SEC Approves NASD and NYSE Rules Relating to Corporate Governance and Director Independence
 
November 25, 2003
 
Steven Sonberg - Miami

On November 4, 2003[1] 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-3[2] (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; (ii) disclosure requirements 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.

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.

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 chose 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.

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 website, made available to shareholders in printed form, and filed with the company’s Form 10-K, as appropriate.

A more detailed memoranda separately addressing the new rules for each NYSE and NASDAQ is available on our website at /id24660/PublicationId2244/ReturnId31/contentid49527/, or by contacting Lola Miranda Hale or Steven Sonberg at 1-888-688-8800.

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[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). (http://www.sec.gov/rules/sro/34-48745.htm).

[2] 17 CFR 240.10A-3.