NASD Rulemaking:
Order Approving Proposed Rule Change Amending the Audit Committee
Requirements and Notice of Filing and Order Granting Accelerated
Approval of Amendments No. 1 and No. 2 Thereto
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SECURITIES AND EXCHANGE COMMISSION
(Release No. 34-42231; File No. SR-NASD-99-48)
December 14, 1999
Self-Regulatory Organizations; Order Approving
Proposed Rule Change by the National Association of Securities Dealers,
Inc. Amending Its Audit Committee Requirements and Notice of Filing
and Order Granting Accelerated Approval of Amendments No. 1 and No.
2 Thereto
I. Introduction
On September 20, 1999, the National Association
of Securities Dealers, Inc. ("NASD" or "Association"),
through its wholly owned subsidiary, The Nasdaq Stock Market, Inc.
("Nasdaq"), submitted to the Securities and Exchange Commission
("SEC" or "Commission"), pursuant to Section
19(b)(1) of the Securities Exchange Act of 1934 ("Act")1
and Rule 19b-4 thereunder,2 a proposed rule change amending Nasdaq's
audit committee requirements.
The Federal Register published the proposed
rule change for comment on October 13, 1999.3
In response, the Commission received fourteen comment letters. On
November 15, 1999 and December 9, 1999, the Association submitted
Amendments No. 14 and No. 2,5
respectively, to the proposed rule change. This order approves the
proposed rule change and grants accelerated approval to Amendments
No. 1 and No. 2. The Commission is also soliciting comment on Amendments
No. 1 and No. 2 to the proposed rule change.
II. Description of the Proposed Rule
Change
A. Background
In February 1999, the Blue Ribbon Committee on
Improving the Effectiveness of Corporate Audit Committees ("Blue
Ribbon Committee") issued a report containing recommendations
aimed at strengthening the independence of the audit committee;
making the audit committee more effective; and addressing mechanisms
for accountability among the audit committee, the outside auditors,
and management.6 In response to the Blue Ribbon Committee's
recommendations, Nasdaq proposes to amend its listing standards
regarding audit committee requirements. The proposed changes cover
three general areas: 1) the definition of independence; 2) the structure
and membership of the audit committee; and 3) the audit committee
charter.
The text of the proposed rule change, as amended
by Amendments No. 1 and No. 2, is as follows. Language deleted by
Amendments No. 1 and No. 2 is in brackets. Language added by Amendments
No. 1 and No. 2 is in italics.
Rule 4200. Definitions
(a) For purposes of the Rule 4000 Series, unless
the context requires otherwise:
(1) - (14) No change
(15) "Independent director" means a person
other than an officer or employee of the company or its subsidiaries
or any other individual having a relationship which, in the opinion
of the company's board of directors, would interfere with the exercise
of independent judgment in carrying out the responsibilities of
a director. The following persons shall not be considered independent:
(a) a director who is employed by the corporation
or any of its affiliates for the current year or any of the past
three years;
(b) a director who accepts any compensation from
the corporation or any of its affiliates in excess of $60,000 during
the previous fiscal year, other than compensation for board service,
benefits under a tax-qualified retirement plan, or non-discretionary
compensation;
(c) a director who is a member of the immediate
family of an individual who is, or has been in any of the past three
years, employed by the corporation or any of its affiliates as an
executive officer. Immediate family includes a person's spouse,
parents, children, siblings, mother-in-law, father-in-law, brother-in-law,
sister-in-law, son-in-law, daughter-in-law, and anyone who
resides in such person's home;
(d) a director who is a partner in, or a controlling
shareholder or an executive officer of, any for-profit business
organization to which the corporation made, or from which the corporation
received, payments (other than those arising solely from investments
in the corporation's securities) that exceed 5% of the corporation's
or business organization's consolidated gross revenues for that
year, or $200,000, whichever is more, in any of the past three years;
(e) a director who is employed as an executive
of another entity where any of the company's executives serve on
that entity's compensation committee.
(15) - (36) renumbered as (16) - (37)
(b) No change
Rule 4310. Qualification Requirements for Domestic
and Canadian Securities
To qualify for inclusion in Nasdaq, a security
of a domestic or Canadian issuer shall satisfy all applicable requirements
contained in paragraphs (a) or (b), and (c) hereof.
(a) - (b) No change
(c) In addition to the requirements contained in
paragraph (a) or (b) above, and unless otherwise indicated, a security
shall satisfy the following criteria for inclusion in Nasdaq:
(1) - (24) No change
(25) Corporate Governance Requirements
* * * * * *
(A) No change
(B) Independent Directors
Each issuer shall maintain a sufficient number
of independent directors on its board of directors to satisfy the
audit committee requirement set forth in Rule 4310(c)(26)(B).
