Proposed New Corporate Governance Listing Standards by the New York Stock Exchange and Nasdaq

Originally published on June 19, 2002

In reaction to the perceived corporate governance failures at Enron and other recently humbled public companies, both the NYSE and Nasdaq have recently proposed a number of corporate governance rule changes for their listed companies. These corporate governance initiatives portend some significant changes in the composition, role and management of the boards of directors of publicly traded companies, and also reflect a substantially new role for Federal and national market regulation of listed companies in the corporate governance arena, which has traditionally been the exclusive domain of state corporate law.1

These newly proposed corporate governance standards come on the heels of five significant recent SEC proposals that would increase and accelerate reporting of financial results, significant accounting policies, trading in company equity securities by insiders and other insider transactions.2 The NYSE and Nasdaq proposals are still subject to review, public comment and approval by the SEC and, in the case of the NYSE proposal, also to approval by the NYSE board of directors, which may significantly refine or alter these proposals.

We recognize, however, that the SEC, the securities exchanges and Nasdaq are endeavoring to respond forcefully to market concerns raised in the post-Enron era and generally believe that these proposed corporate governance standards will ultimately be adopted in substantial part by fall 2002. These proposals seek an appropriate balance of the inherent tensions between strengthening companies' boards of directors and their independence without creating an internal board environment that becomes so cumbersome, bureaucratic and separated from management that corporate entrepreneurship and quick, decisive risk-taking are sacrificed.

This article highlights and summarizes the new NYSE and Nasdaq proposals and concludes with several practical observations in light of these proposals. While these proposals are subject to change, they are likely to impose significant new substantive and disclosure burdens on listed companies, and we urge our clients to review the proposals with us to understand the new requirements and prepare for their eventual adoption. You may also want to consider commenting on these proposals during the SEC's public comment period, and we can assist you in doing so.

Highlights

NYSE Listing Standards. The NYSE proposed listing standards include the following changes for NYSE listed companies:

A majority of a listed company's board would be independent

The definition of "independence" would be tightened for board members

Boards of listed companies would convene regular executive sessions in which the non-management directors would meet

A listed company would be required to have audit, nominating/corporate governance and compensation committees comprised solely of independent directors

Audit committees would have the sole authority for hiring and firing independent auditors and for approving non-audit work performed by the company's auditors

The chair of the audit committee would be required to have accounting or financial management experience

A listed company would be required to have formal corporate governance guidelines and a formal code of business conduct, ethics and corporate governance, as well as formal charters for its audit, compensation and nominating/corporate governance committees

A listed company would be required to make publicly available key committee charters, its corporate governance guidelines and its code of business conduct and ethics and would be required to promptly publicly disclose any waivers of such charters or codes for insiders

Shareholders of listed companies would be required to vote on all equity-based plans for management and employees, including amendments and option repricings

Each listed company's CEO would be required to certify annually to the NYSE that the company has established and complied with procedures for veri-fying the accuracy and completeness of financial and other information provided to investors and that he or she has no reasonable cause to believe that such information is not accurate and complete and is not aware of any violations of the NYSE listing standards

Foreign companies that are listed companies would be required to disclose any significant variations from NYSE listing standards

Nasdaq Listing Standards. Nasdaq's proposed new corporate governance requirements include the following changes:

The definition of "independence" would be tightened for board members

A listed company's audit committee or a comparable body of the board of directors would be required to review and approve all related-party transactions

A listed company would be required to obtain shareholder approval for all stock option plans in which officers and directors participate

A listed company may be delisted for a material misrepresentation or omission to Nasdaq

Any listed company receiving an audit opinion with a going concern qualification would be required to inform its investors and potential investors by issuing a press release

In addition, the Nasdaq Listing and Hearing Review Council will discuss a second round of corporate governance reforms at its meeting on June 26-28, 2002, including proposals regarding the following:

A majority of a listed company's board would be independent

Former auditors of a listed company would not be able to serve on the company's audit committee until after a cooling-off period

The scope of the authority of the audit committee would be expanded

A listed company would be required to have a compensation committee comprised solely of independent directors

A listed company would be required to have formal corporate codes of conduct with a supporting compliance system

Foreign companies that are listed companies would be required to disclose the receipt of a wavier of corporate governance standards

Continuing education for directors would be strengthened

Proposed Changes to NYSE Listing Requirements

Summarized below are the new NYSE corporate accountability listing standards proposed by the NYSE's Corporate Accountability and Listing Standards Committee. The NYSE has published the Committee's report for comment and expects to take final action on the report at its August 1, 2002 board meeting before forwarding the proposals to the SEC for its approval.3

Director Independence

Independent Directors. The NYSE will require that a majority of a company's directors be independent, and that all members of the audit, nominating and compensation committees be independent, within 24 months of the adoption of the proposed rules. Currently, the NYSE requires only that audit committee members be independent and defines independence for this purpose as having "no relationship to the company that may interfere with the exercise of. Independence from management and the company."

Tighter Definition of Director Independence. The NYSE will tighten the definition of what constitutes an "independent director." Under the proposed definition, no director will qualify as "independent" unless the board of directors affirmatively determines that the director has no material relationship with the listed company (either directly or as a partner, shareholder or officer of an organization that has a relationship with the company). The board of directors would be required to affirmatively determine, and publicly disclose the determination, that the director has no material relationship with the company.

When assessing the materiality of a director's relationship with the company, the board would be directed to consider the issue of independence not merely from the standpoint of the director, but also from that of persons or organizations with which the director has an affiliation. Material relationships could include, for this purpose, commercial, industrial, banking, consulting, legal, accounting, charitable and familial relationships (among others). Additionally, a director would not be considered independent until after the expiration of a five-year "cooling off" period following employment by the company, employment or affiliation with a present or former auditor of the company, or association with an executive officer of the listed company serving on the compensation committee of another company that employed the director. Directors with immediate family members in any of these categories would also be subject to the same five-year "cooling-off " period. The proposed tightening of the concept of director independence results in a stricter standard, in some respects, than other legal concepts of director independence traditionally utilized by companies in connection with corporate governance and securities law compliance. As a result, directors who were considered independent or unaffiliated for some board purposes in the past may no longer be viewed as independent for purposes of these proposed NYSE listing standards.

Item 404(a) of S-K. For example, under Item 404(a) of Regulation S-K (which guides disclosures of related party transactions by companies filing registration statements under the Securities Act of 1933 and annual reports and proxy statements under the Securities Exchange Act of 1934), transactions involving...