On August 1, 2002, the New York Stock Exchange (the "NYSE") board of directors adopted the changes to the NYSE listing standards ("NYSE Proposal") proposed by its Corporate Accountability and Listing Standards Committee (the "NYSE Committee"). The adoption followed a two-month comment period on the proposed corporate governance changes that the NYSE announced on June 6, 2002 (the "Initial NYSE Proposal"). The report of the NYSE Committee, as approved by the NYSE board, is available on their website (pdf format). On August 16, 2002, the NYSE submitted the NYSE Proposal to the Securities and Exchange Commission ("SEC"); the NYSE Proposal will be subject to a period of public comment prior to SEC approval.

On July 24, 2002, the Nasdaq Stock Market ("Nasdaq") board of directors approved 25 corporate governance proposals (the "Additional Nasdaq Proposal"). These add to the proposals on corporate governance approved by the board on May 24, 2002 (the "Initial Nasdaq Proposal" and, with the Additional Nasdaq Proposal, the "Nasdaq Proposal"). The Initial Nasdaq Proposal was publicly released and filed with the SEC on June 5, 2002. On July 29, the SEC approved the Nasdaq proposal clarifying that a material misrepresentation or omission by a company to Nasdaq may result in the company being delisted.¹ Nasdaq has not yet filed with the SEC a formal rule change proposal covering the Additional Nasdaq Proposal. As with the NYSE Proposal, the SEC must approve the Nasdaq Proposal before the changes can be implemented.

On July 30, 2002, the President signed into law the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act"). The Sarbanes-Oxley Act requires companies, including those subject to Nasdaq and NYSE listing requirements, to comply with a number of new corporate governance provisions, some of which overlap with the NYSE Proposal and the Nasdaq Proposal. The Director of the Division of Corporate Finance of the SEC has indicated that, before the formal rule proposals are filed with and published by the SEC for comments, an effort will be made to achieve consistency between the proposals and the provisions of the Sarbanes-Oxley Act, which could delay publication.

While the Nasdaq Proposal and the NYSE Proposal (the "SRO Proposals") are still subject to the SEC rulemaking process (except as noted above), and in certain cases to harmonization with the Sarbanes-Oxley Act, we encourage listed companies to carefully review their board and committee compositions and corporate governance practices in light of the SRO Proposals. In particular, companies may need time to review and implement the changes to various committee charters and codes of conduct, and to locate suitable independent director candidates. Because many of the SRO Proposals were adopted in response to the request of SEC Chairman Pitt that the NYSE and Nasdaq review their corporate governance standards, we expect the SEC to move quickly on the NYSE Proposal, and the Additional Nasdaq Proposal once it is filed.

Changes from the Initial NYSE Proposal

In adopting the NYSE Proposal, the NYSE board made a number of changes from the Initial NYSE Proposal, based in part of the comments received by the NYSE board. A number of the changes were also made to avoid conflict with overlapping provisions of the Sarbanes-Oxley Act and SEC rulemaking initiatives. (A list compiled by the NYSE of clarifications and modifications from the Initial NYSE Proposal is attached to this memorandum as Appendix A.)² Some of these changes and clarifications are as follows:

