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Nasdaq Proposed Rule Changes To Its Discretionary Listing And Continued Listing Standards

On April 21, 2020, the SEC Chairman Jay Clayton and a group of senior SEC and PCAOB officials issued a joint statement warning about the risks of investing in emerging markets, especially China, including companies from those markets that are accessing the U.S. capital markets (see HERE).  Previously, in December 2018, Chair Clayton, SEC Chief Accountant Wes Bricker and PCAOB Chairman William D. Duhnke III issued a similar cautionary statement, also focusing on China (see HERE).

Following the public statements, in June 2020, Nasdaq issued new proposed rules which would make it more difficult for a company to list or continue to list based on the quality of its audit, which could have a direct effect on companies based in China.

Nasdaq Proposed Rule Changes

On June 2, 2020, the Nasdaq Stock Market filed a proposed rule change to amend IM-5101-1, the rule which allows Nasdaq to use its discretionary authority to deny listing or continued listing to a company.  The rule currently provides that Nasdaq may use its authority to deny listing or continued listing to a company when an individual with a history of regulatory misconduct is associated with that company.  The rule sets out a variety of factors that may be considered by the exchange in making a determination.  I’ve detailed the current rule below.

The proposed rule change will add discretionary authority to deny listing or continued listing or to apply additional or more stringent criteria to an applicant based on considerations surrounding a company’s auditor or when a company’s business is principally administered in a jurisdiction that is a “restrictive market.”  The proposed rule change is meant to codify Nasdaq’s current interpretation of its discretionary authority to provide clarity to the marketplace on its position related to the importance of quality audits.

Nasdaq’s listing requirements are designed to ensure that a company is prepared for the reporting and administrative requirements of being a public company, to provide for transparency and the protection of investors, and to ensure sufficient investor interest to support a liquid market.  Rule 5101 describes Nasdaq’s broad discretionary authority over the initial and continued listing of securities on Nasdaq in order to maintain the quality of and public confidence in the market, to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, and to protect investors and the public interest.

Part of both the general federal securities laws and Nasdaq requirements relate to properly completed audits by an independent auditor.  Investors need to be able to rely on the audit report to gain confidence that the financial statements are properly completed and free of material misstatements due to mistakes or fraud.  For more on the requirements for an audit report, see HERE.

Auditors are subject to oversight by both the SEC and PCAOB.  PCAOB inspections are designed to, among other things, identify deficiencies in audits and/or quality control procedures.  Investigations can lead to the audited public company having to revise and refile its financial statements or its assessment of the effectiveness of its internal control over financial reporting.  In addition, through the quality control remediation portion of the inspection process, inspected firms identify and implement practices and procedures to improve future audit quality.  Accordingly, Nasdaq relies on auditors and the PCAOB oversight to maintain audit integrity.

Citing the recent joint public statement by SEC Chair Clayton, SEC Chief Accountant Sagar Teotia, SEC Division of Corporation Finance Director William Hinman, SEC Division of Investment Management Director Dalia Blass, and PCAOB Chairman William D. Duhnke III (see HERE), Nasdaq notes that audit work and the practices of auditors in certain countries, cannot be effectively reviewed or subject to the usual oversight.  Those countries currently include Belgium, France, China and Hong Kong.

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: (i) has not been subject to an inspection by the PCAOB, (ii) is an auditor that the PCAOB cannot inspect, or (iii) 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.  The proposed rule change is meant to codify the existing rights of Nasdaq in that regard.

The proposed rule change would add a new paragraph (b) to IM-5101-1 detailing factors that Nasdaq will consider including:

(i) whether the auditor has been subject to PCAOB inspection including due to the audit firm being located in a jurisdiction that limits the PCAOB’s inspection ability;

(ii) if the auditor has been inspected, whether the results of the inspection indicate the auditor has failed to respond to inquiries or requests by the PCAOB or that the inspection revealed significant deficiencies in the auditors’ conduct in other audits or in its system of quality controls;

(iii) whether the auditor can demonstrate that it has adequate personnel in offices participating in the audit with expertise in applying U.S. GAAP, GAAS or IFRS, in the company’s industry;

(iv) whether the auditor’s training program for personnel participating in the company’s audit is adequate;

(v) for non-U.S. auditors, whether the auditor is part of a global network or other affiliation of auditors where the auditors draw on globally common technologies, tools, methodologies, training and quality assurance monitoring; and

(vi) whether the auditor can demonstrate to Nasdaq sufficient resources, geographic reach or experience as it relates to the company’s audit.

