February 18, 2005

Are You Really a “Controlled Company?”

As you know, controlled companies are exempt from certain NYSE and NASD board and committee independence requirements pursuant to NYSE Rule 303A.00 and NASD Rule 4350(c)(5). Both the NYSE and NASD have defined a controlled company as “a company in which any individual or group of shareholders control more than 50% of the shares of the company.” But what exactly constitutes a group? The NYSE states in its Frequently Asked Question C.5. that they will look to the concept of “group” as set forth in Section 13(d)(3) of the Exchange Act. Under Rules 13d-3 and 13d-5(b)(1) of the Exchange Act, a “group” is deemed to exist when “two or more persons agree to act together for the purpose of acquiring, holding, voting or disposing of equity securities of an issuer.”

As most M&A practitioners know, it is relatively easy for two or more shareholders to come together and become a 13(d) group, which has led some companies to claim “controlled company” status whenever there is a group of two or more shareholders with shared voting or dispositive power and the aggregate beneficial ownership of the group exceeds 50% of the company’s outstanding shares. Recently, however, the NYSE has indicated that they are focusing on shared voting power and not shared dispositive power. As a result, those companies who may have thought they were a controlled company, based on shared dispositive power likely do not satisfy the NYSE definition of “controlled company”. According to the NYSE, a 13(d) group will be recognized only when the members share voting power and in fact vote as a block on one or more matters. The NYSE also indicated that it will look at whether members of a 13(d) group have historically voted together as a group in deciding whether to recognize a 13(d) group for controlled company purposes.

This has some NYSE-listed companies second guessing their earlier conclusions regarding the existence of a group and thus their controlled company status. So practitioners should be aware that even if two or more shareholders report their combined beneficial ownership on Schedule 13D or 13G and the members in fact admit 13(d) group status, the group still may not satisfy the NYSE’s definition of “controlled company” under Rule 303A. As a result, companies may want to re-evaluate whether they are a “controlled company” if they are relying on a 13(d) group sharing only dispositive power over the group’s shares.

While the NASD rules track the language of the NYSE rule, they define “group” in Interpretive Material 4350-4 as shareholders that have “publicly filed a notice that they are acting as a group (e.g., a Schedule 13D).” For now, it appears that if shareholders are obligated to file and in fact file a joint 13D or 13G with the SEC, they should be accorded group status for purposes of the NASD controlled company exemption, but it is possible the NASD will follow the NYSE’s lead in this area as they have done on other similar corporate governance issues. Interestingly, for Section 16 purposes a group may not result where the agreement to hold, dispose or vote shares is involuntary or imposed on shareholders by the issuer. For more information on this recent development, see Romeo & Dye’s It is unclear whether the NYSE or NASD would take a similar approach when determining whether to recognize a listed company as a “controlled company”.

So, what’s the bottom line here? If your company has several large shareholders reporting on 13D or 13G and they vote together as a group, they should be accorded “group” status by the NYSE and NASD. But controlled companies relying on 13(d) groups with shared “dispositive” power should really reconsider the basis upon which they claim “controlled company” status. They will need more than just an agreement to hold or sell shares. As for the NYSE, such 13(d) groups will not be recognized. Thanks to Heather Waldbeser for bringing this to our attention. In addition to multiple definitions of “independent director” we now have slightly different definitions of 13(d) “group” applied by the SEC and the SROs.