Nasdaq proposed rule changes have been filed amid growing scrutiny over accounting scandals involving Chinese companies trading in the U.S.
On June 2, 2020, Nasdaq filed a rule proposal with the SEC to amend IM-5101-1 (Use of Discretionary Authority) to deny listing or continued listing or to apply additional and more stringent criteria to an applicant or listed company based on considerations related to the company’s auditor or when a company’s business is principally administered in a jurisdiction that has national security laws, secrecy laws or blocking statutes that otherwise restrict access to information sought by regulators of U.S.-listed companies (a so-called "Restrictive Market").
Nasdaq rules and U.S. federal securities laws require a company’s financial statements included in its initial registration statement or annual report to be audited by an independent public accountant that is registered with the Public Company Accounting Oversight Board (PCAOB). The PCAOB is currently prevented from inspecting the audit work and practices of PCAOB-registered auditors in Belgium, France, China and Hong Kong (to the extent their audit clients have operations in mainland China).
Currently, Nasdaq may rely upon its broad authority provided under Rule 5101 to deny initial or continued listing or to apply additional and more stringent criteria when the auditor of an applicant or a Nasdaq-listed company: (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. As noted in the proposal:
Nasdaq believes that codifying the nature and scope of its existing discretion when assessing the qualifications of a company’s auditor will increase transparency to investors, companies and market participants.
Nasdaq proposes to amend IM-5101-1 to add a new subparagraph (b) that sets forth factors Nasdaq may consider in applying additional and more stringent criteria to an applicant or listed company based on the qualifications of the company’s auditor. The proposed rule will include examples of additional and more stringent criteria that Nasdaq may apply to an applicant or a Nasdaq-listed company to obtain comfort that the company satisfies the financial listing requirements and is suitable for listing. These could include requiring: (i) higher equity, assets, earnings or liquidity measures than otherwise required under the Rule 5000 Series; (ii) that any offering be underwritten on a firm commitment basis, which typically involves more due diligence by the broker-dealer than would be done in connection with a best-efforts offering; or (iii) companies to impose lock-up restrictions on officers and directors to allow market mechanisms to determine an appropriate price for the company before such insiders can sell shares.
Nasdaq also proposes to amend IM-5101-1 to add a new subparagraph (c) to clarify that Nasdaq may also use its discretionary authority to impose additional or more stringent criteria, including the criteria set forth in IM-5101-1(b), in other circumstances, including when a company’s business is principally administered in a Restrictive Market.
In the event that Nasdaq relies on its discretionary authority and determines to deny the initial or continued listing of a company, it would issue a denial or delisting letter to the company that will inform the company of the factual basis for the Nasdaq’s determination and its right for review of the decision pursuant to the Rule 5800 Series.
Nasdaq proposed rule changes have been filed amid growing scrutiny over accounting scandals involving Chinese companies trading in the U.S. For instance, Nasdaq is currently seeking to delist Luckin Coffee Inc., a Chinese coffee company accused of accounting fraud.
The Nasdaq proposal follows on the back of the proposed Holding Foreign Companies Accountable Act, which if adopted into law, would delist companies from U.S. exchanges if they fail to open their audits to inspection by the PCAOB for three consecutive years. The proposed act is squarely aimed at Chinese and Hong Kong companies.
Nasdaq’s filing is available on the SEC website.
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