• The NYSE has dropped its proposed annual CEO certification on the quality of information provided to investors in light of the CEO and CFO certification provisions in the Sarbanes-Oxley Act and in SEC proposals (the proposed CEO certification regarding NYSE rule compliance is retained).
• The NYSE has dropped a provision calling for special expertise in the audit-committee chairperson, pending SEC rulemaking on qualifications for audit committee members as required by the Sarbanes-Oxley Act.
• The NYSE has dropped a provision calling for an affiliate of a 20% or greater shareholder not to chair or vote on the audit committee in light of the provision of the Sarbanes-Oxley Act disqualifying affiliated persons from service on the audit committee.
• The NYSE has dropped a provision requiring that the audit committee appoint and oversee the company's auditor, in light of a similar requirement of the Sarbanes-Oxley Act.
• The NYSE Proposal clarifies that disallowed compensation for audit committee members includes fees paid for services as consultant or a legal or financial advisor, regardless of the amount. This helps bring the NYSE Proposal in line with the Sarbanes-Oxley Act provision on independence of audit committee members.
• The NYSE Proposal provides an exception to the board and committee independence requirements for "controlled companies," however such companies must continue to comply with the existing requirement of a minimum three-person audit committee comprised entirely of independent directors.
• The NYSE Proposal permits companies to delegate the enumerated responsibilities of the nominating/corporate governance and compensation committees to a committee of their own choosing, provided that all the members of the committee are independent.
• The NYSE Proposal adds exceptions to the requirement that shareholders be allowed to vote on all stock options plans for employment-inducement options, options plans acquired through mergers and tax-qualified plans such as 401(k) plans.
• The NYSE Proposal adds a requirement that listed companies have internal audit functions.
• The NYSE Proposal clarifies that the disclosure of significant differences between a foreign private issuer's corporate governance and the NYSE requirements for domestic companies was not intended to be a "laundry list" and may be made in a brief, general summary.

The NYSE Proposal

As adopted by the NYSE Board, the following are highlights of the NYSE Proposal (a chart prepared by the NYSE comparing the NYSE Proposal to existing NYSE listing standards is attached to this memorandum as Appendix B):

Majority of Independent Directors

• A majority of a listed company's board must be "independent," rather than the minimum of three required under the existing listing standards (companies would have 24 months from the rule's adoption to comply); as noted above, there is an exception for "controlled companies."

Narrower Definition of "Independence"

• No director would be deemed "independent" unless the board of directors affirmatively determined that the director had 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 basis for a board determination that a relationship is not material must be disclosed in the company's annual proxy statement. The NYSE Proposal, as adopted, clarified that in this regard a board may adopt and disclose standards to assist in determining whether a director is independent. The NYSE Committee stated that, when assessing the materiality of a director's relationship with the company, the board of directors should consider the issue not merely from the standpoint of the director, but also from that of persons or organizations with which the director has an affiliation, including from a commercial, industrial, banking, consulting, legal or accounting standpoint.
• The existing standards of independence currently applicable to audit committee members would apply to directors in general; in addition, under the NYSE Proposal, the following persons would not be independent:³
  • former employees of the company until five years after the employment ended;
  • persons presently or formerly affiliated with or employed by a present or former auditor of the company (or of an affiliate) until five years after the affiliation or auditing relationship has ended; and
  • persons who are, or in the past five years have been, part of an interlocking directorate in which the CEO or other executive officer of the company serves on the compensation committee of another corporation that employs any such person.
  • A person with an "immediate family member," which family member is, or in the past five years was, in one of the foregoing categories.

Executive Sessions for Non-Management Directors

• Non-management directors must meet regularly without management and disclose in the annual proxy statement either the name of the director presiding at such meetings, or the procedure by which a presiding director is selected. There is no current NYSE listing rule on this topic.

Independent Nominating/Corporate Governance Committee

• A listed company, subject to the controlled company exception, must have a nominating/corporate governance committee (or a committee performing similar functions) comprised entirely of independent directors; current NYSE listing rules do not require such a committee.
• The nominating/corporate governance committee must have a charter addressing:
  • the committee's purposes, including (1) identifying individuals qualified to become board members and selecting, or recommending the full board select, the director nominees for the next annual shareholders meeting and (2) developing and recommending a set of corporate governance principles applicable to the company;
  • the committee's goals and responsibilities, including establishing criteria for selecting new directors and overseeing the evaluation of the full board and management of the company; and
  • annual performance evaluation of the committee.

The NYSE also indicated a number of items that the nominating/corporate governance committee charter should address, including committee member qualifications, appointment and removal procedures and committee structure and operations. The NYSE noted that if a company is legally required to provide third parties with the ability to nominate directors, the selection and nomination of such directors need not be subject to the nominating committee process.

