New NYSE and NASD Rules Regarding Standards for Listed Companies

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Violet Cain
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1 BUSINESS DEPARTMENT E-NEWS ALERT NOVEMBER 22, 2002 New NYSE and NASD Rules Regarding Standards for Listed Companies On November 4, 2003, the Securities and Exchange Commission ( Commission ) approved new rules proposed by the New York Stock Exchange, Inc. (the NYSE ) and the The Nasdaq Stock Market, Inc. ( Nasdaq ) intended to strengthen the corporate governance standards and ensure director independence for listed companies. These new corporate governance listing standards supplement the corporate governance reforms already adopted by the Commission pursuant to the Sarbanes-Oxley Act of Originally filed in 2002, these proposed reforms were in response to a request from the Commission that the exchanges review the listing standards, focusing specifically on corporate governance standards. The NYSE and the National Association of Securities Dealers, through its subsidiary, Nasdaq, filed amendments to their proposed standards in response to the Commission s adoption of Rule 10A-3 pursuant to the Sarbanes-Oxley Act of 2002 and to harmonize the proposed NYSE and Nasdaq listing rules. 1 The NYSE rules are codified in Section 303A of the NYSE s Listed Company Manual. The Nasdaq rules amend Nasdaq Marketplace Rules 4200 and COMPLIANCE DATES Companies currently listed on the NYSE or Nasdaq exchanges are required to comply with the new rules upon the earlier of the first annual meeting after January 15, 2004 or October 31, Classified or staggered boards may have additional time to comply. If it would be necessary to change a classified board member who is not scheduled for election at the first annual meeting, then that election can be postponed until the second annual meeting, but in no event later than December 31, The exception for classified boards does not apply to the adopted audit committee requirements. Private foreign issuers and Nasdaq small business issuers must comply with any audit committee requirements (as set forth in Rule 10A-3 of the Securities Exchange Act of 1934, as amended (the Exchange Act )) by July 31, Companies listing on the NYSE or Nasdaq exchanges in conjunction with their initial public offering are required to have committees with at least one independent member at the time of listing, a majority of independent members within 90 days of listing and a fully independent audit, compensation and nominating committees within one year of listing. Additionally, newly listed companies must have a board made up of a majority of independent directors within one year of listing. Companies listing on the NYSE or Nasdaq upon transfer from another exchange are required to comply with the listing rules within one year of the date of transfer for requirements not imposed by the previous exchange. A transferring company will be deemed in compliance if it adopts the new standards within any transition or grace period provided by the rules of the other market. Additionally, Nasdaq provides for cure periods for non-compliance with its rules regarding independent directors and audit committees when a member ceases to be independent for reasons reasonably out of the member s control or due to one vacancy in the committee. In such circumstances, the listing company has until the earlier of the next annual shareholders meeting or one year from the date of non-compliance to be in compliance. The 1 On October 27, 2003 the American Stock Exchange filed proposed amended rules for enhanced corporate governance with the Commissions (SR-Amex ). These rules have not yet been approved.

