Drill Down On NASDAQ Audit Committee Requirements

by Laura Anthony, Esq. on December 17, 2019 in Uncategorized

I’ve written several times about Nasdaq listing requirements including the general listing requirements and the significant listing standards changes enacted in August of this year.  This blog will drill down on audit committees which are part of the corporate governance requirements for listed companies.  Nasdaq Rule 5605 delineates the requirements for a Board of Directors and committees.  The Nasdaq rule complies with SEC Rule 10A-3 related to audit committees for companies listed on a national securities exchange.

SEC Rule 10A-3

SEC Rule 10A-3 requires that each national securities exchange have initial listing and ongoing qualification rules requiring each listed company to have an audit committee comprised of independent directors.  Although the Nasdaq rules detail its independence requirements, the SEC rule requires that at a minimum an independent director cannot directly or indirectly accept any consulting, advisory or other compensation or be affiliated with the company or any of its subsidiaries.  The prohibition against compensation does not include a reasonable compensation for serving as a director.

Like the Nasdaq rules, the SEC allows for different independence standards for foreign private issuers (FPI) following their home country rules and even allows for affiliation as long as the person is not an executive officer of the FPI.

The audit committee of each listed company, in its capacity as a committee of the board of directors, must be directly responsible for the appointment, compensation, retention and oversight of the work of any registered public accounting firm engaged for auditing and audit-related services.  Furthermore, the SEC requires that an executive officer of a listed company promptly notify the national exchange if he or she becomes aware of any material non-compliance with the audit committee requirements by that listed company.

Although charter requirements are detailed in the Nasdaq rule, the SEC rule requires that the audit committee establish certaDrill Down On NASDAQ Audit Comin processes and procedures for handling complaints regarding accounting, internal financial controls and auditing matters, including for the confidential submission by employees.  The SEC rule also requires that an audit committee be given the power, authority and funding to engage independent counsel and other advisors to carry out its tasks.  Funding must also be provided to hire audit firms and pay administrative expenses.

The SEC allows for a phase-in for compliance when a company is completing an initial public offering.  In particular, all but one director may be dependent for 90 days following the IPO and a minority of the audit committee may be dependent for one year from effectiveness of the registration statement.  The SEC rule also contains general exemptions from the audit committee requirements including: (i) for consolidated subsidiaries that are listed on another exchange with similar audit committee requirements; (ii) FPI’s that follow home country rules and have a similar committee to an audit committee and satisfy certain additional conditions; and (iii) related to the listing of certain options, futures, asset-backed issuers, investment trusts, a passive trust or foreign governments.  Specific disclosure is required when an exemption is being relied upon including an assessment of whether, and if so, how, such reliance would materially adversely affect the ability of the audit committee to act independently and to satisfy the other requirements of Rule 10A-3.

The SEC rule specifically requires that an exchange must give a listed company the opportunity to cure a defect in the audit committee requirements prior to delisting.  Moreover, the SEC rule provides that if an independent director on the audit committee loses independence as a result of factors outside of their control, that person may remain on the audit committee until the next annual shareholders meeting or one year from the date of the occurrence that caused the board member to no longer be independent.

Nasdaq Rule 5605

Audit Committee Composition

One of the corporate governance related listing requirements is that a company have an audit committee consisting solely of independent directors who also satisfy the requirements of SEC Rule 10A-3 and who can read and understand fundamental financial statements including a balance sheet, income statement and cash flow statement. The audit committee must have at least three members. One member of the audit committee must have employment experience in finance or accounting, an accounting certification or other experience that results in the individual’s financial sophistication.

None of the committee members can have participated in the preparation of the financial statements of the company or any of its current subsidiaries for the prior three years.  An individual will be considered to have participated in the preparation of the company’s financial statements if the individual has played any role in compiling or reviewing those financial statements, including a supervisory role. An interim officer who signed or certified the company’s financial statements will be deemed to have participated in the preparation of the company’s financial statements and, therefore, could not serve on the audit committee for three years.

The eligibility requirements to serve on the audit committee apply to all committee members whether or not such member is afforded non-voting status or other limitations on their participation with the committee.

Nasdaq has a limited exception to the independence requirements where a director meets the independence standards in SEC Rule 10A-3 but not the more detailed requirements of Nasdaq rules, is not currently an executive officer, employee or family member of an executive officer and exceptional circumstances makes the appointment of the person in the best interests of the company and its shareholders.  Specific disclosures are required when relying on this exception including the nature of the relationship that makes the person non-independent and the reasons for the board’s determination.  A committee member appointed under this exception may not serve for more than two years and cannot be chair of the audit committee.  Unlike the implementation of many exceptions to Nasdaq rules (such as for example the 20% rule), the limited exception for audit committee compliance for exceptional circumstances does not require Nasdaq approval.

Audit Committee Charter

Rule 5605(c) requires that each company must certify that it has adopted a formal written committee charter and that the audit committee will review and reassess the charter on an annual basis.  The certification is submitted one time and a copy of the actual charter does not need to be provided to Nasdaq.  However, Item 407(d)(1) of Regulation S-K requires that companies report whether a current copy of its audit committee charter is available on its website and provide the website address.  If the charter is not on the website, companies should include the charter as an appendix to its proxy statement at least once every three years or in any year in which the charter has been materially amended.

The charter must specify: (i) the scope of the audit committee’s responsibilities and how it carries out those responsibilities including structure, processes and membership requirements; (ii) the audit committee’s responsibility to ensure they receive written statements from the outside auditor regarding relationships between the auditor and the company and actively taking steps for ensuring the independence of the auditor; (iii) the committee’s purpose of overseeing the accounting and financial reporting processes of the company and the audits of the financial statements of the company; and (iv) the specific audit committee responsibilities and authority.

Furthermore, the charter must establish procedures for the confidential, anonymous submission by employees of the listed company of concerns regarding questionable accounting or auditing matters.

Audit Committee Responsibilities and Authority

The audit committee is responsible for items delineated in SEC Rule 10A-3 and in particular related to: (i) registered public accounting firms, (ii) complaints relating to accounting, internal accounting controls or auditing matters, (iii) authority to engage advisers, and (iv) funding as determined by the audit committee.

Cure Periods

All non-compliance with audit committee requirements requires prompt notification to Nasdaq.

Consistent with SEC Rule 10A-3, if a member of the audit committee loses independent status for reasons outside the member’s reasonable control, the audit committee member may remain on the audit committee 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. A company relying on this provision must provide notice to Nasdaq immediately upon learning of the event or circumstance that caused the noncompliance.

If noncompliance is a result of dropping below the minimum member requirements (three members), the company will have until the earlier of the next annual shareholders meeting or one year from the occurrence of the event that caused the failure to comply with this requirement – provided, however, that if the annual shareholders meeting occurs no later than 180 days following the event that caused the vacancy, the company shall instead have 180 days from such event to regain compliance. A company relying on this provision must provide notice to Nasdaq immediately upon learning of the event or circumstance that caused the noncompliance.

Exception

If a company has a class of equity securities listed on another exchange with SEC Rule 10A-3 audit committee requirements, they may list securities of a consolidated subsidiary on Nasdaq without having a separate audit committee for that subsidiary.

The Author

Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com

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 sitting 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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