Nasdaq has proposed to modify some of its corporate governance rules—specifically Rules 5605, 5615 and 5810—to modify the phase-in schedules for the independent director and committee requirements in connection with IPOs, spin-offs and carve-outs, bankruptcy and other specified circumstances and to clarify the applicability of certain cure periods.

General

Nasdaq proposes to add an introductory paragraph to Rule 5615(b) and to codify its current policy that a company that complies with a requirement during a phase-in period, but subsequently falls out of compliance before the end of the phase-in period, would not be considered deficient with the requirement until the end of the phase-in period.  Nasdaq observes that this treatment is consistent with treatment of a company that relied on a phase-in period throughout its duration.

IPOs

Audit committees. Currently, the Nasdaq rules simply refer to SEC Rule 10A-3(b)(1)(iv)(A) under the Act but don‘t restate the provisions of this rule.  Nasdaq proposes to restate in Rule 5615(b), without substantive change, the provisions allowing a phase-in of compliance with the audit committee independence and professional competence requirements set forth in Rule 5605(c)(2):  (1) one member must satisfy the requirements by the date the company‘s securities first trade on Nasdaq (the “Listing Date”); (2) a majority of members must satisfy the requirements within 90 days of the effective date of the registration statement; and (3) all members must satisfy the requirements within one year of the effective date of the registration statement.  In addition, under Rule 5605(c)(2)(A), a company is required to have at least three members on its audit committee. Because IPO companies are not required to have a fully independent audit committee until one year after the Listing Date, they may appoint non-independent directors to satisfy the three-person minimum. Nasdaq proposes to amend Rule 5615(b)(1) to provide a phase-in for a company listing in connection with its IPO: it must have at least one member on its audit committee by the Listing Date, two members within 90 days of the Listing Date and three members within one year of the Listing Date.  Nasdaq states that this proposal is consistent with the approach of the NYSE.

Nominations and compensation committees. Currently, under Rule 5615(b)(1), IPO companies are required to have one member on their independent nominations and compensation committees at the Listing Date but can otherwise phase-in the requirements. According to Nasdaq, some companies complained that this requirement was not consistent with a common practice to hold a board meeting to appoint additional independent directors shortly after the Listing Date, but prior to the closing of the IPO.  To accommodate this practice, Nasdaq proposes to amend Rule 5615(b)(1) to require companies to appoint one independent director on each of the comp and nominations committees no later than the earlier of the date the IPO closes or five business days from the Listing Date.  Nasdaq states that this proposal is consistent with the approach of the NYSE.  With regard to the requirement to have at least two members on the comp committee, IPO companies must have at least one member by the Listing Date and two members within one year of the Listing Date.

Nasdaq is also proposing to correct an erroneous reference in Rule 5615(b)(1), which allows a company, instead of creating a nominating committee, to rely on a majority of the independent directors to discharge the responsibilities of the nominating committee under Rule 5605(b). Oops, the responsibilities of the nominating committee are found in Rule 5605(e), not Rule 5605(b). So that reference is proposed to be fixed in new Rule 5615(b)(1)(C).

Companies Listing in Connection with a Carve-out or Spin-off Transaction

As with current policy, Nasdaq proposes to provide phase-ins for companies listing as a consequence of  carve-outs or spin-offs similar to those provided for IPOs.  For example, Nasdaq proposes to require similar phase-ins for spin-offs and carve-outs as provided for IPO companies for the majority independent board requirement set forth in Rule 5605(b) (i.e., 12 months from the date the Listing Date) to comply with the majority independent board requirement. Nasdaq also proposes to adopt Rule 5615(b)(4) to provide a phase-in period with regard to audit committee independence and professional competence requirements set forth in Rule 5605(c)(2) like the phase-in periods for IPO companies. The phase-in for the number of members on the audit committee under Rule 5605(c)(2)(A) would also be comparable to the phase-in for IPO companies.

For the nominations and comp committee requirements set forth in Rules 5605(d)(2) and (e)(1)(B), Nasdaq proposes to require companies listing as a consequence of carve-outs or spin-offs to have one independent director by the date the transaction closes, a majority of independent directors within 90 days of the Listing Date, and a fully independent committee within one year of the Listing Date.  Nasdaq reports that this proposal is consistent with the approach of the NYSE. Regarding the requirement to have at least two members on the comp committee set forth in Rule 5605(d)(2)(A), as proposed, companies must have at least one member on their comp committees by the date the transaction closes and at least two members within one year of the Listing Date.

Companies Emerging from Bankruptcy

Nasdaq proposes to amend Rule 5615(b)(2) to codify its current position that a company emerging from bankruptcy must comply with the audit committee composition requirements (three members with independence and professional competence) in Rule 5605(c)(2) by the Listing Date unless an exemption is available under Rule 10A-3. 

