650 Page Mill Road Palo Alto, CA 94304-1050 PHONE 650.493.9300 FAX 650.493.6811 www.wsgr.com SEC Approves NYSE Final Corporate Governance Listing Standards December 2003 Introduction On November 4, 2003, the SEC approved the NYSE s new corporate governance listing standards (see SEC Release No. 34-48745). Time Frame for Compliance The NYSE s revised listing standards related to stockholder approval of equity compensation (now contained in Section 303A(8) of the NYSE Listed Company Manual) became effective June 30, 2003 and are discussed in a separate WSGR memorandum. The remainder of the new corporate governance listing standards, which are described in this memorandum, will become effective for each current NYSE listed company upon the earlier of their first annual meeting after January 15, 2004 or October 31, 2004 (although a company with a classified board may delay the replacement of certain directors until the earlier of the second annual meeting after January 15, 2004 or December 31, 2005). Key Changes The following briefly summarizes the key differences between the final NYSE corporate governance listing standards and its most recent proposal of April 2003: Director Independence Standards Look back periods for director independence determinations have been reduced from five years to three years, with a special one year transitional period applicable to the first year of effectiveness of the new listing standards; The look back period is now clearly applied in determining the independence of directors who are employees or family members of employees of the company; Directors who receive or whose immediate family members receive $100,000 or more in direct annual compensation from the company (subject to certain exceptions described below) are now per se not independent (as opposed to merely being presumed not independent as in the prior draft); The 2% of revenue independence test for payments between the company and other companies with which a director is affiliated is now measured against the other company s revenue rather than the NYSE listed company s revenue (i.e., from the listed company s perspective, 2% of their revenue, not 2% of your revenue); Charitable organizations are not included in the 2% of revenue independence test, although a disclosure requirement for certain contributions to charities with which a director is affiliated is now required; and Director relationships with the company s parent or subsidiaries are clarified to be treated as equivalent to relationships with the company itself for independence determinations. Executive Sessions A new suggestion is added to require an annual executive session of the independent directors (who may be different from the nonmanagement directors as independence is defined). Independent Board Committees The final listing standards clarify that CEO compensation may be discussed by all directors
and approved by all of the independent directors (as compared to solely by the compensation committee); and SEC Rule 10A-3 (addressing standards for audit committees) is now incorporated by reference rather than restated in the listing standards. The following is a summary of the final listing standards: Board Structure and Composition Independent Board Members Under the NYSE listing standards, independent directors must comprise a majority of the board. Prior NYSE listing standards required only that a listed company have enough independent directors to form an audit committee comprised solely of at least three independent directors. Executive Sessions The listing standards provide that non-management directors must meet at regularly scheduled executive sessions without management present. The listing standards specify that non-management directors include any directors who are not company officers, even if they do not meet the higher independence requirements described below, although the listing standards now recommend a separate meeting of the independent directors at least once a year if there are non-management directors who are not independent. Independent Committees NYSE-listed companies will also be required to have standing committees that address three areas: audit, compensation and nominating/corporate governance. Each of these committees will be required to be comprised solely of independent directors. The committees will each have to comply with specified responsibilities, which are summarized below under Board Responsibilities. 2 Additional Audit Committee Requirements The listing standards require that the audit committee have at least three members, all of whom are, or become within a reasonable time after appointment, financially literate, and one of whom must have accounting or related financial management expertise. Further, if a member of the audit committee simultaneously serves on the audit committee of more than three public companies and the company does not limit the number of audit committees on which its members serve, then the board will be required to determine that this simultaneous service would not impair the ability of the member to serve. In addition, the listing standards require the members of the audit committee to satisfy the additional Sarbanes-Oxley requirements now contained in SEC Rule 10A-3. This rule, which is discussed in a separate WSGR memorandum, addresses audit committee independence, oversight of independent auditors, whistle-blower requirements, authority to engage advisers and funding for the committee. The additional independence requirements of the rule are that audit committee members may not, other than in their capacity as a member of the board or a committee: (i) accept directly or indirectly any consulting, advisory or other compensatory fee from the company or any subsidiary (excluding fixed amounts under a retirement plan for prior service not contingent on future service); and (ii) be an affiliated person of the company or any subsidiary. Disclosure Requirements Although no presiding director is required for board executive sessions, if a director is chosen to preside, either his or her name or the procedure used for selecting the presiding director will be required to be disclosed in the company s annual proxy statement (or annual report if the company does not file an annual proxy statement). Similarly, the proxy statement (or annual report) will be required to include disclosure of any board determination that an audit committee member s service on four or more audit committees would not impair his or her ability to serve. In addition, under the listing standards, listed companies will be required to disclose a method for interested parties to make concerns known to the nonmanagement directors or the presiding director.
