Client Alert

SEC Issues Notices of NYSE and Nasdaq Proposed Rules Requiring Shareholder Approval of Most Equity Compensation Plans

On October 8, 2002, the Securities and Exchange Commission ("SEC") issued a notice[fn1] that the New York Stock Exchange, Inc. ("NYSE") had filed with the SEC proposed rule changes to require shareholder approval of virtually all equity-compensation plans and to limit the discretion of brokers in the voting of proxies with respect to those plans (collectively, the "NYSE Rules"). In addition, on October 11, 2002, the SEC issued another notice[fn2] that the National Association of Securities Dealers, Inc. (the "NASD") through its subsidiary, The Nasdaq Stock Market, Inc. ("Nasdaq") had filed with the SEC similar proposed rule changes to require shareholder approval of most stock option plans and other arrangements (collectively, the "Nasdaq Rules").

NYSE Proposed Rules

On August 16, 2002, the NYSE filed with the SEC amendments to its listing standards aimed at helping to restore investor confidence by empowering and ensuring the independence of directors and strengthening corporate governance practices. Subsequent to August 16th, the SEC staff requested that the NYSE submit the proposed changes relating to shareholder approval of equity-compensation plans and the voting of proxies by brokers separately to expedite review. The October 8th filing was in response to the SEC staff's request. The Commission is requesting comment on the NYSE Rules by no later than November 1, 2002. As so many comments have already been received, we expect the NYSE Rules to become effective shortly after that date with no significant changes.

Required Shareholder Approval. Proposed Section 303A(8) of the NYSE's Listed Company Manual is as follows:

8. To increase shareholder control over equity-compensation plans, shareholders must be given the opportunity to vote on all equity-compensation plans, except inducement awards, plans relating to mergers or acquisitions, and tax qualified and parallel nonqualified plans.
The NYSE continues to believe that equity-compensation plans can help align shareholder and management interests, and that equity-based awards remain very important components of employee compensation. In order to provide checks and balances on the process of earmarking shares to be used for equity-based awards, and to provide shareholders a voice regarding the resulting dilution, the NYSE proposes that all equity-compensation plans, and any material revisions to the terms of such plans, be subject to shareholder approval.

For these purposes, a "material revision" would include, but not be limited to, a revision that:

  • materially increases the number of shares available under the plan (other than an increase solely to reflect a reorganization, stock split, merger, spin-off or similar transaction); for this purpose, an automatic increase in the shares available under a plan pursuant to a formula set forth in the plan (sometimes referred to as an "evergreen" formula) will not be considered a revision if the term of the plan is limited to a specified period of time not in excess of ten years;
  • changes the types of awards available under the plan;
  • materially expands the class of persons eligible to receive awards under or otherwise participate in the plan;
  • materially extends the term of the plan; or
  • materially changes the method of determining the strike price of options under the plan.
In addition, if a plan contains a provision that prohibits repricing of options, any revision that deletes or limits the scope of such a provision will be considered a material revision for purposes of this rule. If a plan does not contain a provision that specifically permits repricing of options, the plan will be considered for this purpose as prohibiting repricing, and any actual repricing of options will be considered a material revision of the plan, even if the plan itself is not revised.

"Grandfathered" Plans. The NYSE Rules will apply to a plan adopted before the NYSE Rules are made effective by the SEC only with respect to any subsequent material revision of the "grandfathered" plan. However, any such plan that contains an evergreen formula rather than setting forth a specific number of shares available under the plan must be submitted to the shareholders for approval before the next increase in shares pursuant to the evergreen formula that occurs on or after the effective date of the NYSE Rules unless the plan (including the evergreen formula) was approved by shareholders before the effective date of the Proposed Rule.

Exceptions to Shareholder Approval. Under the proposal, certain types of plans and awards will be exempt from the shareholder approval requirement. Employment inducement awards - that is, grants of options or shares as a material inducement to such person's first becoming an employee of the issuer or any of its subsidiaries - will not be subject to shareholder approval under the NYSE Rules.

There are two exceptions in the case of corporate acquisitions and mergers. First, shareholder approval will not be required to convert, replace or adjust outstanding options or other equity-compensation awards to reflect the transaction. Second, shares available under certain plans acquired in corporate acquisitions and mergers may be used for certain post-transaction grants without further shareholder approval. This exception applies to situations where the party that is not a listed company following the transaction has shares available for grant under pre-existing plans that were previously approved by shareholders. These shares may be used for post-transaction grants of options and other equity awards by the listed company (after appropriate adjustment of the number of shares to reflect the transaction), either under the pre-existing plan or another plan, without further shareholder approval, so long as (1) the time during which those shares are available for grants is not extended beyond the period when they would have been available under the pre-existing plan, absent the transaction, and (2) such options and other awards are not granted to individuals who were employed by the granting company at the time the merger or acquisition was consummated. Please note that the NYSE would view a plan adopted in contemplation of the merger or acquisition transaction as not pre-existing for purposes of this exception. The NYSE believes that this exception is appropriate because it believes that it will not result in any increase in the aggregate potential dilution of the combined enterprise.

Because inducement awards and mergers or acquisitions are not routine occurrences, and are not likely to be abused, the NYSE considers these exceptions to be consistent with the fundamental policy underlying the NYSE Rules.

