Nasdaq Stockholder Approval of Equity Compensation—Trap for the Unwary

Public companies commonly use their equity as a component of incentive compensation awarded to their executives and other employees.

Under Nasdaq Listing Rule 5635(c), prior stockholder approval is generally required before a listed company may issue shares under an equity compensation plan or other arrangement.  To satisfy this requirement, public companies typically adopt and obtain stockholder approval of an incentive plan that provides for a reserve of shares that may be issued pursuant to various enumerated types of awards.

The plan is then amended from time to time to, among other things, increase the number of shares available under the plan.  Stockholder approval of each material revision is required, and no awards out of the share increase may be made until that approval is obtained.  The potential for these arrangements to dilute the interests of stockholders is the primary rationale for this requirement, but Nasdaq interprets this provision broadly so that it may cover arrangements that involve open market transactions.

For example, the grant of a cash bonus that is conditioned on all or a portion of such bonus being used to buy company shares on the open market, if material, would be subject to stockholder approval under Rule 5635(c).  Nasdaq regards this transaction structure as the equivalent of the company making a grant of the shares, despite the fact that no new shares are being issued.  The transaction is functionally the same, in Nasdaq’s view, as an open market purchase of shares by the company and the grant of the same number of shares to the recipient.

As public companies are increasingly adopting stock ownership guidelines and otherwise encouraging executives to have “skin in the game” evidenced by material equity ownership, companies should carefully consider whether any equity arrangements may be subject to prior stockholder approval under applicable listing rules.

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