Nasdaq's New IPO Rules for Chinese Companies
Understanding Reporting and Compliance Rules for Restricted Markets
The Nasdaq Stock Market (Nasdaq) has notified the Securities and Exchange Commission (SEC) that they are planning to tighten listing standards for companies based in “Restricted Markets,” which are jurisdictions with laws that limit transparency for U.S. securities regulators. While the new rules would apply to all countries with information restrictions, recent corporate governance scandals suggest that China-based companies are likely to be most affected by the new rules.
As one of the largest, and fastest-growing stock exchanges in the world, the Nasdaq is a highly-sought after destination for foreign companies seeking access to U.S. public markets. While there will be more rules dictating eligibility for issuing IPOs on the Nasdaq, it is MGO’s interpretation that these changes are not retributive but are instead designed to simply increase transparency and accountability to protect the investor community.
It is our hope that companies from China, and other affected countries, are not discouraged by these new rules and, in fact, feel emboldened. These new rules give companies bright lines in order to have a successful offering and will eliminate much of the subjectivity around the qualifications to go public. With these guidelines in place, issuances that meet the new Nasdaq requirements are expected to be enthusiastically embraced by an investor community with greater confidence that their money is in safe hands.
In the following we will explore the new rules, what they mean, and steps affected companies considering an IPO should take to prepare.
What are “Restrictive Markets?”
At the center of the Nasdaq’s proposed listing requirement changes is a new definition of “Restrictive Markets,” which defines the regions and companies affected by the new rules. According to the Nasdaq’s public notice to the SEC, Restrictive Markets are 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 is based in a Restrictive Market, Nasdaq will consider the primary location of:
- Principal business segments, operations or assets;
- Board and shareholders’ meetings;
- Headquarters or principal executive offices;
- Senior management and employees; and
- Books and records.
Nasdaq will take a holistic approach to assessing these factors and determining whether a company is based in a Restrictive Market, bearing in mind that a company’s headquarters may not be the office from which it conducts its principal business activities.
This definition (and pursuant rules) would apply to both foreign private issuers based in Restricted Markets and companies based in other jurisdictions that principally administer their businesses in Restricted Markets.
Nasdaq has not officially provided a list of jurisdictions they consider Restrictive Markets.
The details of proposed Nasdaq rules changes
Rule #1: Additional Listing Criteria for Restrictive Market Companies
- For an IPO: A Restrictive Market company must offer a minimum amount of securities totaling at least $25 million; or 25% of the company’s post-market value.
- For a Business Combination: A Restrictive Market company to have a minimum market value of unrestricted publicly held shares following the business combination equal to the lesser of: $25 million; or 25% of the post-business combination entity’s market value of listed securities.
- For a Direct Listing: A Restrictive Market company is only permitted to list on the Nasdaq Global Select Market or Nasdaq Global Market in connection with a Direct Listing.
Reasoning: This rule represents the first time the Nasdaq has created minimum values for an IPO. The Nasdaq justifies the move by commenting that small offerings often do not reflect the true value of the company, and a lack of liquidity can create opportunities for price manipulation, and may make issuances unappealing to institutional investors and the secondary market.
Impact: For over a decade, smaller Chinese companies have pursued IPOs as a liquidity/exit event that provides access to U.S. dollars. The Nasdaq only wants companies genuinely seeking to raise capital and trade shares. Chinese companies only seeking a limited liquidity event will be turned away if they do not meet the float percentage requirements.
Rule #2: “Restricted Market” companies must have senior management or a director with experience with U.S. regulatory and reporting requirements, Nasdaq rules, and federal securities laws. Currently listed companies will have a period to get in compliance, while IPOs must have this member on the leadership team. Compliance will be on-going.
Reasoning: A number of corporate governance issues have created scandals and other disruptions that have cost U.S. investors millions, if not billions, of dollars. By requiring that a member of senior-level management have a qualified understanding of regulatory, reporting and securities laws, Nasdaq intends to ensure there is institutional understanding of applicable rules and requirements.
Impact: Many businesses seeking to go public on the Nasdaq will likely already have a member of leadership with this experience. And if they don’t, rule or not, they certainly should. Nasdaq’s proposed rules allow for an advisory role that meets their standards. This position will be expected to provide on-going guidance related to corporate governance, internal controls, and other securities law concerns.
Rule #3: More stringent criteria for auditors of companies (not only Restrictive Market) applying for IPOs or that are already listed. These criteria include:
- Auditor must be subject to PCAOB inspections.
- Auditor must pass PCAOB inspections, sufficiently respond to inspection requests, and not have significant deficiencies in their conduct or systems of quality controls, as observed by the PCAOB.
- Auditor must be able to demonstrate that it has adequate personnel participating in the audit with expertise applying U.S. GAAP, GAAS or IFRS, as applicable, in the company’s industry.
- Auditor’s training program for personnel participating in a company’s audit is adequate;
- For non-U.S. auditors, whether the auditor is part of a global network or other affiliation providing sufficient, globally common technologies, tools, methodologies, training and quality assurance monitoring.
- Auditor must demonstrate to Nasdaq it has sufficient resources, geographic reach, or experience as it relates to the company’s audit.
Reasoning: Audit quality is at the center of investor confidence in a company and its listed shares on the Nasdaq. Implementing greater controls and expectations for audit providers is a no-nonsense approach to both improving the reliability of listed securities, and improving investor confidence.
Impact: This rules applies to all companies listed on the Nasdaq, and is not specific to Restricted Market entities. The result will simply be greater demand for qualified audit providers that have the expertise, global reach, and sufficient quality controls.
In a year of unprecedented global market disruption caused by external factors, and with the high profile Luckin Coffee accounting scandal rocking investor confidence, Nasdaq’s proposed rule changes are common sense steps toward creating greater transparency and accountability for all listed companies, and especially those originating in countries with laws limiting transparency.
The ultimate goal of these rules and their enforcement is to provide greater stability for both companies and investors. The former must only take the time to carefully consider their path to the IPO and engage qualified auditors and advisors familiar with Nasdaq rules, SEC laws and international reporting requirements.