NYSE 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. 34-42233; File No. SR-NYSE-99-39)
December 14, 1999
Self-Regulatory Organizations;
Order Approving Proposed Rule Change by the New York Stock Exchange,
Inc. Amending the Exchange's 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 New York Stock Exchange,
Inc. ("NYSE" or "Exchange") 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 the Exchange's audit committee requirements.
The Federal Register published the proposed
rule change for comment on October 13, 1999.3
In response, the Commission received 25 comment letters.4
On October 15, 1999 and December 8, 1999, the Exchange submitted
Amendments No. 15 and No. 2,6
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.7
The Exchange distributed to its listed companies
the Exchange staff's suggestions for rule changes in response to
the Blue Ribbon Committee's report. The comments from the Exchange's
listed companies were generally supportive of the suggestions put
forth by the Exchange, with some commenters expressing concerns
about "financial literacy" requirement.
In response to the Blue Ribbon Committee's recommendations,
the Exchange proposes to revise its listing standards regarding
audit committees. The proposed rule change specifies four requirements
for a qualified audit committee and defines the terms "Immediate
Family" and "Affiliate" for purposes of the proposed
audit committee requirements.
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.
NYSE Listed Company Manual
* * *
Section 3
Corporate Responsibility
303.00 Corporate Governance Standards
In addition to the numerical listing standards,
the Exchange has adopted certain corporate governance listing standards.
These standards apply to all companies listing common stock on the
Exchange. However, the Exchange does not apply a particular standard
to a non-U.S. company if the company provides the Exchange with
a written certification from independent counsel of the company's
country of domicile stating that the company's corporate governance
practices comply with home country law and the rules of the principal
securities market for the company's stock outside the United States.
303.01 Audit Committee
(A) Audit Committee Policy. Each company must have a qualified
audit committee.
(B) Requirements for a Qualified Audit Committee.
(1) Formal Charter. [Each audit committee must adopt a formal written
charter that is approved by the Board of Directors.] The Board
of Directors must adopt and approve a formal written charter for
the audit committee. The audit committee must review and reassess
the adequacy of the audit committee 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) that the outside auditor for the company is
ultimately accountable to the Board of Directors and audit committee
of the company, that the audit committee and Board of Directors
have the 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); and
(c) that the audit committee is responsible for
ensuring that the outside auditor submits on a periodic basis to
the audit committee a formal written statement delineating all relationships
between the auditor and the company and that the audit committee
is responsible for actively engaging in a dialogue with the outside
auditor with respect to any disclosed relationships or services
that may impact the objectivity and independence of the outside
auditor and for recommending that the Board of Directors take appropriate
action [to ensure the independence of the outside auditor] in
response to the outside auditors' report to satisfy itself of the
outside auditors' independence.
(2) Composition/Expertise Requirement of Audit Committee Members.
(a) Each audit committee shall consist of at least three directors,
all of whom have no relationship to the company that may interfere
with the exercise of their independence from management and the
company ("Independent");
(b) Each member of the audit committee shall be financially literate,
as such qualification is interpreted by the company's Board of Directors
in its business judgment, or must become financially literate within
a reasonable period of time after his or her appointment to the
audit committee; and
(c) At least one member of the audit committee
must have accounting or related financial management expertise,
as the Board of Directors interprets such qualification in its business
judgment.
(3) Independence Requirement of Audit Committee
Members. In addition to the definition of Independent provided above
in (2)(a), the following restrictions shall apply to every audit
committee member:
(a) Employees. A director who is an employee (including
non-employee executive officers) of the company or any of its affiliates
may not serve on the audit committee until three years following
the termination of his or her employment. In the event the employment
relationship is with a former parent or predecessor of the company,
the director could serve on the audit committee after three years
following the termination of the relationship between the company
and the former parent or predecessor.
(b) Business Relationship. A director (i) who is
a partner, controlling shareholder, or executive officer of an organization
that has a business relationship with the company, or (ii) who has
a direct business relationship with the company (e.g., a
consultant) may serve on the audit committee only if the company's
Board of Directors determines in its business judgment that the
relationship does not interfere with the director's exercise of
independent judgment. In making a determination regarding the independence
of a director pursuant to this paragraph, the Board of Directors
should consider, among other things, the materiality of the relationship
to the company, to the director, and, if applicable, to the organization
with which the director is affiliated.
"Business relationships" can include
commercial, industrial, banking, consulting, legal, accounting and
other relationships. A director can have this relationship directly
with the company, or the director can be a partner, officer or employee
of an organization that has such a relationship. The director may
serve on the audit committee without the above-referenced Board
of Directors' determination after three years following the termination
of, as applicable, either (1) the relationship between the organization
with which the director is affiliated and the company, (2) the relationship
between the director and his or her partnership status, shareholder
interest or executive officer position, or (3) the direct business
relationship between the director and the company.
