SEC Approves NASDAQ And NYSE Rules Relating To Corporate Governance And Director Independence

Thursday, January 1, 2004 - 01:00
Lola Miranda Hale

On November 4, 20031 the Securities and Exchange Commission (Commission) approved the New York Stock Exchange (NYSE) and the NASDAQ Corporate Governance Proposal; the NASDAQ Going Concern Proposal; the NASDAQ Related Party Transaction Proposal; the NASDAQ Issuer Applicability Proposal; and the NASDAQ Code of Conduct Proposal, each as amended.

The NYSE New Director Independence standards are found in Section 303A of the NYSE Listed Company Manual. The NASD standards regarding Director Independence are found in Rules 4200 and 4300 of the NASD manual.

Both the NYSE and NASDAQ require listed issuers to:

• have a majority of independent directors on their board;

• have boards make an affirmative determination of independence and provide information to investors about their determination;

• comply with significant responsibilities for nomination, compensation and audit committees;

• identify certain relationships that automatically preclude a board finding of independence;

• have non-management directors meet at regularly scheduled executive sessions;

• comply with the standards set forth in Rule 10A-32 (listing standards relating to audit committees);

• adopt a cure period as provided in Rule 10A-3(a)(3) for audit committee members who cease to be independent for reasons outside their reasonable control;

• have an audit committee that is comprised of at least three directors, who are required to meet the NYSE or NASDAQ respective definitions of independence, in addition to the independence requirements of Rule 10A-3;

• adopt and make publicly available a code of conduct with enforcement provisions that is applicable to all directors, officers and employees, and disclose any waivers of the code for directors or executive officers.

NASDAQ final rules include:

(i) an expansion of certain per se disqualifications from independent director standards to cover family members;

• Payments Provision. A director who accepts, or has a family member who accepts, any payments from the company, or any parent or subsidiary of the company, in excess of $60,000 during the current fiscal year or any of the past three fiscal years, other than certain committed payments, would not be deemed independent.

The Payments Provision is generally intended to capture situations where a payment is made directly to, or for the benefit of, the director or family member of the director. Such situations may include a consulting or personal service contract with a director or family member of the director, or political contributions to the campaign of a director or family member of the director.

• Family of Executive Officer Provision. A director who is a family member of an individual who is currently, or was at any time during the past three years, employed as an executive officer by the company or by any parent or subsidiary of the company would not be deemed independent.

• Business Relationship Provision. A director who is, has a family member who is, a partner, a controlling shareholder or an executive officer of any organization to which the company made, or from which the company received, payments for property or services in the current or any of the past three fiscal years that exceed the greater of 5 percent of the recipient's consolidated gross revenues for that year or $200,000, other than certain permitted payments.

This provision is intended to capture payments to an entity with which the director or family member of the director is affiliated by serving as a partner (other than a limited partner), controlling shareholder or executive officer of such entity.

• Auditor Relationship Provision. A director who is, or has a family member who is, a current partner of the company's outside auditor, or was a partner or employee of the company's outside auditor, and who worked on the company audit at any time during the past three years would not be deemed independent.

• Interlocking Directorate Provision. A director of a listed company who is, or has a family member who is, employed as an executive officer of another entity at any time during the past three years, or any of the executive officers of the listed company serves on the compensation committee of such other entity, would not be deemed independent.

(ii) disclosure requirements in the annual proxy (or if the issuer does not file a proxy, in its Form 10-K or 20-F) regarding board determinations of independence;

(iii) explaining that compensation, nomination committees and/or a majority of independent directors may recommend action to the full board for determination, instead of acting unilaterally; and

(iv) adding a requirement for issuers to adopt a formal written charter or board resolution to cover the nominations process and to certify that they have done so.

NYSE final rules now include (i) a reduction of the look-back period in the per se disqualifications from independent director status from five years to three years, with a limited one year look-back which applies only in the first year after November 4, 2003; (ii) suggested annual independent director only executive sessions; and (iii) an explanation that all independent directors, rather than just the compensation committee, may be involved in approving the CEO's compensation.