Similarly, any plan intended to meet the requirements of Section 401(a) of the Internal Revenue Code (e.g., ESOPs), any parallel nonqualified plan, and any plan intended to meet the requirements of Section 423 of the Internal Revenue Code is exempt from the shareholder approval requirement. Equity-compensation plans that would qualify for the exception described in this paragraph but for features necessary to comply with foreign tax law in the non-U.S. jurisdiction in which the employees covered by the plan reside, are also exempt from shareholder approval under this section.

Board Approvals. It is important to note that in circumstances in which equity-compensation plans and amendments thereto are not subject to shareholder approval, the NYSE requires that the plans and amendments still must be subject to the approval of the company's compensation committee or a majority of the company's independent directors.

Broker Votes. In addition, the NYSE will preclude its member organizations from giving a proxy to vote on equity-compensation plans unless the beneficial owner of the shares has given voting instructions. This will be codified in proposed changes to NYSE Rule 452.

Nasdaq Proposed Rules

Nasdaq has also proposed significant changes to its corporate governance provisions. On October 9, 2002, as amended by a subsequent filing on October 10, 2002, Nasdaq proposed the following changes to its qualitative requirements with respect to shareholder approval of most equity-compensation plans. These changes are very similar to the ones proposed in the NYSE Rules. The Commission is requesting comment on the Nasdaq Rules by no later than November 7, 2002. As with the NYSE Rules, there have been so many comments and public discussions, we expect the Nasdaq Rules to become effective shortly after that date with no significant changes.

Required Shareholder Approval. Nasdaq proposes to amend Rule 4350 NASD Manual as set forth below (proposed new language is underscored and proposed deletions are bracketed):

Rule 4350. Qualitative[fn3] Listing Requirements for Nasdaq National Market and Nasdaq SmallCap Market Issuers Except for Limited Partnerships

. . . (i) Shareholder Approval . . .

(1) Each issuer shall require shareholder approval [of a plan or arrangement under subparagraph (A) below, or] prior to the issuance of designated securities under subparagraph (A), (B), (C), or (D) below:

(A) when a stock option or purchase plan is to be established or materially amended or other arrangement made pursuant to which options or stock may be acquired by officers, [or] directors, employees, or consultants, except for:

(i) warrants or rights issued generally to all security holders of the company; or

(ii) [broadly based plans or arrangements including other employees (e.g. ESOPs).] tax qualified, non-discriminatory employee benefit plans (e.g., plans that meet the requirements of Section 401(a) or 423 of the Internal Revenue Code) or parallel nonqualified plans, provided such plans are approved by the issuer's compensation committee or a majority of the issuer's independent directors; or

(iii) plans relating to an acquisition or merger as permitted under IM-4350-5; or

(iv) [In a case where the shares are] issuances[ed] to a person not previously an employee[d by] or director of the company, as an inducement [essential] material to the individual's entering into [an] employment [contract] with the company, provided such issuances are approved by the issuer's compensation committee or a majority of the issuer's independent directors. [shareholder approval will generally not be required. The establishment of a plan or arrangement under which the amount of securities that may be issued does not exceed the lesser of 1% of the number of shares of common stock, 1% of the voting power outstanding, or 25,000 shares will not generally require shareholder approval.] . . .

In addition, Rule 4310, "Qualification Requirements for Domestic and Canadian Securities," and Rule 4320, "Qualification Requirements for Non-Canadian Foreign Securities and American Depositary Receipts," are proposed to be amended to provide that the issuer shall notify Nasdaq no later than 15 calendar days prior to "establishing or materially amending a stock option plan, purchase plan or other arrangement pursuant to which stock may be acquired by officers, or directors, employees or consultants without shareholder approval" [proposed language is underscored].

As indicated in Rule 4350, Nasdaq is also proposing to add new interpretive material, IM-4350-5. In addition to explaining the purposes of the changes to Rule 4350, IM-4350-5 sets forth the identical requirements for excepting plans involving an acquisition or merger that the NYSE includes in its explanation of its proposal in the NYSE Rules.

Material Amendments. Nasdaq will continue to provide guidance as to what constitutes a material amendment. Nasdaq currently determines the existence of a material amendment to a plan consistent with the SEC's position under former Rule 16b-3 of the Securities Exchange Act of 1934. Nasdaq looks to whether there is a material change to:

  • the benefits available to potential recipients under the plan;
  • the number of shares available under the plan; or
  • the class of eligible participants under the plan.
Nasdaq is further reviewing these factors and may issue additional guidance on this.

"Grandfathered" Plans. Nasdaq has proposed that these Nasdaq Rules become effective upon SEC approval and that existing plans be grandfathered. Any material modification to plans in place or adopted after the effective date of the Nasdaq Rules would require shareholder approval. Unlike the NYSE Rules, the Nasdaq Rules do not specifically require subsequent shareholder approval of an evergreen formula contained in a grandfathered plan prior to the first increase in shares pursuant to the formula that occurs after the effective date of the Nasdaq Rules.

Comments and More Information

For more information, please visit the SEC, the NYSE or the Nasdaq websites.


1: Release No. 34-46620; File No. SR-NYSE-2002-46;

2: Release No. 34-46649; File No. SR-NASD-2003-140;

3: The SEC Release says "Quantitative" in error.




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