Definition of Independence Independence Generally For a director to be independent under the listing standards (other than the additiona l requirements applicable to audit committee members under SEC Rule 10A-3 discussed above), the board must affirmatively determine that the director has no material relationship with the company either directly or as a partner, stockholder or officer of an organization that has a relationship with the company. A commercial, industrial, banking, consulting, legal, accounting, charitable and familial relationship can be material. However, because the concern is independence from management, ownership of even a significant amount of the company s stock would not, by itself, bar an independence determination under the NYSE s listing standards (although it could be problematic under SEC Rule 10A-3 for audit committee members). Per Se Bars to Independence Regardless of the board s determination, under the listing standards, directors could not qualify as independent if they fall into any of the following categories at any time during the look back period described below: Employees of the company (other than prior service as an interim CEO or Chairman) or immediate family members of an executive officer of the company; Directors who receive, or whose immediate family member receives (other than for service by an immediate family member as a nonexecutive employee), more than $100,000 per year in direct compensation from the company, other than director and committee fees, pension or other deferred compensation for prior service (and not contingent on future service) or compensation for former service as an interim CEO or Chairman; Directors who are affiliated with or employed by, or whose immediate family member is affiliated with or employed in a professional 3 capacity by, a present or former internal or external auditor of the company; A director who is employed, or whose immediate family member is employed, as an executive officer of another company where any of the company s present executives serves on that other company s compensation committee; or A director who is an executive officer or an employee, or whose immediate family member is an executive officer, of a company that makes payments to, or receives payments from, the company for property or services in an amount which, in any single fiscal year, exceeds the greater of $1 million or 2% of the other company s consolidated gross revenues. This last independence bar (2% of revenue) does not apply to director relationships with charitable organizations. In addition, all of these per se tests now consider relationships with the company s parent or subsidiaries as equivalent to relationships with the company itself. Look-Back Period Directors are also barred from being determined independent if they would not have been independent under the bullets in Per Se Bars to Independence above at any time during the prior three years. However, for the first year of the new listing standards (i.e., until November 4, 2004), the look back period will only be for one year. Immediate Family Member The listing standards define immediate family member to include 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 the person s home. Disclosure Requirements If the board makes a determination that a director s particular relationship (which is not barred by the per se rules) is not material, the basis for this determination must be disclosed in the company s
annual proxy statement (or annual report if the company does not file an annual proxy statement). As an alternative, a board may adopt and disclose categorical standards to assist it in making independence determinations and may make a general disclosure that the independent directors meet these standards or, if they do not, provide a specific explanation. In addition, the company will be required to disclose any contributions made by the company to any charitable organization as to which a director serves as an executive officer if in the last three years they exceeded the greater of $1 million or 2% of the charity s consolidated gross revenues. Board Responsibilities Adoption of Corporate Governance Guidelines Listed companies will be required to adopt and disclose corporate governance guidelines. These guidelines should address: Director qualification standards; Director responsibilities, including meeting attendance and advance review of meeting materials; Director access to management and independent advisors; Form and amount of director compensation; Director orientation and continuing education; Management succession, including CEO selection and performance review policies and principles as well as policies regarding succession; and Annual performance evaluation of the board. The listing standards encourage companies to address other qualification requirements, including policies limiting the number of boards on which a director may sit, and director tenure, retirement and succession. Expanded Audit Committee Charter The listing standards require that companies adopt and publish a written audit committee charter. The charter must provide for an annual performance evaluation of the committee and must address the committee s purpose and responsibilities which, at a minimum, must be to: Assist board oversight of: o The integrity of the company s financial statements; o The company s compliance with legal and regulatory requirements; o The independent auditor s qualifications and independence; and o The performance of the company s internal audit function and independent auditors; Comply with the requirements of SEC Rule 10A-3 relating to audit committee oversight of independent auditors, whistle -blower requirements, authority to engage advisers and funding for the committee; Discuss the company s annual and quarterly financial statements and MD&A with management and the independent auditors; Generally discuss the company s earnings releases (including pro forma information), as well as financial information and earnings guidance provided to analysts and ratings agencies; Review: o 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 internal control issues; o Analyses prepared by management or the independent auditors describing significant financial reporting issues and judgments, 4