2 listing company must provide Nasdaq with immediate notification of non-compliance. Finally, Nasdaq allows for limited appointments of non-independent directors to the compensation, nomination and audit committees and under exceptional and limited circumstances. EXEMPT ORGANIZATIONS The new rules generally apply to all domestic corporations listed on either the NYSE or Nasdaq. Foreign Private Issuers The NYSE allows foreign private issuers to follow home country practices except for audit committee requirements in lieu of the new requirements except that they are required to have an audit committee that satisfies the requirements of Rule 10A-3 of the Exchange Act, notify the NYSE in writing after any executive officer becomes aware of any non-compliance with any applicable provision of the new rules, and to provide a summary of the significant ways in which its governance differs from those followed by domestic companies under the NYSE listing standards (either on their website or in their annual report). Nasdaq may grant exemptions to foreign private issuers for acts that are contrary to the laws, rules or regulations of their home country or are contrary to the generally accepted business practices of their home country. However, Nasdaq will not grant exemptions to foreign private issuers that are contrary to U.S. federal securities laws, including the recently adopted Rule 10A-3. Controlled Companies Companies of which more than 50% of the voting power is held by an individual, group or other company ( Controlled Companies ) are exempt from the NYSE and Nasdaq s rules regarding independent directors, corporate governance and compensation committees. A Controlled Company seeking to take advantage of such exemptions must disclose that choice in their annual proxy statement (or if not filed with the Commission, in its Form 10-K). Limited Partnerships and Bankrupt Companies The NYSE exempts limited partnerships and companies in bankruptcy proceedings from the rules regarding independent directors, corporate governance and compensation committees. Registered Management Investment Companies Because of the pervasive federal regulations applicable to registered management investment companies, the NYSE and Nasdaq exempt these companies, with a few exceptions. The NYSE requires registered closed-end management investment companies to have an audit committee composed of a minimum of three persons, to comply with listing company audit committee provisions (except for the disclosure of simultaneous service on multiple committees) and to comply with listing company certification and notification procedures. Nasdaq exempts management investment companies (including business development companies) from the requirements regarding board and key committee independence and codes of conduct. Passive Business and Other Organizations The NYSE and Nasdaq generally exempt passive business organizations, except to the extent that Rule 10A-3 applies. The NYSE also generally exempts derivatives and special purpose securities and companies listing only preferred or debt securities. Finally, Nasdaq generally exempts cooperative entities that do not have a publicly traded class of common stock. The final rules regarding corporate governance listing standards are as follows:

3 Director Independence The Board of Directors of a NYSE listed company is required to consist of a majority of independent 2 directors The Board of Directors of a Nasdaq listed company is required to consist of a majority of independent 3 directors The listed company is required to disclose the basis for determination of director independence in its annual proxy statement (or if it does not file a proxy, in its Form 10-K annual report) The listed company is required to disclose those directors that it has determined to be independent in its annual proxy statement (or if it does not file a proxy, in its Form 10-K or 20-F) Stricter Definition of Independence 4 The following persons are not deemed to be independent: employees or immediate family members of executive officers of the listed company persons or their immediate family members who receive more than $100,000 per year in direct compensation from the listed company persons or their immediate family members affiliated with or employed in a professional capacity by a present or former internal or external auditor of the listed company persons or their immediate family members who are employed by another company where any of the The following persons are not deemed to be independent: 5 employees or family members of an executive officer (of the listed company or a subsidiary or parent of the listed company) persons or family members of persons who receive more than $60,000 per year in direct payments from the issuer (or a subsidiary or parent company of the listed company) other than certain permitted payments partners or family members of partners of external auditors or persons or family members of persons employed by the listed company s external auditors who worked on the listed company s audit 2 Independent directors are those that have no material relationship with the company, either directly with the company, or as a partner, shareholder or officer of an organization that has a relationship with the company. 3 Independent directors are those that are not employees of the company or its subsidiaries and have no relationship with the company that would interfere with the exercise of independent judgment. 4 Independence can be obtained if the prohibited relationship has been terminated for more than three years. For the NYSE, this look-back is to be phased in one year after the Commission approves the proposed rule change. 5 In the case of an investment company, a director is not independent if he or she is an interested person of the listed company (as defined in Section 2(a)(19) of the Investment Company Act of 1940) other than in his or her capacity as a member of the board of directors or one of its committees 3

4 executive officers of the listed company serve on that company s compensation committee executive officers or employees or their immediate family members who are employed by of a company that makes payments to, or receives payments from the listed company for property or services in an amount exceeding the greater of $1 million or 2% of such company s consolidated gross revenues in any fiscal year 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 share such person s home worked on the listed company s audit persons or their family members employed as executive officers of another entity where any of the executive officers of the listed company serve on that entity s compensation committee persons or family members who are partners, controlling shareholders or executive officers of an entity which the listed company made or from which it received payments for property or services in an amount exceeding $200,000 or 5% of the entity s consolidated gross revenues per year A director who is or has a family member who is an executive officer of a charitable organization, if the company makes payment to the charity in excess of the greater of 5% of the charity s revenues or $200,000 Separate Meetings for Board Members Non-management directors are required to meet at regularly scheduled sessions without management Listed companies are to disclose a method for interested parties to communicate directly with the presiding director of such executive sessions or with nonmanagement directors as a group Independent directors are required to meet at regularly scheduled meetings at which only independent directors are present Non-management directors are all those who are not company officers and includes such directors who are not independent by virtue of a material relationship, former status or family membership, of for any other reason 4

