Understanding the Corporate Governance Requirements for NASDAQ Listing

Some may perceive that listing on NASDAQ requires higher standards of corporate governance than listing on Japanese stock markets. However, the conclusion is that it cannot be said that NASDAQ’s governance requirements are more stringent. This article will explain the corporate governance requirements of NASDAQ listing criteria, specifically with Japanese companies in mind as they consider listing on NASDAQ.

As will be discussed later, when Japanese companies list on NASDAQ, they are generally subject to the “special provisions for foreign companies listing in the United States.” Therefore, the corporate governance requirements for Japanese companies listing on NASDAQ differ from those for American companies, which is a crucial point to understand.

NASDAQ Listing Standards and Corporate Governance Requirements

The NASDAQ listing standards are published as the “Rulebook – The Nasdaq Stock Market”.

Reference: Rules | The Nasdaq Stock Market

The NASDAQ market is divided into three tiers, with the listing standards becoming progressively more stringent in the following order: “Global Select Market,” “Global Market,” and “Capital Market.” Many Japanese companies are listed on the Capital Market, which has the most lenient listing standards.

Assuming a company aims to list on the NASDAQ Capital Market, the requirements to be met fall broadly into two categories:

• “Quantitative listing requirements” from Rule 5100, 5200, and 5500 Series (referenced by Rule 5005(a)(28) for listing on the Capital Market)
• “Corporate governance requirements” from Rule 5600 Series (referenced by Rule 5001 for all companies)

This article will explain the latter, the corporate governance requirements.

Additionally, it should be noted that for markets other than the Capital Market, the 5300 Series applies to the Global Select Market, and the 5400 Series applies to the Global Market.

Japanese Companies and ‘Foreign Private Issuers’

In general, Japanese companies are listed on NASDAQ as Foreign Private Issuers (FPIs), which are defined by Rule 3b-4 of the Securities Exchange Act of 1934 (1934).

A Foreign Private Issuer is a foreign issuer, other than a foreign government, that does not meet any of the following conditions as of the last business day of its most recently completed second fiscal quarter:
(1) More than 50% of the issuer’s outstanding voting securities are directly or indirectly owned by residents of the United States
(2) Any of the following apply:
(i) The majority of the executive officers or directors are U.S. nationals or residents
(ii) More than 50% of the issuer’s assets are located in the United States
(iii) The issuer’s business is administered principally in the United States

Securities Exchange Act of 1934 Rule 3b-4 / Interpretation by our firm

To put it simply, a Foreign Private Issuer is a company whose shareholders, officers, assets, and business operations are primarily centered in Japan (or outside the United States).

The above is the definition of a Foreign Private Issuer according to the Securities Exchange Act of 1934, but it is also synonymous with the NASDAQ listing standards in Rules 5005(19) and 5005(1).

Regulatory Framework for Foreign Private Issuers

Rule 5615(a)(3) applies to foreign private issuers, allowing for the following provisions:

• Foreign private issuers may follow their home country practices instead of the requirements of the Rule 5600 series, the director compensation disclosure requirements of Rule 5250(b)(3), and the annual and interim reporting distribution requirements of Rule 5250(d).
• However, they must comply with the notification requirements for compliance violations (Rule 5625), voting rights requirements (Rule 5640), board diversity requirements (Rule 5605(f)), and disclosure rules regarding board diversity (Rule 5606). Additionally, they must establish an audit committee that meets the requirements of Rule 5605(c)(3), and the members of this audit committee must satisfy the independence requirements of Rule 5605(c)(2)(A)(ii).
• Except as provided in this section, foreign private issuers must conform to the requirements of the Rule 5000 series.

As a result of these provisions, foreign private issuers are subject to the following disciplines:

• For the matters specified in Rules 5250(b)(3) and 5250(d) of the 5200 series, they may follow their home country practices instead.
• For the 5600 series, in principle, they may follow their home country practices instead.
• Exceptionally, for Rules 5625, 5640, 5605(f), 5606, 5605(c)(3), and 5605(c)(2)(A)(ii), they must apply the NASDAQ listing standards.

As a consequence, Japanese companies listed on NASDAQ are generally exempt from the majority of NASDAQ’s corporate governance requirements. For instance, while NASDAQ generally requires the establishment of a compensation committee, Japanese companies may instead follow their own country’s practices. This has become the ‘standard’ approach for Japanese companies listed on NASDAQ, allowing their boards to assume the same functions.

Corporate Governance Requirements Applicable to Foreign Private Issuers

Foreign private issuers that cannot “instead comply with their own country’s practices” must adhere to the following NASDAQ listing standards requirements:

• Rule 5625 (Notification of Non-compliance): A company must promptly notify NASDAQ if it becomes aware of any non-compliance with the Rule 5600 Series. However, this should be categorized more as a post-listing compliance matter rather than a “listing requirement”.
• Rule 5640 (Voting Rights): Shareholders’ voting rights must not be unfairly reduced or restricted by corporate actions or issuances. Examples of such corporate actions or issuances include the adoption of staggered voting plans, capped voting rights, the issuance of multiple voting shares, or the issuance of shares with fewer voting rights per share than the existing common shares through an exchange offer, but are not limited to these.
• Rule 5605(f) (Board Diversity): The board must include a certain number of directors who self-identify as diverse (belonging to at least one of the categories of women, minorities, LGBTQ+)—at least one director if there are five or fewer directors, and at least two if there are six or more—or provide an explanation if it does not.
• Rule 5606 (Disclosure of Board Diversity): There is a requirement to disclose information about the diversity of the board of directors.
• Rule 5605(c)(2)(A)(ⅱ) (Audit Committee Composition): An audit committee must be established, consisting of at least three members who meet the “independence” requirements set forth in Section 10A-3(b)(1) of the Securities Exchange Act of 1934.
• Rule 5605(c)(3) (Audit Committee Responsibilities and Powers): The audit committee must have the powers specified in Sections 10A-3(b)(2)(3)(4)(5) of the Securities Exchange Act of 1934. For investment companies, anonymous reporting is also a requirement.

