[Federal Register: April 17, 2003 (Volume 68, Number 74)]
[Notices]
[Page 19051-19063]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr17ap03-136]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-47672; File No. SR-NYSE-2002-33]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change and Amendment No. 1 Thereto by the New York Stock Exchange, Inc.
Relating to Corporate Governance
April 11, 2003.
Pursuant to Section 19(b)(1)\1\ of the Securities Exchange Act of
1934 (``Act'') and Rule 19b-4 thereunder,\2\ notice is hereby given
that on August 16, 2002, the New York Stock Exchange, Inc. (``NYSE'' or
``Exchange''), filed with the Securities and Exchange Commission
(``Commission'') the proposed rule change as described in Items I, II,
III below, which Items have been prepared by the NYSE. On April 4,
2003, the NYSE submitted Amendment No. 1 to the proposed rule
change.\3\ The Commission is publishing this notice to solicit comments
on the proposed rule change, as amended, from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See letter from Darla C. Stuckey, Corporate Secretary, NYSE,
to Nancy J. Sanow, Assistant Director, Division of Market Regulation
(``Division''), Commission, dated April 3, 2003 (``Amendment No.
1''). Amendment No. 1 replaces the original filing in its entirety.
Telephone call between Annemarie Tierney, Office of General Counsel,
NYSE, and Jennifer Lewis, Attorney, Division, Commission, on April
9, 2003.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The NYSE proposes to amend its Listed Company Manual (``Manual'')
to implement significant changes to its listing standards aimed at
helping to restore investor confidence by empowering and ensuring the
independence of directors and strengthening corporate governance
practices. The text of the proposed rule change is below. Proposed new
language is in italics; proposed deletions are in brackets.
* * * * *
301.00 Introduction
* * * * *
This section describes the Exchange's policies and requirements
with respect to independent [audit committees] directors, [ownership
interests of corporate directors and officers,] shareholders' voting
rights, and other matters affecting [shareholders' ownership interests
and the maintenance of fair and orderly markets
[[Page 19052]]
in listed securities] corporate governance.
When used in this Section 3, ``officer'' shall have the meaning
specified in Rule 16a-1(f) under the Securities Exchange Act of 1934,
or any successor rule.
* * * * *
303.00 Corporate Governance Standards
Pending the implementation of the new corporate governance
standards set forth in Section 303A infra, in accordance with the
transition provisions adopted by the Exchange, the standards contained
in this Section 303.00 will continue to apply.
303A
General Application
Companies listed on the Exchange must comply with certain standards
regarding corporate governance as codified in this Section 303A.
Consistent with the NYSE's traditional approach, as well as the
requirements of the Sarbanes-Oxley Act of 2002, certain provisions of
Section 303A are applicable to some listed companies but not to others.
Equity Listings
Section 303(A) applies in full to all companies listing common
equity securities, with the following exceptions:
Controlled Companies--
A company of which more than 50% of the voting power is held by an
individual, a group or another company need not comply with the
requirements of Sections 303A(1), (4) or (5). A controlled company that
chooses to take advantage of any or all of these exemptions must
disclose in its annual meeting proxy that choice, that it is a
controlled company and the basis for the determination. Controlled
companies must comply with the remaining provisions of Section 303A.
Limited Partnerships and Companies in Bankruptcy--
Due to their unique attributes, limited partnerships and companies
in bankruptcy proceedings need not comply with the requirements of
Sections 303A(1), (4) or (5). However, all limited partnerships (at the
general partner level) and companies in bankruptcy proceedings must
comply with the remaining provisions of Section 303A.
Closed-End Funds--
The Exchange considers the significantly expanded standards and
requirements provided for in Section 303A to be unnecessary for closed-
end management companies given the pervasive federal regulation
applicable to them. However, closed-end management companies must
comply with the requirements set out in Sections 303A(6), (7) and
(12)(b).
Other Entities--
Section 303A does not apply to passive business organizations in
the form of trusts (such as royalty trusts) or to derivatives and
special purpose securities (such as those described in Sections 703.16,
703.19, 703.20 and 703.21).
Foreign Private Issuers--
Listed companies that are foreign private issuers (as such term is
defined in Rule 3b-4 under the Exchange Act) are permitted to follow
home country practice in lieu of the provisions of this Section 303A,
except that such companies are required to comply with the requirements
of Sections 303A(6) (including the applicable commentary), (7)(a) and
(c), (11) and (12)(b).
Preferred and Debt Listings
Section 303A does not generally apply to companies listing only
preferred or debt securities on the Exchange. To the extent required by
Rule 10A-3 under the Exchange Act, all companies listing only preferred
or debt securities on the NYSE are required to comply with the
requirements of Sections 303A(6) (including the applicable commentary),
(7)(a) and (c), and (12)(b).
Effective Dates/Transition Periods
Companies that do not already have majority-independent boards will
need time to recruit qualified independent directors, and companies
with classified boards may need additional time to implement the new
standards in a series of director elections. Accordingly, all listed
companies will be required to comply with the standards in Sections
303A(1) and (2) no later than eighteen months following publication of
SEC approval of these standards in the Federal Register. If a company
has a classified board and a change would be required for a director
who would not normally stand for election within the 18-month period,
the company will have an additional year, or a total of 30 months after
publication of SEC approval of Section 303A in the Federal Register, to
effect the change in that director position.
Companies will have the same 18-month and 30-month periods
described above to comply with the new qualification standards
applicable to audit, nominating and compensation committee members. As
a general matter, the existing audit committee requirements provided
for in Section 303 continue to apply to NYSE listed companies pending
the transition to the new rules.
Companies listing in conjunction with their initial public offering
must comply within 24 months of listing. Companies listing upon
transfer from another market have 24 months from the date of transfer
in which to comply with any requirement to the extent the market on
which they were listed did not have the same requirement. To the extent
the other market has a substantially similar requirement but also had a
transition period from the effective date of that market's rule, which
period had not yet expired, the company will have at least as long a
transition period as would have been available to it on the other
market.
While the above time periods are needed to recruit directors, the
Exchange believes that listed companies, IPOs and transfers can much
more quickly implement the other requirements of Section 303A. The
provision for a public reprimand letter set out in Section 303A(13) is
effective upon publication of SEC approval of Section 303A in the
Federal Register. The remaining requirements can also be implemented
quickly.
Accordingly, the following standards are effective six months from
publication of SEC approval of Section 303A in the Federal Register:
[sbull] Executive sessions of non-management directors (subsection
3);
[sbull] Nomination and compensation committees with requisite
charters (subsections 4 and 5);
[sbull] Audit committee with requisite charter (subsection 7);
[sbull] Corporate governance guidelines and code of business
conduct and ethics (subsections 9 and 10);
[sbull] Foreign private issuer statement of significant differences
from NYSE standards (subsection 11); and
[sbull] CEO certification of compliance with listing standards
(subsection 12).
Once those six months are expired, we expect all newly listed
companies, both IPOs and transfers, to have provided for these
requirements by the time of listing on the Exchange.
1. Listed companies must have a majority of independent directors.
Commentary: Effective boards of directors exercise independent
judgment in carrying out their responsibilities. Requiring a majority
of independent directors will increase the quality of board oversight
and lessen the possibility of damaging conflicts of interest.
2. In order to tighten the definition of ``independent director''
for purposes of these standards:
[[Page 19053]]
(a) No director qualifies as ``independent'' unless the board of
directors affirmatively determines that the director has no material
relationship with the listed company (either directly or as a partner,
shareholder or officer of an organization that has a relationship with
the company). Companies must disclose these determinations.