(D) - (H) renumbered as (C) - (G)
(26) Audit Committee
(A) Audit Committee Charter
Each Issuer must certify that it has adopted a
formal written audit committee charter and that the Audit Committee
has reviewed and reassessed the adequacy of the formal written charter
on an annual basis. The charter must specify the following:
(i) the scope of the audit committee's responsibilities,
and how it carries out those responsibilities, including structure,
processes, and membership requirements;
(ii) the audit committee's responsibility for ensuring
its receipt from the outside auditors of a formal written statement
delineating all relationships between the auditor and the company,
consistent with Independence Standards Board Standard 1, and the
audit committee's responsibility for actively engaging in a dialogue
with the auditor with respect to any disclosed relationships or
services that may impact the objectivity and independence of the
auditor and for taking, or recommending that the full board take,
appropriate action to [ensure] oversee the independence of
the outside auditor; and
(iii) the outside auditor's ultimate accountability
to the board of directors and the audit committee, as representatives
of shareholders, and these shareholder representatives' ultimate
authority and responsibility to select, evaluate, and, where appropriate,
replace the outside auditor (or to nominate the outside auditor
to be proposed for shareholder approval in any proxy statement).
(B) Audit Committee Composition
(i) Each issuer must have, and certify that it
has and will continue to have, an audit committee of at least three
members, comprised solely of independent directors, each of whom
is able to read and understand fundamental financial statements,
including a company's balance sheet, income statement, and cash
flow statement or will become able to do so within a reasonable
period of time after his or her appointment to the audit committee.
Additionally, each issuer must certify that it has, and will continue
to have, at least one member of the audit committee that has past
employment experience in finance or accounting, requisite professional
certification in accounting, or any other comparable experience
or background which results in the individual's financial sophistication,
including being or having been a chief executive officer, chief
financial officer or other senior officer with financial oversight
responsibilities.
(ii) Notwithstanding paragraph (i), one director
who is not independent as defined in Rule 4200, and is not a current
employee or an immediate family member of such employee, may be
appointed to the audit committee, if the board, under exceptional
and limited circumstances, determines that membership on the committee
by the individual is required by the best interests of the corporation
and its shareholders, and the board discloses, in the next annual
proxy statement subsequent to such determination, the nature of
the relationship and the reasons for that determination.
(iii) Exception for Small Business Filers -- Paragraphs
(B)(i) and (B)(ii) do not apply to issuers that file reports under
SEC Regulation S-B. Such issuers must establish and maintain an
Audit Committee of at least two members, a majority of the members
of which shall be independent directors.
(26) - (28) renumbered as (27) - (29)
(d) No change
Rule 4320. Qualification Requirements for Non-Canadian
Foreign Securities and American Depositary Receipts
To qualify for inclusion in Nasdaq, a security
of a non-Canadian foreign issuer, an American Depositary Receipt
(ADR) or similar security issued in respect of a security of a foreign
issuer shall satisfy the requirements of paragraphs (a), (b) or
(c), and (d) and (e) of this Rule.
(a) - (d) No change
(e) In addition to the requirements contained in
paragraphs (a), (b) or (c), and (d), the security shall satisfy
the following criteria for inclusion in Nasdaq:
(1) - (20) No change
(21) Corporate Governance Requirements -- No provisions
of this subparagraph or of subparagraph (24) shall be construed
to require any foreign issuer to do any act that is contrary to
a law, rule or regulation of any public authority exercising jurisdiction
over such issuer or that is contrary to generally accepted business
practices in the issuer's country of domicile. Nasdaq shall have
the ability to provide exemptions from the applicability of these
provisions as may be necessary or appropriate to carry out this
intent.
Nasdaq shall review the issuer's past corporate
governance activities. This review may include activities taking
place while the issuer is listed on Nasdaq or an exchange that imposes
corporate governance requirements, as well as activities taking
place after the issuer is no longer listed on Nasdaq or an exchange
that imposes corporate governance requirements. Based on such review,
Nasdaq may take any appropriate action, including placing of restrictions
on or additional requirements for listing, or the denial of listing
of a security if Nasdaq determines that there have been violations
or evasions of such corporate governance standards. Determinations
under this subparagraph shall be made on a case-by-case basis as
necessary to protect investors and the public interest.
(A) No change
(B) Independent Directors
Each issuer shall maintain a sufficient number
of independent directors on its board of directors to satisfy the
audit committee requirement set forth in Rule 4320(e)(22)(B).
