More than one. A distressed company must grapple not only with its business problems, but also with a host of difficult disclosure and other securities law issues. Among other things, a distressed company must decide:

How much detail to disclose about its business problems in its periodic reports, or in “informal” disclosures, such as press releases. See more at Disclosure and Registration Issues;
Whether it should ask the SEC staff for permission to report on a modified basis. See more at Modified Reporting after Bankruptcy;
Whether to negotiate or replace its auditors if the auditors seek to include a “going concern” qualification in the audit opinion. See more at Auditor “Going Concern” Issues;
How to avoid delisting if the exchange threatens to commence delisting proceedings. See more at Delisting Procedures; and
Whether to deregister and discontinue filing periodic reports during bankruptcy proceedings. See more at Deregistration under the Securities Exchange Act of 1934.

Source: A good article about the duties of directors of a distressed company is Andrew E. Bogen, “ Managing a Faltering Business: Legal Duties of Directors,” Insights (September 2001).

B. Disclosure and Registration Issues

What should a distressed company disclose about its problems in MD&A?

Probably more than management wants to disclose. MD&A requires disclosure of material known problems and uncertainties, and MD&A is part of both Form 10-Q and Form 10-K. Because investors undoubtedly will be angry about a depressed stock price and willing to sue a distressed company, full and complete disclosure probably is the best course of action. Typical disclosure issues include:

plans to cut back operations and lay-off staff;
violations of covenants under credit agreements or debt indentures (including whether waivers of the violations have been obtained, along with any time limits on the waivers);
any cash flow problems and plans to resolve them;
any plans or proposals for new financing, and if the company believes there is a reasonable likelihood that it will not be able to continue operations in the current form without new financing, it must discuss this probability (see more at “When should a distressed company disclose that it is considering filing for bankruptcy?” ); and
whether the company is seeking a buyer (see more at “How should a distressed company disclose that it is seeking a buyer?” ).

Although management may argue that too much disclosure will upset delicate negotiations with lenders and undermine customer and supplier confidence (which may necessitate some balancing in deciding what to disclose), it is clear that providing as much disclosure as possible under the circumstances can go a long way towards minimizing liability, and may increase the likelihood that the company can obtain modified reporting relief from the SEC staff if it files for bankruptcy. See more at Modified Reporting after Bankruptcy.

Source: MD&A is Item 303 of Regulation S-K.

How should a distressed company disclose that it is seeking a buyer?

By merely noting that it is seeking a buyer and describing what will happen if it cannot find one. In most circumstances, a company need not identify prospective merger partners or state that it is in negotiations with a specific buyer. The exception is when a company has previously affirmatively denied negotiations were taking place and negotiations between a prospective buyer and seller have progressed to the point that a deal is reasonably likely.

Source: The disclosure standards about when to disclose a probable acquisition are set forth in Basic v. Levinson, 485 U.S. 224 (1988).

When should a distressed company disclose that it is considering filing for bankruptcy?

Once a filing becomes reasonably likely. However, a company does not have to disclose the fact that it is reviewing the pros and cons of a bankruptcy filing.

Once the filing is reasonably likely, it is advisable to file a voluntary Form 8-K on Item 8.01 rather than wait for the actual bankruptcy filing. In addition, the company should consider issuing a press release to inform investors and comply with the applicable exchange requirements.

The Supreme Court in Basic v. Levinson, 485 U.S. 224 (1988), announced that in determining whether preliminary merger negotiations should be disclosed, the issuer must assess the “magnitude” of the prospective transaction and the “probability” of its occurrence. By analogy, the same approach can be used to determine whether preliminary restructuring negotiations or plans need to be disclosed. The magnitude of a restructuring transaction can be measured by the economic effect on the issuer; the amount of debt and/or equity involved; the effect, if any, on employees, customers, and suppliers; and the anticipated reaction of the market for the issuer's securities. The probability of occurrence may be gleaned from the steps taken by the issuer to effect the transaction (e.g., whether professional advisors have been engaged, formal proposals have been submitted, due diligence has been substantially completed, actual negotiations have commenced, agreements have been executed, and board action has been taken).

