Securities Regulation: Actions Taken to Improve Nasdaq Listing Procedures
(Letter Report, 04/26/99, GAO/GGD-99-53).
This report follows up on whether the Securities and Exchange Commission
(SEC) and the Nasdaq Stock Market have implemented GAO's earlier
recommendations for improving the oversight and operations of Nasdaq's
Listing Qualifications Department. (See GAO/GGD-98-45, Feb. 1998.) GAO
also includes information on the status of Nasdaq's response to
recommendations SEC made as part of its oversight of the Listing
Qualifications Department and information on the status of Nasdaq's new
automated Risk Scoring Compliance System.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: GGD-99-53
TITLE: Securities Regulation: Actions Taken to Improve Nasdaq
Listing Procedures
DATE: 04/26/99
SUBJECT: Management information systems
Securities regulation
Stock exchanges
Brokerage industry
Self-regulatory organizations
Performance measures
Stocks (securities)
Securities fraud
Financial analysis
IDENTIFIER: SEC Electronic Data Gathering, Analysis, and Retrieval
System
Nasdaq Risk Scoring Compliance System
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SECURITIES REGULATION Actions Taken toImprove Nasdaq Listing
Procedures
United States General Accounting OfficeGAO Report to the Ranking
Minority Member Committee on CommerceHouse of Representatives
April 1999
GAO/GGD-99-53
United StatesGeneral Accounting Office Washington, D.C. 20548
General Government Division B-281373
Page 1 GAO/GGD-99-53 Oversight of Listing Procedures
GAO
April 26, 1999 The Honorable John D. DingellRanking Minority
Member Committee on CommerceHouse of Representatives
Dear Mr. Dingell: This report responds to your request that we
determine whether theSecurities and Exchange Commission (SEC) and
Nasdaq Stock Market, Inc. (Nasdaq) have implemented the
recommendations in our report,Securities Regulation: Oversight of
SRO's Listing Procedures Could Be Improved (GAO/GGD-98-45, Feb. 6,
1998). We made our recommendationsto improve the oversight and
operations of Nasdaq's Listing Qualifications Department (NLQ). As
also requested, we include information on thestatus of Nasdaq's
response to recommendations SEC made as part of its oversight of
NLQ and information on the status of Nasdaq's newautomated Risk
Scoring Compliance System (RSCS).
SEC and Nasdaq have implemented our report's two
recommendations.First, SEC's Office of Compliance Inspections and
Examinations (OCIE) developed and issued its first report to SEC
Commissioners on significant,open recommendations resulting from
OCIE inspections. OCIE's report included not only recommendations
involving listings programs, but alsothose from OCIE inspections
of various other self-regulatory organization (SRO) regulatory
programs.1 Bringing open, significant inspectionrecommendations to
the attention of SEC Commissioners, and letting the SROs know that
this is being done, provides additional incentive for SROsto
comply with OCIE recommendations. Second, NLQ has started
preparing quarterly reports to Nasdaq's management that
providestatistical measures of the listing program's results. The
report contains information pertaining to three primary NLQ
activities, including(1) exception granting and administration,
(2) application review, and (3) compliance monitoring. Routinely
reporting these overall programstatistics to Nasdaq management
should help to keep officials informed
1National securities exchanges and registered securities
associations, along with registered clearing
agencies and the Municipal Securities Rulemaking Board, are
collectively termed SROs under Section3(a)(26) of the Securities
Exchange Act of 1934.
Results in Brief
B-281373
Page 2 GAO/GGD-99-53 Oversight of Listing Procedures about whether
the listings program is achieving results appropriate toprogram
goals. Nasdaq and SEC officials said that Nasdaq has addressed all
27 of therecommendations resulting from OCIE's 1997 inspection of
NLQ. SEC officials told us that they would follow up on three of
theserecommendations during the next OCIE inspection of Nasdaq to
ensure that the actions taken have been effective. For example,
SECrecommended that to remain listed on Nasdaq, companies
receiving "going concern" audit opinions must submit business
plans that demonstrate theirability to continue in business.
