Foreign Private Issuer Exemptions: NASDAQ Rule 5615(a)(3) - China

This post is the second part of a three part series exploring NASDAQ's rules regarding foreign private issuer exemptions.  In this post, we look at China.

The country with the largest amount of foreign securities listed on NASDAQ is China.  Please note of the securities used for sampling, all were incorporated in the Cayman Islands or British Virgin Islands and followed home country practices of the incorporating country.  An increasing number of Chinese companies are choosing to incorporate in the Caribbean due to more favorable tax considerations and faster incorporation times. The most common rules that Chinese companies elect to follow home country practices for are:

• 5620(a) – Annual Shareholder Meetings
• 5605 Series – Board Composition
• 5635(c) – Shareholder approval for equity incentive plans

NASDAQ Rule 5620(a) requires issuers of stock to hold an annual shareholder meeting no later than one year after the company’s fiscal year end. The laws in the Cayman Islands and the British Virgin Islands do not require companies to hold annual shareholder meetings.  Looking specifically at AMCN, the company did not hold a shareholder meeting in 2008 but may hold annual meetings in the event that shareholder approval is required. APWR and LTON followed suit and did not hold annual meetings for their prior fiscal year ends.

By opting out of the required NASDAQ annual shareholder meeting under Cayman Island law, these companies save on expenses associated with hosting a shareholder meeting.  On the contrary, forgoing an annual meeting could result in less shareholder involvement and awareness. 

The NASDAQ Rule Series 5605 sets the standard for board and committee composition.  Rule 5605(b)(1) calls for the majority of an issuer’s board of directors to be independent.  Independent directors, as defined in Rule 5605(a)(2) do not have a relationship with the company that would create a conflict of interest.  The Cayman Islands does not have a rule governing composition of boards and committees.  For example, only three of the seven directors sitting on CEDU’s board are considered independent. 

Under 5605(c) the audit committee should include at least three independent members.  LTON’s auditing committee was only comprised of two members for 2008 and is currently one independent director. 

NASDAQ Rule 5605(e)(1)(A-B) states that nominees for a director position within the board must be selected by either a vote of independent directors only or by a nomination committee made up of independent directors.  Since there is no applicable law in the Cayman Islands, several companies have deviated from this rule.  For instance, LTON’s nomination committee currently has two non-independent members.  While non-independent directors may have better knowledge of the company and its operations, this exemption could create a conflict of interest.  Under Cayman Island law, it is possible to have a non-independent director serve on both the auditing and nomination committees. 

According to Rule 5635(c), shareholder approval is required for new issuances or amendments to equity compensation plans.  Under Cayman Island law, issuing companies do not have to seek shareholder approval for amendments to equity compensation plans. For example, AMCN followed home country practice with regards to Rule 5635(c) and allowed its board to re-price stock options without seeking shareholder approval. 

Since shareholder approval is not required, companies following home country practice can approve and implement equity based incentive plans more efficiently.  Conversely, the shareholders do not have a voice presenting the opportunity for the board to approve and implement questionable incentive packages.  The reasoning behind the NASDAQ rule is to provide checks and balances for equity incentive packages.  Getting rid of shareholder approval for equity incentive plans, although more efficient, does not follow that rationale.