Independent Compensation Committee

• A listed company, subject to the controlled company exception, must have a compensation committee (or a committee performing similar functions), comprised entirely of independent directors; current NYSE listing rules do not require such a committee.
• The compensation committee must have a charter addressing:
  • the committee's purposes, including determining and reporting on executive compensation and preparing a compensation committee report for inclusion in the company's proxy statement;
  • the committee's duties and responsibilities, including reviewing and approving corporate goals and objectives relevant to CEO compensation, evaluating the CEO's performance in light of these goals and objectives, and setting the CEO's compensation based on such evaluation;
  • the procedure by which the committee would make recommendations to the full board with respect to incentive compensation plans; and
  • annual performance evaluation of the committee.

The NYSE also indicated a number of items that the compensation committee charter should address, including committee member qualifications, appointment and removal procedures and committee structure and operations.

Additional Audit Committee Standards and Responsibilities

Independence and Expertise

• Directors' fees (including normal equity-based awards) are the only permitted form of compensation (receipt of deferred compensation for prior services will not preclude a director from satisfying this requirement); fees paid directly or indirectly for services as a consultant or a legal or financial advisor are specifically disallowed.

Increased Authority and Responsibilities

The audit committee charter must include an enhanced statement of the audit committee's purpose, and the additional responsibilities of the audit committee, including:

• retaining and terminating the company's independent auditors (subject, if applicable, to shareholder ratification);
• discussing the annual and quarterly financial statements and the Management's Discussion and Analysis in the company's SEC filings with management and the independent auditor;
• reviewing the company's internal control procedures (the NYSE Proposal clarifies that each listed company will be required to have an internal control function);
• discussing earnings press releases and financial information and earnings guidance provided to analysts and rating agencies;
• obtaining advice and assistance, where appropriate, from outside legal, accounting and other advisors;
• discussing policies with respect to risk assessment and management;
• meeting periodically, with management, with internal auditors and with independent auditors;
• reviewing with the independent auditors any audit problems and management's response;
• setting clear hiring policies for employees or former employees of the company's independent auditors;
• reporting regularly to the board of directors; and
• performing an annual evaluation of the audit committee's work.

Equity Compensation Plans

• The NYSE Proposal eliminates certain exceptions to the requirement in the NYSE listing standards that shareholders approve equity compensation plans in which officers and directors participate; only the following plans would be exempt: (1) employment-inducement options, (2) option plans acquired through mergers and (3) tax-qualified plans such as Employee Stock Ownership Plans ("ESOPs").

Corporate Governance Plans

• Companies must adopt and disclose corporate governance standards, including provisions that cover:
  • director qualifications (including independence requirements) and responsibilities;
  • director access to management and independent advisors;
  • director compensation guidelines;
  • director orientation and continuing education;
  • management succession; and
  • annual performance evaluation of the board.
• Companies must disclose on their web sites the corporate governance standards, the charters of their most important committees (including at least the audit, compensation and nominating committees) and their code of business conduct and ethics.

Business and Ethics Code of Conduct

• Companies must adopt and disclose a code of business conduct and ethics for directors, officer and employees, covering matters including:
  • conflicts of interest;
  • corporate opportunities;
  • confidentiality;
  • fair dealing;
  • protection and proper use of company assets;
  • compliance with laws and regulations (including insider trading laws); and
  • reporting of illegal or unethical behavior.
• Waivers may be made only by the board or a board committee and must be promptly disclosed to shareholders.

Disclosure by Foreign Private Issuers of Differences in Corporate Governance Practices

• Foreign private issuers must disclose any significant ways in which their corporate governance practices differ from those followed by U.S. companies under the NYSE listing standards. Disclosure may be made through the company's website if in English and accessible from the U.S.

Other Proposals

The NYSE Proposal would also:

• require the CEO to annually certify that he or she is not aware of any violation of the NYSE listing standards; and
• enable the NYSE to issue a public reprimand letter to any listed company that violates a NYSE listing standard, in addition to the existing penalty of delisting.

Time of Effectiveness of NYSE Proposals

The NYSE Proposal indicates the following time periods for the effectiveness of the new requirements:

Immediately upon SEC Approval:

• companies must obtain stockholder approval of equity compensation plans, as proposed; and
• the NYSE may issue a public reprimand letter for violation of NYSE listing standards.