Companies Transferring from Other National Securities Exchanges; Listing Securities Previously Registered under Section 12(g)

Nasdaq proposes to differentiate between companies transferring from other exchanges with securities registered under Section 12(b) versus Section 12(g). For companies with securities registered under Section 12(b), where the original exchange had requirements substantially similar to those in Rule 5605, the company will be allowed the balance of any grace period afforded by the other exchange. Where the original exchange does not have substantially similar requirements, the transferring company will be allowed one year from the date of listing on Nasdaq to comply with those requirements. Nasdaq states that this transition period is not intended to supplant any applicable requirements of Rule 10A-3 under the Act.  

A company with securities registered under Section 12(g) will be permitted to phase in as follows: as with an IPO company, a transferring company will have 12 months from its Listing Date to comply with the majority independent board requirement set forth in Rule 5605(b).  However, the company will be required to satisfy the audit committee requirements set forth in Rule 5605(c) by the Listing Date, unless an exemption is available under Rule 10A-3 under the Act, except that, with respect to the requirement to have at least three members on the audit committee, the company can comply with a phase-in like that for IPO companies.  In addition, with respect to the independent comp and nominations committee composition requirements set forth in Rules 5605(d)(2) and (e)(1)(B), Nasdaq proposes to adopt rules similar to those applicable to spin-offs: one independent member by the Listing Date, a majority within 90 days of the Listing Date and all members within one year of the Listing Date.  Regarding the requirement to have two members on the comp committee set forth in Rule 5605(d)(2)(A), the company must have at least one member on its comp committee by the Listing Date and at least two members within one year of the Listing Date.

Companies Ceasing to Qualify as Foreign Private Issuers

Under Rule 5615(a)(3),  a Foreign Private Issuer may follow its home country practice in lieu of most Nasdaq rules, but must comply with certain of the rules, including some relating to audit committees. An FPI that ceases to qualify as an FPI becomes subject to all relevant corporate governance requirements of Rule 5605. Under Rule 3b-4 under the Act, a company must test its FPI status annually. Nasdaq proposes to require a company that ceases to be an FPI to be in compliance with the domestic company requirements by the first day of the fiscal year following the determination date (i.e., six months from the determination date), except for the independence requirement.  During the phase-in period, the company must have an audit committee that satisfies Rule 5605(c)(3) and members of the audit committee that meet the independence criteria in Rule 5605(c)(2)(A)(ii). Nasdaq advises that this proposal is consistent with the approach of the NYSE.

Companies Ceasing to be Controlled Companies

A company that ceases to be a Controlled Company may phase in its independent nominations and comp committees and majority independent board on the same schedule as IPO companies.  Nasdaq proposes to amend Rule 5615(c)(3) to clarify that the applicable phase-in periods will be calculated beginning on the date the company ceases to be a Controlled Company.

Unavailability of Grace Periods Following the Expiration of Phase-in Periods

Nasdaq proposes to amend Rules 5605(b)(1), 5605(c)(4), 5605(d)(4) and 5810(c)(3)(E) to codify its current position that, if a company complied with the audit or comp committee composition or majority independent board requirements during a phase-in period but fell out of compliance before the end of the phase-in period, the company can be eligible for a cure period provided by Rule 5810(c)(3)(E). Otherwise, a company relying on any phase-in period in Rule 5615(b) is not eligible for a cure period immediately following the expiration of the phase-in period;  Nasdaq believes it would be inappropriate because it would, in effect, be like extending the phase-in period.  In that case, Nasdaq would issue a Staff Delisting Determination letter to delist the Company’s securities.

Nasdaq also proposes to codify its current policy that, for a company coming into and falling out of compliance during the phase-in period, “for purposes of computing the applicable cure period, the event that caused the failure to comply is the event causing the company to fall out of compliance after having complied with the requirement, and not the end of the phase-in period. In these circumstances, as described above, the company would not be considered deficient with the requirement until the end of the phase-in period.”

Nasdaq also proposes to amend Rule 5810(c)(3)(E) to describe procedures for a cure period in the event a company fails to comply with the comp committee composition requirement under Rule 5605(d)(2)(A) as a result of a vacancy.  Under the proposed amendment, if a company fails to meet the comp committee composition requirement due to one vacancy, or a comp committee member ceases to be independent due to circumstances beyond the member’s reasonable control, the Listing Qualifications Department will promptly notify the company that it has until the earlier of its next annual shareholders’ meeting or one year from the occurrence of the event that caused the failure to comply with this requirement to cure the deficiency. However, if the company’s next annual shareholders’ meeting is held sooner than 180 days after the event that caused the deficiency, then the cure period shrinks to 180 days from the event that caused the deficiency.

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