Commentary: It is not possible to anticipate, or explicitly to
provide for, all circumstances that might signal potential conflicts of
interest, or that might bear on the materiality of a director's
relationship to a listed company. Accordingly, it is best that boards
making ``independence'' determinations broadly consider all relevant
facts and circumstances. In particular, when assessing the materiality
of a director's relationship with the company, the board should
consider the issue not merely from the standpoint of the director, but
also from that of persons or organizations with which the director has
an affiliation. Material relationships can include commercial,
industrial, banking, consulting, legal, accounting, charitable and
familial relationships, among others. However, as the concern is
independence from management, the Exchange does not view ownership of
even a significant amount of stock, by itself, as a bar to an
independence finding. Of course in no event can any current employee of
the listed company be deemed independent of management.
The basis for a board determination that a relationship is not
material must be disclosed in the company's annual proxy statement or,
if the company does not file an annual proxy statement, in the
company's annual report on Form 10-K filed with the SEC. In this
regard, a board may adopt and disclose categorical standards to assist
it in making determinations of independence and may make a general
disclosure if a director meets these standards. Any determination of
independence for a director who does not meet these standards must be
specifically explained. A company must disclose any standard it adopts.
It may then make the general statement that the independent directors
meet the standards set by the board without detailing particular
aspects of the immaterial relationships between individual directors
and the company (except where there is a presumption of non-
independence, as described in the commentary to Section 303A(2)(b)). In
the event that a director with a business or other relationship that
does not fit within the disclosed standards is determined to be
independent, a board must disclose the basis for its determination in
the manner described above. This approach provides investors with an
adequate means of assessing the quality of a board's independence and
its independence determinations while avoiding excessive disclosure of
immaterial relationships.
(b) In addition:
(i) A director who receives, or whose immediate family member
receives, more than $100,000 per year in direct compensation from the
listed company, other than director and committee fees and pension or
other forms of deferred compensation for prior service (provided such
compensation is not contingent in any way on continued service), is
presumed not to be independent until five years after he or she ceases
to receive more than $100,000 per year in such compensation.
Commentary: A listed company's board may negate this presumption
with respect to a director if the board determines (and no independent
director dissents) that, based upon the relevant facts and
circumstances, such compensatory relationship is not material. Any
affirmative determination of independence made by the board in these
circumstances must be specifically explained in the listed company's
proxy statement, or, if the company does not file a proxy statement, in
the company's annual report filed on Form 10-K with the SEC, and cannot
be covered by a categorical standard adopted in accordance with the
commentary to Section 303A(2)(a). Compensation received by a director
for former service as an interim Chairman or CEO does not need to be
considered as a factor by a board in determining independence under
this presumption. If a person who received more than $100,000 per year
in direct compensation from a listed company dies or becomes
incapacitated, the presumption of non-independence applicable to his or
her immediate family members will cease immediately upon such death or
determination of incapacity.
(ii) A director who is affiliated with or employed by, or whose
immediate family member is affiliated with or employed in a
professional capacity by, a present or former internal or external
auditor of the company is not ``independent'' until five years after
the end of either the affiliation or the auditing relationship.
(iii) A director who is employed, or whose immediate family member
is employed, as an executive officer of another company where any of
the listed company's present executives serves on that company's
compensation committee is not ``independent'' until five years after
the end of such service or the employment relationship.
(iv) A director who is an executive officer or an employee, or
whose immediate family member is an executive officer, of another
company (A) that accounts for at least 2% or $1 million, whichever is
greater, of the listed company's consolidated gross revenues, or (B)
for which the listed company accounts for at least 2% or $1 million,
whichever is greater, of such other company's consolidated gross
revenues, in each case is not ``independent'' until five years after
falling below such threshold.
General Commentary to Section 303A(2)(b): An ``immediate family
member'' includes a person's spouse, parents, children, siblings,
mothers and fathers-in-law, sons and daughters-in-law, brothers and
sisters-in-law, and anyone (other than domestic employees) who shares
such person's home.
Transition Rule. During the five years immediately following
[insert the effective date of this listing standard], each five year
``look back'' period referenced in sub-paragraphs (b)(i) through
(b)(iv) shall instead be the period since [insert effective date of
this listing standard]. For example, if a director received in excess
of $100,000 per year in direct compensation from a listed company
during the year prior to [insert effective date of this listing
standard], there will be no required presumption that the director is
not independent unless such compensatory relationship extended past
[insert effective date of this listing standard].
3. To empower non-management directors to serve as a more effective
check on management, the non-management directors of each company must
meet at regularly scheduled executive sessions without management.
Commentary: To promote open discussion among the non-management
directors, companies must schedule regular executive sessions in which
those directors meet without management participation. ``Non-
management'' directors are all those who are not company officers (as
that term is defined in Rule 16a-1(f) under the Securities Act of
1933), and includes such directors who are not independent by virtue of
a material relationship, former status or family membership, or for any
other reason. Regular scheduling of such meetings is important not only
to foster better communication among non-management directors, but also
to prevent any negative inference from attaching to the calling of
executive sessions. There need not be a single presiding director at
all executive
[[Page 19054]]
sessions of the non-management directors. If one director is chosen to
preside at these meetings, his or her name must be disclosed in the
annual proxy statement or, if the company does not file an annual proxy
statement, in the company's annual report on Form 10-K filed with the
SEC. Alternatively, a company may disclose the procedure by which a
presiding director is selected for each executive session. For example,
a company may wish to rotate the presiding position among the chairs of
board committees. In order that interested parties may be able to make
their concerns known to the non-management directors, a company must
disclose a method for such parties to communicate directly and
confidentially with the presiding director or with the non-management
directors as a group. That method can follow the same process
established for communications to the audit committee required by
Section 303A(7)(c)(ii).
4. (a) Listed companies must have a nominating/corporate governance
committee composed entirely of independent directors.
(b) The nominating/corporate governance committee must have a
written charter that addresses:
(i) the committee's purpose--which, at minimum, must be to:
identify individuals qualified to become board members, and to select,
or to recommend that the board select, the director nominees for the
next annual meeting of shareholders; and develop and recommend to the
board a set of corporate governance principles applicable to the
corporation;
(ii) the committee's goals and responsibilities--which must
reflect, at minimum, the board's criteria for selecting new directors,
and oversight of the evaluation of the board and management; and
(iii) an annual performance evaluation of the committee.
Commentary: A nominating/corporate governance committee is central
to the effective functioning of the board. New director and board
committee nominations are among a board's most important functions.
Placing this responsibility in the hands of an independent nominating/
corporate governance committee can enhance the independence and quality
of nominees. The committee is also responsible for taking a leadership
role in shaping the corporate governance of a corporation.
If a company is legally required by contract or otherwise to
provide third parties with the ability to nominate directors (for
example, preferred stock rights to elect directors upon a dividend
default, shareholder agreements, and management agreements), the
selection and nomination of such directors need not be subject to the
nominating committee process.
The nominating/corporate governance committee charter should also
address the following items: committee member qualifications; committee
member appointment and removal; committee structure and operations
(including authority to delegate to subcommittees); and committee
reporting to the board. In addition, the charter should give the
nominating/corporate governance committee sole authority to retain and
terminate any search firm to be used to identify director candidates,
including sole authority to approve the search firm's fees and other
retention terms. Boards may allocate the responsibilities of the
nominating/corporate governance committee to committees of their own
denomination, provided that the committees are composed entirely of
independent directors. Any such committee must have a published
committee charter. To avoid any confusion, note that the audit
committee functions specified in Section 303A(7) may not be allocated
to a different committee, other than as noted in the General Commentary
to Section 303A(7).
5. (a) Listed companies must have a compensation committee composed
entirely of independent directors.
(b) The compensation committee must have a written charter that
addresses:
(i) the committee's purpose--which, at minimum, must be to
discharge the board's responsibilities relating to compensation of the
company's executives, and to produce an annual report on executive
compensation for inclusion in the company's proxy statement, or, if the
company does not file a proxy statement, in the company's annual report
filed on Form 10-K with the SEC, in accordance with applicable rules
and regulations;
(ii) the committee's duties and responsibilities--which, at
minimum, must be to:
(A) review and approve corporate goals and objectives relevant to
CEO compensation, evaluate the CEO's performance in light of those
goals and objectives, and have sole authority to determine the CEO's
compensation level based on this evaluation; and
(B) make recommendations to the board with respect to non-CEO
compensation, incentive-compensation plans and equity-based plans; and
(iii) an annual performance evaluation of the compensation
committee.