2 Nasdaq reported that it would require such
companies to submit business plans. Nasdaq officials said they
used thesebusiness plans to focus the companies' attention on
issues raised by the
going concern opinions and compliance with listing
requirements.However, Nasdaq officials reported that OCIE
recognizes that Nasdaq would refrain from making subjective
determinations regarding thepotential success of the business
plans while the companies are still in compliance with listing
requirements. Nasdaq officials told us that they have made
substantial progress in theirdevelopment of RSCS. They said that
they expect RSCS to be implemented into Nasdaq's compliance
monitoring program some time during mid-1999.They said that RSCS
is to help NLQ analysts more quickly detect problem companies that
are falling out of compliance with Nasdaq listingrequirements.
Nasdaq is the subsidiary of the National Association of Securities
Dealers(NASD) that is responsible for developing, operating, and
maintaining systems, services, and products for the Nasdaq over-
the-counter securitiesmarket. It is also responsible for
formulating regulatory policies and listing requirements
applicable to this market. The Nasdaq unit responsible
foradministering its program to list companies on the Nasdaq
market is NLQ.
NASD is the largest SRO in the United States, with a membership
thatincludes virtually every broker-dealer in the nation that does
securities business with the public. NASD is subject to SEC
oversight and isresponsible for ensuring that its members comply
with federal securities laws and NASD rules. NASD, through its
regulatory subsidiary NASDRegulation, Inc., is responsible for
regulating Nasdaq's over-the-counter securities market. NASD
develops rules and regulations, conducts
2A going concern opinion may be issued as a result of an external
auditor's review of a company's
financial status that raises questions about the company's ability
to remain in business.
Background
B-281373
Page 3 GAO/GGD-99-53 Oversight of Listing Procedures regulatory
reviews of members' business activities, and designs andoperates
marketplace services and facilities. Nasdaq began operation in
1971 as the first electronic, screen-based stockmarket for over-
the-counter securities. Nasdaq enables securities firms to execute
transactions for investors and for themselves in an environment
ofreal-time trade reporting and automated market surveillance. As
of December 1998, more than 5,580 securities were traded on
Nasdaq,representing about 5,100 companies. In addition to its
screen-based operations, Nasdaq is distinguished from stock
exchanges by its use ofmultiple market makers--independent dealers
who openly compete with one another for investors' orders in each
Nasdaq security. Nasdaq has twotiers: the Nasdaq National Market,
where about 3,900 of Nasdaq's larger companies are listed and
traded; and the Small Cap Market, where about1,200 smaller
emerging growth companies are traded.
Our February 1998 report made two recommendations for improving
theoversight and operations of NLQ. First, we recommended that
OCIE periodically report the status of all open, significant
recommendations inits oversight inspections to the SEC
Commissioners. Second, we recommended that SEC require NASD to
develop management reportsbased on overall program statistics to
demonstrate NLQ's operating results. In August 1997, OCIE
completed a periodic compliance inspection of NLQ.The SEC staff
made 27 recommendations for improving NLQ's review of listing
applicants and the compliance status of listed companies.
Theinspection report placed special emphasis on five of these
recommendations. Our objectives were to determine whether SEC and
Nasdaq haveimplemented our recommendations and to determine the
actions Nasdaq has taken to respond to SEC's inspection
recommendations. We alsodetermined the operational status of RSCS.
We interviewed SEC and Nasdaq officials and reviewed applicable
documents regarding thesematters.
To determine whether our recommendations have been implemented,
wemet with appropriate SEC and Nasdaq officials; examined OCIE's
August 20, 1998, information memorandum to SEC Commissioners; and
examinedreports of Nasdaq Listing Qualifications Program
Statistics for the quarters ended June 30 and September 30, 1998.
To determine the status ofNasdaq's compliance with OCIE's
inspection recommendations, we met
Objectives, Scope, andMethodology
B-281373
Page 4 GAO/GGD-99-53 Oversight of Listing Procedures with
appropriate SEC and Nasdaq officials, reviewed documents
relatingto SEC's follow-up to the 1997 inspection, and reviewed
NLQ procedures. To assess the operational status of RSCS, we
obtained a briefing on anddemonstration of RSCS from Nasdaq
officials.
