Community banks look ahead to a new stock exchange regime

The NASDAQ Stock Market may soon be phasing out the OTC Bulletin Board exchange system (OTCBB). Pending approval by the Securities and Exchange Commission, the NASDAQ will launch a new listed market in the fourth quarter of 2003 that is designed to take the place of the OTCBB.

This new market,

the Bulletin Board Exchange (BBX), is intended to execute trades with greater speed and efficiency, leading to a higher-quality trading platform. As described below, the BBX will require companies to comply with listing standards and other qualitative requirements consistent with those imposed on companies that trade on the NASDAQ National Market and the NASDAQ SmallCap Market.

In addition, all companies that have securities quoted on the BBX will be required to register securities under the securities Exchange Act of 1934, as amended, and be subject to its rules and regulations (and potential liabilities). This includes the obligation to file periodic reports with their appropriate bank regulator. These reports include 10-K's and 10-Qs. Furthermore, as registered companies, BBX issuers will be subject to many of the rules and regulations of the Sarbanes-Oxley Act of 2002.

This new regulatory regime will represent a significant change for affected banks and savings associations. For years, community banks that have not met the criteria for listing (or have not desired to list) on the New York Stock Exchange, the American Stock Exchange, or the NASDAQ Stock Market, have had their securities quoted on the OTCBB, which did not require them to register their securities under the Securities Exchange Act. Instead, these financial institutions could rely on the OTCBB rule that permits the quotation of a bank or savings association security if the institution is current with all required filings with the appropriate federal or state bank regulator. Accordingly, banks that had filed timely call reports could have their securities quoted on the OTCBB.

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Craig D. Miller

Allen Lee

Choosing not to comply with the new BBX requirements may seem attractive at first for many current OTCBB issuers. However, issuers who qualify for Bulletin Board Exchange listing will reap potential benefits, including the stature of trading on a listed market, increased liquidity for their securities, a better opportunity to access the capital markets, and access to more reliable trading data. With proper planning and foresight, OTC Bulletin Board issuers can make the transition to the BBX a cost-effective process.

Listing Standards and Requirements NASDAQ has made the following proposals for companies intending to quote on the BBX.

Public Interest Standard. The BBX will impose public interest standards comparable to those currently used for the NASDAQ National Market and the NASDAQ SmallCap market. For example, the Bulletin Board will review all directors, officers, and major shareholders of issuers for past regulatory or legal issues. The BBX will retain the discretion to deny listing or to delist an issuer if such action is deemed necessary to protect investors.

Public Float/Shareholder Requirement. Issuers will be required to demonstrate the existence of 100 round-lot shareholders (a round lot being equal to 100 shares) and of 200,000 shares in the public float (shares held by noninsiders). The BBX intends this requirement to assure a minimum level of public ownership in listed companies. In addition, listed companies will need to have confirmation that at least one market maker maker will participate in their security. A letter from a market-making firm-indicating that it plans to make a market in that particular stock-is sufficient to meet this requirement.

Corporate Governance Standards. The BBX will implement corporate governance standards that are consistent with those imposed by the NASDAQ National Market and SmallCap markets, including:

* Independent Directors. The BBX will require that listed companies appoint at least one independent director. Issuers will be given a grace period of 12 months upon launch of the new market to retain the independent director. Factors that will determine if a director is "independent" include, but are not limited to, whether that director receives any compensation outside of board fees from the company, and whether the director has been employed by-or has had family members employed by-the company.

* Audit Committees/Conflicts of Interest. Issuers will be required, following the mandate of the Sarbanes-Oxley Act, to have an audit committee comprised entirely of independent directors, but with the proviso that one director may act as the entire audit committee.

* Voting Rights. The BBX will adopt NASDAQ rules that prohibit the disenfranchisement of the voting rights of existing shareholders. For example, these rules prohibit listed companies from issuing any class of securities or taking any corporate action that would have the effect of nullifying, restricting, or disparately reducing the per share voting rights of holders of an outstanding class of common stock.

* Auditor Review. Issuers must engage auditors that are subject to peer review consistent with the American Institute of Certified Public Accountants procedures. In addition, upon completion of the creation of the audit oversight board mandated by the Sarbanes-Oxley Act, BBX will require that this board review all auditors of these quoted securities.

* Shareholder Approval. The BBX will adopt comparable NASDAQ rules requiring shareholder approval of certain transactions, including: (1) stock option plans, (2) large, below-market issuances of stock that are in excess of 20 percent of the company's outstanding stock, (3) acquisitions of the stock or assets of another company, if the stock to be issued in such acquisition represents more than 20 percent of the company's outstanding stock or if a director, officer, or shareholder is interested in the transaction and the acquisition represents more than 5 percent of the company's outstanding stock, and (4) changes of control.

* Distribution of Annual Reports, Availability of Quarterly Reports. The BBX will require companies to distribute annual reports and make quarterly reports available upon request. The issuers 10-K or 10-KSB filing may be used as the annual report.

* Annual Shareholder Meetings, Quorum Requirements. Companies will be required to hold annual meetings of shareholders and to solicit proxies for such meetings. At least one-third of the total shares outstanding must be represented at an annual meeting to constitute a quorum for the conduct of business.

Minimum Share Price, Income and Asset Requirements. The BBX will continue the OTCBB's practice of having no minimum share price, market capitalization, income, or asset requirements.

Listing Fees. The OTCBB is a dealer-driven quotation service, and therefore does not charge issuers listing or maintenance fees. In contrast, the BBX will be an issuer driven exchange. BBX issuers will be required to pay both initial and annual listing fees to be listed. For example, there will be an initial listing fee of $5,000 for the first class of securities listed, along with a $1,000 non-refundable application fee. A $4,000 annual fee will also apply to the first class of securities listed. Note that $2,500 of the initial listing fee will be waived for applicants who apply up to six months after the launch.

Transitioning Process

NASDAQ will continue to operate the OTCBB for six months after the launch of the BBX. After this time, companies currently trading on the OTCBB will be dropped as the OTCBB is turned off after the six-month period. Companies listing on the OTCBB that cannot meet the new BBX standards, or do not wish to list, can have their stock quoted on the other private over-the-counter (OTC) trading platform, known as the Pink Sheets.

Looking Ahead

Although the new BBX regime may seem daunting in scope to banks that have only been required to file timely call reports, it will improve the transparency and efficiency of the securities markets. The question left for community banks and savings associations will be whether the cost of compliance outweighs the need for a liquid securities market and happy shareholders.

AUTHOR_AFFILIATION

All views expressed in this article are the authors'. Craig D. Miller is a partner and Allen M. Lee is an associate in the Business and Transactions Division of the PaloAlto, Calif., office of Manatt, Phelps & Phillips, LLP. They specialize in mergers and acquisitions, corporate governance, and corporate securities work for financial institutions.