When a bankruptcy filing is actually made and a receiver is appointed, a mandatory Form 8-K is required on Item 1.03, and the reorganization plan (if it then exists) should be filed as an exhibit. Note that the SEC staff considers the adequacy and timing of disclosure when granting or denying modified reporting relief to companies in bankruptcy. See more at Modified Reporting after Bankruptcy.

Source: MD&A (Item 303 of Regulation S-K) requires disclosure of known trends, demands, events, or uncertainties that are “reasonably likely” to occur and to have a material impact on the issuer.

Item 1.03 of Form 8-K requires a filing if a receiver, fiscal agent, or similar officer has been appointed for a registrant or its parent, in a proceeding under the Bankruptcy Code or in any other proceeding under state or federal law in which a court or governmental agency has assumed jurisdiction over substantially all of the assets or business of the registrant or its parent, or if such jurisdiction has been assumed by leaving the existing directors and officers in possession but subject to the supervision and orders of a court or governmental body. The filing under Item 1.03 of Form 8-K must identify the proceeding; the court or governmental authority; the date jurisdiction was assumed; the receiver, fiscal agent, or similar officer; and the date of his or her appointment. Item 1.03 also requires disclosure if an order confirming a plan of reorganization, arrangement, or liquidation has been entered by a court or governmental authority having supervision or jurisdiction over substantially all of the assets or business of the registrant or its parent. The following must be disclosed:

the identity of the court or governmental authority;
the date the order confirming the plan was entered by the court or governmental authority;
a summary of the material features of the plan and, pursuant to Item 9.01 (Financial Statements and Exhibits), a copy of the plan as confirmed;
the number of shares or other units of the registrant or its parent issued and outstanding, the number reserved for future issuance in respect of claims and interests filed and allowed under the plan, and the aggregate total of such numbers; and
information as to the assets and liabilities of the registrant or its parent as of the date the order confirming the plan was entered, or a date as close thereto as practicable. Such information may be presented in the form in which it was furnished to the court or governmental authority.

What disclosure is required when a company emerges from bankruptcy?

Upon confirmation of a company's reorganization plan, the company must promptly file a Form 8-K that includes an audited balance sheet. After the plan becomes effective, the company must file Form 10-Ks and Form 10-Qs — even if it had been granted modified reporting relief during the pendency of its bankruptcy proceeding. In other words, the modified relief has terminated. See more at “ When does modified reporting relief for a bankrupt company terminate?”

The company's post-reorganization filings must include audited financial statements prepared in accordance with GAAP for all periods for which audited financial statements are required, even though the company may have been subject to bankruptcy proceedings during some portion of those periods. Any request for financial statement relief must be made directly to the Division of Corporation Finance's Office of Chief Accountant.

Source: Section IV(B)(1) of Staff Legal Bulletin No. 2 (April 15, 1997).

What should a liquidating company disclose?

A company should disclose any material events relating to the liquidation on Form 8-K. When the liquidation is complete, it must file a final Form 8-K to report the completed liquidation.

Source: Section IV(B)(2) of Staff Legal Bulletin No. 2 (April 15, 1997).

Must a company register securities that it issues as part of its bankruptcy reorganization plan?

Not necessarily. It may not have to if it can avail itself of the exemption from Securities Act registration under Section 1145 of the Bankruptcy Code, or Section 3(a)(7) or 3(a)(9) of the Securities Act.

Section 1145 permits a company engaged in a reorganization under Chapter 11 to issue securities, without registration under the Securities Act, if the plan of reorganization provides for the issuance of such securities and if the securities are issued in exchange (or at least principally in exchange) for the debtor's existing debts or securities. However, the exemption generally does not permit the issuance of unregistered securities to the public to raise “fresh capital” in connection with the reorganization. Generally speaking, if a company's plan of reorganization calls for issuing securities for “fresh capital” and the recipients of such securities are not principally exchanging claims against, or equity interests in, the company, the offering will be conducted on a private basis (e.g., under Section 4(2) of the Securities Act) due to the difficulties of complying with the financial statement and other requirements of full-blown Securities Act registration. See more at “ When does modified reporting relief for a bankrupt company terminate?” Some bankruptcies involve an exchange offer that requires registration with the SEC. See more at “ What is a “prepackaged” bankruptcy?”

