the controlling shareholder). The operating company (rather than the other subsidiary) will typically survive a reverse triangular merger, which usually requires a majority vote. Minority shareholders are commonly cashed out or assigned acquirer stock as compensation.

A going private transaction in the form of a freezeout merger is typically negotiated between the acquirer and an independent committee negotiating on behalf of minority shareholders. The reason is fiduciary duties, specifically the duty of loyalty. Given that the controlling shareholder has the power to push the transactions with its voting power, such a transaction is inherently conflicted. By default, the Delaware courts would apply the ‘entire fairness’ standard to such a transaction, which the defendants (ie the directors and the controlling shareholder) have the burden to show. Even with a controlling shareholder present, case law has held that approval by an independent committee (which must fulfill certain requirements) or informed approval by a majority of disinterested minority shareholders can shift the burden of proof. In recent years, the courts have gone even further: In Kahn v. MFW (88 A.3d 635, 645 [Del. 2014]), the Delaware Supreme Court found that approval of both an independent committee and the majority of minority shareholders can give the transaction the protection of the business judgment rule. To qualify, a certain number of conditions must be met. The business judgment rule applies ‘if, but only if:

1. the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders;
2. the Special Committee is independent;
3.  the Special Committee is empowered to select its own advisors freely and to say no definitively;
4.  the Special Committee meets its duty of care in negotiating a fair price;
5. the vote of the minority is informed; and
6.  there is no coercion of the minority.’

This creates an incentive to structure going private transactions in a way that will give the majority shareholder the benefit of the business judgment rule in case of litigation.

Disclosure requirements preceding a voluntary delisting are governed by the SEC’s ‘going private’ rule. Rule 13e-3 applies to transactions or series of transactions involving (a) purchases of equity securities, (b) tender offers, and (c) proxy solicitation relating to certain types of transactions (such as mergers and reverse stock splits) by the issuer and its affiliates. First, written notice to the Exchange and information to the public must be given, and second, it must file Form 25 to the SEC as an application to delist a class of securities. Under Rule 12d-2(c)(2)(ii), the issuer must ‘provide written notice’ to the exchange ‘no fewer than 10 days’ prior to filing the form. The ‘issuer must publish notice of its intention to withdraw along with its reasons for such withdrawal, via a press release and’ must post the notice on its website.

If a firm does not eliminate all outside shareholders, its stock may continue trading in the over-the-counter market. ‘Deregistration’ refers to removing the securities from registration with the SEC, which is necessary to remove an issuer from the reach of securities law and escape disclosure requirements. Registration under the Exchange Act is not automatically linked to stock exchange trading. An issuer can become subject to the Securities Exchange Act’s reporting requirements in several ways, namely (1) by listing a class of securities on a national stock exchange (Securities Exchange Act, § 12(b)), (2) by exceeding certain quantitative thresholds regarding shareholder ownership dispersion and total assets (§ 12(g)), and (3) by having filed an effective registration statement under the Securities Act (§ 15(d)). Delisting only eliminates registration under § 12(b). The other two forms of registration, which are suspended while a company is traded on an exchange, reemerge, meaning that disclosure requirements persist. If a firm then ‘goes dark’ by falling under the thresholds of § 12(g) and § 15(d) and then deregisters, it may escape disclosure requirements even if there are significant numbers of beneficial securities holders. Such companies will often continue to trade in the OTC market, often with adverse effects on outside investors whose shares have lost their liquidity.

2. Involuntary delisting

 Involuntary delisting is a sanction used by the stock exchange and the Securities and Exchange Commission (SEC) against an issuer. The threat of a potential delisting is part of the arsenal of instruments that help to induce compliance. Delisting and suspensions of trading can be initiated by both the SEC and the stock exchange. § 12(d) of the Securities Exchange Act, among other things, provides that a ‘security registered with a national securities exchange may be […] stricken from listing and registration in accordance with the rules of the exchange and, upon such terms as the Commission may deem necessary to impose for the protection of investors, upon application by the issuer or the exchange to the Commission.’ In addition, § 12(j) authorizes the SEC ‘to deny, to suspend the effective date of, to suspend for a period not exceeding twelve months, or to revoke the registration of a security’ if the SEC has found that ‘the issuer […] has failed to comply with any provision of [the Securities Exchange Act] or the rules and regulations thereunder.’ The SEC must notify the issuer and give it the opportunity for a hearing and may then issue an order to suspend or revoke the registration (and hence the listing) of a security. Delisting is a harsh sanction and typically unnecessary, given that the SEC has other enforcement tools.

3. Conclusion

The overall picture of the law governing delisting in the United States is complex. Federal securities laws govern the delisting process, but state corporate law largely controls going private transactions. In the going-private process, investors are reasonably well-protected by lawsuits based on fiduciary duties. While the Delaware courts have moved away from substantive review as long as the decision-making process is sound, this has probably made planning easier while not undercutting the protection of minority shareholders too much. The fact that securities law still applies to delisted firms sets incentives to freeze out the minority against cash compensation. State corporate law is thus the main mechanism for shareholders to rely on for protection.

Securities law adds a layer of complexity, with the distinction between delisting and deregistration as an extra step. The possibility for firms with some public ownership to ‘go dark’ and avoid the securities law remains a gap in the regulatory framework.

Involuntary delisting is, to a large extent, subject to the discretion of the Exchange, given that the SEC reviews the delisting decision mainly for consistency but does not review the Exchange’s exercise of discretion.

Martin Gelter is Professor of Law, Fordham Law School.

Steven Thel is Wormser Professor of Law, Fordham Law School.

The full paper is available here.