11.23.2004

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Updates

The Securities and Exchange Commission recently approved and made effective amendments to the New York Stock Exchange corporate governance standards, Section 303A of the NYSE Listed Company Manual, primarily to clarify standards that were adopted last year.  This Update summarizes the amendments and offers practical guidance.

Director Independence Standards Clarified

    • Proxy Statement Must Name Independent Directors and Disclose Board Determination and its Basis. A listed company's board of directors is required to affirmatively determine that each "independent" director has no material relationship with the company. The amendments clarify that listed companies must specifically name their independent directors, state that the board has determined that these directors are independent and disclose the basis for the board's determination in the company's annual proxy statement or, if no proxy statement is filed, in its annual report on Form 10‑K.
Practical Tips

Board Should Consider Adopting Categorical Independence Standards. As discussed in the commentary to the NYSE rules, a board should consider adopting and disclosing categorical standards upon which independence determinations are made, so that independence determinations on a detailed basis would be required only if the categorical standards are not met. In most cases, the company will only need to confirm that independent directors meet the disclosed standards.

Board Must Consider All Relevant Factors and Relationships. When assessing the materiality of a director's relationship with the company, the board should consider all relevant matters affecting a director's independence, not just the specific "bright-line" tests included in the NYSE corporate governance standards.  This overall review should consider different kinds of direct and indirect relationships, such as commercial, industrial, banking, consulting, legal, accounting, charitable and familial relationships, among others.

  • Bright-Line Compensation Look-Back Applies to Full 12-Month Periods Only. NYSE rules specifically preclude independence if a director or a director's immediate family member has received annual compensation from the company, in the past three years, in excess of $100,000, other than for director or committee fees. The amendments clarify that the applicable look-back period is any full 12‑month period included in the three-year period preceding the independence analysis. This amendment rejects an interpretation that the period extends beyond three years.
  • Prior Director Service As Interim Executive Officer Does Not Preclude Independence. NYSE rules specifically preclude independence if, in the past three years, a director has been an employee of the company or an immediate family member has been an executive officer of the company.  In connection with the $100,000 compensation test described above or this employment test, the amendments clarify that employment (or receiving compensation for employment) as an interim executive officer, not just as an interim Chairman or CEO as stated in the original rule, would not preclude a director's independence following that employment. 
  • Auditor Relationship Test Liberalized. The original NYSE rule precluded independence if a director was affiliated with or employed by, or a director's immediate family member was affiliated with or employed in a professional capacity by, the company's current or former internal or external auditor. The amended auditor-relationship test is tied just to the company's current internal or external auditor and generally loosens the standard by providing greater specificity as to the "affiliation" and "employment-in-a-professional-capacity" parts of the test.

Under the amended standard, a director is not independent if:

  • the director or an immediate family member is a current partner of the firm that is the company's current internal or external auditor;
  • the director is a current employee of the auditing firm; 
  • the director's immediate family member is a current employee of the auditing firm and participates in the firm's audit, assurance or tax compliance (but not tax planning) practice; or 
  • the director or an immediate family member was within the last three years (but no longer is) a partner or employee of the auditing firm and personally worked on the listed company's audit within that time.

Listed companies have until their first annual meeting after June 30, 2005 to replace any director who was independent under the original auditor-relationship test but is not independent under the amended test.

  • Distinction Drawn Between "Contributions" and "Payments" to Tax-Exempt Organizations — Proxy Statement Must Disclose Contributions that Exceed Threshold. NYSE rules specifically preclude independence if a director is an employee, or a director’s immediate family member is a current executive officer, of a company that has made payments to or received payments from the listed company for property or services in an amount which, in any of the last three fiscal years, exceeds the greater of $1 million or 2% of such other company's consolidated gross revenues. The amendments clarify that contributions to tax-exempt organizations will not be considered "payments" under this test. However, the board must still consider any contribution to such tax-exempt organizations among the facts and circumstances it evaluates as part of its overall determination of director independence.