including the effects of alternative GAAP methods; and o The effect of regulatory and accounting initiatives as well as off-balance sheet structures; Periodically meet separately with management, internal auditors and the independent auditors; At least annually, obtain and review a report by the independent auditor describing: o The firm s internal quality control procedures; o 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 in the last five years respecting audits, and any steps taken to deal with these issues; and o All relationships between the independent auditor and the company; Review with the independent auditor any audit problems or difficulties and management s response; Set clear hiring policies for employees or former employees of the independent auditors; Discuss risk assessment and risk management policies; and Report regularly to the board. In addition, the listing standards suggest the audit committee should consider whether, in order to assure continuing auditor independence, there should be regular rotation of the company s audit firm. Compensation Committee Charter The listing standards require that companies adopt and publish a written compensation committee charter. The charter must provide for an annual performance evaluation of the committee and must address the committee s purpose and responsibilities which, at a minimum, must be to: Review and approve corporate goals and objectives relevant to CEO compensation; Evaluate the CEO s performance in light of those goals and objectives; Either as a committee or together with the other independent directors (as directed by the board) determine and approve the CEO s compensation level based on the evaluation; Make recommendations to the board with respect to non-ceo compensation, incentivecompensation plans and equity-based plans; and Produce an annual report on executive compensation for inclusion in the company s proxy statement or annual report. The listing standards suggest that the charter should also address: Committee member qualifications; Committee member appointment and removal; Committee structure and operations (including authority to delegate to subcommittees); Committee reporting to the board; and Granting the committee sole authority to retain and terminate any consulting firm to be used to assist in director evaluation or CEO or senior executive compensation, including sole authority to approve their fees and other retention terms. Nominating/Corporate Governance Committee Charter The listing standards require that companies adopt and publish a written nominating/corporate governance committee charter. The charter must provide for an annual performance evaluation of the committee and must address the committee s purpose and responsibilities which, at a minimum, must be to: 5
Identify individuals qualified to become board members, consistent with criteria approved by the board; Select, or recommend that the board select, the director nominees for the next annual meeting of stockholders; Develop and recommend to the board corporate governance principles; and Oversee the evaluation of the board and management. The listing standards suggest that the charter should also address: Committee member qualifications; Committee member appointment and removal; Committee structure and operations (including authority to delegate to subcommittees); Committee reporting to the board; and Granting the committee sole authority to retain and terminate any search firm to be used to identify director candidates, including sole authority to approve their fees and other retention terms. Codes of Business Conduct and Ethics NYSE-listed companies will be required under the listing standards to adopt a code of business conduct and ethics for directors, officers and employees. Items that should be covered in the code include: Conflicts of interest; Corporate opportunities; Confidentiality; Fair dealing; Protection and proper use of company assets; Compliance with laws, rules and regulations (including insider trading laws); and 6 Encouraging the reporting of any illegal or unethical behavior. The listing standards provide that only the board or a board committee can approve a waiver of the code for directors or executive officers. Any such waiver will be required to be promptly disclosed to stockholders. Disclosure Requirements The listing standards will require all listed companies to include on their website their corporate governance guidelines, code of business conduct and ethics and the charters of their most important board committees (including at least the audit, compensation and nominating/corporate governance committees). Further, annual reports will be required to state that this information is available on the website or in print to any requesting stockholder. Independent Audit The listing standards require that each NYSE listed company have an internal audit function. CEO Certifications Each CEO of a listed company will be required to certify annually to the NYSE that he or she is not aware of any violation by the company of NYSE corporate governance listing standards. This certification is in addition to those required by SEC rules and the Sarbanes-Oxley Act. In addition, CEOs will be required to promptly notify the NYSE in writing after any executive officer becomes aware of any material noncompliance with the NYSE s corporate governance listing standards. Application to Foreign Private Issuers The listing standards (other than the requirement to comply with SEC Rule 10A-3 which will be effective for foreign private issuers on July 31, 2005, and the requirement for CEOs to notify the NYSE of noncompliance with the listing standards) will not apply to foreign private issuers; rather, foreign private issuers will be required to disclose in English on their web site and/or in their annual report in the U.S. any signif icant ways in which their corporate governance practices differ from those followed by domestic listed companies.
Reprimand Letters The listing standards provide that the NYSE will be given the authority to issue a public reprimand letter to any listed company that has violated a NYSE listing standard. This memorandum is intended only as general information about the matters discussed, and should not be construed as legal advice. For more information about these matters, please contact your Wilson Sonsini Goodrich & Rosati partner. 7