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Nasdaq Seeks Tougher Rules on RTOs

(Updated to include further details on Nasdaq's reverse-merger rules changes and to clarify that Nasdaq is looking for tougher rules for companies seeking to trade only on its exchange, not all major exchanges.)

NEW YORK (TheStreet) -- The Nasdaq Stock Market wants to make it harder for companies that have come public through reverse mergers to gain listings on its exchange.

On Monday, Nasdaq submitted a proposed rule change to the Securities and Exchange Commission that would heighten the exchange's listing requirements for such companies, which use a so-called "back-door process" to come public. The procedure, critics say, circumvents the stricter scrutiny that financial-markets regulators give to initial public offerings.

According to Nasdaq's proposed rules, a reverse-merger company's stock must trade on one of the over-the-counter markets (or another exchange) for at least six months after filing its first audited financial statements to regulators.

The exchange called it a "seasoning" period. Also, the new rules would require that a company's stock maintain a bid price of more than $4 for at least 30 of the first 60 trading days after applying for a listing on a major exchange.

Nasdaq is required to obtain SEC approval before it can make the change to its listing requirements, according to a Nasdaq spokesman.

Triggering the Nasdaq proposal has been a rash of fraud revelations among Chinese companies that have sought to raise capital on U.S. equities markets by first obtaining stock listings here through the reverse merger process, also known as a reverse takeover, or RTO. Many other Chinese companies have been accused of fraud, particularly by short-sellers. As detailed by the TheStreet in December, the SEC has launched a wide-ranging investigation into the Chinese reverse-merger phenomenon.

Investigating Chinese Reverse Mergers

A flood of trading halts and delistings also have hit Chinese small-cap names over the last two months, and more and more companies face auditor resignations, allegations of accounting irregularity and delays in filing their annual reports with the SEC. The stocks of 15 Chinese small-cap companies listed on major exchanges are currently halted. Some have not traded in more than month, including China MediaExpress (CCME), China Agritech (CAGC) and ShengdaTech (SDTH)

The Nasdaq's proposed rule change does not single out Chinese companies, but rather reverse mergers in general.

The major exchanges -- including Nasdaq as well as the NYSE and its Amex division -- had come under fire from some in the investment community for allowing reverse-merger companies to "uplist" their shares with little due diligence, critics say, on the part of exchange authorities. Defenders of the reverse-merger process say it's an efficient and cost-effective way to bring small companies public.

A Nasdaq official who spoke on condition of anonymity said that, over the last year or so, "a fair number" of reverse-merger companies seeking a listing on Nasdaq have withdrawn their applications after exchange officials raised questions.

The official also said that the exchange has been using an investigative firm to examine the businesses of both applicant companies as well as those with shares already listed on Nasdaq. The official declined to elaborate.

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