In December 2005, the SEC granted Nasdaq the right to issue public letters of reprimand to listed companies for relatively minor violations of certain Nasdaq rules where delisting would be too harsh. In a recent Form 8-K, Paula Financial announced the receipt of the first letter of reprimand.
As the result of the resignation of two independent directors in September 2005, Paula did not comply with Nasdaq’s corporate governance standards requiring (1) a majority of the Board to be independent and (2) the audit committee to be comprised of at least three independent directors. Although the company disclosed the resignations in its September 30, 2005 Form 10-QSB and was eligible for a cure period, it failed to notify Nasdaq of the resignations and the resulting non-compliance, as required by Nasdaq’s rules. In addition, the company’s compensation committee and nominating committee included members who were not independent, and the nominating committee failed to adopt a formal charter, in violation of Nasdaq’s rules. As a result of these violations, the company’s corporate governance certification form was inaccurate The company took prompt action to regain compliance after it was advised of the violations of Nasdaq’s rules, and established a disclosure committee to ensure future compliance with all regulatory requirements.
Nasdaq determined that delisting was not an appropriate sanction, noting that:
- the company had not demonstrated a pattern of non-compliance;
- the company cured each deficiency promptly after it received notice from Nasdaq;
- the company inadvertently violated Nasdaq’s rules and not as the result of a deliberate intent to avoid compliance;
- during the period of non-compliance with the rules regarding the composition of the compensation committee and the nominating committee, (1) no executive compensation matters came before the compensation committee, and (2) all director nominations were made either by a Board comprised of a majority of independent directors or only by the independent directors; and
- the company had taken proactive steps to ensure future compliance.
Review Compliance Procedures
Prior to the addition of the public reprimand letter to its enforcement arsenal, Nasdaq had only the delisting procedure and the deficiency letter on which to rely. The addition of the reprimand letter may signal that Nasdaq intends to more strictly police compliance with its listing requirements. Listed companies should review their procedures for ensuring compliance to avoid the embarrassment of receiving a public letter of reprimand.
Letter of Reprimand
Nasdaq Rule 4801(k)(2) provides that Nasdaq may issue a "public reprimand letter in a case where the Listing Department has determined that the issuer has violated a Nasdaq corporate governance or notification listing standard (other than one required by Rule 10A-3 of the Securities Exchange Act of 1934) and that delisting is not the appropriate sanction."
For a copy of the SEC release approving Nasdaq’s request for the right to issue reprimand letters, including Nasdaq’s statement of the terms and purpose of the proposed right, click here.
The New York Stock Exchange also has the power to issue letters of reprimand for violations of certain listing standards.
In determining whether to issue a public reprimand letter, Nasdaq has announced that it will consider the following factors:
- whether the violation was inadvertent;
- whether the violation materially adversely affected shareholders’ interests;
- whether the violation has been cured;
- whether the issuer reasonably relied on an independent advisor; and
- whether the issuer has demonstrated a pattern of violations.
Nasdaq also has provided the following examples of circumstances in which it could determine to issue a public reprimand letter:
- a company engaged in a pattern of failing to provide to Nasdaq advance notice of press releases;
- a company with a December 31 fiscal year end had not held an annual meeting for the prior year as of January, but had filed a proxy statement to hold the meeting in the next few weeks; and
- an independent director resigned and was replaced by another independent director, but the company did not provide prior notice to Nasdaq.
A company that receives a reprimand letter must publicly disclose through the news media the receipt of the letter and the Nasdaq rules upon which it is based within four business days. A copy of the announcement must be provided to Nasdaq before its release. The company must ensure that the full text of the announcement is publicly disseminated; it is not sufficient that the news service publishes only the headline or does not publish the full text. In addition, Item 3.01 of Form 8-K requires disclosure of receipt of the letter within four business days.
Paula posted its letter of reprimand on its corporate website, but did not file the letter as an exhibit to its Form 8 K. Neither posting the letter on the website, nor filing the letter as an exhibit to the Form 8 K, is required.
The company may appeal Nasdaq’s determination to issue a reprimand letter either by an oral hearing or a hearing based solely on written submissions. For a description of the hearing process, click here.
For further information, please contact Peter M. Menard at (213) 617-5483.