Within Six Months from SEC Approval, companies must:

• provide for executive sessions of non-management directors;
• establish nomination and compensation committees with requisite charters;
• increase the authority and responsibility of the audit committee, adopt the required audit committee charter, and establish an internal audit function;
• adopt corporate governance guidelines and a code of business conduct and ethics;
• in the case of foreign private issuers, provide a description of significant differences from NYSE listing standards; and
• provide CEO certification of compliance with listing standards.

Within 12 Months from SEC Approval, companies must:

• have at least one independent director on each of the nominating and compensation committees.

Within 24 Months from SEC Approval, companies must:

• comply with the majority-independence requirement for the board of directors;
• comply with new qualification standards for audit committee members; and
• have nominating and compensation committees comprised solely of independent directors.

The Initial Nasdaq Proposal

The Initial Nasdaq Proposal:

• Requires stockholders to approve compensation plans that include executive officers or directors, with exceptions for (1) tax qualified, non-discriminatory plans such as ESOPs, (2) rights and warrants offered generally to all shareholders and (3) inducement grants to new executives, conditioned on approval of either the compensation committee or a majority of the independent directors (this is similar to the NYSE Proposal).
• Tightens the definition of independent director, including by (1) extending the current prohibition on the receipt of more than $60,000 in "compensation" to include "any payments" in excess of $60,000, other than compensation for board service, and extending this prohibition to an immediate family member of a director and (2) deleting the phrase "for-profit business" from the existing rule, so that a director will not be considered independent if the company makes payments to a charity where the director is an executive officer and such payments exceed the greater of $200,000 or five percent of either the company's or the charity's gross revenues
• Requires a company's audit committee or a comparable body of the board of directors not only to review but also to approve all related-party transactions.
• Requires a company to disclose an audit opinion with a "going concern" qualification.
• Clarifies that a material misrepresentation or omission by a company to Nasdaq may result in the company being delisted.⁴
• Harmonizes Nasdaq rules on disclosure of material information with those permissible under Regulation FD.

The Additional Nasdaq Proposal

In addition to the Initial Nasdaq Proposals made in May, the Additional Nasdaq Proposal proposes the following (see the attached summary of the proposals prepared by Nasdaq attached to this memorandum as Appendix C):

Board Independence

• A majority of the board must be independent (current Nasdaq rules require a sufficient number of independent directors to satisfy the requirement of an audit committee comprised of at least three directors, all of whom must be independent).
• In addition to the independence criteria in the Initial Nasdaq Proposal, certain additional persons will not be independent, including: (1) a 20% or greater shareholder, (2) any relative of an executive officer of the issuer or its affiliates (the Initial Nasdaq Proposal applied only to "immediate family members"), (3) former partners or employees of the company's auditors.
• Independent directors must approve (1) director nominations and (2) CEO compensation.

Audit Committees

• Audit committees have the sole authority to hire and fire outside auditors.
• Audit committees must preapprove non-audit services provided by the outside auditor.
• All audit committee members must be able to read and understand financial statements at the time of their appointment rather than "within a reasonable period of time" thereafter.
• Companies must limit the time that a non-independent director may serve on the audit committee and prohibit such person from serving as its chair.

Accelerated Disclosure of Insider Transactions

• Companies must disclose transactions in company stock by officers or directors within 2 business days for transactions exceeding $100,000, and by the second business day of the following week for smaller transactions.

Non-U.S. Companies

• Non-U.S. companies must disclose exemptions to Nasdaq's corporate governance requirements.
• Non-U.S. companies must file with the SEC and Nasdaq all interim reports filed in their home country, and at a minimum a semi-annual report, including a statement of operations and an interim balance sheet prepared in accordance with the requirements of the home jurisdiction.
• Non-U.S. companies must satisfy certain SmallCap initial and continued listing requirements.
• Underlying shares of SmallCap issuers with listed ADRs must satisfy the same publicly held shares and shareholder requirements that are applicable to domestic issuers.

