The SEC rejected two proposals to list and trade shares in two Bitcoin exchange-traded funds (“ETFs”).

The SEC rejected a proposal from NYSE Arca, Inc. (“Arca”) to list and trade shares of the Valkyrie Bitcoin Fund. The SEC also rejected a proposal from CBOE BZX Exchange, Inc. (“BZX”) to list and trade shares of the Kryptoin Bitcoin ETF Trust.

The SEC assessed whether the exchanges (i) had a comprehensive surveillance-sharing agreement with a significant, regulated market, and (ii) could effectively prevent fraudulent and manipulative activity. In the rejected proposals, the SEC noted its concerns over the abilities of the exchanges to adequately meet the requirements under SEA Section 6(b)(5) (“Determination by Commission Requisite to Registration of Applicant as a National Securities Exchange”) in protecting investors and the public interest by preventing fraudulent and manipulative practices.

The SEC rejected Arca’s argument that (i) liquidity, (ii) price arbitrage, and (iii) frameworks to value assets would be sufficient to mitigate potential manipulation.

Similarly, the SEC rejected BZX’s proposal, concluding “that BZX has not established that it has a comprehensive surveillance-sharing agreement with a regulated market of significant size related to bitcoin,” and “that BZX has not established that other means to prevent fraudulent and manipulative acts and practices are sufficient to justify dispensing with the requisite surveillance-sharing agreement.”

As a result, the SEC found that both exchanges had failed to prove that they could meet their burdens under SEA Section 6(b)(5).

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Many U.S. listed Chinese companies have their eye on going private, with a growing number of such transactions having recently closed. This is the combined result of the current weakness of the U.S. capital markets, significant losses in the value of many U.S. listed Chinese companies, and pessimistic market forecasts that have resulted in trading at values below what controlling shareholders, management or private equity firms may think certain companies are worth.

Why Companies May Go Private

• To save costs. There are considerable costs associated with being listed on a U.S. exchange, including ongoing regulatory compliance and defending against shareholder lawsuits and other litigation. Further, in the case of leveraged buyouts, acquirers and targets may realize tax and accounting benefits of a more leveraged capital structure, as compared to a public company.
• Strategic business reasons and the ability to manage the company. Private companies are not required to publicly disclose competitive information, are provided more flexible corporate governance, and can focus on business objectives rather than investor relations issues and the short-term pressures of appeasing shareholders. Moreover, a going private transaction can allow for the restructuring of a company’s businesses in ways that would adversely affect its stock prices in the short run if it remained a public company.
• The ability to realize value. Going private may allow shareholders to realize a better price for their shares then they would otherwise realize from continuing to hold the shares or selling them on an exchange. Further, companies may go public because analysts consider a company’s share valuations to be low when compared to what the company could generate from other equity markets such as Hong Kong or Mainland China.

Challenges

Going private presents companies with challenges as well, including the inability to utilize the public markets to obtain immediate financing, a diminished public profile, and less transparency. Further, the going private process can be arduous and many such transactions are challenged in court.

Structures

A going private transaction may take various forms. Factors that influence the choice of structure include the need for outside financing, the composition of shareholders, and the likelihood of a competing bid for the company. Going private transactions are commonly structured as buyouts (either mergers or tender offers), and in some cases as reverse stock splits.

Special Committees

In order to mitigate litigation risks for the breach of fiduciary duties, boards need to ensure the fairness of a transaction to the company’s shareholders, particularly where transactions involve controlling shareholders. As such, it is common for a board to appoint a special committee of independent directors.

Listing in Mainland China or Hong Kong

Some companies plan subsequent listings in Hong Kong or Mainland China, where they speculate the valuation for their companies may be higher. For companies that were delisted or suspended from U.S. exchanges, the stigma associated with such could pose a challenge with respect to a subsequent listing, as stock exchanges and regulators require issuers to disclose their history.

Conclusion

Some basic questions that the directors and senior management of all U.S. listed Chinese companies should be asking themselves when considering going private, include: what is the most appropriate going private structure? What is a price that is demonstrably fair? Is the special committee of the board sufficiently independent? How should detailed records be maintained of board and special committee meetings, transaction negotiations and other proceedings? How can the risk of litigation be minimized?

Copyright © 2012, Sheppard Mullin Richter & Hampton LLP.

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