Yesterday, the SEC formally announced its July 9 roundtable on emerging markets. In the announcement, the SEC observed that, “while the U.S. securities laws and regulations applicable to emerging market companies listed on U.S. exchanges are the same as (or comparable to) the laws and regulations applicable to U.S. public companies, the practical effects often are substantially different, based on the inability of U.S. regulators to inspect for compliance and enforce these rules and regulations.” In the meantime, Nasdaq appears to have taken the matter to the next level. Nasdaq’s three new proposals haven’t been posted by the SEC yet—so there may still be a lot of behind-the-scenes negotiation before they see the light of day on the SEC’s website—but they are clearly designed to address these concerns about emerging market issuers, especially lack of accounting controls and transparency. Not to be outdone, the Senate yesterday passed a bill that could bar from listing on U.S. exchanges companies audited by firms that the PCAOB is prohibited by foreign authorities from inspecting.
There are three new Nasdaq proposals that would apply to companies with businesses principally administered in “Restrictive Markets”:
- a proposal to adopt a new requirement related to the qualifications of management (Update: now posted on the SEC’s website);
- a proposal to apply additional initial listing criteria related to offering size and liquidity (Update: now posted on the SEC’s website); and
- a proposal to apply additional and more stringent criteria to an applicant for listing or a listed company based on the qualifications of the company’s auditor. (Update: now posted on the SEC’s website).
The proposed definition of “Restrictive Market” would apply to all three proposals. Under proposed Rule 5005(a)(37), a “Restrictive Market” would be defined as “a jurisdiction that Nasdaq determines to have secrecy laws, blocking statutes, national security laws or other laws or regulations restricting access to information by regulators of U.S.-listed companies in such jurisdiction.” To determine whether a company’s business is principally administered in a Restrictive Market and thus subject to the requirement, Nasdaq may consider “the geographic locations of the company’s: (a) principal business segments, operations or assets; (b) board and shareholders’ meetings; (c) headquarters or principal executive offices; (d) senior management and employees; and (e) books and records.” In examining where the company conducts its principal business activities, Nasdaq will consider these factors “holistically,” meaning that the location of a company’s headquarters is not necessarily determinative. The rule, which looked to SEC guidance regarding foreign private issuer status, is designed to cover both FPIs based in Restrictive Markets and companies based in the U.S. or another jurisdiction that principally administer their businesses in Restrictive Markets.
Because management is responsible for ensuring compliance with the corporate governance listing requirements on an ongoing basis, Nasdaq believes it is necessary that management be familiar with these responsibilities. However, “Nasdaq has observed instances where it appears that management lacked familiarity with the requirements to be a Nasdaq-listed public company in the U.S. or was otherwise unprepared for the rigors of operating as a public company.” Nasdaq contends that the risks arising in these circumstances are intensified when a company’s business is principally administered in a Restrictive Market.
To address this issue, Nasdaq is proposing a new listing standard in Rule 5210(c) that would require listing applicants with businesses that are principally administered in Restrictive Market countries to have, and certify to Nasdaq that they will continue to have, a
“member of senior management or a director with relevant past employment experience at a U.S.-listed public company or other experience, training or background which results in the individual’s general familiarity with the regulatory and reporting requirements applicable to a U.S.-listed public company under Nasdaq rules and federal securities laws. Alternatively, in the absence of such an individual, the company could retain on an ongoing basis an advisor or advisors, acceptable to Nasdaq, that will provide such guidance to the company.”
The individual would be expected to serve as a resource on governance, internal controls and securities issues. Nasdaq notes that other global markets have similar requirements. Proposed Rule 5250(g) would impose an ongoing obligation for companies in Restricted Markets.
Companies that fall out of compliance would need to disclose that information and would have a 180-day compliance period to regain compliance. The proposed rule changes would be applicable to Restrictive Markets companies that apply to list on Nasdaq after the date of effectiveness, but not to companies that were already listed.
Proposal for Additional Listing Criteria
Here again, Nasdaq raises concerns about the lack of transparency, the accuracy of disclosures, accountability and access to information for companies with businesses that are administered principally in Restrictive Markets. In particular, Nasdaq is apprehensive about a lack of liquidity and proper price discovery in the secondary markets, especially when companies conduct IPOs or business combinations with a “small offering size or a low public float percentage because such companies may not attract market attention and develop sufficient public float, investor base, and trading interest to provide the depth and liquidity necessary to promote fair and orderly trading.” Often, these companies also issue a portion of their offerings to investors in their home countries. Together, these factors can contribute to volatility, wider spreads and infrequent trading, which may result in securities “trading at a price that may not reflect their true market value,” leaving these securities susceptible to greater risk of price manipulation. Nasdaq believes that this problem is even “more acute” in Restrictive Markets as a consequence of obstacles to investigations and enforcement.
To address this issue, Nasdaq is proposing new Rules 5210(l)(i) and (ii), which would require a minimum offering size or public float for Restrictive Market companies seeking to list on Nasdaq in connection with an IPO or a business combination. In an IPO, the rule would require the company to offer a “minimum amount of securities in a Firm Commitment Offering in the U.S. to Public Holders that: (i) will result in gross proceeds to the Company of at least $25 million; or (ii) will represent at least 25% of the Company’s post-offering Market Value of Listed Securities, whichever is lower.” Nasdaq has observed that Restrictive Market companies with offerings below these thresholds have a high rate of “compliance concerns.” Nasdaq is also proposing a similar requirement for listing in connection with a business combination.