An auditor would not necessarily have to satisfy each of the factors but rather Nasdaq will consider all facts and circumstances, and may impose additional or more stringent criteria to mitigate concerns.  Additional criteria could include: (i) higher equity, assets, earnings or liquidity measures; (ii) that an offering be completed on a firm commitment basis (as opposed to best efforts); (iii) lock-ups for officers, directors or other insiders; (iv) higher float percentage or market value of unrestricted publicly held shares; or (v) higher average OTC trading volume before an uplisting.

The proposed rule change would also add a new subparagraph (c) to IM-5101-1 to confirm Nasdaq’s ability to impose additional or more stringent criteria in other circumstances, including when a company’s business is principally administered in 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 (a “Restrictive Market”).  In determining whether a company’s business is principally administered in a Restrictive Market, Nasdaq may consider the geographic locations of the company’s: (i) principal business segments, operations or assets; (ii) board and shareholders’ meetings; (iii) headquarters or principal executive offices; (iv) senior management and employees; and (v) books and records.

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.

Current Rule IM-5101-1

Nasdaq may use its authority under Rule 5101 to deny initial or continued listing to a company when an individual with a history of regulatory misconduct is associated with the company. Such individuals are typically an officer, director, substantial shareholder, or consultant to the company. In making this determination, Nasdaq will consider a variety of factors, including:

(i) the nature and severity of the conduct, taking into consideration the length of time since the conduct occurred;

(ii) whether the conduct involved fraud or dishonesty;

(iii) whether the conduct was securities-related;

(iv) whether the investing public was involved;

(v) how the individual has been employed since the violative conduct;

(vi) whether there are continuing sanctions (either criminal or civil) against the individual;

(vii) whether the individual made restitution;

(viii) whether the company has taken effective remedial action; and

(ix) the totality of the individual’s relationship with the company including their current or proposed position, current or proposed scope of authority, responsibility for financial accounting or reporting and equity interest.

Nasdaq may also exercise its discretionary authority with a company filed for bankruptcy, when its auditor issues a disclaimer opinion or when financial statements do not contain a required certification.

Where concerns are raised, Nasdaq will consider remedial measures by the company including the individual’s resignation, divestiture of stock holdings, termination of contractual arrangements or the creation of a voting trust to vote their shares.  Nasdaq will also consider past corporate governance.

Nasdaq may impose restrictions or heightened listing requirements where concerns are raised, but may not allow for exceptions or lower standards to the listing rules. In the event that Nasdaq staff denies initial or continued listing based on such public interest considerations, the company may seek review of that determination through the procedures set forth in the Rule 5800 Series. On consideration of such appeal, a listing qualifications panel comprised of persons independent of Nasdaq may accept, reject or modify the staff’s recommendations by imposing conditions.

The Author

Laura Anthony, Esq.

Founding Partner

Anthony L.G., PLLC

A Corporate Law Firm


Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service.  The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

Ms. Anthony is a member of various professional organizations including the Crowdfunding Professional Association (CfPA), Palm Beach County Bar Association, the Florida Bar Association, the American Bar Association and the ABA committees on Federal Securities Regulations and Private Equity and Venture Capital. She is a supporter of several community charities including siting on the board of directors of the American Red Cross for Palm Beach and Martin Counties, and providing financial support to the Susan Komen Foundation, Opportunity, Inc., New Hope Charities, the Society of the Four Arts, the Norton Museum of Art, Palm Beach County Zoo Society, the Kravis Center for the Performing Arts and several others. She is also a financial and hands-on supporter of Palm Beach Day Academy, one of Palm Beach’s oldest and most respected educational institutions. She currently resides in Palm Beach with her husband and daughter.

Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.

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