We obtained written comments on a draft of this report from SEC
andNasdaq (see apps. I and II, respectively); and their comments
are discussed at the end of this letter. We did our work in
Washington, D.C., betweenOctober 1998 and March 1999 in accordance
with generally accepted government auditing standards. In August
1998, in response to our recommendation, OCIE submitted
aninformation memorandum to the SEC Commissioners that included
the status of significant open recommendations resulting from
OCIEinspections of the securities SROs. The memorandum provided
background and operational information on OCIE's SRO
inspectionprogram and a discussion of the status of open
recommendations that OCIE considered significant. The purpose of
our recommendation was tokeep the commissioners informed and to
provide an additional incentive for SROs to comply with OCIE
recommendations. OCIE's memorandumaddressed recommendations from
all OCIE SRO inspection programs. These included inspections of
SRO listing programs, as well as other SROactivities, such as
* arbitration;*
broker-dealer examination;* financial surveillance and
enforcement; and* trading surveillance, investigation, and
enforcement.
OCIE indicated that it would annually report the status of all
open,significant recommendations to the Commissioners.
In August and November 1998, NLQ sent Nasdaq management
quarterlystatistical summary reports on the progress of the Nasdaq
listing program. These summaries used statistical information as
indicators of theeffectiveness of Nasdaq's listing program. The
reports provided information pertaining to three primary
activities within NLQ--exceptiongranting and administration,
application review, and compliance monitoring. For example, the
reports for the quarters ended June 30, 1998,and September 30,
1998, indicated that the number of issuers granted exceptions as a
percent of those requesting exceptions to Nasdaq's
listingrequirements generally had diminished. They also indicated
that the
SEC and NasdaqDeveloped Reports in Response to OurRecommendations
B-281373
Page 5 GAO/GGD-99-53 Oversight of Listing Procedures percentage of
issuers removed from the listings for failing to comply withthe
terms of their exceptions increased. The quarterly report is
expected to support NLQ's primary objective ofpromoting the
integrity of the Nasdaq Stock Market through the consistent
application of Nasdaq's listing requirements. The report was
developed inresponse to our recommendation that NASD use
statistics to demonstrate NLQ's operating results and evaluate
program effectiveness. In August 1997, OCIE reported on its
inspection of NLQ and maderecommendations for improving Nasdaq's
review of applicants for listing and companies already listed. In
total, OCIE made 27 recommendations toimprove the operations of
the Nasdaq listing program. OCIE officials told us that Nasdaq had
addressed all of the 27 recommendations. Theyreported that they
intend to follow up on three of the recommendations to ensure that
the actions taken have been effective. OCIE's inspection report
highlighted its recommendations in five keyareas. OCIE recommended
that NLQ:
* implement procedures requiring its analysts to closely
scrutinize the valueof unaudited assets and the value of audited
assets that are unusual or of
questionable value;* train its analysts to thoroughly
investigate and evaluate disclosures madeby issuers in public
filings and press releases and require its analysts to
routinely conduct investigations into the backgrounds of those
individualsinvolved with issuers, including independent
accountants and underwriters;* implement procedures to require
companies that receive going concernopinions to set forth a
business plan demonstrating their ability to
continue business operations in compliance with listing
requirements;* create a uniform, concise compilation of its
basic review procedures; and* modify its program to monitor
listed companies to enable NLQ to morequickly detect companies
that are falling out of compliance.
In responding to each of these recommendations, Nasdaq has
madevarious procedural and program changes. Nasdaq officials
reported that Nasdaq has revised its procedures manuals to include
detailed writtenprocedures for valuing assets. For example, they
said the procedures now document Nasdaq's practice to consider
requesting corroboration of thevalue of assets if the issuer's
financial statements contain nonperforming assets, assets related
to discontinued operations, significant percentagesof intangible
assets, undeveloped natural resources, or assets acquired
Nasdaq Has Acted toComply with SEC's Recommendations
B-281373
Page 6 GAO/GGD-99-53 Oversight of Listing Procedures related to
nonmonetary transactions. However, unless unusualcircumstances
exist, Nasdaq staff are to continue to rely upon asset valuations
that have been validated by a company's independent auditor.To
improve its ability to investigate issuers and company
information, Nasdaq created the Nasdaq Listing Investigations
Department (NLI) in July1997. NLI is responsible for doing in-
depth investigations into Nasdaqlisted issuers. Nasdaq officials
told us that NLI has experienced legal andaccounting staff
dedicated to this effort. Nasdaq reported that as of midFebruary
1999, NLI had initiated about 85 investigations. About 20 of
thesehave involved, at least in part, questions concerning asset
valuation. Nasdaq reported that, in several instances, these
investigations causedcompanies to restate their financial
statements. Other investigations have focused primarily on the
adequacy and accuracy of issuers' press releases.3Nasdaq officials
said that although a number of these investigations are ongoing,
the ultimate disposition has ranged from requiring or
encouragingclarifying or corrective public disclosures to removing
companies from the listings, at least in part, because of their
misleading press releases. To address issues related to companies
receiving going concern opinions,Nasdaq officials reported that
they would require these companies to submit business plans.