The amended commentary also clarifies that payments made to a charitable organization relating to a commercial or vendor business relationship would remain subject to the test. If a company's contributions to a tax-exempt organization exceed the thresholds specified in the test, the company must disclose the contributions in its proxy statement or, if no proxy statement is filed, in its annual report on Form 10-K.

Other Corporate Governance Requirements Clarified

  • Non-Management Director Must Preside Over Executive Sessions — Proxy Statement Must Identify Presiding Director. The NYSE rules require regular executive sessions of non-management directors. The amendments clarify that a non-management director must preside over each executive session, although the same director is not required to preside at each meeting. The amended rule commentary requires disclosure of the presiding director or the procedure by which the presiding director is chosen for each executive session when the same director does not preside at every meeting. A listed company must make this disclosure in its proxy statement or, if no proxy statement is filed, in its annual report on Form 10-K. 
     
  • Compensation Committee Also Has Authority Over Non-CEO Executive Compensation. The NYSE rules require the board's compensation committee to make recommendations to the board about non-CEO executive officer compensation and incentive-compensation and equity-based plans. The amendments reaffirm that this rule focuses on compensation of the executive officers, rather than all employees, and clarify that the board may delegate its authority to approve non-CEO executive officer compensation to the compensation committee.  

  • Audit Committee Must Review MD&A Disclosures. The original NYSE rules required audit committees to meet and review the company's audited and quarterly financial statements with management and the independent auditors. The revised rules also require the audit committee to review the company's specific disclosures under Management's Discussion and Analysis of Financial Condition and Results of Operations.
    Practical Tip Audit Committee Should Plan on Scheduling Additional Meetings or Meetings Later in the Review Process. To comply with the amended rule, the audit committee must review and discuss a relatively advanced draft of the MD&A, instead of discussing the MD&A disclosure generally. Accordingly, the audit committee may need to delay or schedule additional meetings until the MD&A disclosure is sufficiently specific for the committee's review.
     
  • Proxy Statement Must Include Corporate Governance Disclosures. Previously, a listed company was required to disclose in its annual reports on Form 10-K:
    • that its corporate governance guidelines, code of business conduct and ethics and key committee charters are available on the company's website or in print for any shareholder upon request; and 
    • the manner by which interested parties may communicate with non-management directors.

To increase consistency with other disclosure requirements in the corporate governance rules, the amendments require these disclosures to be included in the company's proxy statement or, if no proxy statement is filed, in its annual report on Form 10-K.

  • Foreign Private Issuers Must Disclose Significant Differences Between NYSE Corporate Governance Requirements and Actual Practices. The amendments clarify that a foreign private issuer must disclose any significant differences between the NYSE's corporate governance requirements for U.S. companies and the listed company's actual corporate governance practices, rather than between the NYSE standards and the general corporate governance practices in the company's home country. 
  • Annual NYSE CEO Certification May Be Qualified. The CEO of each listed company must certify to the NYSE each year that he or she is not aware of any violation by the company of the NYSE corporate governance listing standards. The amendments permit the CEO to qualify this annual certification to the extent necessary and provides that the listed company must disclose any qualifications, along with this certification, in the company's annual report to shareholders or, if none is prepared, in its annual report on Form 10-K. 
  • Listed Companies Must Submit Annual and Interim Written Affirmations. The amendments now require each company to submit a written affirmation annually to the NYSE relating to its compliance with the corporate governance rules. Each company must also submit to the NYSE an interim written affirmation each time a change occurs to the company's board or to any of the committees subject to the corporate governance rules. Each company must use the annual and interim written affirmation forms specified by the NYSE.

Additional Information

This Update is only intended as a summary of the amendments to the NYSE corporate governance standards. You can find the full text of the SEC's adopting release at http://www.sec.gov/rules/sro/nyse/34-50625.pdf.

You can find further discussion of other recent laws, regulations and rule proposals of interest to public companies on our website.


 

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