Commentary: In determining the long-term incentive component of CEO
compensation, the committee should consider the company's performance
and relative shareholder return, the value of similar incentive awards
to CEOs at comparable companies, and the awards given to the listed
company's CEO in past years. To avoid confusion, note that the
compensation committee is not precluded from approving awards (with or
without ratification of the board) as may be required to comply with
applicable tax laws (i.e., Rule 162(m)).
The compensation committee charter should also address the
following items: committee member qualifications; committee member
appointment and removal; committee structure and operations (including
authority to delegate to subcommittees); and committee reporting to the
board.
Additionally, if a compensation consultant is to assist in the
evaluation of director, CEO or senior executive compensation, the
compensation committee charter should give that committee sole
authority to retain and terminate the consulting firm, including sole
authority to approve the firm's fees and other retention terms.
Boards may allocate the responsibilities of the compensation
committee to committees of their own denomination, provided that the
committees are composed entirely of independent directors. Any such
committee must have a published committee charter. To avoid any
confusion, note that the audit committee functions specified in Section
303A(7) may not be allocated to a different committee, other than as
noted in the General Commentary to Section 303A(7).
6. Add to the ``independence'' requirement for audit committee
membership the requirements of Rule 10A-3(b)(1) under the Exchange Act,
subject to the exemptions provided for in Rule 10A-3(c).
Commentary Applicable to All Companies: While it is not the audit
committee's responsibility to certify the company's financial
statements or to guarantee the auditor's report, the committee stands
at the crucial intersection of management, independent auditors,
internal auditors and the board of directors. The Exchange supports
additional directors' fees to compensate audit committee members for
the significant time and effort they expend to fulfill their duties as
audit committee members, but does not believe that any member of the
audit committee should receive any compensation other than such
director's fees from the company. If a director satisfies the
definition of ``independent
[[Page 19055]]
director'' set out in Section 303A(2), then his or her receipt of a
pension or other form of deferred compensation from the company for
prior service (provided such compensation is not contingent in any way
on continued service) will not preclude him or her from satisfying the
requirement that director's fees are the only form of compensation he
or she receives from the company.
An audit committee member may receive his or her fee in cash and/or
company stock or options or other in-kind consideration ordinarily
available to directors, as well as all of the regular benefits that
other directors receive. Because of the significantly greater
commitment of audit committee members, they may receive reasonable
compensation greater than that paid to the other directors (as may
other directors for other committee work). Disallowed compensation for
an audit committee member includes fees paid directly or indirectly for
services as a consultant or a legal or financial advisor, regardless of
the amount. Disallowed compensation also includes compensation paid to
such a director's firm for such consulting or advisory services even if
the director is not the actual service provider. Disallowed
compensation is not intended to include ordinary compensation paid in
another customer or supplier or other business relationship that the
board has already determined to be immaterial for purposes of its basic
director independence analysis. To avoid any confusion, note that this
requirement pertains only to audit committee qualification and not to
the independence determinations that the board must make for other
directors.
Commentary Applicable to All Companies Other than Foreign Private
Issuers: Each member of the committee must be financially literate, as
such qualification is interpreted by the company's board in its
business judgment, or must become financially literate within a
reasonable period of time after his or her appointment to the audit
committee. In addition, at least one member of the audit committee must
have accounting or related financial management expertise, as the
company's board interprets such qualification in its business judgment.
A board may presume that a person who satisfies the definition of audit
committee financial expert set out in Item 401(e) of Regulation S-K has
accounting or related financial management expertise.
Because of the audit committee's demanding role and
responsibilities, and the time commitment attendant to committee
membership, each prospective audit committee member should evaluate
carefully the existing demands on his or her time before accepting this
important assignment. Additionally, if an audit committee member
simultaneously serves on the audit committee of more than three public
companies, and the listed company does not limit the number of audit
committees on which its audit committee members serve, then in each
case, the board must determine that such simultaneous service would not
impair the ability of such member to effectively serve on the listed
company's audit committee and disclose such determination in the annual
proxy statement or, if the company does not file an annual proxy
statement, in the company's annual report on Form 10-K filed with the
SEC.
7. (a) Each company is required to have a minimum three person
audit committee composed entirely of independent directors that meet
the requirements of Section 303A(6).
(b) The audit committee must have a written charter that addresses:
(i) the committee's purpose-which, at minimum, must be to:
(A) assist board oversight of (1) the integrity of the company's
financial statements, (2) the company's compliance with legal and
regulatory requirements, (3) the independent auditor's qualifications
and independence, and (4) the performance of the company's internal
audit function and independent auditors; and
(B) prepare the report required by the SEC's proxy rules to be
included in the company's annual proxy statement, or, if the company
does not file a proxy statement, in the company's annual report filed
on Form 10-K with the SEC;
(ii) the duties and responsibilities of the audit committee set out
in Section 303A (7)(c) and (d); and
(iii) an annual performance evaluation of the audit committee.
(c) As required by Rule 10A-3(b)(2), (3), (4) and (5) of the
Securities Exchange Act of 1934, and subject to the exemptions provided
for in Rule 10A-3(c), the audit committee must:
(i) directly appoint, retain, compensate, evaluate and terminate
the company's independent auditors;
Commentary: In connection with this requirement, the audit
committee must have the sole authority to approve all audit engagement
fees and terms, as well as all significant non-audit engagements with
the independent auditors. In addition, the independent auditor must
report directly to the audit committee. This requirement does not
preclude the committee from obtaining the input of management, but
these responsibilities may not be delegated to management. The audit
committee must be directly responsible for oversight of the independent
auditors, including resolution of disagreements between management and
the independent auditor and pre-approval of all non-audit services.
(ii) establish procedures for the receipt, retention and treatment
of complaints from listed company employees on accounting, internal
accounting controls or auditing matters, as well as for confidential,
anonymous submissions by listed company employees of concerns regarding
questionable accounting or auditing matters;
(iii) obtain advice and assistance from outside legal, accounting
or other advisors as the audit committee deems necessary to carry out
its duties; and
Commentary: In the course of fulfilling its duties, the audit
committee may wish to consult with independent counsel and other
advisors. The audit committee must be empowered to retain and
compensate these advisors without seeking board approval.
(iv) receive appropriate funding, as determined by the audit
committee, from the listed company for payment of compensation to the
outside legal, accounting or other advisors employed by the audit
committee.
(d) In addition to the duties set out in Section 303(A)(7)(c), the
duties of the audit committee must be, at a minimum, to:
(i) at least annually, obtain and review a report by the
independent auditor describing: the firm's internal quality-control
procedures; any material issues raised by the most recent internal
quality-control review, or peer review, of the firm, or by any inquiry
or investigation by governmental or professional authorities, within
the preceding five years, respecting one or more independent audits
carried out by the firm, and any steps taken to deal with any such
issues; and (to assess the auditor's independence) all relationships
between the independent auditor and the company;
Commentary: After reviewing the foregoing report and the
independent auditor's work throughout the year, the audit committee
will be in a position to evaluate the auditor's qualifications,
performance and independence. This evaluation should include the review
and evaluation of the lead partner of the independent auditor. In
making its evaluation, the audit committee should take into account the
opinions of management and the company's internal auditors (or other
personnel responsible
[[Page 19056]]
for the internal audit function). In addition to assuring the regular
rotation of the lead audit partner as required by law, the audit
committee should further consider whether, in order to assure
continuing auditor independence, there should be regular rotation of
the audit firm itself. The audit committee should present its
conclusions with respect to the independent auditor to the full board.
