The New York Stock Exchange has filed a proposed rule change with the Securities and Exchange Commission that would modify some of its corporate governance requirements related to director independence.
Experts say that, even if they aren’t implemented in time for the 2006 proxy season, NYSE-listed companies should look to the proposed rules for guidance.
Langan
“I don’t think there’ll be lot of controversy around the proposals,” says Richard Langan Jr., partner and chair of the business and finance department at Nixon Peabody. “It’s likely they’ll be in place for the upcoming proxy season, but even if they aren’t implemented by then, many NYSE-listed companies will look to them for guidance.”
The expected rule proposal, filed Nov. 23, would, among other things, clarify the disclosure requirements under Section 303A of the Listed Company Manual as to what the Big Board expects to see in listed companies’ independence determination disclosures.
O’Neill
As Compliance Week reported in October, NYSE Vice President of Listed Company Compliance Janice O’Neill said the NYSE planned to file the proposal in an effort to clarify the rules to get more complete disclosure from some companies. For the full text of the rule proposal and Compliance Week’s related coverage, see box above, right.
In its filing with the SEC, the NYSE said that, in some cases, the disclosures provided by listed companies were not sufficient enough for investors to understand the board’s independence determination. “We believe that many companies have been confused by the concept of ‘categorical standards’ that exists in the current rule and are often using the bright line tests set out in Section 303A.02(b) as the sole criteria in determining whether or not a director is independent.”
In some cases, the NYSE said companies are disclosing that relationships exist between a director and the listed company, but aren’t disclosing the basis for the board’s determination that such relationship doesn’t preclude independence.
Uniformity And Clarity
Under the proposed rule, for each independent director, companies would have to disclose either that the director has no relationships with the listed company (other than being a director and/or a shareholder) or has only immaterial relationships with the listed company. If an immaterial relationship exists, the company must disclose the relationship along with the basis for the board’s determination that the relationship doesn’t preclude independence. Or, in lieu of disclosing specific immaterial relationships, a board can deem certain relationships “categorically immaterial,” and disclose the types of relationships it has determined to be categorically immaterial. The NYSE noted that companies wouldn’t be able to treat as categorically immaterial any relationship required to be disclosed under Item 404 of SEC Regulation S-K.
PROPOSED CHANGES
The excerpt below is from the proposed changes to Section 303A of the NYSE's Listed Company Manual relating to corporate governance. Please keep in mind that this is only an excerpt; the complete proposal is available for download below:
Section 303A.02—Independence Requirements
We propose to revise the Commentary to Section 303A.02(a) with respect to the
disclosure that must be provided with respect to a board’s determination that a director is
independent. In some cases, the disclosure provided by listed companies in 2005 was not
sufficient to allow investors to adequately assess the quality of the board’s independence
determination. We believe that many companies have been confused by the concept of
“categorical standards” that exists in the current rule and are often using the bright line
tests set out in Section 303A.02(b) as the sole criteria in determining whether or not a
director is independent.
In some cases, the disclosure provided was not sufficient to allow investors to adequately
assess the quality of the board’s independence determination. Other companies are
disclosing that relationships exist between a director and the listed company, but are not
disclosing the basis for the board’s determination that such relationship does not preclude
independence. To clarify the type of disclosure that listed companies must provide, we
propose to require that, with respect to each independent director, the listed company
must disclose either that the director has no relationships with the listed company (other
than being a director and/or a shareholder of the listed company) or has only immaterial
relationships with the listed company. If an immaterial relationship exists, the company must disclose a specific description of such relationship, as well as the basis for the
board’s determination that such relationship does not preclude an independence
determination, except to the extent the company chooses to utilize the proposed
alternative disclosure approach described in the next paragraph.
The alternative disclosure approach provides that, in lieu of disclosing specific
immaterial relationships, a board may determine that certain relationships are
categorically immaterial. A listed company must disclose the types of relationships it has
determined to be categorically immaterial and need not disclose the specifics of any
relationship that falls within such categories. A listed company, however, may not treat
as categorically immaterial any relationship required to be disclosed pursuant to Item 404
of SEC Regulation S-K.
To reflect an interpretation from the SEC, we propose to revise the General Commentary
to Section 303A.02(b) to clarify that the term “immediate family member” does not
include step-children that do not share a step-parent’s home, or the in-laws of such stepchildren.
We also propose to revise the General Commentary to Section 303A.02(b) to clarify that
the terms “listed company ” and “company” each include any parent or subsidiary that
would be required under U.S. GAAP to be in a consolidated group with the company.
Section 303A.03—Requirement For Meetings Of Non-Management Directors
Our current rule requires that listed companies hold regular meetings of non-management
directors. In addition, our current rule requires that companies limit such meetings to
only independent directors at least once a year. Some companies have expressed a
preference to always limit the meetings to independent directors. We believe that
limiting all meetings to only independent directors satisfies the original intention of the
rule, so we propose to revise the Commentary accordingly.
Section 303A.06—Requirements For Audit Committees
In an effort to highlight listed companies’ disclosure requirements, we propose to revise
the Commentary to Section 303A.06 to specifically point out that SEC Rule 10A-3
requires disclosure of reliance on certain exceptions contained in that rule.