(D) - (H) renumbered as (C) - (G)
(22) Audit Committee
(A) Audit Committee Charter
Each Issuer must certify that it has adopted a
formal written audit committee charter and that the Audit Committee
has reviewed and reassessed the adequacy of the formal written charter
on an annual basis. The charter must specify the following:
(i) the scope of the audit committee's responsibilities,
and how it carries out those responsibilities, including structure,
processes, and membership requirements;
(ii) the audit committee's responsibility for ensuring
its receipt from the outside auditors of a formal written statement
delineating all relationships between the auditor and the company,
consistent with Independence Standards Board Standard 1, and the
audit committee's responsibility for actively engaging in a dialogue
with the auditor with respect to any disclosed relationships or
services that may impact the objectivity and independence of the
auditor and for taking, or recommending that the full board take,
appropriate action to [ensure] oversee the independence of
the outside auditor; and
(iii) the outside auditor's ultimate accountability
to the board of directors and the audit committee, as representatives
of shareholders, and these shareholder representatives' ultimate
authority and responsibility to select, evaluate, and, where appropriate,
replace the outside auditor (or to nominate the outside auditor
to be proposed for shareholder approval in any proxy statement).
(B) Audit Committee Composition
(i) Each issuer must have, and certify that it
has and will continue to have, an audit committee of at least three
members, comprised solely of independent directors, each of whom
is able to read and understand fundamental financial statements,
including a company's balance sheet, income statement, and cash
flow statement or will become able to do so within a reasonable
period of time after his or her appointment to the audit committee.
Additionally, each issuer must certify that it has, and will continue
to have, at least one member of the audit committee that has past
employment experience in finance or accounting, requisite professional
certification in accounting, or any other comparable experience
or background which results in the individual's financial sophistication,
including being or having been a chief executive officer, chief
financial officer or other senior officer with financial oversight
responsibilities.
(ii) Notwithstanding paragraph (i), one director
who is not independent as defined in Rule 4200, and is not a current
employee or an immediate family member of such employee, may be
appointed to the audit committee, if the board, under exceptional
and limited circumstances, determines that membership on the committee
by the individual is required by the best interests of the corporation
and its shareholders, and the board discloses, in the next annual
proxy statement subsequent to such determination, the nature of
the relationship and the reasons for that determination.
(iii) Exception for Small Business Filers -- Paragraphs
(B)(i) and (B)(ii) do not apply to issuers that file reports under
SEC Regulation S-B. Such issuers must establish and maintain an
Audit Committee of at least two members, a majority of the members
of which shall be independent directors.
(22) - (24) renumbered as (23) - (25)
(f) No change
Rule 4460. Non-Quantitative Designation Criteria
for Issuers Excepting Limited Partnerships
(a) - (b) No change
(c) Independent Directors
Each NNM issuer shall maintain a sufficient number
of independent directors on its board of directors to satisfy the
audit committee requirement set forth in Rule 4460(d)(2).
(d) Audit Committee
(1) Audit Committee Charter
Each Issuer must certify that it has adopted a
formal written audit committee charter and that the Audit Committee
has reviewed and reassessed the adequacy of the formal written charter
on an annual basis. The charter must specify the following:
(A) the scope of the audit committee's responsibilities,
and how it carries out those responsibilities, including structure,
processes, and membership requirements;
(B) the audit committee's responsibility for ensuring
its receipt from the outside auditors of a formal written statement
delineating all relationships between the auditor and the company,
consistent with Independence Standards Board Standard 1, and the
audit committee's responsibility for actively engaging in a dialogue
with the auditor with respect to any disclosed relationships or
services that may impact the objectivity and independence of the
auditor and for taking, or recommending that the full board take,
appropriate action to [ensure] oversee the independence of
the outside auditor; and
(C) the outside auditor's ultimate accountability
to the board of directors and the audit committee, as representatives
of shareholders, and these shareholder representatives' ultimate
authority and responsibility to select, evaluate, and, where appropriate,
replace the outside auditor (or to nominate the outside auditor
to be proposed for shareholder approval in any proxy statement).
(2) Audit Committee Composition
(A) Each issuer must have, and certify that it
has and will continue to have, an audit committee of at least three
members, comprised solely of independent directors, each of whom
is able to read and understand fundamental financial statements,
including a company's balance sheet, income statement, and cash
flow statement or will become able to do so within a reasonable
period of time after his or her appointment to the audit committee.
Additionally, each issuer must certify that it has, and will continue
to have, at least one member of the audit committee that has past
employment experience in finance or accounting, requisite professional
certification in accounting, or any other comparable experience
or background which results in the individual's financial sophistication,
including being or having been a chief executive officer, chief
financial officer or other senior officer with financial oversight
responsibilities.