Source: Section 3(a)(7) is a very narrow, specialized exemption that applies only to certificates issued by a debtor in possession or a trustee, which are typically debt securities issued during the course of a reorganization to raise cash for use in the reorganization effort. Section 1145 of the Bankruptcy Code is the general exemption for securities issued under a Chapter 11 plan in exchange for claims against or equity interests in a debtor.

Must a company emerging from bankruptcy register a new class of common stock under the Exchange Act?

Sometimes. A company's plan of reorganization may provide for the issuance of a new class of common stock with a par value (or other characteristics) different from its other prior class of common stock. If the prior class of common stock is cancelled as part of the plan of reorganization, the company will be permitted by the SEC to amend its current Exchange Act registration statement to register the new class of common stock.

Source: The SEC's July 1997 Manual of Publicly Available Phone Interpretations under “S. Other Exchange Act Forms,” interpretation #11.

Is the Trust Indenture Act applicable to issuances of debt securities under a plan of reorganization?

Maybe. Except for short term notes that mature within one year after the effective date of the plan, Section 1145 of the Bankruptcy Code does not exempt debt securities issued under a plan from the qualification requirements of the Trust Indenture Act of 1939. Therefore, the issuer may be required to file a Form T-3 to qualify the indentures for the new debt securities. If the issuer is required to file a Form T-3, such filing must occur before the issuer solicits votes to approve its plan of reorganization, although clearance from the SEC does not need to occur until prior to the effective date of the plan.

Source: Division of Corporation Finance, Securities and Exchange Commission, Current Issues and Rulemaking Projects, Section VII(a)(13) (November 14, 2000)

What is a “prepackaged” bankruptcy?

A prepackaged bankruptcy (also known as a “prepack”) is a restructuring technique whereby a company obtains the acceptance of its creditors to a plan of reorganization before it files for relief under Chapter 11 of the Bankruptcy Code. In other words, a company prepares a reorganization plan that is negotiated and voted on by creditors and possibly stockholders before it actually files for bankruptcy.

Under Section 1126(c) of the Bankruptcy Code, a plan of reorganization must be approved by creditors that hold at least two-thirds in amount, and more than one-half in number, of the allowed claims actually voting on the plan and, if applicable, by the holders of at least two-thirds in amount of equity interests. Under Section 1126(b) of the Bankruptcy Code, pre-bankruptcy solicitations of creditors and equity interest holders must comply with “applicable non-bankruptcy law.” If holders of a class of securities registered under the Exchange Act of 1934 are solicited to vote on the plan, then the company must comply with the SEC's proxy rules when conducting the solicitation.

If a prepackaged plan involves an offer to sell a security, it probably either has to be registered with the SEC or subject to an exemption, such as 4(2) or 3(a)(9) of the Securities Act of 1933, even though the Section 1145 exemption would be available to exempt the actual issuance of the securities under the plan. See more at “ Why do companies attempt to avoid registration of prepackaged bankruptcies?”

Section 316(b) of the Trust Indenture Act of 1939 restricts the ability of issuers to amend fundamental payment terms of public debt securities without the consent of each affected bondholder. As a result, distressed companies use exchange offers to obtain payment concessions from public bondholders outside of bankruptcy. See more at “ Why do companies use prepackaged bankruptcies?” By offering to issue new debt securities with payment modifications in exchange for outstanding debt securities, companies can restructure payment terms of their public debt without resorting to bankruptcy. See more at “ What is the ‘holdout' problem in prepackaged bankruptcies?”

For a partial list companies that have done prepackaged bankruptcies, click here.

Why do companies use prepackaged bankruptcies?

It shortens and simplifies the bankruptcy process, saves the company money, and frequently generates more for the creditors, as there is less spent in legal and related fees. In addition, there is less disruption to the company's business and less damage to its goodwill. For example, in Independent Wireless One Corporation's prepackaged bankruptcy, the company's plan of reorganization was confirmed by the bankruptcy court thirty-six days after filing its Chapter 11 case.