Nasdaq is also proposing new Rule 5210(l)(iii), which would permit Restrictive Market companies seeking to list in connection with a Direct Listing to list on the Nasdaq Global Select or Nasdaq Global Markets, but not on the Nasdaq Capital Market, which has lower requirements for unrestricted publicly held shares.
Proposal Regarding Audit Concerns
Nasdaq and investors rely on the work of auditors to express an opinion on whether the financial statements present fairly, in all material respects, the company’s financial position, results of operations and cash flows, and on the work of the PCAOB to oversee the quality of the auditor’s work. The Chairs of both the SEC and PCAOB have
“raised concerns that national barriers on access to information can impede effective regulatory oversight of U.S.-listed companies with operations in certain countries, including the PCAOB’s inability to inspect the audit work and practices of auditors in those countries….Nasdaq is concerned that constraints on the PCAOB’s ability to inspect auditor work in countries with national barriers on access to information weaken assurances that the disclosures and financial information of companies with operations in such countries are not misleading.”
Currently, as part of its discretionary authority to deny initial or continued listing, Nasdaq may apply additional or more stringent criteria when the auditor
“(1) has not been subject to an inspection by the PCAOB (either historically or because it is newly formed and as therefore not yet undergone a PCAOB inspection),
(2) is an auditor that the PCAOB cannot inspect, or
(3) otherwise does not demonstrate sufficient resources, geographic reach or experience as it relates to the company’s audit, including in circumstances where a PCAOB inspection has uncovered significant deficiencies in the auditors’ conduct in other audits or in its system of quality controls.”
Nasdaq believes that codifying that authority would help to increase transparency. Accordingly, Nasdaq proposes to add new subparagraph (b) to IM-5101-1, identifying the factors Nasdaq may take into account in applying additional or more stringent criteria to an applicant or listed company based on the qualifications of the company’s auditor. These factors include:
“(1) whether the auditor has been subject to a PCAOB inspection, such as where the auditor is newly formed and has therefore not yet undergone a PCAOB inspection or where the auditor, or an accounting firm engaged to assist with the audit, is located in a jurisdiction that limits the PCAOB’s ability to inspect the auditor;
(2) if the company’s auditor has been inspected by the PCAOB, whether the results of that inspection indicate that the auditor has failed to respond to any requests by the PCAOB or that the inspection has uncovered significant deficiencies in the auditors’ conduct in other audits or in its system of quality controls;
(3) whether the auditor can demonstrate that it has adequate personnel in the offices participating in the audit with expertise in applying U.S. GAAP, GAAS or IFRS, as applicable, in the company’s industry;
(4) whether the auditor’s training program for personnel participating in the company’s audit is adequate;
(5) for non-U.S. auditors, whether the auditor is part of a global network or other affiliation of individual auditors where the auditors draw on globally common technologies, tools, methodologies, training and quality assurance monitoring; and
(6) whether the auditor can demonstrate to Nasdaq sufficient resources, geographic reach or experience as it relates to the company’s audit.”
Once again, Nasdaq will consider these factors “holistically and may be satisfied with an auditor’s qualifications notwithstanding the fact that the auditor raises concerns with respect to some of the factors set forth above.”
Nasdaq may also apply additional and more stringent criteria to the company to ensure suitability for listing, such as requiring higher equity, assets, earnings or liquidity measures, that any offering be underwritten on a firm commitment basis (which typically involves more due diligence), or that companies impose lock-up restrictions on officers and directors. These higher standards may provide comfort that, even if the company’s equity, assets and revenues are inflated, the company still satisfies the financial listing criteria or that the company will have adequate public float.
Nasdaq also proposes to add new subparagraph (c) to IM-5101-1, which would clarify that Nasdaq may also impose additional or more stringent criteria, including the criteria identified above, in other circumstances, including when a company’s business is principally administered in a Restrictive Market.
The proposal indicates that Nasdaq staff would discuss remedial measures on a case-by-case basis. However, Nasdaq may deny listing if it concludes that “a public interest concern is so serious that no remedial measure would be sufficient to alleviate it.” In that event, companies may seek review of that determination.
Holding Foreign Companies Accountable Act
Yesterday, the Senate passed by unanimous consent the Holding Foreign Companies Accountable Act, co-sponsored by Senators John Kennedy, a Republican from Louisiana, and Chris Van Hollen, a Democrat from Maryland. The bill would amend SOX to impose certain requirements on a public company that is audited by a registered public accounting firm with a branch or office located in a foreign jurisdiction that the PCAOB is “unable to inspect or investigate completely because of a position taken by an authority in the foreign jurisdiction.” First, the company would be required to submit to the SEC documentation that establishes that the company is not owned or controlled by a governmental entity in the foreign jurisdiction. In a “non-inspection year,” a foreign issuer would need to disclose in its reports the percentage of its shares owned by governmental entities in the jurisdiction where it is incorporated, whether governmental entities in the accounting firm’s jurisdiction have a controlling financial interest and other specified information. Moreover, if the SEC determines that the company has three consecutive “non-inspection years,” the SEC “shall prohibit the securities of the covered issuer from being traded” on a national securities exchange, over the counter or through any other method within the jurisdiction of the SEC. If the issuer then certifies to the SEC that it has retained a registered public accounting firm that the PCAOB has inspected to the satisfaction of the SEC, the SEC is then required to end that prohibition. If there is a recurrence of a non-inspection year, the SEC is required to ban the issuer again for at least five years. As reported by Fortune, “224 U.S.-listed companies representing more than $1.8 trillion in combined market capitalization are located in countries where there are obstacles to PCAOB inspections of the kind this legislation mandates.”