(c) Cross Compensation Committee Link. A director
who is employed as an executive of another corporation where any
of the company's executives serves on that corporation's compensation
committee may not serve on the audit committee.
(d) Immediate Family. A director who is an Immediate
Family member of an individual who is an executive officer of the
company or any of its affiliates cannot serve on the audit committee
until three years following the termination of such employment relationship.
See para. 303.02 for definition of "Immediate Family."
303.02 Application of Standards
(A) "Immediate Family" includes a person's
spouse, parents, children, siblings, mothers-in-law and fathers-in-law,
sons and daughters-in-law, brothers and sisters-in-law, and anyone
(other than employees) who shares such person's home.
(B) "Affiliate" includes a subsidiary,
sibling company, predecessor, parent company, or former parent company.
(C) Written Affirmation. As part of the initial
listing process, and with respect to any subsequent changes to the
composition of the audit committee, and otherwise approximately
once each year, each company should provide the Exchange written
confirmation regarding:
(1) any determination that the company's Board
of Directors has made regarding the independence of directors pursuant
to any of the subparagraphs above;
(2) the financial literacy of the audit committee
members;
(3) the determination that at least one of the
audit committee members has accounting or related financial management
expertise; and
(4) the annual review and reassessment of the adequacy
of the audit committee charter.
(D) Independence Requirement of Audit Committee
Members. Notwithstanding the requirements of subparagraphs (3)(a)
and (3)(d) of para. 303.01, one director who is no longer an employee
or who is an Immediate Family member of a former executive officer
of the company or its affiliates, but is not considered independent
pursuant to these provisions due to the three-year restriction period,
may be appointed, under exceptional and limited circumstances, to
the audit committee if the company's board of directors determines
in its business judgment that membership on the committee by the
individual is required by the best interests of the corporation
and its shareholders, and the company discloses, in the next annual
proxy statement subsequent to such determination, the nature of
the relationship and the reasons for that determination.
(E) "Officer" shall have the meaning
specified in Rule 16a-1(f) under the Securities Exchange Act of
1934, or any successor rule.
(F) Initial Public Offering. Companies listing in conjunction
with their initial public offering (including spin-offs and carve
outs) will be required to have two qualified audit committee members
in place within three months of listing and a third qualified member
in place within twelve months of listing.
B. Charter
The Exchange proposes to require audit committees to adopt a formal
written charter that is approved by the company's board and to review
and reassess annually the adequacy of the charter. The charter must
specify: (i) the scope of the audit committee's responsibilities
and how they are being carried out; (ii) the ultimate accountability
of the outside auditor to the board and audit committee; (iii) the
responsibility of the audit committee and board for selection, evaluation
and replacement of the outside auditor; and (iv) the responsibility
of the audit committee for ensuring the independence of the outside
auditor by reviewing, and discussing with the board if necessary,
any relationships between the auditor and the company or any other
relationships that may adversely affect the independence of the
auditor.
C. Structure and Membership of the Audit Committee
The Exchange also proposes to change the structure
and membership qualifications of the audit committee. Under the
proposed rule change, each audit committee must have at least three
independent directors, subject to a board override for one director.
The board may override the three-year bar for one audit committee
member after finding that an override is required in the best interests
of the company and its shareholders. If it exercises the override,
the company must disclose in its next annual proxy statement the
nature of the relationship and the reasons for that determination.
Potential candidates that are not considered independent because
of a business relationship with the company or a cross compensation
committee link may not be the subject of a board override.
As a result of the audit committee's responsibility
for a company's accounting and financial reporting, the Exchange
believes that audit committee members should have a basic understanding
of financial statements. Therefore, the proposed rule change requires
each audit committee member to be financially literate, or to become
financially literate within a reasonable period of time after his
or her appointment to the audit committee, as such qualification
is interpreted by the company's board in its business judgment.
Furthermore, in order to further enhance the effectiveness of the
audit committee, the proposal requires at least one member of each
audit committee to have accounting or related financial management
expertise, as the company's board interprets such qualification
in its business judgment.
D. Independence
The proposed rule change places four restrictions
on audit committee members for purposes of determining each member's
independence. First, employees (including non-employee executive
officers) of the company or its affiliates may not serve on the
audit committee until three years following the termination of employment.
However, if the relationship is with a former parent or predecessor
of the company (see definition of "Affiliate" described
in Subsection F below), the three-year bar applies to the time period
following the severance of the relationship between the company
and the former parent or predecessor.
