[Text only of letters sent from the Commerce Committee Democrats]
The Honorable Arthur Levitt, Jr.
Chairman
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Mr. Alfred R. Berkeley III
President
The Nasdaq Stock Market
1735 K Street, N.W.
Washington, D.C. 20006
Dear Chairman Levitt and Mr. Berkeley:
In the wake of the highly publicized fraud involving Comparator Systems Corp. and the SEC's lawsuit against the company and three of its officials, I asked the General Accounting Office (GAO), by a letter dated November 21, 1996, to conduct an audit of Nasdaq's Listing Department and SEC's oversight with specific reference to this debacle. That report, Securities Regulation: Oversight of SRO's Listing Procedures Could Be Improved (GAO/GGD-98-45, February 1998) -- based largely on nonpublic SEC inspection reports, inspection work papers, and other internal documents -- is damning.
GAO reports that Comparator had problems complying with Nasdaq's listing and maintenance requirements but was able to remain listed without Nasdaq granting the company any exceptions. SEC found that Comparator's continued listing was "inappropriate" because, among other deficiencies, Nasdaq failed to investigate the value of Comparator's assets. As the SEC noted In the Matter of Tassaway, Inc.: "the presence in Nasdaq of non-complying securities could have a serious deceptive effect." From all appearances, in this case, that is exactly what happened.
As for the SEC's role, it created the Office of Compliance Inspections and Examinations (OCIE) in 1995 to streamline and improve the agency's inspection process. GAO reports that, before OCIE established new procedures, SEC used follow-up inspections as its primary method for checking whether its recommendations were implemented. Even though SEC found significant problems in a 1986 inspection of Nasdaq's Listing Department, SEC did not follow up on its 1986 recommendations until 1997, 11 years later. At that time, SEC found some of the same deficiencies and additional deficiencies as well.
The principle deficiencies (in addition to the serious asset-value-verification problems noted previously and described in greater detail in the GAO report) were: Nasdaq failed to devote sufficient resources to the Listings Department; Nasdaq failed to follow up on or refer for further investigation possible securities law violations it discovered in its review process; Nasdaq failed to highlight the differences between companies trading in the National Market and the SmallCap Market and the risks of investing in either market; Nasdaq generally failed to enforce filing deadlines; Nasdaq had difficulty producing files in a timely manner; Nasdaq's Review Committee was dominated by members of the securities industry, and about 70 percent of its pool of hearing panel members were employed by market makers; and the senior official in charge of the Listing Department also had marketing responsibilities, raising conflict of interest issues.
GAO reports that Nasdaq has improved its Listing Department operations in response to its own inquiry as well as SEC's. After I requested the GAO audit, NASD filed enhanced listing requirements with SEC which were approved on August 22, 1997, and Nasdaq announced the creation of a new unit to investigate questionable claims by its listed companies. However, GAO reports that not all of the SEC's recommendations have been completely implemented and others have not been in place long enough to adequately assess their effectiveness. Further, GAO recommends that the SEC
require OCIE to periodically report the status of all open, significant recommendations to the Commissioners; and require NASD to develop management reports based on overall program statistics that demonstrate its Listing Department's operating results, such as the number of companies granted exceptions to listing and maintenance requirements along with their ultimate disposition, and to submit this data periodically to the Commissioners for review.
I agree with GAO's recommendations, and I respectfully request that you both report back in six months on your progress in addressing them. In the case of Nasdaq, I also request that you report on your progress in addressing the SEC's findings and recommendations as well.
Thank you for your cooperation and attention to this matter. I look forward to receiving your responses and to working with you to ensure that investors can rely on the existence of adequate protections when they make investment decisions regarding the Nasdaq SmallCap Market. Failure to maintain that confidence may seriously undermine the ability of small companies to raise capital in this market.
Sincerely,
JOHN D. DINGELL
RANKING MEMBER
cc: The Honorable Tom Bliley
The Honorable Michael Oxley
The Honorable Thomas Manton
Mr. Mike Burnett (GAO)
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