A prepackaged bankruptcy enables companies to make use of rules under Chapter 11 that foster negotiated restructurings, without incurring the disruption and the costs of a traditional Chapter 11 proceeding. It also eliminates a “holdout” problem. See more at “ What is the ‘holdout' problem in prepackaged bankruptcies?” As part of this process, a prepackaged bankruptcy permits management to control more of the restructuring process because a company is subject to the bankruptcy court only after its restructuring plan has been formulated, negotiated, and approved by all classes of creditors.

What is the “holdout” problem in prepackaged bankruptcies?

Bondholders who can successfully “hold out” of an exchange offer may be able to reap a windfall at the expense of bondholders who tender in the exchange. A holdout maintains the original payment terms, and prospects for payment on those terms—even after the loss or modification of financial covenants—may have improved because of the financial concessions made by the bondholders who do tender in the exchange offer.

A significant number of holdouts can block prepackaged bankruptcies, since these arrangements normally are conditioned upon a high level of acceptance—maybe as high as 85 to 95 percent. These high levels are required by both the company and the tendering holders. The holdout problem can be exacerbated in a restructuring that involves multiple classes of debt securities.

Source: A good article on this topic is John J. Huber, Bryant B. Edwards, and Jeffrey C. Soza, “Restructuring High-Yield Securities Through Prepackaged Bankruptcies,” Insights (May 1991).

Why do companies attempt to avoid registration of prepackaged bankruptcies?

To minimize publicity and to avoid SEC staff processing delays. Time is of the essence for companies in distress, and registered offerings can run into SEC staff processing snafus, particularly disagreements over accounting issues that could lead to restatement of the financial statements. As a result, most companies try to avail themselves of an exemption from registration, such as exchange offers under Section 3(a)(9) of the Securities Act of 1933. However, relying on exemptions can run into complicated integration issues.

C. Modified Reporting after Bankruptcy

Does a public company still have to file periodic reports with the SEC after it files for bankruptcy?

Yes, even after a company files for bankruptcy, it must continue to file reports under the Securities Exchange Act of 1934. This is because neither the Bankruptcy Code nor the federal securities laws provide an exemption from Exchange Act reporting for companies that have filed for bankruptcy. However, in some circumstances, SEC staff will permit a registrant to file the monthly operating reports it submits to the bankruptcy court in lieu of the Form 10-Ks and 10-Qs that a bankrupt company would otherwise be obligated to file with the SEC. However, the registrant must continue to make filings in accordance with the Form 8-K rules. This is known as “modified reporting.”

Source: Section I of Staff Legal Bulletin No. 2 (April 15, 1997).

Under what circumstances will the SEC staff permit a bankrupt company to use modified reporting?

The factors the staff will consider include:

Whether the company complied with its Exchange Act reporting obligations before filing for protection under the Bankruptcy Code;
Whether the company timely filed a Form 8-K announcing the bankruptcy filing and made other efforts to advise the market of its financial condition;
Whether the company is able to continue Exchange Act reporting without undue hardship;
The adequacy of the disclosure that will be contained in the bankruptcy court reports;
Whether there is any trading in the company's securities; and
The timeliness of the request for modified reporting.

See more at “ How should a bankrupt company approach the SEC staff to seek modified reporting relief?”

Source: The factors that the staff will take into account in deciding whether to grant this relief are outlined in Staff Legal Bulletin No. 2 (April 15, 1997) and Release 34-9660 (June 1972).

How should a bankrupt company approach the SEC staff to seek modified reporting relief?

The request must be submitted in the form of a no-action request. See more at “ When should a bankrupt company file a no-action request with the SEC staff to seek modified reporting relief?” The no-action request should, if true:

Explain that the company was current in its Exchange Act reporting before it filed for bankruptcy;
Set forth the date that a Form 8-K reporting the bankruptcy was filed (if the 8-K was filed late, explain why);
Disclose any other efforts to inform the marketplace that the company was filing for bankruptcy;
Provide a detailed explanation for why the company cannot continue Exchange Act reporting, with a focus on the expense and administrative burdens of reporting, the difficulties associated with making the disclosures required by the Forms 10-K and 10-Q, and the absence of harm to investors;
Argue that the bankruptcy court reports would contain sufficient information to protect investors; and
Show that trading in the company's securities has essentially ceased (otherwise, it is unlikely that relief will be granted by the staff).