(B) Notwithstanding paragraph (i), one director
who is not independent as defined in Rule 4200, and is not a current
employee or an immediate family member of such employee, may be
appointed to the audit committee, if the board, under exceptional
and limited circumstances, determines that membership on the committee
by the individual is required by the best interests of the corporation
and its shareholders, and the board discloses, in the next annual
proxy statement subsequent to such determination, the nature of
the relationship and the reasons for that determination.
(C) Exception for Small Business Filers -- Paragraphs
(2)(A) and (2)(B) do not apply to issuers that file reports under
SEC Regulation S-B. Such issuers must establish and maintain an
Audit Committee of at least two members, a majority of the members
of which shall be independent directors.
(e) - (n) No change
B. Independence
Nasdaq proposes to narrow its current definition
of "independent director" by specifying five new relationships
that could impair a director's independent judgment as a result
of financial, familial, or other material ties to management or
the corporation. The proposed definition will apply to all directors,
not just those serving on audit committees. Under the proposed rule
change, directors with any of the following five relationships will
not be considered independent: (1) employment by the corporation
or any of its affiliates for the current year or any of the past
three years; (2) acceptance of any compensation from the corporation
or any of its affiliates in excess of $60,000 during the previous
fiscal year, other than compensation for board service, benefits
under a tax-qualified retirement plan, or non-discretionary compensation;
(3) member of the immediate family of an individual who is, or has
been in any of the past three years, employed by the corporation
or any of its affiliates as an executive officer; (4) partnership
in, or a controlling shareholder or an executive officer of, any
for-profit business organization to which the corporation made,
or from which the corporation received, payments (other than those
arising solely from investments in the corporation's securities)
that exceed five percent of the corporation's or business organization's
consolidated gross revenues for that year, or $200,000, whichever
is more, in any of the past three years; or (5) employment as an
executive of another entity where any of the company's executives
serve on that entity's compensation committee.
C. Structure and Membership of the
Audit Committee
Nasdaq also proposes to change the structure and
membership qualifications of the audit committee. Specifically,
Nasdaq proposes to change the required composition of the audit
committee from at least two to at least three members. Furthermore,
the audit committee must be comprised solely of independent directors
rather than a majority of independent directors. Nasdaq is conscious
of the fact that in exceptional circumstances, issuers may appropriately
conclude that it would be in the best interests of the corporation
for a non-independent director to serve on the audit committee.
In such exceptional and limited circumstances, a non-independent
director can serve on the audit committee, provided that the board
determines that it is required by the best interests of the corporation
and its shareholders, and the board discloses its reasons for the
determination in the next annual proxy statement. Due to the nature
of this exception, however, a corporation could have no more than
one non-independent director serving on its audit committee. Also,
current employees or officers, or their immediate family members,
may not serve on the audit committee under this exception.
As a result of the audit committee's responsibility
for a corporation's accounting and financial reporting, Nasdaq believes
that audit committee members should have a basic understanding of
financial statements. Therefore, the proposed rule change requires
each member of the audit committee to be able to read and understand
fundamental financial statements, including a company's balance
sheet, income statement, and cash flow statement, or become able
to do so within a reasonable period of time after his or her appointment
to the audit committee. Furthermore, in order to further enhance
the effectiveness of the audit committee, at least one member of
the audit committee must have past employment experience in finance
or accounting, requisite professional certification in accounting,
or any other comparable experience or background which results in
the individual's financial sophistication, including being or having
been a chief executive officer, chief financial officer, or other
senior officer with financial oversight responsibilities.
Nasdaq is sensitive to the potential burden that
the proposed changes to the audit committee composition requirements
may place on small companies. Therefore, Nasdaq proposes to exempt
those corporations that file under SEC Regulation S-B ("Small
Business Filers").7 Small
Business Filers will be held to Nasdaq's existing requirements with
respect to audit committee composition. That is, they must maintain
an audit committee of at least two members, a majority of whom are
independent.