Specifically, Nasdaq would require companiesreceiving going
concern opinions from their auditors to provide business plans
that show how the company intends to continue business
operationsin compliance with listing requirements. SEC stated that
this should allow better communication between Nasdaq and issuers
about the chances ofcontinued listing, given operating problems
that caused the companies to receive going concern opinions.
Nasdaq officials said they used thesebusiness plans to focus the
companies' attention on issues raised by the going concern
opinions and compliance with listing requirements. Nasdaqofficials
also reported that OCIE recognizes that Nasdaq would refrain from
making subjective determinations regarding the potential success
ofthe business plans while the companies are still in compliance
with listing requirements. They also reported that they have
heightened their scrutinyof companies that receive going concern
opinions. For example, they said they can identify companies that
have going concern opinions in anautomated information system,
called the Issuer Support Services system. They said they note
which companies have going concern opinions onNasdaq's filing
review form, which Nasdaq uses for reviewing periodic filings, and
they assign higher risk factors to these companies in Nasdaq's
3 Nasdaq's Market Watch Department has primary responsibility for
timely review of companies' press
releases and, when appropriate, may implement temporary trading
halts in a company's stock for thedissemination of material news.
B-281373 Page 7 GAO/GGD-99-53 Oversight of Listing Procedures new
RSCS. Further, they said all Nasdaq hearing memoranda
involvingnoncompliant companies reflect the presence of going
concern opinions. To make Nasdaq procedures manuals more uniform
and concise, Nasdaqofficials have revised the manuals and included
indexes and tables of contents. These officials said Nasdaq
reviews its compliance programquarterly and updates the manuals as
needed. NLQ has provided OCIE and us with copies of the revised
manuals. To more quickly detect companies that may be subject to
complianceproblems, Nasdaq began developing its automated RSCS in
January 1997. Nasdaq officials reported that RSCS is to monitor,
among other things,significant changes in the value or composition
of a company's assets. Also, in June 1997, Nasdaq established an
electronic interface with SEC'sElectronic Data Gathering,
Analysis, and Retrieval (EDGAR) system, which provides real-time
access to issuer filings. Nasdaq officials said thatthis will
enable Nasdaq to evaluate issuer filing delinquencies on a
substantially accelerated basis. They said financial data obtained
throughEDGAR is used to update Nasdaq's database, allowing Nasdaq
to focus more quickly on an issuer's compliance with listing
requirements. OCIE officials told us that they intend to follow up
during OCIE's nextNLQ inspection to ensure that Nasdaq
corroborates asset valuations, evaluate Nasdaq's approach to going
concern opinions, and assessNasdaq's handling of companies with
filing delinquencies. With respect to delinquent filings, OCIE
recommended that Nasdaq remove companiesfrom its listings after a
specified number of delinquencies. Nasdaq reported that it
believes the issue of companies with chronic delinquent
filingsshould be aggressively addressed. However, Nasdaq officials
told us that they were concerned that changing listing
requirements to removecompanies after a specified number of
delinquent filings would imply a "safe harbor" for companies that
have received fewer than the specifiednumber. They said the filing
requirement could be better enforced on a case-by-case basis. OCIE
officials told us that the next inspection ofNasdaq's listings
department is scheduled for August 1999.