Source: The staff made clear what should be presented in no-action requests in Section III of Staff Legal Bulletin No. 2 (April 15, 1997) and Release 34-9660 (June 1972).

When should a bankrupt company file a no-action request with the SEC staff to seek modified reporting relief?

As soon as possible after the bankruptcy case commences because it normally takes the staff at least 30 days to process a request. However, the no-action request will be considered timely so long as it is filed before the filing date for the first Exchange Act report due after the bankruptcy case commences.

Source: Section III(C) of Staff Legal Bulletin No. 2 (April 15, 1997).

What, and when, should a bankrupt company file with the SEC if it is granted modified reporting relief?

The company should file its monthly bankruptcy court reports under cover of a Form 8-K under Item 8.01 or Item 7.01. Under Staff Legal Bulletin No. 2 the reports must be filed with the SEC within 15 days after the date they are due in bankruptcy court. However, if the filing is under Item 7.01, the filing should be made simultaneously with the filing of the monthly operating report with the bankruptcy court.

The better practice is to make the filing under Item 7.01 rather than 8.01. The financial information included in the monthly operating reports is arguably the type of material information that must be disclosed under Regulation FD, and most bankruptcy courts that make filings available on the Internet require the payment of a fee to access the documents. Thus, the filing with the bankruptcy court alone probably does not meet the “public filing” requirements of Regulation FD.

An advantage of filing the monthly operating reports under Item 7.01 is that, unlike Item 8.01, filings under Item 7.01 are not subject to liability for false or misleading statements under Section 18 of the Exchange Act.

Sources: General Instruction B.2 of Form 8-K; Section IV(A) of Staff Legal Bulletin No. 2 (April 15, 1997).

Under the securities laws, what does a bankrupt company need to do even if it is granted modified reporting relief?

The company still must comply with all other Exchange Act requirements, including the proxy rules, issuer tender offer rules, and going private rules, as well as file current reports on Form 8-K. For example, if a bankruptcy reorganization requires a stockholder vote or involves a self-tender “going private” transaction, the company still must comply with the relevant provisions of the Exchange Act.

Source: Section IV(A) of Staff Legal Bulletin No. 2 (April 15, 1997).

What are the adverse consequences of obtaining modified reporting relief?

Companies using modified reporting lose any eligibility for short-form registration on Form S-3 for at least one year. In addition, the bankrupt company will not be treated as satisfying the informational requirements set forth in Rule 144(c)(1) or the “reporting issuer” definition set forth in Regulation S.

Source: Section IV(C) of Staff Legal Bulletin No. 2 (April 15, 1997).

When does modified reporting relief for a bankrupt company terminate?

When the bankrupt company's reorganization plan under the Bankruptcy Code is confirmed and becomes effective or if it violates any terms of the SEC staff's no-action response that granted the relief.

Source: Section IV(B)(1) of Staff Legal Bulletin No. 2 (April 15, 1997).

D. Failure to Timely File Regular or Modified Reports

Why might a distressed company have trouble timely filing a periodic report with the SEC?

A company may experience any number of problems, such as accounting irregularities that it must investigate and resolve before it can complete its financial statements or a breach of its credit agreement or debt indenture that it may not want to publicly disclose before it can obtain the necessary waivers. However, under Item 2.04 of Form 8-K, if there is a triggering event that causes the company's financial obligations to be increased or accelerated, then the company is required to file a report on Form 8-K and disclose the occurrence of such triggering event and related information within four business days after such event occurred.

Can a company obtain an extension from the SEC and file its periodic report late?

Yes, but only in limited circumstances. A company must be able to show that it is unable to complete a filing without “unreasonable effort or expense.” See more at “ How can a company obtain an extension from the SEC and file its periodic report late?”