Compliance Dates. For both the NYSE and NASDAQ, companies must comply with these new listing standards as of the earlier of their first annual meeting after January 15, 2004 or October 31, 2004, except as otherwise provided, such as in the case of foreign private issuers, small business issuers, and initial public offerings consistent with Rule 10A-3 of the Securities Exchange Act of 1934.

For both the NYSE and NASDAQ, if a company with a classified board (with the exception of the audit committee requirements) is required to change a director who would not normally stand for election in the first annual meeting following the compliance date, such director will be permitted to remain in office until the second annual meeting after January 15, 2004, but no later than December 31, 2005.

NASDAQ Rule 4350(n) requires issuers to adopt a code of conduct by May 4, 2004. NASDAQ Rule 4350(h), requiring independent committee approval of related party transactions, will be operative January 15, 2004. The remainder of NASDAQ Rules 4350(a) "qualitative listing standards" and 4350(b) "going concern rule" were effective November 4, 2003.

Foreign private issuers have until July 31, 2005 to comply with Rule 10A-3 audit committee requirements and any NASDAQ rules regarding independence, independent committees, limitations on corporate governance exceptions, and notification of non-compliance. A foreign issuer must disclose the receipt of a corporate governance exemption from NASDAQ for any new listings and filings made after January 1, 2004.

IPOs. For both the NYSE and NASDAQ, issuers that have listed or that will be listed in conjunction with their initial public offering are exempt from all board composition requirements, consistent with the exemptions afforded in Rule 10A-3(b)(1)(iv)(A). Each committee that a company adopts must have one independent member at the time of listing, the majority of independent members within 90 days of listing, and all independent members within one year. Issuers can choose not to adopt a compensation or nomination committee and instead rely upon a majority of the independent directors to discharge such responsibilities under the rules. These issuers would be required to meet the majority independent board requirement within one year of listing.

Look-back Periods. For both the NYSE and NASDAQ, the look-back is three (3) years from the first anniversary after November 4, 2003. For the NYSE, there is a transition period. In the first year after adoption, the look-back is one year.

Transfers. Companies listing upon transfer from another market have twelve 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 the market's rule that had not yet expired, the company will have the same transition period as would have been available to it on the other market. This transition period for companies transferring from another market will not apply to the requirements of Section 303A.06 unless a transition period is available pursuant to Rule 10A-3 under the 1934 Act.

Recommended Actions

In view of these amendments, NYSE and NASDAQ listed companies will need to:

• Review and revise their audit, nominating and compensation committee charters.

• Review existing ethics codes and corporate governance guidelines.

• Review existing contractual commitments regarding directors, and implement director and officer questionnaires to reflect the new independence standards.

• Evaluate existing and proposed board members and committee members against new independence standards and look-back periods.

• Prepare procedures to enable the CEO to annually certify compliance with corporate governance listing standards.

• Provide ongoing reviews of related party transactions by the audit committee or other independent committee.

• Prepare required disclosures regarding codes of conduct and ethics, communication with presiding director, corporate governance guidelines, and charters of committees. These disclosures should be posted on the company's Web site, made available to shareholders in printed form, and filed with the company's Form 10-K, as appropriate. 1 SEC Release No. 34-48745; File Nos. SR-NYSE-2002-33, SR-NASD-2002-77, SR-NASD-2002-80, SR-NASD-2002-138, SR-NASD-2002-139, and SR-NASD-2002-141 (November 4, 2003). (
2 17 CFR 240.10A-3.

Lola Miranda Hale is a Partner in the Chicago office of Holland & Knight LLP. A more detailed memorandum separately addressing the new rules for NYSE and NASDAQ, respectively, is available on our Web site at or by contacting Lola Miranda Hale or any of the following Holland & Knight attorneys: Thomas Archer, Rodney H. Bell, Michael J. Boland, Bradley B. Furber, Harvey Alan Goldman, Robert Grammig, James Lurie, Lance D. Myers, Anne Hamblin Schiave, Steven Sonberg, William E. Van Valkenberg, Mark A. von Bergen, Steven J. Weiss at 1-888-688-8800.

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