(ii) discuss the annual audited financial statements and quarterly
financial statements with management and the independent auditor,
including the company's disclosures under ``Management's Discussion and
Analysis of Financial Condition and Results of Operations;''
(iii) discuss earnings press releases, as well as financial
information and earnings guidance provided to analysts and rating
agencies;
Commentary: The audit committee's responsibility to discuss
earnings releases as well as financial information and earnings
guidance may be done generally (i.e., discussion of the types of
information to be disclosed and the type of presentation to be made).
The audit committee need not discuss in advance each earnings release
or each instance in which a company may provide earnings guidance.
(iv) discuss policies with respect to risk assessment and risk
management;
Commentary: While it is the job of the CEO and senior management to
assess and manage the company's exposure to risk, the audit committee
must discuss guidelines and policies to govern the process by which
this is handled. The audit committee should discuss the company's major
financial risk exposures and the steps management has taken to monitor
and control such exposures. The audit committee is not required to be
the sole body responsible for risk assessment and management, but, as
stated above, the committee must discuss guidelines and policies to
govern the process by which risk assessment and management is
undertaken. Many companies, particularly financial companies, manage
and assess their risk through mechanisms other than the audit
committee. The processes these companies have in place should be
reviewed in a general manner by the audit committee, but they need not
be replaced by the audit committee.
(v) meet separately, periodically, with management, with internal
auditors (or other personnel responsible for the internal audit
function) and with independent auditors;
Commentary: To perform its oversight functions most effectively,
the audit committee must have the benefit of separate sessions with
management, the independent auditors and those responsible for the
internal audit function. As noted herein, all listed companies must
have an internal audit function. These separate sessions may be more
productive than joint sessions in surfacing issues warranting committee
attention.
(vi) review with the independent auditor any audit problems or
difficulties and management's response;
Commentary: The audit committee must regularly review with the
independent auditor any difficulties the auditor encountered in the
course of the audit work, including any restrictions on the scope of
the independent auditor's activities or on access to requested
information, and any significant disagreements with management. Among
the items the audit committee may want to review with the auditor are:
any accounting adjustments that were noted or proposed by the auditor
but were ``passed'' (as immaterial or otherwise); any communications
between the audit team and the audit firm's national office respecting
auditing or accounting issues presented by the engagement; and any
``management'' or ``internal control'' letter issued, or proposed to be
issued, by the audit firm to the company. The review should also
include discussion of the responsibilities, budget and staffing of the
company's internal audit function.
(vii) set clear hiring policies for employees or former employees
of the independent auditors; and
Commentary: Employees or former employees of the independent
auditor are often valuable additions to corporate management. Such
individuals' familiarity with the business, and personal rapport with
the employees, may be attractive qualities when filling a key opening.
However, the audit committee should set hiring policies taking into
account the pressures that may exist for auditors consciously or
subconsciously seeking a job with the company they audit.
(viii) report regularly to the board of directors.
Commentary: The audit committee should review with the full board
any issues that arise with respect to the quality or integrity of the
company's financial statements, the company's compliance with legal or
regulatory requirements, the performance and independence of the
company's independent auditors, or the performance of the internal
audit function.
General Commentary to Section 303A(7)(d): While the fundamental
responsibility for the company's financial statements and disclosures
rests with management and the independent auditor, the audit committee
must review: (A) major issues regarding accounting principles and
financial statement presentations, including any significant changes in
the company's selection or application of accounting principles, and
major issues as to the adequacy of the company's internal controls and
any special audit steps adopted in light of material control
deficiencies; (B) analyses prepared by management and/or the
independent auditor setting forth significant financial reporting
issues and judgments made in connection with the preparation of the
financial statements, including analyses of the effects of alternative
GAAP methods on the financial statements; (C) the effect of regulatory
and accounting initiatives, as well as off-balance sheet structures, on
the financial statements of the company; and (D) the type and
presentation of information to be included in earnings press releases
(paying particular attention to any use of ``pro forma,'' or
``adjusted'' non-GAAP, information), as well as review any financial
information and earnings guidance provided to analysts and rating
agencies.
General Commentary to Section 303A(7): To avoid any confusion, note
that the audit committee functions specified in Section 303A(7) are the
sole responsibility of the audit committee and may not be allocated to
a different committee.
(e) Each listed company must have an internal audit function.
Commentary: Listed companies must maintain an internal audit
function to provide management and the audit committee with ongoing
assessments of the company's risk management processes and system of
internal control. A company may choose to outsource this function to a
firm other than its independent auditor.
8. Reserved.
9. Listed companies must adopt and disclose corporate governance
guidelines.
Commentary: No single set of guidelines would be appropriate for
every company, but certain key areas of universal importance include
director qualifications and responsibilities, responsibilities of key
board committees, and director compensation. Given the importance of
corporate governance, each listed company's website must include its
corporate governance guidelines and the charters
[[Page 19057]]
of its most important committees (including at least the audit, and if
applicable, compensation and nominating committees). Each company's
annual report must state that the foregoing information is available on
its website, and that the information is available in print to any
shareholder who requests it. Making this information publicly available
should promote better investor understanding of the company's policies
and procedures, as well as more conscientious adherence to them by
directors and management.
The following subjects must be addressed in the corporate
governance guidelines:
[sbull] Director qualification standards. These standards should,
at minimum, reflect the independence requirements set forth in Sections
303A(1) and (2). Companies may also address other substantive
qualification requirements, including policies limiting the number of
boards on which a director may sit, and director tenure, retirement and
succession.
[sbull] Director responsibilities. These responsibilities should
clearly articulate what is expected from a director, including basic
duties and responsibilities with respect to attendance at board
meetings and advance review of meeting materials.
[sbull] Director access to management and, as necessary and
appropriate, independent advisors.
[sbull] Director compensation. Director compensation guidelines
should include general principles for determining the form and amount
of director compensation (and for reviewing those principles, as
appropriate). The board should be aware that questions as to directors'
independence may be raised when directors' fees and emoluments exceed
what is customary. Similar concerns may be raised when the company
makes substantial charitable contributions to organizations in which a
director is affiliated, or enters into consulting contracts with (or
provides other indirect forms of compensation to) a director. The board
should critically evaluate each of these matters when determining the
form and amount of director compensation, and the independence of a
director.
[sbull] Director orientation and continuing education.
[sbull] Management succession. Succession planning should include
policies and principles for CEO selection and performance review, as
well as policies regarding succession in the event of an emergency or
the retirement of the CEO.
[sbull] Annual performance evaluation of the board. The board
should conduct a self-evaluation at least annually to determine whether
it and its committees are functioning effectively.
10. Listed companies must adopt and disclose a code of business
conduct and ethics for directors, officers and employees, and promptly
disclose any waivers of the code for directors or executive officers.
Commentary: No code of business conduct and ethics can replace the
thoughtful behavior of an ethical director, officer or employee.
However, such a code can focus the board and management on areas of
ethical risk, provide guidance to personnel to help them recognize and
deal with ethical issues, provide mechanisms to report unethical
conduct, and help to foster a culture of honesty and accountability.
Each code of business conduct and ethics must require that any
waiver of the code for executive officers or directors may be made only
by the board or a board committee and must be promptly disclosed to
shareholders. This disclosure requirement should inhibit casual and
perhaps questionable waivers, and should help assure that, when
warranted, a waiver is accompanied by appropriate controls designed to
protect the company. It will also give shareholders the opportunity to
evaluate the board's performance in granting waivers.
Each code of business conduct and ethics must also contain
compliance standards and procedures that will facilitate the effective
operation of the code. These standards should ensure the prompt and
consistent action against violations of the code. Each listed company's
website must include its code of business conduct and ethics. Each
company's annual report must state that the foregoing information is
available on its website, and that the information is available in
print to any shareholder who requests it.
Each company may determine its own policies, but all listed
companies should address the most important topics, including the
following:
[sbull] Conflicts of interest. A ``conflict of interest'' occurs
when an individual's private interest interferes in any way--or even
appears to interfere--with the interests of the corporation as a whole.