Note that there are no extensions available for mandatory Form 8-Ks. They are available just for Forms 10-K , 10-KSB , 10-Q , and 10-QSB.

Source: Rule 12b-25 under the Exchange Act sets forth the only circumstances under which extensions to the Form 10-K, 10-KSB, 10-Q, and 10-QSB filing deadlines will be permitted.

How can a company obtain an extension from the SEC and file its periodic report late?

By filing a Form 12b-25 with the SEC no later than one business day after the Form 10-K (or 10-KSB ) or 10-Q (or 10-QSB ) is due.

In the Form 12b-25, the company must:

set forth the reasons for the inability to file timely, and
represent that the inability to file could not have been eliminated without unreasonable effort or expense.

If the company did not file on time because a third party was unable to provide a required opinion, report, or certification, the form must include a statement from the third party explaining why it could not provide the necessary document. This requirement applies, for example, when the report is late because the auditors were unable to deliver their audit opinion. The auditors must prepare a statement explaining the reasons for their inability to deliver. See more at “What if a company cannot obtain a statement from a third party or cannot accurately represent that it is unable to file without unreasonable effort or expense?”

Source: Rule 12b-25 under the Exchange Act sets forth the only circumstances under which extensions to the Form 10-K, 10-KSB, 10-Q, and 10-QSB filing deadlines will be permitted. The SEC's July 1997 Manual of Publicly Available Phone Interpretations under “M. Exchange Act Rules,” interpretation #13, provides an example of how the 12b-25 deadline is calculated if the periodic report deadline falls on a weekend or holiday.

What if a company cannot obtain a statement from a third party or cannot accurately represent that it is unable to file without unreasonable effort or expense?

It should only provide accurate disclosure and whatever statements from third parties that it can obtain, even if it means that it technically does not meet the Form 12b-25 requirements, and timely file the Form 12b-25.

For how long is an extension from the SEC valid?

An extension is good for 15 calendar days from the Form 10-K (and 10-KSB ) filing deadline, and 5 calendar days from the Form 10-Q (and 10-QSB ) filing deadline. Note that these extensions run from the original deadlines—not from the date that a Form 12b-25 is filed. See more at “ Can a company obtain a new extension if it cannot meet the deadline of its original extension?”

Source: Rule 12b-25 under the Exchange Act sets forth extension periods.

Can a company obtain a new extension if it cannot meet the deadline of its original extension?

No; no other extensions are available under the SEC rules. Companies should file as promptly as they can, even if they are late.

Source: The SEC's July 1997 Manual of Publicly Available Phone Interpretations under “M. Exchange Act Rules,” interpretation #14.

If a company files within an extension period, will it be considered timely for form eligibility purposes?

Yes; the company will be treated as having timely filed its Exchange Act reports for the purposes of the Form S-3 eligibility requirements. (Form S-3 is available only to registrants that have filed their Form 10-Ks and 10-Qs on time during the most recent 12-month period.) Companies that file late and do not use Rule 12b-25 at all, and companies that file a Form 12b-25 but do not submit their reports within the applicable extension period, lose their ability to use short-form registration. See more at “ For how long is an extension from the SEC valid?”

Source: The SEC's July 1997 Manual of Publicly Available Phone Interpretations under “M. Exchange Act Rules,” interpretation #17, discusses how secondary offerings on Form S-3 can continue during an extension until a company fails to make a filing by the Rule 12b-25 deadline.

E. Auditor “Going Concern” Issues

What is a “going concern” auditor's opinion?

This is a qualification in the auditor's opinion on the year end financials included in the Form 10-K (or 10-KSB ) that the company may be unable to continue to operate as a going concern. Under SAS No. 59, this qualification should be included when the auditors determine that there is substantial doubt about the company's ability to continue as a going concern for a reasonable period of time (usually at least a year). See more at “ What do auditors consider when they make a “going concern” determination?” One purpose of these qualifications is to alert investors to serious financial problems with the company.

Source: Statement on Auditing Standards No. 59, The Auditor's Consideration of An Entity's Ability to Continue As a Going Concern.