Second, a director: (i) who is a partner, controlling
shareholder, or executive officer of an organization that has a
business relationship with the company, or (ii) who has a direct
business relationship with the company (e.g., a consultant),
may serve on the audit committee only if the company's board determines
in its business judgment that the relationship does not interfere
with the director's exercise of independent judgment. Business relationships
can include commercial, industrial, banking, consulting, legal,
accounting and other relationships. A director can have this relationship
directly with the company, or the director can be a partner, officer
or employee of an organization that has the business relationship.
Third, a director who is employed as an executive
of another corporation where any of the company's executives serves
on that corporation's compensation committee may not serve on the
audit committee.
Fourth, a director who is "Immediate Family"
(as that term is defined by proposed Exchange Rule 303.01(B)(3)(d))
of an individual who is an executive officer of the company or any
of its affiliates cannot serve on the audit committee until three
years following the termination of such employment relationship.
E. Written Affirmation
To monitor compliance with the proposed rule change,
the Exchange proposes to incorporate an ongoing written affirmation
requirement. In this regard, as part of the initial listing process,
and with respect to any subsequent changes to the composition of
the audit committee, and otherwise approximately once each year,
each company must provide the Exchange written confirmation regarding:
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i)
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any determination that the company's board
has made regarding the independence of directors;
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ii)
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the financial literacy of the audit committee
members;
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iii)
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the determination that at least one of the
audit committee members has accounting or related financial
management expertise; and
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iv)
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the annual review and reassessment of the adequacy
of the audit committee charter.
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F. Definitions
The Exchange proposes to codify two long-standing interpretations
under the current audit committee requirements as follows:
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i)
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"Immediate Family"
includes a person's spouse, parents, children, siblings, mothers-in-law
and fathers-in-law, sons and daughters-in-law, brothers and sisters-in-law,
and anyone (other than employees) who shares such person's home;
and |
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ii)
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"Affiliate" includes
a subsidiary, sibling company, predecessor, parent company, or
former parent company. |
G. Implementation
The Exchange proposes to implement
a transition period to provide its issuers with sufficient time to
comply with the proposed rule change. Specifically, the Exchange proposes
to: (i) "grandfather" all public company audit committee
members qualified under current NYSE rules until they are re-elected
or replaced; and (ii) give companies that have less than three members
on their audit committees eighteen months from the date of Commission
approval of this rule filing to recruit the requisite members. Issuers
listed on the Exchange as of the effective date of the proposed rule
change will have six months to adopt a formal written audit committee
charter.8
VI. Conclusion
For the foregoing reasons, the Commission finds that
the Exchange'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,54 that the amended proposed rule change
(SR-NYSE-99-39) is approved.
For the Commission, by the Division of Market Regulation, pursuant
to delegated authority.55
Jonathan G. Katz
Secretary
FOOTNOTES:
| 1 |
15 U.S.C. 78s(b)(1). |
| 2 |
17 CFR 240.19b-4. |
| 3 |
Securities Exchange Act Release
No. 41980 (Oct. 6, 1999), 64 FR 55514 (Oct. 13, 1999). The Nasdaq
Stock Market, Inc. and The American Stock Exchange LLC have proposed
rule changes relating to audit committees. See Securities
Exchange Act Release No. 41982 (Oct. 6, 1999), 64 FR 55510 (Oct.
13, 1999)("Nasdaq Proposal"), and Securities Exchange
Act Release No. 41981 (Oct. 6, 1999), 64 FR 55505 (Oct. 13, 1999)
("Amex Proposal"). |
| 4 |
The comment letters are discussed
in Section III of this order. |
| 5 |
Letter from James E. Buck, Senior
Vice President and Secretary, NYSE, to Richard Strasser, Assistant
Director, Division of Market Regulation ("Division"),
Commission, dated October 14, 1999 ("Amendment No. 1").
The Exchange submitted Amendment No. 1 to require issuers 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 extends the definition of "officer"
in Rule 16a-1(f) under the Act to Paragraph 303 of the Exchange's
Listed Company Manual. Previously, the Exchange permitted
each company's by-laws and charter to define this term. |
| 6 |
Letter from James E. Buck, Senior
Vice President and Secretary, NYSE, to Richard Strasser, Assistant
Director, Division, Commission, dated December 6, 1999 ("Amendment
No. 2"). Amendment No. 2 revises proposed rule 303.01(B)(1)
to require the board to adopt the audit committee charter. Under
the original proposal, the audit committee adopted the charter,
subject to board approval. Amendment No. 2 also revises proposed
Rule 303.01(B)(1)(c) to replace the provision that required the
board to take appropriate steps to ensure the independence of
the outside auditors. The revised provision requires the board
"to take appropriate action in response to the outside auditors
report to satisfy itself of the outside auditor's independence."