A conflict situation can arise when an employee, officer or director
takes actions or has interests that may make it difficult to perform
his or her company work objectively and effectively. Conflicts of
interest also arise when an employee, officer or director, or a member
of his or her family, receives improper personal benefits as a result
of his or her position in the company. Loans to, or guarantees of
obligations of, such persons are of special concern. The company should
have a policy prohibiting such conflicts of interest, and providing a
means for employees, officers and directors to communicate potential
conflicts to the company.
[sbull] Corporate opportunities. Employees, officers and directors
should be prohibited from (a) taking for themselves personally
opportunities that are discovered through the use of corporate
property, information or position; (b) using corporate property,
information, or position for personal gain; and (c) competing with the
company. Employees, officers and directors owe a duty to the company to
advance its legitimate interests when the opportunity to do so arises.
[sbull] Confidentiality. Employees, officers and directors should
maintain the confidentiality of information entrusted to them by the
company or its customers, except when disclosure is authorized or
legally mandated. Confidential information includes all non-public
information that might be of use to competitors, or harmful to the
company or its customers, if disclosed.
[sbull] Fair dealing. Each employee, officer and director should
endeavor to deal fairly with the company's customers, suppliers,
competitors and employees. None should take unfair advantage of anyone
through manipulation, concealment, abuse of privileged information,
misrepresentation of material facts, or any other unfair-dealing
practice. Companies may write their codes in a manner that does not
alter existing legal rights and obligations of companies and their
employees, such as ``at will'' employment arrangements.
[sbull] Protection and proper use of company assets. All employees,
officers and directors should protect the company's assets and ensure
their efficient use. Theft, carelessness and waste have a direct impact
on the company's profitability. All company assets should be used for
legitimate business purposes.
[sbull] Compliance with laws, rules and regulations (including
insider trading laws). The company should proactively promote
compliance with laws, rules and regulations, including insider trading
laws. Insider trading is both unethical and illegal, and should be
dealt with decisively.
[sbull] Encouraging the reporting of any illegal or unethical
behavior. The company should proactively promote ethical behavior. The
company should encourage employees to talk to supervisors, managers or
other appropriate personnel when in doubt about the best course of
action in a
[[Page 19058]]
particular situation. Additionally, employees should report violations
of laws, rules, regulations or the code of business conduct to
appropriate personnel. To encourage employees to report such
violations, the company must ensure that employees know that the
company will not allow retaliation for reports made in good faith.
11. Listed foreign private issuers must disclose any significant
ways in which their corporate governance practices differ from those
followed by domestic companies under NYSE listing standards.
Commentary: Foreign private issuers must make their U.S. investors
aware of the significant ways in which their home-country practices
differ from those followed by domestic companies under NYSE listing
standards. However, foreign private issuers are not required to present
a detailed, item-by-item analysis of these differences. Such a
disclosure would be long and unnecessarily complicated. Moreover, this
requirement is not intended to suggest that one country's corporate
governance practices are better or more effective than another. The
Exchange believes that U.S. shareholders should be aware of the
significant ways that the governance of a listed foreign private issuer
differs from that of a U.S. listed company. The Exchange underscores
that what is required is a brief, general summary of the significant
differences, not a cumbersome analysis. Listed foreign private issuers
may provide this disclosure either on their web site (provided it is in
the English language and accessible from the United States) and/or in
their annual report as distributed to shareholders in the United States
in accordance with Sections 103.00 and 203.01 of the Listed Company
Manual (again, in the English language). If the disclosure is only made
available on the web site, the annual report shall so state and provide
the web address at which the information may be obtained.
12. (a) Each listed company CEO must certify to the NYSE each year
that he or she is not aware of any violation by the company of NYSE
corporate governance listing standards.
Commentary: The CEO's annual certification to the NYSE that, as of
the date of certification, he or she is unaware of any violation by the
company of NYSE corporate governance listing standards will focus the
CEO and senior management on the company's compliance with the listing
standards. Both this certification to the NYSE, and any CEO/CFO
certifications required to be filed with the SEC regarding the quality
of the company's public disclosure, must be disclosed in the listed
company's annual report to shareholders or, if the company does not
prepare an annual report to shareholders, in the company's annual
report on Form 10-K filed with the SEC.
(b) Each listed company CEO must promptly notify the NYSE after any
executive officer of the listed company becomes aware of any material
non-compliance with any applicable provisions of this Section 303(A).
13. The NYSE may issue a public reprimand letter to any listed
company that violates a NYSE listing standard.
Commentary: Suspending trading in or delisting a company can be
harmful to the very shareholders that the NYSE listing standards seek
to protect; the NYSE must therefore use these measures sparingly and
judiciously. For this reason it is appropriate for the NYSE to have the
ability to apply a lesser sanction to deter companies from violating
its corporate governance (or other) listing standards. Accordingly, the
NYSE may issue a public reprimand letter to a company that it
determines has violated a NYSE listing standard. For companies that
repeatedly or flagrantly violate NYSE listing standards, suspension and
delisting remain the ultimate penalties. For clarification, this lesser
sanction is not intended for use in the case of companies that fall
below the financial and other continued listing standards provided in
Chapter 8 of the Listed Company Manual. The processes and procedures
provided for in Chapter 8 govern the treatment of companies falling
below those standards.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the NYSE included statements
concerning the purpose of, and basis for, the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
item IV below. The NYSE has prepared summaries, set forth in Sections
A, B, and C below of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
The NYSE represents that it has long pioneered advances in
corporate governance. The NYSE has required companies to comply with
listing standards for nearly 150 years, and has periodically amended
and supplemented those standards when the evolution of the U.S. capital
markets has demanded enhanced governance standards or disclosure. Now,
in the aftermath of the ``meltdown'' of significant companies due to
failures of diligence, ethics and controls, the NYSE believes it has
the opportunity--and the responsibility--once again to raise corporate
governance and disclosure standards.
On February 13, 2002, then-Commission Chairman Harvey Pitt asked
the Exchange to review its corporate governance listing standards. In
conjunction with that request, the NYSE appointed a Corporate
Accountability and Listing Standards Committee (``Committee'') to
review the NYSE's current listing standards, along with recent
proposals for reform, with the goal of enhancing the accountability,
integrity and transparency of the Exchange's listed companies.
The Committee believed that the Exchange could best fulfill this
goal by building upon the strength of the NYSE and its listed companies
in the areas of corporate governance and disclosure. This approach
recognizes that new prohibitions and mandates, whether adopted by the
NYSE, the Commission, or Congress, cannot guarantee that directors,
officers and employees will always give primacy to the ethical pursuit
of shareholders' best interests. The system depends upon the competence
and integrity of corporate directors, as it is their responsibility to
diligently oversee management while adhering to unimpeachable ethical
standards. The Exchange now seeks to strengthen checks and balances and
give diligent directors better tools to empower them and encourage
excellence. The Exchange states that, in seeking to empower and
encourage the many good and honest people that serve NYSE-listed
companies and their shareholders as directors, officers and employees,
it seeks to avoid recommendations that would undermine their energy,
autonomy and responsibility.
The NYSE represents that the proposed new corporate governance
listing requirements are designed to further the ability of honest and
well-intentioned directors, officers and employees to perform their
functions effectively. The NYSE believes the resulting proposals will
also allow shareholders to more easily and efficiently monitor the
performance of companies and directors in order to reduce instances of
lax and unethical behavior.
[[Page 19059]]
The NYSE represents that, in preparing the recommendations it made
to the NYSE Board of Directors (``NYSE Board''), the Committee had the
benefit of the testimony of 17 witnesses and written submissions from
21 organizations or interested individuals. The Committee also examined
the excellent governance practices that many NYSE-listed companies have
long followed. In addition, the Committee reviewed extensive commentary
recommending improvement in corporate governance and disclosure,
statements by the President of the United States and members of his
Cabinet, as well as pending Commission proposals and legislation
introduced in Congress.