D. Charter
Nasdaq believes that a written charter will help
the audit committee as well as management and the corporation's
auditors recognize the function of the audit committee and the relationship
among these parties. The proposed rule change requires each issuer
to adopt a formal written charter. This charter must specify the
scope of the audit committee's responsibilities, and how it carries
out those responsibilities, including structure, processes, and
membership requirements. In addition, the charter must specify the
audit committee's responsibility for ensuring its receipt from the
outside auditors of a formal written statement delineating all relationships
between the auditor and the company, consistent with Independence
Standards Board Standard 1.8
The charter must also specify the audit committee's responsibility
for actively engaging in a dialogue with the auditor with respect
to any disclosed relationships or services that may impact the objectivity
and independence of the auditor and for taking, or recommending
that the full board take, appropriate action to oversee the independence
of the outside auditor. Finally, it must specify the outside auditor's
ultimate accountability to the board of directors and the audit
committee, as representatives of shareholders, and these shareholder
representatives' ultimate authority and responsibility to select,
evaluate, and, where appropriate, replace the outside auditor (or
to nominate an outside auditor for shareholder approval in any proxy
statement). The proposed rule change requires issuers to review
their charter on an annual basis.
E. Implementation
In order to minimize disruption to existing issuer
audit committees, to permit current audit committee members to serve
out their terms, and to allow adequate time to recruit the requisite
members, Nasdaq proposes to provide its issuers listed as of the
effective date of the proposed rule change eighteen months after
the proposed rule change is approved by the Commission to meet the
audit committee structure and membership requirements.
Additionally, Nasdaq proposes that issuers listed
as of the effective date of the rule change be provided six months
following the date of Commission approval of the proposed rule change
to adopt a formal written audit committee charter in compliance
with proposed Rules 4310(c)(26)(A), 4320(e)(22)(A), or 4460(d)(1).
Further, for issuers that applied for listing prior
to the effective date of the proposed rule change, Nasdaq proposes
that they be able to qualify for listing under the listing standards
in force at the time of their application, and to receive the same
grace periods provided to currently listed issuers, as described
above. Also, in order to avoid prejudicing issuers that transfer
to Nasdaq from the American Stock Exchange and the New York Stock
Exchange, Nasdaq proposed that these issuers be afforded the same
grace periods they would have received under their previous market's
implementation schedule.
III. Comments
As of December 9, 1999, the Commission received 14 comment letters
on the proposed rule change.9
In general, the commenters favored the proposed rule change but
recommended certain modifications. Two commenters opposed the proposed
rule change.10
In particular, the CII supports the new requirements, but stated
that the proposed override provision, which allows a company's board
to include a non-independent director on the audit committee is
not appropriate because companies should not have a problem finding
financially literate, truly independent directors.11
In addition, the AFL-CIO stated that the restriction period for
former employees, or relatives of former employees, should be five
years instead of three years.12 The AFL-CIO also stated that the $60,000
threshold to disqualify a candidate because of a significant business
relationship is not stringent enough.13
Another commenter, on the other hand, stated that a quantitative
test is too inflexible.14
Keller and Rowe stated that former non-executive employment should
be treated as a significant business relationship.15
This commenter also stated that consultants who receive from the
company more than a de minimis amount of compensation should
be treated as employees, while consultants who do not should be
treated as having a business relationship with the company.16
According to this comment letter, the company's board should be
permitted to determine that the compensation does not impair the
director's objectivity.17
Keller and Rowe also objected to the financial expertise requirement
and stated that no director will want to be designated the financial
expert because of the added exposure to liability.18
Deloitte and Price each stated that requiring a company's board
or audit committee to "ensure" the independence of the
outside auditor goes beyond what can reasonably be expected of the
board and the audit committee in their oversight role.19 Deloitte suggested that Nasdaq replace
the word "ensure" with "monitor" or "actively
oversee."20 E&Y supported the proposed rule
change, but stated that Nasdaq should not exempt Small Business
Filers from the financial literacy and expertise requirements and
also should expand its definition of immediate family member to
include sons-in-law and daughters-in-law.21
NYSBA stated that the company's board should be required to adopt
the audit committee charter, rather than the audit committee adopting
the charter subject to board approval.22
In addition, the NVCA stated that the proposed rule change should
exclude venture capital investors from the independence qualifications.23
The NVCA also stated that the proposed rule change should give companies
that have just completed an initial public offering eighteen months
to comply with the new requirements and that the exemption for Small
Business Filers should be expanded to apply to companies with less
than $50 million in revenue.24
APTC stated that the proposed rule change will be counter productive
to the goal of better audit committees.25
In addition, APTC stated that the proposed rule change will disadvantage
smaller companies more than larger companies, but concluded that
it is appropriate to apply the proposed rule change to all companies,
regardless of size.26 Moreover,
APTC is opposed to the proposal's financial literacy requirement.27
APTC believes that the financial literacy requirement may deprive
audit committees of the service of individuals with "exceptional
character and/or operational experience."28
The commenter suggested that the Exchange replace this requirement
with a requirement that the committee as a whole possess a certain
level of financial acumen.29
Finally, two commenters stated that the proposed rule change should
not apply to closed-end investment companies.30
These commenters noted that closed-end investment companies are
adequately regulated under the 1940 Act.31 The commenters also stated that the
potential abuses that the proposed rule change is designed to address
do not exist with closed-end investment funds.32
Finally, the commenters noted that because the assets of these funds
consist exclusively of investment securities, there is no opportunity
to "manage" earnings or results through selective application
of accounting policies.33
IV. Discussion
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations thereunder
applicable to a national securities association,34
and, in particular, the requirements of Section 15A(b)(6) of the
Act.35 The Commission believes
that the proposed rule change will protect investors by improving
the effectiveness of audit committees of companies listed on Nasdaq.
