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Considering going dark? A company choosing to delist and deregister its securities from a national securities exchange may face a host of legal and economic issues. Four attorneys weigh in on the concerns that need to be addressed.

Most public companies and their shareholders appreciate the benefits of a national exchange listing, but many have begun to question whether it's worth the price. Since passage of the Sarbanes-Oxley Act of 2002, the costs associated with a New York Stock Exchange (NYSE), Nasdaq or American Exchange (AMEX) listing have ballooned. As a result, more and more companies are choosing to "go dark" by delisting and deregistering their securities.

What are the economics driving this trend and what legal issues should be considered--particularly for officers and directors--to minimize litigation risks when considering a going-dark plan?

A company goes "dark" when it delists its securities from a national securities exchange and deregisters with the U.S. Securities and Exchange Commission (SEC). In doing so, the company avoids the burden and expense of complying with the public reporting and other requirements imposed by the commission and applicable securities exchange.

This simple process should not be confused with other types of going-dark transactions, such as leveraged buyouts, management buyouts or tender offers, since these transactions frequently trigger litigation and present more complex legal issues.

Although going-dark plans are often referred to as "going private" transactions, they are not the same thing. Dark companies can still trade in the over-the-counter "Pink Sheets" market, and companies don't necessarily go dark and then go private. In fact, a 2004 study by Christian Leuz, "Why Do Firms Go Dark? Causes and Economic Consequences of Voluntary SEC Deregistrations," suggests there are only a few cases where companies first go dark and then subsequently go private.

The Process for Delisting and Deregistering Securities

The first step in going dark is delisting the company's securities from their exchange. This action eliminates the registration requirements of Section 12(b) of the Securities Exchange Act of 1934 (the Exchange Act). Exchange Act Rule 12d2-2(d) permits a company to file an electronic application to withdraw a class of securities from listing on the exchange in accordance with the exchange's rules.

Thus, an issuer can usually voluntarily request that its stock be removed from the exchange by filing Form 25 through the SEC's Electronic Data Gathering, Analysis, and Retrieval (EDGAR) online system. However, the issuer must first ensure that it complies with any applicable state law or exchange rules for delisting, as well as notify both the exchange and the public that it plans to file Form 25.

The notifications must be given no fewer than 10 days prior to the filing, via a press release and notice posted on any publicly accessible company website. The delisting becomes effective 10 days after the date of filing the Form 25 and requires no further orders from the SEC.

To deregister, or terminate registration of a class of securities registered under Exchange Act Section 12(b), issuers simply file Form 25. Issuers registered under Section 12(g) of the Exchange Act must file a Form 15 with the SEC certifying that either: there are fewer than 300 holders of record of the securities to be deregistered; or there are fewer than 500 holders of record of the securities to be deregistered and the company's total assets have not exceeded $10 million on the last day of each of the company's three most recent fiscal years.

Notably, the concept of "holders of record" does not contemplate the modern distinction between holders of record and beneficial owners (ultimate shareholders). Today, most beneficial owners are no longer the "holders of record" because their securities are held at securities depositories. Because of this anachronism, large public companies with a significant number of investors may still be eligible for deregistration.

Not surprisingly, a group of investors has identified this issue and petitioned the SEC to count ultimate shareholders when permitting companies to go dark.

Upon filing Form 25 or Form 15, the company's registration is suspended. The suspension is effective 90 days (or such shorter period as determined by the SEC) after filing. The issuer's obligation to file periodic reports under Section 13(a) of the Exchange Act, however, is suspended upon the effective date of the delisting. A company with effective registration statements under the Securities Act of 1933 remains obligated to file periodic reports under Section 15(d) of the Exchange Act, and different rules govern termination of the reporting duties under this section.

The Economics of Going Dark: Expect Share Price Decline

The quantifiable costs of complying with Sarbanes-Oxley, which do not include lost productivity due to compliance efforts, have proven much higher than originally estimated by the SEC and are disproportionately higher for smaller issuers relative to their revenues and net income.

A 2004 survey in Corporate Insight, Spring 2004, "The Costs of Complying with Governance Rules," estimated that small companies with annual revenues between $25 million to $99 million suffered Sarbanes-Oxley compliance costs of $740,000 and 3,080 company hours expended on compliance efforts; companies with annual revenues between $500 million to $999 million (a minimum 10-fold increase) incurred compliance costs of only $1 million and 6,900 company hours.

These costs are in addition to the pre-existing costs of being public and the new costs imposed by Regulation FD. A study by Foley & Lardner LLP, The Cost of Being Public in the Era of Sarbanes-Oxley (May 19, 2004), estimated that the average cost of being public in 2004 was $2.86 million, a 130 percent increase from the same study conducted in 2002.

Not surprisingly, market data suggest that more companies are now deregistering. The number of companies deregistering after the enactment of Sarbanes-Oxley jumped from 75 in 2002 to 135 in 2003. And more companies may soon follow. The Foley & Lardner study, Why Do Firms Go Dark? Causes and Economic Consequences of Voluntary SEC Deregistrations, indicated that 20 percent of companies surveyed were considering going private, representing a roughly 50 percent increase from the same study conducted in 2003.