On June 6, 2002, the Committee submitted its report and initial
recommendations to the NYSE Board.\4\ The NYSE states that President
Bush, then-Commission Chairman Harvey Pitt, members of Congress, CEOs
of listed companies, institutional investors and state pension funds,
organizations such as the Business Roundtable and the Council of
Institutional Investors, and leading academics and commentators
expressed strong support for the Committee's initiatives. The Committee
also received insightful and practical suggestions for the improvement
of its recommendations from experts within the NYSE, listed companies,
institutional investors, outside organizations and interested
individuals. In addition to many face-to-face meetings and telephone
calls, the Exchange received over 300 comment letters.
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\4\ Report of the NYSE Corporate Accountability and Listing
Standards Committee, June 6, 2002.
---------------------------------------------------------------------------
Many of the commentators argued for, or sought, guidance from the
Exchange at a level of detail inconsistent with the role that the
Committee was asked to fulfill. However, where appropriate the
Committee reflected cogent comments in clarifications and modifications
to its recommendations.
Following approval of the NYSE Board of Directors on August 1,
2002, on August 16, 2002, the NYSE filed proposed rule changes to its
corporate governance standards with the Commission (the NYSE Corporate
Governance Proposals) which reflect the findings of the Committee. The
proposals for new corporate governance listing standards for companies
listed on the Exchange would be codified in a new Section 303A of the
Manual.\5\
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\5\ In its Report to the NYSE Board, the Committee set forth
basic principles followed in many cases by explanation and
clarification. The Exchange is proposing to adopt the
recommendations as standards in substantially the form they were
made by the Committee and adopted by the NYSE Board. Accordingly,
the format used states a basic principle, with the additional
explanation and clarifications included as ``commentary''. The NYSE
advises readers that the words ``must'' and ``should'' have been
chosen with care when used. The use of the word ``must'' indicates a
standard or practice with which companies would be required to
comply. The use of the word ``should'' indicates a standard or
practice that the Exchange believes is appropriate for most if not
all companies, but failure to employ or comply with such standard or
practice would not constitute a violation of NYSE standards.
While many of the requirements set forth in this new rule are
relatively specific, the Exchange notes that it is articulating a
philosophy and approach to corporate governance that companies would
be expected to carry out as they apply the requirements to the
specific facts and circumstances that they confront from time to
time. Companies and their boards would be expected to apply the
requirements carefully and in good faith, making reasonable
interpretations as necessary, and disclosing the interpretations
that they make.
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Subsequent to the original filing of the NYSE Corporate Governance
Proposals, the Commission requested that the NYSE file separately
proposed Section 303A(8) (relating to shareholder approval of equity-
compensation plans) and the proposed amendment to NYSE Rule 452 (which
would prohibit member organizations from giving a proxy to vote on
equity-compensation plans absent specific instructions from a
beneficial holder). The Exchange made this separate filing with the
Commission on October 7, 2002.\6\
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\6\ See Securities Exchange Act Release No. 46620 (October 8,
2002), 67 FR 63486 (October 11, 2002) (SR-NYSE-2002-46).
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Significant Amendments From Original Proposals
In the NYSE Corporate Governance Proposals filed in August 2002,
the Exchange proposed to continue its longstanding practice of
permitting listed foreign private issuers to follow home country
practice in lieu of the standards specified in Section 303A, subject
only to the new requirement in proposed Section 303A(11) that such
companies must disclose any significant ways in which their corporate
governance practices differ from those followed by domestic companies
under NYSE listing standards. However, as a result of the Sarbanes-
Oxley Act of 2002\7\ (``Sarbanes-Oxley Act'') and Rule 10A-3 (``Rule
10A-3'') under the Act,\8\ the Exchange must propose standards that
require that all listed companies have an independent audit committee
and satisfy certain other requirements. For this reason, among others,
the Exchanges proposes to add a section entitled ``General
Application'' to Section 303A to clarify how the proposed standards
would apply to different kinds of listed entities.
---------------------------------------------------------------------------
\7\ Pub. L. 107-204, 116 Stat. 745 (2002).
\8\ See Securities Exchange Act Release No. 47654 (April 9,
2003).
---------------------------------------------------------------------------
The NYSE also proposes to include a subsection entitled ``Effective
Date/Transition Period'' in the General Application section of Section
303A. The subsection amends certain of the effective dates originally
proposed. NYSE notes, however, that at least certain of those effective
dates will require further amendment. Certain of the requirements of
proposed Section 303A(6), (7) and (12) reflect the requirements of the
Sarbanes-Oxley Act and Rule 10A-3. The Commission's final rules
implementing these provisions specify dates by which companies must
comply with these requirements.\9\ NYSE represents that, of course,
listed companies will be required to apply these particular standards
in accordance with the transition periods adopted by the Commission,
and the rules proposed herein will be amended as necessary to reflect
those periods.
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\9\ Companies must comply with these provisions by the first
annual meeting held after January 15, 2004, but in no event later
than October 31, 2004. Foreign private issuers and small business
issuers will have until July 31, 2005 to comply.
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Proposed Section 303A(2) Regarding Director Independence
The Exchange has made a number of changes to its originally
proposed definition of independence for board membership as a result of
comments from the Commission, although not to the general rule that
charges the board of directors to affirmatively determine independence.
In addition, the Exchange wishes to point out a matter that arises
as a result of the enactment of the Sarbanes-Oxley Act and the
Commission's implementing rules thereunder.
Immediate Family
Certain close family relationships preclude independence under the
NYSE's proposed rule. The definition of ``immediate family'' is
unchanged from that proposed in the NYSE's original filing, which in
turn is the same as that employed in the NYSE's current rule regarding
the independent audit committee.\10\
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\10\ Section 303.02(A) of the Manual.
---------------------------------------------------------------------------
When the Commission proposed its rules implementing Section 301 of
the Sarbanes-Oxley Act, it proposed to use a more limited concept of
family. The Exchange defines ``immediate family'' as including ``a
person's spouse, parents, children, siblings, mothers-in-law and
fathers-in-law, sons and daughters-in-law, brothers and sisters-in-law,
and anyone (other than
[[Page 19060]]
employees) who shares such person's home.'' The Commission's proposal
includes only a person's spouse, minor children or stepchildren or
children or stepchildren sharing the director's home.
2. Statutory Basis
The Exchange believes that the basis under the Act for this
proposed rule change is the requirement under Section 6(b)(5)\11\ that
an exchange have rules that are designed to prevent fraudulent and
manipulative acts and practices, to promote just and equitable
principles of trade, to remove impediments to, and perfect the
mechanism of a free and open market and, in general, to protect
investors and the public interest.
---------------------------------------------------------------------------
\11\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------
B. Self-Regulatory Organization's Statement on Burden on Competition
The Exchange does not believe that the proposed rule change will
impose any burden on competition that is not necessary or appropriate
in furtherance of the purposes of the Act.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants or Others \12\
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\12\ For a discussion of comments received with respect to
NYSE's proposal regarding shareholder approval of equity-
compensation plans which was filed as a separate proposal, see
Securities Exchange Act Release No. 46620 (October 8, 2002), 67 FR
63486 (October 11, 2002) (SR-NYSE-2002-46).
---------------------------------------------------------------------------
Overview
Widespread Support for the Recommendations. The Exchange indicates
that the vast majority of commentators, including listed companies,
institutional investors, and other interested organizations and
individuals enthusiastically embraced the Committee's recommendations
for new corporate governance and listing standards for the NYSE.
Concerns of Smaller Companies. While most large companies, law
firms and institutions expressed general support for the proposals,
commentators who characterized themselves as smaller businesses voiced
concern. All of these companies complained that the recommendations
seem to have been structured for a large-company model, without taking
into account the disproportionate impact the proposed rules would have
on smaller companies. In particular, they argued that the Committee's
recommendations for separate nominating and compensation committees,
together with its requirement of majority-independent boards, combined
to effectively require that smaller companies enlarge their relatively
small boards. These constituents were particularly concerned with the
increased costs that compliance with the recommendations would entail.