The Commission also believes that the new requirements will enhance
the reliability and credibility of financial statements of companies
listed on Nasdaq by making it more difficult for companies to inappropriately
distort their true financial performance.
Specifically, the Commission believes that the proposed definition
of independence will promote the quality and reliability of a company's
financial statements. The Commission believes that directors without
financial, familial, or other material personal ties to management
will be more likely to objectively evaluate the propriety of management's
accounting, internal control, and financial reporting practices.
The Commission believes that the proposal's prohibition against
employees serving on the audit committee is appropriate and that
the Exchange should not be required to distinguish between executive
and non-executive employees.36
The Commission also believes that the proposed provision that permits
a company to appoint one director to its audit committee who is
not independent, if the board determines that membership on the
committee by the individual is required by the best interests of
the corporation and its shareholders, adequately balances the need
for objective, independent directors with the company's need for
flexibility in exceptional and unusual circumstances. The Commission
believes that the requirement that the company disclose in its next
annual proxy statement the nature of the director's relationship
with the company and the board's reasons for determining the appointment
was in the best interests of the corporation will adequately guard
against abuse of the proposed exception to the independence requirement.
Moreover, the Commission believes that the $60,000 threshold to
determine if a potential audit committee director has a significant
business relationship with the company is a reasonable measure to
balance the company's need to recruit audit committee members with
the independence requirement.
The Commission does not believe that venture capital investors
should be excluded from Nasdaq's definition of independence. The
Commission does not believe that the proposed rule change will pose
an undue hardship on venture capital firms or companies listed on
Nasdaq. The Commission notes that the proposed rule change will
only prohibit venture capital investors from sitting on a company's
audit committee if the investor does not fall within Nasdaq's definition
of independent. The proposed rule change will not prohibit previously
eligible investors from serving on the company's board. The Commission
also notes that a venture capital investor that is not considered
independent may serve on the company's audit committee, if the board
determines it is in the best interests of the corporation and its
shareholders and the company discloses its reasons for the determination
and the nature of the director's relationship to the company in
its next annual proxy statement.
In addition, the Commission believes that requiring companies to
adopt formal written charters specifying the audit committee's responsibilities,
and how the committee carries out those responsibilities, will help
the audit committee, management, investors, and the company's auditors
recognize the function of the audit committee and the relationship
among the parties. Moreover, the Commission believes that requiring
the charter to specify that the audit committee is responsible for
taking, or recommending that the company's full board take, appropriate
action to oversee the independence of the outside auditor will make
it more likely that companies will select objective, unbiased auditors.
The Commission believes that the proposed rule change's compositional
requirement that each issuer have an audit committee composed of
three independent directors who are able to read and understand
fundamental financial statements will enhance the effectiveness
of the audit committee and help to ensure that audit committee members
are able to adequately fulfill their responsibilities. The Commission
believes that requiring each audit committee member to satisfy this
standard will help to ensure that the committee as a whole is financially
literate.37 Moreover, the
Commission considers that requiring one member of the audit committee
to have past employment experience in finance or accounting, requisite
professional certification in accounting, or any other comparable
experience or background that indicates the individual's financial
sophistication, will further enhance the effectiveness of the audit
committee in carrying out its financial oversight responsibilities.
In addition, the Commission does not believe that companies will
experience undue difficulty recruiting an audit committee member
that satisfies the financial expertise requirements. Moreover, the
Commission believes that the proposed rule change appropriately
exempts Small Business Filers from the proposed composition requirements
because these companies may experience more difficulty meeting these
enhanced requirements. The Commission notes that these companies
will remain subject to Nasdaq's existing rules on audit committees,
which require an audit committee to have at least two members, a
majority of whom are independent.
Moreover, the Commission does not believe that the proposed rule
change circumvents state law.38
The Commission notes that Nasdaq is amending its own qualification
requirements governing an issuer's listing on Nasdaq, which is an
appropriate function for Nasdaq as long as those requirements are
consistent with the Act.