Codes of Conduct

• Companies must have a publicly available code of conduct addressing, at a minimum, conflicts of interest and compliance with applicable laws, rules and regulations and disclosures of any waivers to executive officers and directors. Waivers can only be granted by independent directors.

Other Proposals

The Nasdaq Proposal would also clarify:

• when Nasdaq will presume that a change of control will occur, for purposes of the shareholder approval rules; and
• the authority of Nasdaq to deny re-listing to a company based upon a corporate governance violation that occurred while that company's appeal of the delisting was pending.

Overlap between Sarbanes-Oxley and the NYSE and Nasdaq Proposals

Because the SRO Proposals were initially made and, in the case of the Nasdaq Proposal, adopted before the enactment of the Sarbanes-Oxley Act, there are a number of areas in which the SRO Proposals overlap with, and may conflict with the Sarbanes-Oxley Act.

Audit Committee Financial Expertise

The Sarbanes-Oxley Act requires the SEC to issue rules to require each listed company to disclose in its periodic reports whether its audit committee includes among its members at least one "financial expert" and if not, why not.⁵

The NYSE currently requires its listed companies' audit committee members to be financially literate and at least one must have accounting or financial management expertise. The NYSE Committee recommended that the chair of the audit committee be required to have accounting or financial management expertise; this provision was dropped in light of the competing provision of the Sarbanes-Oxley Act.

The Additional Nasdaq Proposal requires that all audit committee members be able to read and understand financial statements at the time of their appointment.

While "financial expert" must be defined by the SEC, the Sarbanes-Oxley Act gives a number of factors which the SEC must consider in formulating such definition, including understanding of generally accepted accounting principles and financial statements, experience in preparing or auditing financial statements, and understanding of audit committee functions. Although the Sarbanes-Oxley Act only requires disclosure of whether an audit committee member is a "financial expert," it is unlikely that the Nasdaq and NYSE will impose a requirement of financial expertise that is any less stringent, or in any way inconsistent with, the definition to be proposed by the SEC. In the NYSE Proposal, the NYSE indicated that it will wait until the SEC has interpreted the definition of "financial expert" before imposing any such requirement. In addition, it is possible that Nasdaq also will refrain from proposing specific expertise requirements for audit committee members, pending SEC rulemaking on this issue.

Other Audit Committee Provisions

As noted above, the NYSE Committee indicated that, in light of the provision in the Sarbanes-Oxley Act that the audit committee be "directly responsible for the appointment, compensation, and oversight" of the independent auditor,⁶ the NYSE dropped a duplicative proposal.

The NYSE Proposal specifies that the audit committee have authority, among other things, to (1) retain and terminate the independent auditor and approve all audit engagement fees and terms, (2) approve significant non-audit work, and (3) obtain advice from outside legal, accounting and other advisors.

Similarly, the Nasdaq Proposal provides that audit committees (1) have the sole authority to hire and fire outside auditors, (2) are required to preapprove non-audit services provided by the outside auditor, and (3) have the authority to consult with and retain legal, accounting and other experts in appropriate circumstances.

As noted above, the Sarbanes-Oxley Act⁷ states that the audit committee is directly responsible for the appointment, compensation and oversight of the outside auditor. The Sarbanes-Oxley Act⁸ also requires audit committee pre-approval of all auditing and non-audit services performed by the company's outside auditor, with the non-audit services subject to a de minimis exception, and gives the audit committee the authority to engage independent counsel and other advisers. Because there is some overlap between the SRO Proposals and the Sarbanes-Oxley Act, some harmonization may be required.⁹

Code of Ethics for Senior Financial Officers

The Sarbanes-Oxley Act requires the SEC to issue rules to require companies to disclose whether or not they have a code of ethics for senior financial officers and, if not, the reasons therefor.¹⁰ Companies will also be required to disclose any change in, or waiver, of the code of ethics.

The NYSE Proposal and the Additional Nasdaq Proposal each require a listed company to adopt and disclose its code of business conduct and ethics and to disclose any waivers of the code for its directors or executive officers. It is not clear whether listed companies would be able to have one general code of conduct that would incorporate the code of ethics for senior financial officers, or whether they would be required to adopt two separate codes. In any case, it is unlikely that the SEC rules will require the code of ethics to contain any principles which would conflict with those of the codes of conduct described in the SRO Proposals.