Section 303A.07—Duties Of The Audit Committee
Section 303A.07(c)(iii)(B) requires that audit committees meet to review and discuss the
company’s financial statements and must review the company’s specific Management’s
Discussion and Analysis disclosures. Closed-end funds, however, are not subject to the
requirement to provide this disclosure. We propose to add language to the Commentary
to make clear that, if a closed end fund chooses to voluntarily include a "Management's
Discussion of Fund Performance" in its Form N-CSR, the audit committee is required to
meet to review and discuss it. We also intend to clarify that telephonic conference calls constitute meetings for purposes of Section 303A.07(c)(iii)(B) if allowed by applicable
corporate law, but that polling directors is not allowed in lieu of a meeting.
Section 303A.08—Shareholder Approval Of Equity Compensation Plans
We propose to revise the “Transition Rules” section of this item to specify that the
effective date of this listing standard was June 30, 2003.
Section 303A.10—Code Of Business Conduct And Ethics
Section 303A.10 requires that listed companies disclose any waiver of the code of
business conduct and ethics granted to executive officers and directors. We propose to
add new disclosure requirements specifying that the waiver must be disclosed to
shareholders within four business days of such determination and that disclosure must be
made by distributing a press release, providing website disclosure, or by filing a current
report on Form 8-K with the SEC. This proposed approach varies slightly from the
guidance currently provided by Question G-1 of the NYSE’s Frequently Asked Questions
on Section 303A, which provides that the waiver must be disclosed to shareholders
within two to three business days of the board’s determination. We are proposing a fourday
period in order to be consistent with the requirements of Item 5.05 of Form 8-K
regarding disclosure of waivers from codes of ethics.
Source
NYSE Proposed Changes To Section 303A Of The NYSE's Listed Company Manual Relating To Corporate Governance (Nov. 23, 2005)
“The proposed change provides more clarity to companies as to what types of disclosures the New York Stock Exchange expects to see in proxy statements,” says Langan. “It may also require some review by boards or governance committees of the processes by which they make independence determinations.”
As such, experts note that the disclosures may require annual examination, as the nature of the business and its relationships change. “We recommend to our clients that they annually re-assess not only the independence of their directors, but also the processes by which they make that assessment in order to update those processes to current practices and developments in the law,” says Langan.
Powers
Marc Powers, head of the securities litigation and regulatory enforcement practice at Baker & Hostetler, says the revision is helpful as it will provide both structure and flexibility for public companies. “This allows additional disclosure and transparency for shareholders and allows listed companies the flexibility of providing specificity of the immaterial relationship or lets them put categorical relationships out there so they don’t have to get into the nitty-gritty of things that may not need to be disclosed in a filing,” he says.
Powers adds that the proposal, “provides additional guidance for companies and their counsel in trying to get out as much information as they can with some degree of uniformity and clarity.”
Brighton
“The NYSE is clearly still mindful of the consequences of a board under the sway of management as evidenced by the recent Disney decision in Delaware involving Michael Eisner and the ongoing proceedings against Lord Conrad Black, the former chair of Hollinger International,” says Robert Brighton Jr., an attorney with Ruden McClosky. “The revisions to the Commentary on the NYSE Independence rules indicate that the NYSE is not retreating from a belief in the value of true independence of the boards of its listed companies.”
Sleeper
Another change in the proposed rule would revise the NYSE’s initial public offering phase-in requirement. Currently, companies listing in conjunction with an IPO are able to "phase in" their independent audit, nominating and compensation committees, but are required to have one independent director on each committee as of the date of listing.
Noting that market practice is not to appoint independent directors in advance of the transaction’s closing date to avoid prospectus liability concerns, the NYSE proposed revising the requirement to allow companies until the earlier of the date of closing of the IPO or five business days from the date that trading on the exchange commences to be in compliance, and to allow companies that are listing in conjunction with a spinoff or carve out transaction until the date of effectiveness of the transaction to be in compliance with the 303A requirements.
Lipman
“The change on IPOs is an excellent change,” says Frederick Lipman, partner at Blank Rome. “It will help companies facilitate getting independent directors on their boards.”
Langan at Nixon Peabody agrees. “Phasing in the independent directors after going public should help facilitate the process and make the exchange rules more in line with industry practices,” he said. “It should also benefit the NYSE by putting it in a more competitive position with the NASDAQ.”
Another change, which Lipman calls a “sleeper,” would clarify that—while telephone conference calls (if allowed by applicable corporate law) constitute meetings for satisfying a requirement that the audit committee meet to review and discuss the company’s financial statements and management’s discussion and analysis disclosures—polling directors isn’t allowed in lieu of a meeting.
“That means all of the committee members have to be present on the same conference call; you can’t call them individually,” says Lipman. “A lot of times that doesn’t happen. It’s difficult to get all the members of the audit committee on the same conference call.”
The NYSE also proposed modifying its requirement for meetings of non-management directors. While the current rule requires listed companies hold a meeting limited only to independent directors at least once a year, NYSE proposed modifying the requirement to allow companies to limit all meetings to independent directors, since it said some companies expressed a preference to do so.
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