Moreover, the Commission has concluded that Nasdaq's decision to
include investment companies in the proposed rule change is warranted.
While the Commission recognizes that the opportunity for some types
of financial reporting abuses may be limited by the nature of fund
assets,39 it believes that
audit committees do play an important role in overseeing the financial
reporting process for investment companies
The Commission finds good cause for approving Amendments No. 1
and No. 2 to the proposed rule change prior to the thirtieth day
after publication in the Federal Register. The Commission
notes that Amendment No. 1 merely revises the implementation time
periods for the proposed rule change to provide greater clarity
to issuers and to investors. The Commission believes that Amendment
No. 1 will enable issuers to determine when they must comply with
the new requirements and will enable investors to determine when
to rely on the protections afforded by the proposed rule change.
The Commission notes that Amendment No. 2 simply clarifies that
the audit committee is required to oversee, rather than ensure,
the independence of the company's outside auditors, and expands
Nasdaq's definition of "immediate family." The Commission
believes that accelerated approval will allow Nasdaq to simultaneously
make all relevant modifications to its Rules and will avoid potential
confusion. Accordingly, the Commission finds good cause to accelerate
approval of Amendments No. 1 and No. 2 to the proposed rule change,
consistent with Sections 6(b)(5)40
and 19(b)41 of the Act.
V. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed
rule change is consistent with the Act. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-0609.
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed
with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person,
other than those that may be withheld from the public in accordance
with the provisions of 5 U.S.C. 552, will be available for inspection
and copying in the Commission's Public Reference Room. Copies of
such filing will also be available for inspection and copying at
the principal office of the NASD. All submissions should refer to
the File No. SR-NASD-99-48 and should be submitted by [insert date
21 days from the date of publication].
VI. Conclusion
For the foregoing reasons, the Commission finds that Nasdaq's proposal
to amend its audit committee requirements is consistent with the
requirements of the Act and the rules and regulations thereunder.
It is therefore ordered, pursuant to Section 19(b)(2) of
the Act,42 that the amended proposed rule change
(SR-NASD-99-48) is approved.
For the Commission, by the Division of Market Regulation, pursuant
to delegated authority.43
Jonathan G. Katz
Secretary
FOOTNOTE:
| 1 |
15 U.S.C. 78s(b)(1). |
| 2 |
17 CFR 240.19b-4. |
| 3 |
Securities Exchange Act Release
No. 41982 (Oct. 6, 1999), 64 FR 55510. The American Stock Exchange
LLC and The New York Stock Exchange, Inc. have proposed rule changes
relating to audit committees. See Securities Exchange Act
Release No. 41981 (Oct. 6, 1999), 64 FR 55505 (Oct. 13, 1999)
("Amex Proposal"), and Securities Exchange Act Release
No. 41980 (Oct. 6, 1999), 64 FR 55514 (Oct. 13, 1999) ("NYSE
Proposal"). |
| 4 |
Letter from Robert E. Aber, Senior
Vice President and General Counsel, Nasdaq-Amex Market Group,
to Richard Strasser, Assistant Director, Division of Market Regulation,
Commission, dated November 12, 1999 ("Amendment No. 1").
The Association submitted Amendment No. 1 to require issuers listed
as of the effective date of Commission approval of the proposed
rule change to adopt a formal written audit committee charter
within six months of the effective date of the proposed rule change.
As originally filed, the proposed rule change required issuers
to adopt the charter within eighteen months of the effective date
of the proposed rule change. Amendment No. 1 also states that
issuers that applied for listing prior to the effective date of
the proposed rule change would qualify for listing under the listing
standards in force at the time of their application, and receive
the same grace periods provided to currently listed issuers. Finally,
Amendment No. 1 modifies proposed Rule 4320(e)(21) to provide
that the requirement that each issuer execute a listing agreement
will not be construed to require any foreign issuer to do any
act that is contrary to a law of any public authority exercising
jurisdiction over the foreign issuer. |
| 5 |
Letter from Sara Nelson Bloom, Associate
General Counsel, Nasdaq-Amex Market Group, to Richard Strasser,
Assistant Director, Division, Commission, dated December 8, 1999
("Amendment No. 2"). The Association submitted Amendment
No. 2 to revise proposed Rules 4310(c)(26)(A)(ii), 4320(e)(22)(A)(ii),
and 4460(d)(1)(B) to provide that the audit committee is required
to oversee the independence of the outside auditor, rather than
ensure the independence of the outside auditor. Amendment No.