Statistics published for 2005--based on security deregistrations, reported by the Bloomberg news agency--suggest that up to 214 companies may have voluntarily deregistered last year.

Nadia Massoud and Andras Marosi's 2004 study, Why Do Firms Go Dark?, indicates that companies that go dark suffer more than a 12 percent drop in share price during the first two trading days after the initial announcement.

Christian Leuz's study found that companies suffer a 10 percent drop in share price after the initial announcement and subsequent filing of deregistration. It also concluded that this negative reaction is more pronounced for smaller firms that would expect to benefit the most from the cost savings of deregistration.

Two companies that have been in the news for going dark are Niagara Corp. and SmartDisk Corp. Press covering these companies suggest that the market may question their motives for going dark. Indeed, Niagara and its board of directors have been sued for losses resulting in part from the voluntary delisting.

In Berger v. Spring Partners, L.L.C., plaintiffs sued for breach of loyalty and good faith for losses resulting from Niagara Corp.'s delisting and subsequent "reverse forward split" of stock that essentially cashed out plaintiffs at allegedly artificially low prices.

The court denied the defendants' motion to dismiss the complaint because plaintiffs adequately alleged that the board's decision to delist was not a "valid exercise of business judgment" and lacked independence and disinterestedness for at least half the board. The court later reaffirmed this holding in Berger v. Scharf.

Niagara Corp.'s decision to deregister its stock also led to a books-and-records claim in Delaware. In that litigation, the Chancery Court found that the Niagara board's mere decision to deregister the company's stock, without any specific facts to infer self-interest or failure to exercise due care, was insufficient to support a books-and-records claim.

Litigation Risks of Going Dark

Unlike leveraged buyouts, management buyouts or tender offers, ordinary company deregistrations are not heavily litigated. The fact that deregistering issuers likely will suffer a marked decline in share price, however, creates the potential for litigation, and courts may be receptive to deregistration claims.

For example, while Delaware case law does not expound on a director's fiduciary duties when adopting and executing a going-dark plan, a few cases indicate that a company's directors may breach their duties in pursuing such a plan if they do so for self-interested purposes.

In Hamilton v. Nozko, the court reasoned that corporate action, even where legally permissible, may be forbidden if it's taken for an inappropriate purpose.

Similarly, the court in Seagraves v. Urstadt Property Co. Inc. observed that it is not improper to delist shares. Nonetheless, it allowed the plaintiffs to go forward, alleging that the defendant directors had delisted for an inequitable purpose. Again, in Schnell v. Chris-Craft Industries Inc., the opinion reflected that inequitable action does not become permissible simply because it is legally possible.

If a case is filed, however, then the business judgment rule should apply. Delaware law recognizes the power of a corporation's directors, in a proper exercise of their business judgment, to cause the company to take steps that may result in delisting and deregistration of the company's securities. The Hamilton case noted this power, observing that directors exercising business judgment can incidentally cause delisting and deregistration that might adversely impact the market for the company's securities.

Actions for Reducing Litigation Risks

The following recommended actions should help company officers and directors invoke the protections of the business judgment rule when they approve a "going dark" plan:

* Review the company's certificate or articles of incorporation and bylaws to ensure that delisting and/or deregistration is not somehow limited by these documents (requiring a shareholder vote);

* Form a Special Committee of independent directors to review and approve the plan;

* Because courts can only evaluate a Special Committee's decision by evaluating the adequacy of its processes, extensively document the directors' consideration of the plan in the committee meeting minutes and demonstrate that the committee was adequately informed;

* Establish a clear business purpose supporting the plan, which will most likely be the cost savings of going dark (increased D & O insurance, director compensation, audit and legal expenses, software expenses, outsourcing costs and lost productivity);

* Obtain independent research supporting the cost savings afforded by the plan, including the opportunity cost of lost productivity suffered because of compliance efforts, and quantify the benefit of the cost savings for the company (impact on EPS);

* Ensure that the plan benefits all shareholders and, if not all shareholders have equal rights, that the plan addresses the rights of shareholders that may be disproportionately affected;

* Ensure that no direct or indirect benefits flow to any director or officer as a result of the committee's adoption of the plan; and

* Closely monitor the veracity of the company's public disclosures and communications with shareholders regarding this process, ensuring that such disclosures and communications are thorough, complete and factually supported.

Paul R. Bessette is a Partner at Akin Gump Strauss Hauer & Feld LLP and heads the firm's Securities Litigation Group. Michael J. Biles is a Partner and Christopher W. Ahart and Helen V. Heard are Associates. All the authors are with the firm of Akin Gump ( in Austin, Texas.


* Since passage of the Sarbanes-Oxley Act of 2002, the costs associated with an NYSE, Nasdaq or AMEX listing have ballooned.

* In going "dark," a company delists its securities from a national securities exchange and deregisters with the U.S. Securities and Exchange Commission. In doing so, the company avoids the burden of complying with public reporting and other requirements.

* Unlike leveraged buyouts, management buyouts or tender offers, ordinary company deregistrations are not heavily litigated. But, since deregulating can cause a sharp share price decline, there is potential for litigation.
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Title Annotation:governance
Author:Heard, Helen V.
Publication:Financial Executive
Date:Nov 1, 2006
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