What do auditors consider when they make a “going concern” determination?

Auditors look at a range of factors, including:

recurring operating losses;
negative cash flows;
defaults on loans;
denial of trade credit;
the need to seek new sources of financing or sell assets;
management's plans to solve these problems; and
the likelihood that management's plans will work.

Source: Statement on Auditing Standards No. 59, The Auditor's Consideration of An Entity's Ability to Continue As a Going Concern.

Can a company negotiate with its auditors to avoid a “going concern” opinion?

Not likely, particularly in light of the huge settlements that auditors have recently entered into with regulators after allegations of not properly issuing these opinions. As a result, trying to negotiate with auditors about a going concern qualification is difficult, particularly because the determination is inherently subjective. Management should focus on strengthening its plans to get out of financial difficulty in order to convince the auditor that the company's problems will be resolved.

Firing the company's auditor is not an effective solution because not only is it uncertain that another auditor would issue an opinion without a going concern qualification, but Item 4.01 of Form 8-K requires disclosure of the company's dismissal of its auditor and the disagreement with the auditor, as well as whether the auditor's report for either of the past two years contained an adverse opinion or a disclaimer of opinion or was qualified or modified as to uncertainty, audit scope, or accounting principals and the nature of such adverse opinion, disclaimer of opinion, modification or qualification.

F. Delisting Procedures

What is a “delisting”?

When a company no longer is “listed” by an exchange. In other words, the exchange no longer allows the securities to be traded through its system.

Before a company can begin trading on an exchange or the NASDAQ Stock Market, it must meet certain initial requirements or “listing standards.” The exchanges and the NASDAQ Stock Market—not the SEC—set their own standards for the privilege of listing and continuing to trade. See “What are the ‘listing standards?'” Many distressed companies are at risk of falling out of compliance with listing maintenance standards.

Investors can determine whether the New York Stock Exchange is seeking to delist a company by visiting the NYSE's “Press Releases” Web page and selecting “Reviews/Suspensions” in the drop-down category box. If a company is delisted or receives notice from a national securities exchange or national securities association that it does not satisfy a rule or standard for continued listing, then Item 3.01 of Form 8-K requires the company to disclose this information.

What are the “listing standards”?

Each exchange has minimum qualifications that a company must meet and maintain to be listed. These include quantitative and qualitative (e.g., corporate governance) standards. The initial listing requirements mandate that a company meets specified minimum thresholds for:

the number of publicly traded shares,
total market value,
stock price, and
number of shareholders.

After a company starts trading, it must continue to meet different, less stringent, standards set by the exchanges or NASDAQ. The maintenance standards include, among other requirements, quantitative standards based on:

market capitalization,
minimum bid price for the stock,
market value of the public float, and
number of market makers.

The exchanges and NASDAQ also have broad discretion to delist when they determine that a delisting is in the best interest of investors.

Source: The initial and continued listing requirements are on the Web sites of the NYSE and the NASDAQ. The OTC Bulletin Board and Pink Sheets do not have listing standards, although the SEC requires companies to be current in their filings before their stock can be quoted on the OTCBB.

What happens when a company no longer meets the listing maintenance standards?

When a company no longer meets listing standards, the exchange will notify management that it plans to commence delisting proceedings. When the problem relates to a quantitative listing standard, the exchange or NASDAQ gives the company a grace period during which it can attempt to restore compliance. The exchange or NASDAQ also will ask the company to submit a report explaining how it plans to restore compliance. The plan that the company submits should explain in detail how the company intends to restore compliance. For example, if the problem relates to stock price, the company may describe plans to engage in a reverse stock split or to obtain equity financing, refinance debt or take other steps to improve the company's balance sheet.

At the end of the grace period, if the company has not been able to comply with the quantitative listing criteria, the company will be delisted. The exchange files a Form 25 with the SEC to effect the removal of a company that is delisted.

What is the listing standard regarding stock price?

Exchanges normally require that the closing bid price be at least $1 per share. If the stock price falls below $1 for 30 consecutive trading days for an NYSE listed company, or below $1 for a NASDAQ, listed company, the exchange or NASDAQ will notify the company that it is not in compliance with the stock price standard. It will then give the company a grace period during which the closing bid price must be greater than $1 on at least a certain number of consecutive business days.