2 also revises Nasdaq's definition of immediate family found in
Rule 4200(a)(15)(c) to include sons-in-law and daughters-in-law. |
| 6 |
Report and Recommendations of
the Blue Ribbon Committee on Improving the Effectiveness of Corporate
Audit Committees (1999). A copy of this Report can be found
on-line at www.nasdaqnews.com. |
| 7 |
Small Business Filer is defined
by Regulation S-B as an issuer that: (i) has revenue of less than
$25,000,000; (ii) is a U.S. or Canadian issuer; and (iii) if a
majority owned subsidiary, the parent corporation is a small business
issuer. 17 CFR 228.10(a)(1). |
| 8 |
Independence Standard No. 1, Independence
Discussions with Audit Committees (January 1999), which can be
found on-line at www.cpaindependence.org. |
| 9 |
See letters from: Ernst &
Young LLP ("E&Y") dated November 1, 1999; Deloitte
& Touche LLP ("Deloitte") dated November 3, 1999;
Council of Institutional Investors ("CII") dated November
8, 1999; Brian T. Borders on behalf of the National Venture Capital
Association ("NVCA") dated November 12, 1999; PricewaterhouseCoopers
LLP ("Price") dated November 1, 1999; Gary P. Kreider
("Kreider") dated November 5, 1999; American Federation
of Labor and Congress of Industrial Organizations ("AFL-CIO")
dated November 29, 1999; Mayer, Brown & Platt on behalf of
Morgan Stanley Dean Witter ("MSDW") dated November 29,
1999; Investment Company Institute ("ICI") dated November
3, 1999; Arthur Andersen LLP ("Arthur Andersen") dated
December 3, 1999; Association of Publicly Traded Companies ("APTC")
dated December 6, 1999; Robert A. Profusek ("Profusek")
dated December 3, 1999; Stanley Keller and Richard Rowe ("Keller
and Rowe") dated December 7, 1999; and The Committee on Securities
Regulation of the Business Law Section of the New York State Bar
Association ("NYSBA") dated December 1, 1999. |
| 10 |
See Kreider Letter; APTC
Letter at 2. Kreider stated that the proposed rule change "represent[s]
an awkward attempt to circumvent state corporate law and micro-manage
the functions of audit committees." Id. at 2. |
| 11 |
CII Letter, at 2; see also
AFL-CIO Letter at 2. |
| 12 |
AFL-CIO Letter at 2. |
| 13 |
Id. |
| 14 |
Profusek Letter at 2. In addition,
Keller and Rowe stated that this provision might preclude a number
of highly qualified candidates from serving on audit committees.
Keller and Rowe Letter at 3. |
| 15 |
Keller and Rowe Letter at 2. |
| 16 |
Id. at 3. |
| 17 |
Id. |
| 18 |
Id. |
| 19 |
Deloitte Letter at 1; Price Letter
at 1. |
| 20 |
Id. at 2. |
| 21 |
E&Y Letter at 4. |
| 22 |
NYSBA Letter at 2. |
| 23 |
NVCA Letter at 5. |
| 24 |
Id. at 4. |
| 25 |
APTC Letter at 2. |
| 26 |
Id. at 3. |
| 27 |
Id. at 4-5. |
| 28 |
Id. |
| 29 |
Id. at 5. |
| 30 |
ICI Letter at 2; MSDW Letter at
1. In addition, Keller and Rowe stated that the proposed rule
change should exempt all investment companies because their audit
committee members are already required not to be "interested
persons" as that term is defined in Section 2(a)(9) of the
Investment Company Act of 1940 ("1940 Act"). Keller
and Rowe Letter at 5. |
| 31 |
ICI Letter at 3-4; MSDW Letter at
2. |
| 32 |
ICI Letter at 3; MSDW Letter at
1. ICI and MSDW also noted that the independent accountants of
investment funds are selected by the independent directors of
the fund. |
| 33 |
ICI Letter at 3; MSDW Letter at
1. |
| 34 |
In approving the proposal, the Commission
has considered its impact on efficiency, competition, and capital
formation. 15 U.S.C. 78c(f). |
| 35 |
15 U.S.C. 78o-3(b)(6). |
| 36 |
See Keller and Rowe Letter
at 2. |
| 37 |
See APTC Letter at 5. |
| 38 |
Kreider Letter at 2. |
| 39 |
See Keller and Rowe Letter
at 5; ICI Letter at 3; MSDW Letter at 1. |
| 40 |
15 U.S.C. 78f(b)(5). |
| 41 |
15 U.S.C. 78s(b). |
| 42 |
15. U.S.C. 78s(b)(2). |
| 43 |
17 CFR 200.30-3(a)(12). |
http://www.sec.gov/rules/sros/nd9948o.htm
Last update: 12/16/1999
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