NYSE and Nasdaq Revise Proposed Corporate Governance Rules in Limited Respects Relating to Director Independence and Other Matters

The New York Stock Exchange and the Nasdaq Stock Market have filed interim amendments with the SEC that revise limited, but potentially important, aspects of their previously proposed corporate governance rules. The NYSE revisions affect their director independence proposals, while the Nasdaq revisions affect their proposals on director independence, audit committee matters and codes of conduct. The remainder of the originally proposed corporate governance rules remain unchanged.

It is important to note that the SEC has not yet published for comment any of the corporate governance rules proposed by the NYSE or Nasdaq, other than the proposals concerning shareholder approval of equity plans. Accordingly, the proposed rules remain subject to further revisions by the NYSE or Nasdaq, as well as publication for public comment and possible further changes in response to public comments, before they are adopted in final form. The anticipated timing for finalizing these proposed rules remains uncertain at this time. Under the Sarbanes-Oxley Act of 2002, the SEC has until April 26, 2003 to issue rules requiring the NYSE and Nasdaq (and other self regulatory organizations) to adopt rules implementing §301 of Sarbanes-Oxley, which focuses solely on audit committees and related issues. The remaining corporate governance proposals address other topics and are not subject to any specific Sarbanes-Oxley deadline. A formal publication of the proposals for public comment and approval by the SEC will be necessary before any of the rules can become effective.

Although these recent filings are interim revisions to the proposals, as opposed to listing standards that are currently in effect and need to be complied with at this time, the revisions may change proposed requirements that certain companies have already considered in preparing for the post-Sarbanes-Oxley environment.

The following summary highlights the most significant changes contained in the revised NYSE and Nasdaq proposals:

At the request of the SEC, on March 12, 2003, the NYSE filed a revised listing standard proposal, which excerpted its previously proposed rules concerning director independence so that they can be published (and thus adopted) separately from the other previously proposed corporate governance rules. A copy of the revisions can be found at http://www.nyse.com/pdfs/2003-06fil.pdf.

In addition to being filed separately, the new amended rules differ from the original proposals in several key aspects, including:

The amended proposals delete the per se rule that employees and former employees cannot be considered independent. Instead, the amended proposals establish a rebuttable presumption that a director is not independent if he or she, or a family member, received more than $100,000 in compensation in any of the past five years. A company’s board of directors may overcome this presumption by making an affirmative determination that a particular director is nevertheless independent so long as no independent directors dissent from the determination. Any such determination must be specifically explained in the company’s proxy statement.

The amendments add a bright line test for determining when a director is no longer independent as a result of a relationship with another company that does business with the listed company. The director is not independent if, within the preceding five years, he or she, or an immediate family member, was an executive officer or employee 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.

The amended proposals include a transition period that effectively "grandfathers" many existing directors’ status as independent. The proposed independence standards generally require that a director not have any of the prescribed relationships currently or within the past five years. The new revisions begin this five-year "look-back" period from the effective date of the new rules. Thus, directors will not be disqualified on the basis of events that occurred before the final SEC approval of the NYSE’s proposed director independence rules.

Under the amended proposals, companies generally will have 18 months, rather than the previously proposed 24 months, to comply with the new director independence standards. If a change would be required for a director who would not normally stand for election in the first annual meeting after this 18-month implementation period (e.g., in the case of a staggered board), the NYSE would allow for an additional year to effect the change in that director position. Finally, companies listing in conjunction with their IPO or transferring from another exchange will have 24 months to comply.

The NYSE also stated that it expects the director independence rules to be published separately from its other corporate governance proposals, but anticipates SEC approval will occur so that all of the rules become effective at the same time. NASDAQ Revisions to Director Independence, Audit Committee and Code of Conduct Proposals

On March 11, 2003, Nasdaq filed a revised proposal amending its original proposal with respect to director independence matters and audit committee matters, a copy of which can be found at http://www/nasdaq.com/about/2002_141_A_1.pdf.

On January 15, 2003, Nasdaq filed a revised proposal amending its original proposal with respect to codes of conduct for listed companies, a copy of which can be found at http://www.nasdaq.com/about/SR-NASD-2002-139-Amendment1.pdf.

Among other changes, these revised filings amend the original Nasdaq corporate governance proposals as follows:

The amendments revise the proposed Nasdaq rule disqualifying directors from being independent if a family member received more than $60,000 in payments from the listed company in any of the past three years to exclude compensation paid to family members who are employees but not executive officers. Thus, a director can still be independent if he or she has a family member employed by the company who was paid more than $60,000 per year so long as the relative is not an executive officer.

Audit Committee Charter. The revised Nasdaq proposals add a requirement that Nasdaq companies’ audit committee charters expressly state that the committee’s purpose is to oversee the accounting and financial reporting processes of the company and the audits of the financial statements of the company.

Financial Expert. The amended proposals withdraw the earlier proposal that at least one audit committee member qualify as a "financial expert" and retain the existing requirement that at least one audit committee member have suitable financial oversight experience. Companies will still need to disclose whether they have an "audit committee financial expert" in accordance with Sarbanes-Oxley and related SEC rules.

Engagement of Outside Consultants. The revised proposals add commentary clarifying that, while audit committees have the power to engage outside advisors, they are "not expected to do so routinely," but are expected to do so in specific circumstances when the audit committee determines it is in the best interest of the company and its shareholders.

Employees of 20% Stockholders Not Considered Independent for Audit Committee Purposes. Under Sarbanes-Oxley and related SEC rules, audit committee members must satisfy heightened standards of independence, including the requirement that they not be "affiliated persons." The original Nasdaq proposals included commentary stating that, for these purposes, 20% stockholders will be considered "affiliated persons." The revised proposals include additional commentary clarifying that employees of 20% stockholders will also be considered "affiliated persons" for these purposes.

Codes of Conduct. The revised Nasdaq proposals amend the proposed rule requiring listed companies to have a code of conduct. The more substantive revisions were to:

• require that listed companies have codes of conduct applicable to all directors, officers and employees that satisfy the requirements for "codes of ethics" under §406 of Sarbanes-Oxley and related SEC rules, which require disclosure as to whether companies have codes of ethics for senior financial officers that include standards reasonably necessary to promote the ethical handling of conflicts of interest, full and fair disclosure, and compliance with laws, rules and regulations;

• revise the requirement to "promptly disclose" any waivers to require disclosure in public filings no later than the listed company’s next periodic report (e.g., Form 10-K or Form 10-Q); and

• revise the proposed implementation period to require compliance with six months following SEC approval, as opposed to the originally proposed compliance deadline of the company’s first annual meting after January 1, 2004.