G. Deregistration under the Securities Exchange Act of 1934

How do companies register to file periodic reports under the Securities Exchange Act of 1934?

Registration depends on where the company is listed, or how many holders and assets they have at calendar year end. There are three alternatives:

Section 12(b): A company that is listed on the NYSE or Amex must register pursuant to Section 12(b) of the Securities Exchange Act of 1934.
Section 12(g): A company listed on NASDAQ must register pursuant to Section 12(g). In addition, companies that have more than 500 record holders of any class of equity securities and $10 million in assets at calendar year end must register under this section.
Section 15(d): This section creates reporting obligations for companies that are not registered under Section 12(b) or 12(g) but that have registered a distribution of securities under the Securities Act of 1933.

These three sections operate in order, from Section 15(d) to Section 12(g) to Section 12(b). A class of securities is never considered registered under more than one section at a time. For example, if a Section 15(d) reporting company registers a class of securities under Section 12(b) or 12(g), its Section 15(d) reporting obligation is suspended while the class of securities is registered under Section 12. Note that Section 13 and its related rules require companies registered under Sections 12(b) and 12(g) to file periodic reports (i.e. Forms 10-Ks and 10-Qs) and satisfy other reporting obligations.

Why do companies want to deregister?

They do not want to go through the time and expense required to prepare the reports, particularly if they are distressed (and lacking in funds and resources). However, since deregistration results in an inability to list securities on an exchange or NASDAQ, a company should consider the effects of the loss of a liquid market in its securities before deregistering. See more at “Should companies deregister?”

Should companies deregister?

Like many major decisions, deregistration has both positive and negative aspects. The cost of maintaining registration is a major issue. There are legal, accounting, and other expenses associated with being a public company. Also, mandatory periodic disclosure can severely limit a company's flexibility. A company must weigh these costs against the benefits of public company status in light of the trading market, the company's need for capital, the company's financial status, etc.

Not all of the benefits of public company status can be boiled down to dollars and cents. For instance, creditors, banks, and potential acquirers are more likely to have confidence in a company that is filing periodic reports. In addition, security holders may revolt if the company does not maintain its Exchange Act registration and support a liquid market for the company's stock, even if only in the over-the-counter market.

How do companies deregister?

The method of deregistering depends on whether the company is registered under Section 12(b), 12(g) , or 15(d). See more at “ How do companies register to file periodic reports under the Securities Exchange Act of 1934?”. When a company deregisters from one of these three sections, it must analyze whether it is then registered by default under another section, and then deregister from that section too.

Section 12(b) companies. First, apply to the exchange to remove its stock from listing in accordance with the rules of the exchange. The exchange files a Form 25 to effect the removal under Section 12(d). Once the Form 25 is filed, the company's stock is deregistered under Section 12(b). The company should then consider whether its stock was previously registered under Sections 12(g) or 15(d). If so, the Section 12(g), and in the absence of a 12(g) obligation, Section 15(d) registration automatically revives without further filing and the company will have to deregister pursuant to the conditions below.
Section 12(g) companies. If a company has fewer than 300 record holders of any class of equity securities, it can terminate its Section 12(g) registration by filing a Form 15. If it has 300 or more record holders, but fewer than 500 record holders and less than $10 million in assets at the end of each of the last three fiscal years, it also can terminate its Section 12(g) registration by filing a Form 15. Even if the company can terminate its Section 12(g) registration, it must consider whether it continues to have a Section 15(d) reporting obligation and it has to deregister pursuant to the conditions below.
Section 15(d) companies: If a company filed a registration statement that went effective in the fiscal year, it must continue to file periodic reports. If it did not have a registration statement that went effective in the fiscal year, and if it has fewer than 300 record holders or has fewer than 500 record holders and less than $10 million in assets at the end of each of the last three years, it may be able to suspend its reporting obligations by filing a Form 15.

Note that these steps only apply to U.S. companies. Foreign private issuers have a different path to follow to deregister.