Independent Directors

The NYSE and the Nasdaq have proposed different definitions of independence. Both provisions differ from the standards of independence that the Sarbanes-Oxley Act requires of audit committee members.

In the NYSE Proposal, a company's board must affirmatively determine that a director is "independent," meaning that he or she 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. As discussed above, certain persons are specifically excluded from the definition of "independent."

In the Nasdaq Proposal in order for a director to be found "independent," in addition to the requirements in the existing listing rules, no payments, other than directors' fees, may be made to a director or a family member of a director in excess of $60,000 (including any payments to a charity where the director is an executive officer and such payments exceed the greater of $200,000 or 5% of the company's or the charity's gross revenues).

The Sarbanes-Oxley Act only addresses the independence of audit committee members, each of who is required to be "independent." This means that a member of an audit committee may not, other than in his or her capacity as a member of the audit committee or the board, (1) accept any consulting, advisory, or other compensatory fee from the company, or (2) be an affiliated person of the company or any subsidiary thereof¹¹. This provision of the Sarbanes-Oxley Act amends the Exchange Act and requires that, no later than April 26, 2003, the SEC direct both Nasdaq and the NYSE to prohibit the listing of any security of an issuer that is not in compliance with the provisions of Section 301 of the Sarbanes-Oxley Act. While it may be that a director could comply with both the Exchange Act, as amended, and the SRO Proposals, it is likely that both the NYSE and Nasdaq will harmonize their rules with the SEC directive, once it is made.

Auditors

Initially, the NYSE Committee did not recommend mandatory periodic rotation of the lead audit partner or audit firm, indicating that it believed it might undercut the effectiveness of the independent auditor and the quality of the audit. Instead the NYSE Committee recommended that each audit committee make its own decision as to whether rotation would be helpful. In light of the Sarbanes-Oxley Act requirement of audit partner rotation,¹² the commentary has been revised in the NYSE Proposal as adopted. The commentary in the NYSE Proposal states that, in addition to assuring the regular rotation of the lead audit partner as required by law, the audit committee should also consider regular rotation of the audit firm itself in order to assure continuing auditor independence.

Exemptions for Non-U.S. Companies

Currently, both the NYSE and Nasdaq provide foreign companies with waivers from certain corporate governance standards that differ from those of the companies' home jurisdiction and rules of their principal securities markets. Although both the NYSE Proposal and the Nasdaq Proposal would require foreign issuers to disclose differences between their corporate governance standards and those required by the applicable listing requirements, it is not clear whether the SEC will go beyond this and require such foreign issuers to comply with at least some of the new corporate governance requirements of the Sarbanes-Oxley Act.

Reporting of Insider Transactions

The Nasdaq Proposal would require companies to disclose transactions in company stock by officers or directors within 2 business days for transactions exceeding $100,000, and by the second business day of the following week for smaller transactions. The Sarbanes-Oxley Act requires the SEC to adopt rules effective no later than August 29, 2002 for accelerated reporting of transactions by Section 16 insiders (generally within 2 business days).¹ Given the similarity of these provisions, it is unlikely that the Nasdaq will file a formal rule proposal with the SEC on this point.

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1: Release 34-46270.

2: Please note that the NYSE-compiled list does not include some of the changes discussed below.

3: Under current listing rules, the cooling-off period is three years and references only former employees of the company. The board of directors can make an exception for one former officer, provided the reason is explained in the next proxy statement.

4: Approved by the SEC in Release No. 34-46270.

5: Section 407.

6: Section 301.

7: Section 301.

8: Sections 201 and 202.

9: The SEC is to issue final regulations to carry out the provisions of the Sarbanes-Oxley Act regarding audit committees by January 26, 2003. By April 26, 2003, the SEC is to require the SROs to prohibit the listing of any security of an issuer that is not in compliance with the audit committee rules of Sarbanes-Oxley.

10: Section 406.

11: Section 301.

12: Section 209.

13: Section 403.