Nasdaq to Chinese Companies: Is $25 Million Too Much to Ask?

Breaking down proposed Nasdaq rules and pending legislation for U.S.-listed Chinese stocks.

Author: Anna Vodopyanova   

On Friday, New York Governor Andrew Cuomo, wearing a mask, rang the opening bell at the New York Stock Exchange. In a sign that Wall Street is moving on from Covid-19 closures, the NYSE reopened its doors for in-person trade while most other stock markets feature online-only trading. Meanwhile, a more significant change than that which the pandemic caused may be coming to U.S. markets: Increased control of foreign companies.

U.S.-listed Chinese companies have long raised regulators' eyebrows. And it's not just that the vast majority of the Asia-based IPOs of 2019 are today trading below their issue price – just this year, four companies were hit with allegations of false disclosures. The biggest of them, Luckin Coffee (Nasdaq: LK), tanked from trading over $50 to under $2 per American depositary share after 2 billion yuan in uncovered fraud. It is now fighting delisting from the Nasdaq.

In April, chairman of the U.S. Securities and Exchange Commission (SEC), Jay Clayton, advised against investing into Chinese companies due to lack of audit. Clayton told Fox Business Network that investing in a Chinese firm and in a domestic issuer "is not the same kind of investing" and involves more risks.

Shortly after, Nasdaq Inc. (Nasdaq: NDAQ) has proposed a minimum IPO value. Under the new policy, foreign companies will be required to raise $25 million at IPO – or, at least a quarter of their post-listing market cap, Reuters reported. That would exclude at least 40 Chinese companies listed since 2000.

Battling ‘Material Misstatements'

The capital market also sought to review the work of auditors working with Chinese firms. In a recent rule filing, the Nasdaq Stock Market proposed "to apply additional and more stringent criteria to an applicant or listed company based on the qualifications of the company's auditor." Specifically, the exchange proposed the Nasdaq to review six factors, whether:

(1) The PCAOB has inspected the auditor; (2) the auditor failed to respond to any requests by the PCAOB or that the inspection revealed "significant deficiencies in the auditors' conduct"; (3) the auditor has expertise in U.S. GAAP, GAAS or IFRS; (4) the auditor's employee training program is "adequate"; (5) for non-U.S. auditors, whether it uses "globally common technologies, tools, methodologies, training and quality assurance monitoring"; and (6) the auditor has sufficient resources and expertise in relation to a company's audit.

In addition, the Nasdaq may consider whether the listed company satisfies certain additional requirements, such as: (1) higher equity, assets, earnings or liquidity measures than required by earlier regulations; (2) that any offering be underwritten on a firm commitment basis; and (3) 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.

Under the new regulations, the Nasdaq may even prevent the company's insiders from selling their shares "if material misstatements are detected by the company's auditors and have not been disclosed to investors."

Lastly, and especially pertaining to Chinese companies, the Nasdaq proposed that it may impose more stringent criteria 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."

U.S. Lawmakers In on the Act

At about the same time, the U.S. Senate unanimously passed the Holding Foreign Companies Accountable Act, sponsored by Louisiana Republican Sen. John Kennedy and co-sponsored by Democratic Sen. Chris Van Hollen of Maryland and Republican Sen. Kevin Cramer of North Dakota. The bill would ban foreign firms that refuse U.S. audits for three consecutive years from trading on both the NYSE and the Nasdaq.

Last week, the House followed with its own version of the Act. Democratic Rep. Brad Sherman of California is looking to increase investor protection and pass a law that would require all foreign firms to disclose whether they have ties to the government and – similar to the Nasdaq proposal – to submit to PCAOB auditing.

The Public Company Accounting Oversight Board (PCAOB) is a nonprofit that reviews the audits of public companies to ensure transparency and increase the protection of investors. It has been doing so with most foreign companies since established by the Sarbanes-Oxley Act of 2002. However, Beijing has taken a stance against that extra review process – in fact, it outright prohibits taking books overseas – and the PCAOB-registered audit firms in mainland China and Hong Kong have circumvented the U.S. oversight.

By 2022, PCAOB's authority may shift to the SEC, according to White House budget cited by The National Law Review in February, to "reduce regulatory ambiguity."

On a positive note, March and April showed a "huge spike" in trading activity in the U.S., said Nasdaq Chief Economist Phil Mackintosh on Nasdaq Trade Talks a week ago. The contributing factors were commission-free trading, stocks going on sale, and fiscal stimulus that is growing close to $4 trillion.

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