They argued that this would cause the diversion of shareholder value to
unrelated third parties and the misdirection of board and management
time and effort from productive to bureaucratic activities.
Difficulty of Obtaining Independent Directors. Several large
companies expressed concern that the new rules would make it more
difficult for companies to find quality independent directors because
of the increased responsibilities and time commitment that the rules
would require of independent directors (especially audit committee
members), as well as a perceived increase in such directors' exposure
to liability.
Majority-Independent Boards
Many commentators applauded the recommendation that listed
companies be required to maintain majority-independent boards. However,
numerous constituents, large and small, raised concerns that the
requirement would have a variety of adverse consequences.
(a) Controlled Companies
Most prominently, more than half of the commenting companies noted
that the majority-independent board requirement would create
insuperable difficulties for companies controlled by a shareholder or
parent company. They argued that the rule would be inequitable as
applied to them in that it would deprive a majority holder of its
shareholder rights; unnecessary in that the Committee's other
recommendations (in particular the independent committee and disclosure
requirements) would adequately protect minority shareholders; and
undesirable in that it would reduce access to capital markets by
discouraging spin-offs, by inducing some currently public companies to
go private rather than lose control of their subsidiary, and by
discouraging those who manage buyout funds and venture capital funds
from using initial public offerings and NYSE listings as a means for
achieving liquidity and raising capital. One company argued that the
majority-independent board requirement would vitiate the ability of a
parent to effectively manage its subsidiary, in the process denying to
shareholders of the parent the benefits associated with its controlling
stake in the subsidiary and requiring them instead to transfer control
of the subsidiary to third parties.
Similarly, commentators suggested that companies that are majority-
owned by officers and directors should be exempt from this
recommendation. One such company argued that where corporate insiders
own a majority of the stock of a company, the interests of outside
minority shareholders can be adequately protected by the proposed
requirement of an independent compensation committee. Family-owned
companies also expressed concern with the majority-independence
requirement because the proposal would limit the families' involvement
with the board.
The provision in subsection 1 of Section 303A exempting controlled
companies from the requirements to have a majority independent board
and independent nominating and compensation committees is intended to
address these concerns.
(b) Shareholder Agreements and Multiple Classes of Stock
Companies with multiple classes of securities, some of which have a
right of representation on the board, argued that they should not have
to meet the majority-independence requirement because doing so would be
in direct conflict with their equity structure and the shareholder
rights embedded therein.
Companies with multiple classes of stock representing different
constituencies also had difficulty with this recommendation. One
company that recently gave organized labor the right to appoint a
director to the board as part of a collective bargaining agreement
requested that the NYSE allow grandfathering of such arrangements. This
company noted that compliance with this recommendation would effect a
retroactive change in the bargains that brought about these
arrangements and might trigger stockholder approval requirements.
The Exchange clarified in subsection 4 of Section 303A that the
selection and nomination of such directors need not be subject to the
nominating committee process.
Tighter ``Independent Director'' Definition
Most commentators were in favor of tightening the definition of
``independence,'' with only a quarter advocating the continued use of
existing standards. Certain institutional investors praised with
particular emphasis the five-year look-back on compensation committee
interlocks. However, commentators have raised several general
questions, described below, as well as numerous specific
[[Page 19061]]
questions with respect to materiality determinations.
(a) Share Ownership
Many commentators expressed a desire for additional clarification
of the interaction between share ownership and independence.
Several commentators opposed viewing any degree of share ownership
as a per se bar to ``independence'' (absent such other factors as an
employment relationship or other financial or personal tie to the
company). They argued that directors who own or represent institutions
that own very significant economic stakes in the listed companies are
often effective guardians of shareholders' interests not only as
members of the full board but also of compensation and nominating
committees, while directors whose only stake in the membership on the
board is the director's fee may be unduly loyal to management. Several
venture capitalists raised a similar concern that they would run afoul
of the new independence definition, even though venture capitalists,
acting as fiduciaries to funds with significant shareholdings,
typically have all the qualities that the independent director
definition is intended to ensure.
The question of the impact of ownership on independence was
particularly vexing to companies with listed subsidiaries. They were
concerned that a director who is deemed independent with respect to a
parent company may not be considered independent with respect to the
parent-controlled subsidiary.
The Exchange has clarified in subsection 2 of Section 303A that,
since the concern is independence from management, ownership of even a
significant amount of stock, by itself, is not necessarily a bar to an
independence finding.
(b) Safe Harbors for Independence Determinations
Several financial institutions specifically applauded the
committee's recommendation that non-materiality determinations be made
on a case-by-case basis and publicly disclosed and justified. However,
a number of companies objected to the affirmative determination
requirement, requesting that the NYSE specify a safe harbor for
materiality. These companies cited the competing demands on the board's
time and attention; the likelihood that the ``no material
relationship'' requirement would unduly shrink the pool of qualified
directorship candidates; and the possibility that the fact-specific
inquiry required would expose directors to additional scrutiny and
potential liability, which they may be unwilling to assume without
additional compensation and/or protection.
Many commentators would like to be able to fulfill their
affirmative determination requirement through the establishment of
their own safe harbors. For example, one commentator attached a
detailed safe harbor proposal covering various types of credit
transactions. In addition, a vast majority of commenting banks and
financial institutions asked for clarification regarding the treatment
of loans to directors. In light of the existing regulatory framework
that controls relationships between a bank and its directors and
affiliated entities, banks desired to establish categorically that
arm's-length loans to directors would not negate independence.
Numerous companies and organizations argued that if there are no
material relationships, the NYSE should allow the statement of reasons
for the board's determination of independence to be omitted from the
proxy statement, and suggested that the rules should not require
details of each relationship regardless of size.
The Exchange has clarified in subsection 2 of Section 303A that
categorical standards are permissible.
(c) Five-Year Cooling-Off Period
More than half of the companies commenting on this issue protested
that five years is too long, advocating a two-to-three year period
instead. Five companies, reflecting their individual circumstances,
requested an exemption for interim CEOs who have served for less than
one year. One commentator objected to subjecting all former employees
to the cooling-off period, recommending that the prohibition be limited
to former executive officers only.
Several commentators agreed with the five-year period for former
employees, but found the period too long with respect to compensation
committee interlocking directorates. Notably, one company thought that
the five-year look-back on interlocking directorates would strain
parent-subsidiary relations. Likewise, one parent of a controlled
public subsidiary expressed its belief that its executives should be
able to sit on the subsidiary's compensation committee to ensure that
subsidiary's compensation policies are compatible with those of its
parent. In addition, a few companies asked whether the inquiry would
end by examining the present and past relationships at companies where
directors are currently employed, or if one would be required to search
back for possible interlocks at companies that may have since been
acquired or dissolved `` pointing out that with the immediate family
overlay to the rule, the latter inquiry could become extremely
cumbersome.
Several financial institutions (along with several smaller
companies) took issue with the blanket exclusion of family members for
five years. One company argued that when a family member's relationship
has terminated, there should be independence. Another commentator
recommended that relatives of deceased or disabled former officers be
classified as independent as long as they themselves have no financial
involvement other than ownership in the company.
The Exchange has clarified several of these issues with specified
provisions in subsection 2(b) of Section 303A.
Non-Management Executive Sessions
The great majority of the commentators objected to the executive
session requirement, to the requirement to designate and disclose a
presiding director for such sessions, or to both. They argued that the
sessions (a) were unnecessary because the mandated audit, compensation
and nominating committees would provide sufficient checks; (b) would
bifurcate the board into two tiers, turning management directors into
second-class directors; and (c) would deprive directors of guidance by
management. In addition, they argued that mandating such sessions could
result in mechanical, pro forma meetings.