Finally, Amendment No. 2 revises proposed Rule 303.02 to require
companies listing on the Exchange in conjunction with an initial
public offering to have two qualified audit committee members
in place within three months of listing, and a third qualified
member within twelve months of listing. |
| 7 |
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. |
| 8 |
See Amendment No. 1, supra
n.5. |
| 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; Investment
Company Institute ("ICI") dated November 3, 1999; PricewaterhouseCoopers
LLP ("PWC") dated November 1, 1999; Gary P. Kreider
("Kreider") dated November 5, 1999; Emerson Electric
Co. ("Emerson") dated November 1, 1999; Exxon Corporation
("Exxon") dated November 3, 1999; McDonald's Corporation
(McDonald's) dated November 1, 1999; Connectiv ("Connectiv")
dated November 2, 1999; Texas Instruments ("TI") dated
November 2, 1999; Dime Bancorp, Inc. ("Dime") dated
November 3, 1999; Airlease Management Services, Inc. ("Airlease")
dated November 3, 1999; The Dun & Bradstreet Corporation ("D&B")
dated November 3, 1999; EMC Corporation ("EMC") dated
November 1, 1999; Dorsey & Whitney LLP ("Dorsey")
(on behalf of nine closed-end investment management companies
whose stock is listed on the Exchange) dated October 28, 1999;
Massachusetts Financial Services Company ("MFSC") (on
behalf of six closed-end funds advised by MFSC) dated November
22, 1999; Meritor Automotive, Inc. ("Meritor") dated
November 24, 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; 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 at 2;
EMC Letter at 2; APTC Letter at 2. Kreider stated his belief that
the proposed rule change circumvents state corporate law. EMC
stated that the proposed rule change substitutes over-generalized
restrictions for the more flexible, traditional standards of good
faith, candor, care and loyalty that underlie the business judgment
rule under state law. EMC also stated that the independence standards
may deprive audit committees of valuable financially-expert directors. |
| 11 |
CII Letter at 2; see also
AFL-CIO Letter at 2. |
| 12 |
AFL-CIO Letter at 2. |
| 13 |
MFSC Letter at 1. |
| 14 |
Dorsey Letter at 7, 9; E&Y Letter
at 3; Connectiv Letter at 2; D&B Letter at 2; Emerson Letter
at 2; NYSBA Letter at 5. In addition, two commenters stated that
the terms financial literacy and expertise are too subjective
and should be further defined, but did not state the Amex/Nasdaq
versions should be adopted. See McDonald's Letter at 1;
MFSC Letter at 2. MFSC also stated that it is not reasonable to
expect a company's board to request agreement from a potential
audit committee candidate that he will become financially literate
because there are no accreditation criteria or specific timeframes
for completing this undertaking. MFSC Letter at 2. |
| 15 |
Dime Letter at 2; NVCA Letter at
2; D&B Letter at 2; MFSC at 2. |
| 16 |
Keller and Rowe Letter at 2. |
| 17 |
E&Y Letter at 2; Emerson at
2; Arthur Andersen Letter at 1. In addition, the AFL-CIO stated
that the NYSE should adopt a bright line test, but does not think
the $60,000 threshold adopted by the Amex and Nasdaq is stringent
enough. AFL-CIO Letter at 3. |
| 18 |
Profusek Letter at 2 |
| 19 |
Keller and Rowe Letter at 2. |
| 20 |
Id. at 3. |
| 21 |
Id. |
| 22 |
Id.; see also NYSBA
Letter at 6. |
| 23 |
APTC Letter at 2. |
| 24 |
Id. at 3. |
| 25 |
Id. at 4-5. |
| 26 |
Id. |
| 27 |
Id. at 5. |
| 28 |
TI Letter at 1. |
| 29 |
Exxon Letter at 1; NYSBA Letter
at 2. |
| 30 |
Exxon Letter at 2. The Commission
notes that proposed Rule 303.01(B)(2)(b) and (c) require each
company's board to interpret the terms "financial literary"
and "financial expertise." The business judgment standard
therefore applies to the board's interpretation of these terms.
Subpart (a) of the rule does not require the board to interpret
the term "independence" and, thus, there is no need
for a business judgment standard. |
| 31 |
Exxon Letter at 1. |
| 32 |
Id. |
| 33 |
McDonald's Letter at 2. |
| 34 |
Deloitte Letter at 1; PWC Letter
at 1; Meritor Letter at 2. |
| 35 |
Id. at 2. |
| 36 |
E&Y Letter at 4. In addition,
the NVCA stated that the exemption for Small Business Filers should
be expanded to apply to companies with less than $50 million in
revenue. NVCA Letter at 4. The Commission notes, unlike the Nasdaq
Proposal and the Amex Proposal, there is no exemption for Small
Business Filers under the NYSE's proposed rule
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