Even before the Sarbanes-Oxley Act of 2003 ("SOX") became law, self-regulatory organizations, including the New York Stock Exchange ("NYSE") and The Nasdaq Stock Market ("Nasdaq"), were considering revisions to the corporate governance standards applicable to listed companies. On November 4, 2003, the Securities and Exchange Commission (the "SEC") approved revised NYSE and Nasdaq listing standards which implement many important corporate governance reforms. While largely similar in substantive terms, the NYSE and Nasdaq standards also differ in some significant ways. This article provides a broad overview of the new listing standards and highlights certain of the differences between the new NYSE and Nasdaq rules.
Both NYSE and Nasdaq now require boards to be comprised of a majority of independent directors. In this regard, both require regularly scheduled executive session meetings for independent directors. Furthermore, listed companies must disclose in their annual proxies those directors that the board has determined to be independent.
Both NYSE and Nasdaq revised their definitions of "independent director" to clarify instances in which directors are automatically disqualified from being deemed "independent". Furthermore, as discussed below, both NYSE and Nasdaq have adopted heightened independence standards for audit committee members.
Under the NYSE standards, a director would not be deemed independent if the director:
Is an employee, or has an immediate family member who is an executive officer, of the company until three years after the end of such employment relationship;
Receives, or has an immediate family member who receives, more than $100,000 per year in direct compensation from the listed company, except for certain permitted payments, until three years after he or she ceases to receive more than $100,000 per year in such compensation;
Is affiliated with or employed by, or has an immediate family member who is affiliated with or employed in a professional capacity by, a present or former internal or external auditor of the company until three years after the end of the affiliation or the employment or auditing relationship;
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 serve on the compensation committee until three years after the end of such service or employment relationship;
Is an executive officer or an employee, or whose immediate family member is an executive officer, of a company (including charitable organizations if certain conditions are met) that makes payments to, or receives payments from, the listed company for property or services in an amount which, in any single fiscal year, exceeds the greater of $1 million, or 2% of such other company's consolidated gross revenues, until three years after falling below such threshold.
Under the Nasdaq standards, a director would not be deemed independent if the director:
Is, or at any time during the past three years was, employed by the company or any parent or subsidiary;
Accepts, or has a family member who accepts, any payments from the company, or any parent or subsidiary, in excess of $60,000 during the current fiscal year or any of the past three fiscal years, with limited exceptions;
Is a family member of an individual who is, or at any time during the past three years was, employed by the company or any parent or subsidiary as an executive officer;
Is, or has a family member who is, a partner in, or a controlling shareholder or an executive officer of, any organization (including charitable organizations) 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% of the recipient's consolidated gross revenues for that year, or $200,000, with limited exceptions;
Is, or has a family member who is, employed as an executive officer of another entity at any time during the past three years where any executive officer of the listed company serves on the compensation committee of such entity;
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 worked on the company's audit, at any time during the past three years;
In the case of an investment company, is an "interested person" of the company as defined in Section 2(a)(19) of the Investment Company Act, other than in his or her capacity as a member of the board of directors or any board committee.
Both NYSE and Nasdaq have implemented the audit committee composition requirements set forth under Section 301 of SOX and the rules and regulations thereunder. Under Section 301 and SEC Rule 10A-3 thereunder, each audit committee member must meet heightened "independence" standards under which an audit committee member may not, except in his or her capacity as a member of the audit committee, the board, or any other board committee "(A) accept directly or indirectly any consulting, advisory, or other compensatory fee from the issuer or any subsidiary thereofÉ ; or (B) be an affiliated person of the issuer or any subsidiary thereof."
Under the NYSE listing standards, audit committee charters must, at a minimum, set out the audit committee's responsibilities to:
Perform those duties set forth in SEC Rule 10A-3(b)(2)-(5);
Annually obtain and review an independent auditor report;
Discuss the annual audited financial statement and quarterly financial statements with management and the independent auditor;
Discuss the company's earnings press releases and financial information and earnings guidance provided to analysts and rating agencies;
Discuss policies relating to risk assessment and management;
Meet separately, periodically, with management, internal auditors, and independent auditors;
Review with the independent auditors any audit problems or difficulties and management's response;
Set clear hiring policies for employees or former employees of the independent auditors; and
Report regularly to the board.