Nasdaq officials told us that they have made substantial progress
in theirdevelopment of RSCS. They said that they expect RSCS to be
implemented into Nasdaq's compliance monitoring program some time
during mid-1999.They said they had experienced some technical
difficulties with RSCS, but they have continued to fine-tune the
system and increase its technologicalcapabilities. They said the
purpose of RSCS is to help NLQ analysts more
RSCS Is Scheduled forImplementation During Mid-1999
B-281373
Page 8 GAO/GGD-99-53 Oversight of Listing Procedures quickly
detect companies with potential compliance problems that
mightrequire additional scrutiny. Nasdaq designed RSCS to assign
risk scores to companies by evaluatingvarious factors called
"alert items." Alert items are indicators that Nasdaq has
identified as predictors of potential problems at a company or
withsome aspect of a company's securities on the Nasdaq market.
Specific alert items include data on changes in trading volume,
share price, or totalshares outstanding; listing requirement
statistics, such as net tangible assets, market capitalization, or
market value of public float; and theauditor's opinion of the
company's financial statements. Each alert item is associated with
a threshold value. Data for a company are evaluatedagainst each of
these thresholds; and if the threshold is exceeded, the alert item
for that company is assigned a score. Scores for each alert
itemassociated with a company are totaled. The companies with the
highest scores are those that may require more diligent monitoring
by NLQanalysts.
Nasdaq officials said that they are obtaining most of the data
required forRSCS from databases available within NASD. They said
the exact items included in the final RSCS depend, in part, on the
availability of externaldata.
SEC and Nasdaq promptly responded to both of our February
1998recommendations. In addition, OCIE and Nasdaq have worked
closely to implement and resolve any differences concerning OCIE's
inspectionrecommendations. As a result, OCIE has stated that it is
satisfied that Nasdaq has addressed all of its recommendations.
OCIE's plans to followup on three recommendations should help
ensure that Nasdaq has appropriately responded to those
recommendations. It is too early to tell whether RSCS can provide
effective early warning ofcompanies that may be falling out of
compliance with Nasdaq listing requirements. If effective, RSCS
could help analysts identify troubledcompanies that need
additional scrutiny.
SEC and Nasdaq generally agreed with and had no substantive
commentson this report. They orally provided technical comments,
which we incorporated where appropriate. Their written comments
are shown inappendixes I and II, respectively.
Conclusions Agency Comments andOur Evaluation
B-281373
Page 9 GAO/GGD-99-53 Oversight of Listing Procedures As agreed
with your office, unless you publicly announce its
contentsearlier, we plan no further distribution of this report
until 10 days from its issue date. At that time, we will send
copies to Representative Tom Bliley,Chairman, Committee on
Commerce; the Honorable Arthur Levitt, Chairman, SEC; Mr. Frank
Zarb, Chairman, NASD; and other interestedparties. We will also
make copies available to others upon request.
Major contributors to this report are listed in appendix III.
Please contactme at (202) 512-8678 if you or your staff have any
questions. Sincerely yours,
Richard J. HillmanAssociate Director, Financial Institutions and
Markets Issues
Page 10 GAO/GGD-99-53 Oversight of Listing Procedures
Contents
Letter 1 Appendix IComments From the
Securities andExchange Commission
12
Appendix IIComments From the Nasdaq Stock Market,Inc.
14
Appendix IIIMajor Contributors to This Report
15
Abbreviations EDGAR Electronic Data Gathering and Retrieval NASD
National Association of Securities Dealers NLI Nasdaq Listing
Investigations Department NLQ Nasdaq Listing Qualifications
Department OCIE Office of Compliance Inspections and Examinations
RSCS Risk Scoring Compliance System SEC Securities and Exchange
Commission SRO self-regulatory organization
Page 11 GAO/GGD-99-53 Oversight of Listing Procedures
Appendix IComments From the Securities and Exchange Commission
Page 12 GAO/GGD-99-53 Oversight of Listing Procedures Appendix I
Comments From the Securities and Exchange Commission
Page 13 GAO/GGD-99-53 Oversight of Listing Procedures Appendix
IIComments From the Nasdaq Stock Market, Inc.
Page 14 GAO/GGD-99-53 Oversight of Listing Procedures Appendix
IIIMajor Contributors to This Report
Page 15 GAO/GGD-99-53 Oversight of Listing Procedures Michael A.
Burnett, Assistant DirectorEdwin J. Lane, Evaluator David P.
Tarosky, Senior EvaluatorGeneral GovernmentDivision,
Washington,D.C.
Page 16 GAO/GGD-99-53 Oversight of Listing Procedures Ordering
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