5 Nominating/Corporate Governance Committee The committee must be composed entirely of independent directors The committee must have a written charter that addresses annual performance evaluations of the committee The committee must identify individuals qualified to become board members, consistent with criteria approved by the board Director nominees are required to be selected or recommended for the board s selection either by a majority of independent directors or a committee composed entirely of independent directors Each listed company is required to certify that it has adopted a charter or resolution addressing the nomination process (The form of certification a listed company will be required to submit to Nasdaq is in the process of being prepared and should be available in January 2004) Compensation Committee The committee must be composed entirely of independent directors The committee must have a written charter that addresses annual performance evaluations of the committee The compensation of the CEO of a listed company is to be determined or recommended to the board for determination either by a majority of independent directors or by a compensation committee comprised solely of independent directors The committee is required to produce a report on executive compensation to be included in the listed company s annual proxy statement or annual report Audit Committee The committee is required to have a minimum three person committee composed entirely of independent and financially literate directors (or that must become financially literate within a reasonable period of time after appointment to the committee) The committee is required to have a minimum three person committee composed entirely of independent and financially literate directors who have not participated in the preparation of financial statements of the listed company or any of its subsidiaries One member is required to be a financial expert One member is required to be a financial expert If a committee member serves on more than three Each listed company must certify that the committee has 5

6 public company audit committees, and the listed company does not limit the number of audit committees upon which they can serve, the board would be required to determine that such simultaneous service would not impair the ability of such member to effectively serve on the listed company s audit committee (and to disclose the determination) a charter (which includes committee responsibilities and authority) and has reviewed and reassessed the adequacy of the charter on an annual basis (The form of certification a listed company will be required to submit to Nasdaq is in the process of being prepared and should be available in January 2004) The committee must have a charter (which includes committee duties and responsibilities) and addresses annual performance evaluations Internal Audit Function Each listed company is required to have an internal audit function N/A Corporate Governance Guidelines Each listed company is required to adopt and disclose corporate governance guidelines (including director qualification standards, director responsibilities; director access to management, and as necessary and appropriate, independent advisors; director compensation; director orientation and continuing education; management succession; and annual performance evaluation of the board) N/A Corporate governance guidelines and committee charters must be included on the listed company s website Code of Business Conduct and Ethics Each listed company is required to adopt and disclose a code of business conduct and ethics for directors, officers and employees Each listed company is required to adopt and disclose a code of business conduct and ethics for directors, officers and employees 6

7 Each listed company is required to promptly disclose any waivers of the code of conduct The code must provide for an enforcement mechanism and a fair process to determine violations The code shall be included on listed company s website Any waivers of the code for directors or executive officers must be approved by the board and disclosed in a Form 8- K within five days CEO Certification The CEO of each listed company is required to certify that he or she is not aware of any violation by the company of the NYSE s corporate governance standards listing standards (which would be required to be disclosed in the listed company s annual report or annual report on Form 10-K filed with the Commission) The listed company is required to provide Nasdaq with prompt notification after an executive officer becomes aware of any material non-compliance with Nasdaq Rule 4350 The CEO is required to provide the NYSE with prompt notice after any executive officer of the listed company becomes aware of any material non-compliance with any applicable provisions of the new NYSE rules Public Announcements The NYSE may issue public reprimand letters to listed companies violating a NYSE listing standard Each listed company that receives an audit opinion that contains a going concern qualification must disclose receipt of the qualification through the news media within seven calendar days following the filing of the audit opinion in a public filing with the Commission Related Party Transaction N/A Each listed company is required to conduct a review of related party transactions for conflicts of interest and to obtain approval of such transactions from the audit committee or other committees of independent directors 7

NASD and NYSE Rulemaking: Relating to Corporate Governance

Home Previous Page NASD and NYSE Rulemaking: Relating to Corporate Governance SECURITIES AND EXCHANGE COMMISSION (Release No. 34-48745; File Nos. SR-NYSE-2002-33, SR-NASD-2002-77, SR- NASD-2002-80, SR-NASD-2002-138,