The majority of commentators argued that the presiding director
requirement would have a divisive effect. In addition, they argued that
the requirement would deprive the board of needed flexibility; they
would like the NYSE to allow any independent director to preside over a
given executive session. Some commentators also complained that the
presiding director requirement amounts to the NYSE's mandating
separation of the roles of Chairman and CEO. (Conversely, one non-U.S.
company urged the NYSE to require the designation of a ``lead
director'', or to mandate separation of these roles.) One organization
suggested that the NYSE should instead require that the corporate
governance guidelines specify procedures for the selection of a chair
for each executive session. Even commentators who did not vigorously
object to the recommendation that a presiding director be designated
objected to the requirement that such designation be publicly
disclosed.
The Exchange has clarified in subsection 3 of Section 303A that no
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designation of a ``lead director'' is intended, and that companies
would have some flexibility in how they provide for conduct of the
executive sessions.
General Comments on the Committee Requirements
More than half of all commentators thought that boards should have
the flexibility to divide responsibilities among committees differently
than as contemplated in the Report. In addition, a number of
commentators were concerned that the recommendations have a tendency to
blur the line between the roles of the board and management, involving
the board too deeply in the day-to-day operations of listed companies.
A substantial number of commentators argued that the board as a
whole should be allowed to retain its major oversight responsibilities,
such as decisions on nominating director candidates, adopting
governance guidelines, adopting incentive plans, and hiring outside
consultants.
One company suggested that, as with the majority-independent
director requirement, there should be a 24-month transition period for
the requirements that audit, compensation and nominating committees be
comprised entirely of independent directors.
The Exchange has clarified in subsection 4 of Section 303A that the
nomination/corporate governance and compensation committee
responsibilities could be allocated to other or different committees,
as long as they have published charters.
Independent Nomination/Corporate Governance Committee
Approximately one-fifth of the commenting companies thought that
nominating committees should not have to consist solely of independent
directors, some arguing that a majority of non-management directors
would be sufficient, some requesting that at least one insider be
allowed on the nominating committee. Some commentators suggested that a
nominating committee is not necessary.
Independent Compensation Committee
There was opposition to this recommendation from several companies.
One company argued that the full board should set the salary of the
CEO. Similarly, several commentators commented that although the
procedure for determining CEO compensation could originate from the
compensation committee, the results of the compensation committee's
work should be presented to the entire board, with ultimate decision-
making responsibility residing in the board as a whole. Another company
objected to the committee's exclusive role in evaluation of CEO and
senior executive compensation on the ground that management should be
free to explore new compensation arrangements with consultants.
Audit Committee Member Qualification
There was a broad call from attorneys, associations and companies
alike for clarification on the question of what constitutes
``directors'' fees.'' Questions arose in particular with respect to
pension and other deferred compensation, long-term incentive awards,
and compensation in the form of company products, use of company
facilities and participation in plans available generally to the listed
company's employees.
Several companies and law firms objected to the recommendation that
audit committee members' fees be limited solely to directors' fees,
arguing that this would reduce a company's access to its directors'
expertise and suggesting instead a more liberal restriction, such as an
annual cap on consulting fees.
The Exchange has clarified this issue in commentary to subsection 6
of Section 303A.
Though one institutional investor specifically applauded the 20%
ownership ceiling for voting participation in the audit committee,
approximately ten commentators objected on the ground that this would
disqualify certain types of large shareholders, such as venture capital
investors, who may be excellent audit committee members.
The requirement that the chair of the audit committee have
accounting or related financial management expertise drew opposition
from a number of commentators who felt that it was enough for one
member of the committee to have such expertise. Several companies
protested that the requirement would unduly limit the number of
candidates available to chair the audit committee and unnecessarily
dictate which member should be chair.
As noted, the Exchange did not make proposals in these two areas in
view of provisions in the recently adopted Sarbanes-Oxley legislation.
Audit Committee Charter
The majority of commentators were concerned about the capacity of
the audit committee to handle the list of responsibilities assigned to
it by the recommendation. There were also numerous requests for
clarification as to whether the recommendation mandates review of all
10-Qs, press releases, and disclosures to analysts on a case-by-case
basis, or whether the audit committee's task is rather to set policy
with regard to the form of the financials in those releases.
Commentators emphasized that the former alternative would be overly
burdensome to the audit committee, would tie management's hands to the
point where it would not be able to respond to analyst calls without
first obtaining approval from the audit committee and would ultimately
chill the distribution of information to the public.
The Exchange has clarified this issue in its commentary to
subsection 7(b)(ii)(D) of Section 303A.
About a quarter of the commentators objected to the recommendation
that sole authority to retain and terminate independent auditors be
granted to the audit committee, suggesting that the entire board should
be able to act on the recommendation of the audit committee and arguing
that this would not pose any governance problems in light of the
majority-independence requirement.
Some commentators rejected wholesale the committee's enumeration of
minimum duties and responsibilities for the audit committee, arguing,
for example, that the board should have the flexibility to allocate
responsibility for the oversight of compliance with legal and
regulatory requirements as it deems appropriate, and that the audit
committee should not be obligated to assist board oversight of such
compliance. Several commentators objected to the recommendation's
requirement that the audit committee discuss policies with respect to
risk assessment and management. For example, one company has a risk
committee devoted solely to this purpose and would like the requirement
to accommodate such arrangements.
The Exchange has clarified this issue in commentary to subsection
7(b)(ii)(F) of Section 303A.
Some commentators requested that the audit committee be allowed to
delegate to a member or subcommittee some of the proposed
responsibilities, particularly the review of guidance given to analysts
and earnings releases, on the ground that without such delegation the
roster of duties would be too burdensome.
A few commentators pointed out that it was unclear whether and to
what extent there would be an internal audit requirement.
The Exchange has clarified this matter in subsection 7(c) of
Section 303A.
[[Page 19063]]
Required Adoption and Disclosure of Corporate Governance Guidelines
A number of commentators argued that companies should have broader
discretion in drafting their governance guidelines.
Required Adoption and Disclosure of a Code of Business Conduct and
Ethics
Many of those who commented on this recommendation urged that only
material waivers of the business ethics policy be required to be
disclosed.
Disclosure by Foreign Private Issuers
Two commentators urged tougher treatment of foreign companies, with
one suggesting that exemptions from listing requirements for foreign
private issuers should be the exception rather than the rule.
CEO Certification
More than half of the commenting companies and organizations
opposed this recommendation. The overwhelming majority of comments
protested that the requirement would duplicate the recent SEC rules
requiring CEO certification for periodic reports. They opposed the
expansion of the certification requirement to all statements made by
the company to investors and urged the NYSE to defer final action on
this subject until the SEC issues a final rule, or to coordinate its
action on this issue with the SEC, so as to avoid different standards
by different regulatory bodies. Some commentators suggested language
enabling the CEO to rely on the CFO, external auditors, internal
auditors, the audit committee, inside and outside counsel and other
consultants in making his or her certification.
A few commentators expressed concern that the recommendation raised
potential for pernicious private litigation and urged the NYSE to make
clear that the certification requirement, if adopted, creates no
private cause of action.
The Exchange has decided not to require its own CEO certification
of financials in light of the certifications required by the Sarbanes-
Oxley legislation and SEC rules.
Public Reprimand Letter From NYSE
Several companies stressed the importance of providing offenders
with due process through notice and an opportunity to cure prior to any
public reprimand.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
A. By order approve the proposed rule change, or
B. Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the amended
proposal is consistent with the Act. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street NW., Washington, DC 20549-0609.
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for inspection and copying in the
Commission's Public Reference Room. Copies of such filing will also be
available for inspection and copying at the principal office of the
NYSE. All submissions should refer to File No. SR-NYSE-2002-33 and
should be submitted by May 8, 2003.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\13\
Margaret H. McFarland,
Deputy Secretary.
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\13\ 17 CFR 200.30-3(a)(12).
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[FR Doc. 03-9473 Filed 4-16-03; 8:45 am]
BILLING CODE 8010-01-U