Under the Nasdaq listing standards, audit committee charters must, at a minimum:
Set out the audit committee's responsibility to oversee the accounting and financial reporting processes and the audits of the financial statements of the issuer;
Include specific audit committee responsibilities and authority;
Address the scope of the audit committee's responsibilities and the means by which the committee carries out those responsibilities;
Address the outside auditor's accountability to the audit committee; and
Address the audit committee's responsibility to ensure the independence of the outside auditors.
The NYSE corporate governance standards now require compensation committees to be composed entirely of independent directors. Compensation committees of NYSE listed issuers must have written charters that address, among other things, the committee's purpose and responsibilities and an annual performance evaluation of the compensation committee. Compensation committees must also produce a compensation committee report on executive compensation to be included in the company's annual proxy statement or annual report on Form 10-K. With respect to compensation of the chief executive officer ("CEO"), the NYSE provides that either as a committee or together with the other independent directors (as directed by the board), the committee is to determine and approve the CEO's compensation level based on the committee's evaluation of the CEO's performance.
Under the new Nasdaq standards, compensation of the CEO and all other officers must be determined or recommended to the board for determination either by a majority of the independent directors or by a compensation committee comprised solely of independent directors.
Nominating/Corporate Governance Committees
While the SEC adopted final rules to enhance the disclosure requirements with respect to the operations of board nominating committees and a new disclosure requirement regarding the means (if any) by which security holders may communicate with directors, the SEC does not require companies to have nominating/corporate governance committees. Nonetheless, both NYSE and Nasdaq adopted standards relating to the nomination of board members.
Under the NYSE standards, each NYSE listed company must have a nominating/corporate governance committee composed entirely of independent directors. Such committee must have a written charter that addresses, among other things, the committee's purpose and responsibilities, and an annual performance evaluation of the nominating/corporate governance committee. In addition, the committee must identify individuals qualified to become board members, consistent with criteria approved by the full board.
Nasdaq amended its listing standards to require director nominees to be selected or recommended for the board's selection either by a majority of independent directors, or by a nominations committee comprised solely of independent directors.
Codes of Business Conduct And Ethics
While Section 406 of SOX and the rules and regulations thereunder only require issuers to disclose whether they have adopted a code of ethics applicable to an issuer's principal executive officer and senior financial officers and if they have not done so, why not, the new NYSE and Nasdaq listing standards require listed company's to adopt and publicly disclose codes of ethics applicable to all directors, officers and employees. Both NYSE and Nasdaq require company codes of ethics to include appropriate compliance standards and procedures. Furthermore, both NYSE and Nasdaq require companies to make certain disclosures regarding codes of ethics and any waivers of codes.
The NYSE commentary describes a number of important topics that codes of ethics should address, including, among others, conflicts of interest; corporate opportunities; confidentiality of information; fair dealing; protection and proper use of company assets; compliance with laws, rules and regulations (including insider trading laws); and encouraging the reporting of any illegal or unethical behavior.
NYSE Only Listing Standards
The following are certain of the corporate governance provisions that were adopted by NYSE but not Nasdaq:
NYSE listed companies must have an internal audit function.
NYSE listed companies must adopt and disclose corporate governance guidelines addressing certain topics, such as director qualification standards, director responsibilities, director access to management and independent advisors, director compensation, director orientation and continuing education, management succession, and annual performance evaluation of the board. In addition, NYSE requires companies to make certain disclosures regarding their corporate governance guidelines.
The CEO of each NYSE listed company must annually certify to NYSE (and disclose in its annual report to shareholders or annual report on Form 10-K) that such CEO is not aware of any violation by the company of the NYSE's corporate governance listing standards.
NYSE may now issue public reprimand letters to companies that violate NYSE listing standards.
Nasdaq Only Listing Standards
The following are certain of the corporate governance provisions that were adopted by Nasdaq but not NYSE:
An issuer must provide prompt notice to Nasdaq after an executive officer becomes aware of any material noncompliance by the issuer with NASD Rule 4350.
Boards must conduct an appropriate review of all related party transactions for potential conflict of interests.
With certain exceptions, NYSE and Nasdaq listed companies will generally have to comply with most of the new listing requirements by the earlier of their first annual meetings after January 15, 2004 or October 31, 2004. Therefore, because it will take some time for companies to implement all of the new corporate governance reforms (e.g., identifying additional independent directors, revising corporate charters and bylaws, committee charters and codes of ethics, implementing appropriate controls and procedures, etc.), companies should begin to plan and implement such changes now to ensure that they are in compliance with the standards.