Nasdaq makes it more difficult for companies based in “restrictive markets” to list

The U.S. Securities and Exchange Commission (the “SEC”) has approved the Nasdaq Stock Market’s (“Nasdaq”) revised proposal to impose further listing conditions on companies principally administered in jurisdictions, such as China, that do not provide the U.S. Public Company Accounting Oversight Board (“PCAOB”) with access to conduct inspections of public accounting firms that audit Nasdaq-listed companies (a “Restrictive Market”). 

For a company that chooses to list on Nasdaq through a traditional IPO or a merger with a special purpose acquisition company (“SPAC”), the additional condition is a minimum amount or market value of securities in public hands. For a company that lists through a direct listing, Nasdaq will only allow listing on the Nasdaq Global Select Market or Nasdaq Global Market, and not the Nasdaq Capital Market. 

Background

Companies that are public in the United States are required to file audited financial statements with the SEC. Under the Sarbanes-Oxley Act of 2002, the auditor of the financial statements filed with the SEC must be registered with the PCAOB, which means that the audit firm is subject to regular PCAOB inspections to assess the auditor’s compliance with applicable U.S. laws and professional standards in connection with its audits of public companies. Auditing firms that are based in China – including the local affiliates of the “Big Four” accounting firms – have to date refused to allow PCAOB inspections. The China-based auditors maintain that the production of audit papers would violate Chinese law, potentially as a disclosure of state secrets. The SEC and PCAOB have made accommodations for this situation, to enable listings of China-based issuers, under a 2013 Memorandum of Understanding with Chinese securities regulators. However, PCAOB access to the work papers of China-based auditors has remained restricted.

In 2020, the U.S. Congress adopted legislation, known as the Holding Foreign Companies Accountable Act (the “HFCA Act”), which requires the SEC to prohibit from trading, on a U.S. securities exchange or “over-the-counter,” the securities of SEC-reporting issuers whose financial statements have not been audited, for three consecutive years, by accounting firms subject to PCAOB inspection. It also requires non-U.S. issuers that use accounting firms not subject to PCAOB inspection to disclose ownership and control by non-U.S. governmental entities, and to identify Chinese Communist Party officials on their boards of directors.

Earlier this year, the SEC took its first step towards implementing the HFCA Act by adopting an interim final rule that will require certain SEC-reporting companies – mainly those based in China – to make specific disclosures regarding government control and influence over these companies. However, the SEC has not yet identified the affected issuers and not acted on the HFCA Act provisions that would require trading prohibitions on the securities of these companies.

Nasdaq’s revised amendments

Nasdaq is concerned that the lack of transparency in Restrictive Markets compromises the accuracy of disclosures, accountability, and access to information, which is compounded when a “Restrictive Market Company” lists with a small offering size or a low public float percentage because they 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. 

Consequently, the new listing conditions with respect to listings through IPOs and SPAC mergers focus on a minimum amount or market value of publicly held securities. The new restrictions include: 

• Listing by IPO – New Nasdaq Rule 5210(k)(i) will require a Restrictive Market Company listing its primary equity securities on Nasdaq in connection with its IPO to offer a minimum amount of securities in a firm commitment offering in the United States 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. Public holders include both beneficial holders and holders of record, but do not include any holder who is, either directly or indirectly, an executive officer, director, or the beneficial holder of more than 10% of the total shares outstanding. A Restrictive Market Company listing on the Nasdaq in connection with an IPO that is subject to the new rule would also need to comply with all other applicable listing requirements.
• Listing by SPAC merger – New Nasdaq Rule 5210(k)(ii) will require a company that is conducting a business combination with a Restrictive Market Company to have a minimum market value of unrestricted publicly held shares following the business combination equal to the lesser of (i) $25 million or (ii) 25% of the post-business combination entity’s market value of listed securities. Unrestricted publicly held shares are publicly held shares (i.e. not held directly or indirectly by an officer, director or any person who is the beneficial owner of more than 10% of the total shares outstanding) that are not restricted securities. A Restrictive Market Company subject to the proposed rule would also need to comply with all other applicable listing requirements.

Under the new rules, a Restrictive Market Company may not list on the Nasdaq Capital Market (which has easier listing requirements than the other Nasdaq markets) in connection with a direct listing, but may list on the Nasdaq Global Select Market or Nasdaq Global Market, provided that it meets all applicable initial listing requirements for those markets.

Earlier versions of Nasdaq’s proposals would have required Restrictive Market Companies to certify that they had a member of senior management or a director with relevant employment experience at a U.S.-listed public company. Nasdaq was also considering imposing additional conditions on Restrictive Market Company listings such as higher equity, assets, earnings or liquidity measures; any offering to be underwritten on a firm commitment basis; and the imposition of lock-up restrictions on officers and directors. “Restrictive Markets" had also previously been defined more broadly to include jurisdictions with secrecy laws, blocking statutes, national security laws, or other laws or regulations restricting access to information by regulators of U.S.-listed companies in these jurisdictions. 

What is a Restrictive Market Company? 

Nasdaq will consider a company’s business to be principally administered in a Restrictive Market if: (i) the company’s books and records are located in that jurisdiction; (ii) at least 50% of the company’s assets are located in such jurisdiction; or (iii) at least 50% of the company’s revenues are derived from such jurisdiction.

If Company X’s books and records are located in Country Y (not a Restrictive Market), while 90% of its revenues are driven from operations in Country Z (a Restrictive Market), Nasdaq would consider Company X’s business to be principally administered in Country Z, so Company X would be considered a Restrictive Market Company. 

If Company A’s books and records are located in Country B (a Restrictive Market), but 90% of its revenues are derived from Country C (not a Restrictive Market, Nasdaq would consider Company A’s business to be principally administered in Country B, so Company A would be considered a Restrictive Market Company. 

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We will continue to monitor developments in this area and welcome any queries you may have about the new Nasdaq rules, the HFCA Act and your listing options.