Composition of Audit Committees in NASDAQ-Listed Companies

As indicated above, a distinctive feature of NASDAQ-listed companies is the necessity to establish an “Audit Committee.” However, the Japanese Board of Corporate Auditors or Audit & Supervisory Committees typically meet the requirements set forth by the Securities Exchange Act of 1934. Therefore, establishing a Board of Corporate Auditors or an Audit & Supervisory Committee under Japanese law and designating it as the Audit Committee for NASDAQ listing has become the ‘standard’ approach for Japanese companies seeking to list on NASDAQ.

To elaborate, the structure is as follows:

Under Japanese law, the establishment of a Board of Corporate Auditors or Audit & Supervisory Committees is not always mandatory. There is an option not to appoint any corporate auditors or to appoint only one and not establish a Board of Corporate Auditors. However, for public companies and large corporations (companies meeting certain criteria such as having a capital of over 500 million yen), the establishment is mandatory. Normally, when raising funds through a NASDAQ listing, the capital will exceed 500 million yen, and even if it does not, setting up a Board of Corporate Auditors is still advisable for companies of a certain size.

While this article will not delve into the detailed requirements of the Board of Corporate Auditors or Audit & Supervisory Committees under Japanese law, both must consist of three or more members, with the majority being external members.

Thus, establishing a Board of Corporate Auditors or an Audit & Supervisory Committee that meets these conditions and designating it as the Audit Committee for NASDAQ listing is the ‘standard’ method mentioned above.

Responsibilities and Authorities of the Audit Committee Under Japanese Law

The responsibilities and authorities that an audit committee should possess are defined in the Securities Exchange Act of 1934 (1934) as follows:

(Omitted)
(2) Responsibility regarding registered public accounting firms: As a committee of the board of directors, the audit committee must directly assume responsibility for the appointment, compensation, continued employment, and oversight of the work of any registered public accounting firm employed for the purpose of preparing or issuing an audit report or performing other audit, review, or attest services for the issuer, including resolution of disagreements between management and the auditor regarding financial reporting. Each registered public accounting firm must report directly to the audit committee.
(3) Complaints: Each audit committee must establish procedures for:
(i) The receipt, retention, and treatment of complaints received by the issuer regarding accounting, internal accounting controls, or auditing matters
(ii) The confidential, anonymous submission by employees of the issuer of concerns regarding questionable accounting or auditing matters
(4) Authority to engage advisors: The audit committee must have the authority to engage independent legal counsel and other advisors as it determines necessary to carry out its duties.
(5) Funding: The issuer must provide for appropriate funding, as determined by the audit committee, for payment of:
(i) Compensation to any registered public accounting firm employed for the purpose of preparing or issuing an audit report or performing other audit, review, or attest services for the issuer
(ii) Compensation to any advisors employed by the audit committee pursuant to paragraph (b)(4) of this section
(iii) Ordinary administrative expenses of the audit committee that are necessary or appropriate in carrying out its duties

Securities Exchange Act of 1934 Rule 10A-3(b) / Interpretation by our firm

In this regard, there are elements not required by the Japanese Companies Act for audit boards or audit and supervisory committees, thus necessitating the establishment of new systems for NASDAQ listing in Japan.

Compliance with Japanese Law and Corporate Governance

Under Rule 5615-3, foreign private issuers that opt to follow their home country practices instead of the requirements of Rule 5600.5250(b)(3) or 5250(d) must submit a written statement from an independent attorney in their home country to NASDAQ, certifying that their practices are not prohibited by the laws of their home country. In other words, compliance with Japanese law is required.

However, the key point here is that the compliance required is specifically with Japanese law, not with the so-called soft law, such as listing standards, established by securities exchanges within Japan. For instance, the establishment of a compliance manual is not legally mandated by Japanese law, so it is not “necessary” for listing on NASDAQ.

Nevertheless, for example, the creation of affiliate management regulations to control related-party transactions is often desirable in practice. This is because NASDAQ and auditors conduct stringent reviews of related-party transactions from the perspective of preventing conflicts of interest and protecting shareholder interests. Due to these detailed discussions, the extent of governance to be implemented should be considered by each company on a case-by-case basis.

Corporate Governance Japanese Companies Should Achieve

From the above, we can summarize the governance required for Japanese companies listed on NASDAQ as follows:

• Even when listed as a foreign private issuer, compliance with certain NASDAQ listing standards is necessary.
• In particular, understanding the detailed NASDAQ listing standards for the responsibilities and powers of the audit committee is essential, as these differ from the requirements for listing in the Japanese market.
• For other aspects, adhering to Japanese laws and regulations is sufficient.

Therefore, in terms of “requirements,” the level of corporate governance demanded from Japanese companies at the time of NASDAQ listing is not particularly high. However, there remains the issue of whether a company with inadequate corporate governance can achieve a fair stock price. For instance, it can be said that having a compliance manual, as mentioned above, is desirable to ensure proper governance, internal control, and risk management.

Guidance on Measures by Our Firm

Monolith Law Office is a law firm with high expertise in both IT, particularly the internet, and legal matters. With experience and a proven track record in venture law, Monolith Law Office operates as a law firm that collaborates with an international network, providing comprehensive support for Japanese companies aiming to list on NASDAQ. For more information on NASDAQ listing support, please refer to the article below.

Areas of practice at Monolith Law Office: NASDAQ Listing Support