The Board of the New York Stock Exchange (NYSE) submitted its proposed final listing and corporate governance rules to the Securities and Exchange Commission (SEC) on August 16, 2002, following a two-month comment period in which NYSE received more than 300 comment letters. NYSE's Board largely adopted the final recommendations of its Corporate Accountability & Listing Standards Committee, with some refinements to reflect the Sarbanes-Oxley Act and comment letters received during the comment process. The rules are now subject to SEC review and approval and to a public comment period.

In using this summary of the proposed final rules, please note that NYSE has used the words "must" and "should" with great care. "Must" indicates a NYSE requirement. "Should" indicates a standard or practice that NYSE believes is appropriate for most if not all companies; failure to comply with a "should" practice will not violate NYSE standards.

Majority of Independent Directors

Each listed company's board must have a majority of "independent" directors within 24 months from the date the SEC approves the rules. Companies listing on NYSE in conjunction with their initial public offering or upon transfer from another market or exchange must comply within 24 months of listing or transfer. In the case of transfer, if the former exchange had a substantially similar requirement but also had an unexpired transition period from the effective date of the rule, the transferring company will have at least as long a transition period for compliance.

A "controlled company"–a company of which more than 50% of the voting power is held by an individual, a group or another company–need not have a majority of independent directors on its board, but must have a three or more member audit committee composed entirely of independent directors. A controlled company need not have nominating/corporate governance and compensation committees composed of independent directors. A controlled company that chooses to take advantage of the "controlled company" exemptions must disclose in its annual meeting proxy statement that it is a controlled company and the basis for that determination.

Definition of "Independent Director"

In order to qualify a director as "independent," a listed company's board of directors will now need to affirmatively determine that the director has "no material relationship with the listed company (either directly or as a partner, shareholder or officer of an organization that has a relationship with the company)." Material relationships can include, among others, commercial, industrial, banking, consulting, legal, accounting, charitable and familial relationships. However, as the concern is independence from management, "ownership of even a significant amount of stock, [is not] by itself, . . . a bar to an independence finding."

Five-Year Cooling Off Period.
No director will be considered independent if he or she:

• was an employee of the listed company during the previous five years;
• is, or has been during the previous five years, affiliated with or employed by the present or former auditors of the listed company or an affiliate of the listed company;
• is, or has been during the previous five years, part of an "interlocking directorate," in which an executive officer of the listed company serves on the compensation committee of another company that concurrently employs such director; and
• has, or has had during the previous five years, family members in any of the foregoing categories.

The basis for a board determination that a relationship is not material or that a director who does not meet these standards is, in the board's view, nevertheless independent must be disclosed in the company's annual proxy statement.

Executive Sessions for Non-Management Directors

Within six months of SEC approval of the rules, listed companies must schedule "regular" executive sessions in which "non-management directors" meet without management participation. The term "non-management directors" excludes company officers, but includes other directors who are not independent because of a material relationship, former status or family membership.

The non-management directors may either appoint a single presiding director for all executive sessions or rotate the presiding position among the chairs of board committees. The name of the presiding director or the procedure by which the presiding director is selected for each or all executive sessions must be disclosed in the listed company's proxy statement.

A listed company must also disclose a method for interested parties to communicate directly with the presiding director or with the non-management directors as a group.

Audit Committee

Member Independence
NYSE will continue to require each listed company to have at a minimum a three-member audit committee composed entirely of independent directors.

Financial Literacy
Each member of the committee must be or become "financially literate" within a reasonable period of time. At least one member must have accounting or related financial management expertise. In view of the express provision in the Sarbanes-Oxley Act that at least one member of the audit committee qualify as a "financial expert," NYSE will await the SEC's interpretation of "financial expert" before acting on this specific recommendation. NYSE will not (at least until the SEC acts) require that the chairperson of the committee have financial expertise.

Committee Charter
Within six months of SEC approval of the rules, a listed company's Audit Committee must have a written charter that specifies the committee's:

• Purpose–which, in addition to preparing the annual Audit Committee report for the proxy statement, must, at a minimum, assist the Board to oversee the:
  –integrity of the financial statements;
  –company's legal and regulatory compliance;
  –independent auditors' qualifications and independence; and
  –performance of both the internal audit function and independent auditors.
• Duties and responsibilities–which, at a minimum, must be to:
  –retain and terminate the company's independent auditors, including setting the terms of engagement;
  –obtain an annual report by the independent auditors as to the independence of the auditor and of the firm's internal quality control procedures;
  –discuss quarterly and annual financial statements with management and the independent auditors, including management's discussion and analysis;
  –discuss earnings releases or guidance to analysts and rating agencies-but stopping short of mandatory pre-release review;
  –retain outside advisors (legal, accounting, etc.) as appropriate;
  –discuss the company's process for setting policies to govern risk management;
  –separately meet, "periodically," with management, internal auditors and independent auditors;
  –review audit problems or difficulties (and management's response) with the independent auditors;
  –set clear hiring policies for employees or former employees of the independent auditors; and
  –report regularly to the board on:
  –financial statements,
  
  
  –compliance with law,
  
  
  –auditor performance and
  
  
  –internal audit procedures.
• Responsibility to perform an annual performance evaluation of the committee.

Member Compensation
Beginning 24 months after SEC approval of the rules, audit committee members of listed companies may receive only director's fees in remuneration for their services. An audit committee member may receive his or her fee in cash and/or company stock or options or other in-kind consideration ordinarily available to directors, as well as all of the regular benefits that other directors receive. However, because of the significantly greater time commitment of audit committee members, they may receive reasonable compensation greater than that paid to the other directors (as may other directors for other time-consuming committee work).

Audit committee members will not be able to receive fees paid directly or indirectly for services as a consultant or a legal or financial advisor, regardless of the amount, including compensation paid to a director's firm for consulting or advisory services even if the director is not the actual service provider. Independent directors may receive a pension or other form of deferred compensation for prior service, provided the compensation is not contingent in any way on continued service.

Service on Multiple Audit Committees
If an audit committee member serves on the audit committee of more than a total of three public companies, then the board must determine whether the member's simultaneous service will impair the member's ability to effectively serve on its own audit committee and disclose that determination in its annual proxy statement. Listed companies will have 24 months from SEC approval of the rules to comply with this rule.

Nominating/Corporate Governance Committee

Each listed company must have a nominating/corporate governance committee within six months of SEC approval of the rules. Controlled companies need not comply with this rule.

Member Independence
The committee must have at least one independent director within 12 months, and it must be composed entirely of independent directors within 24 months.

Committee Charter
The committee must have a written charter that specifies the committee's:

• Purpose–which at a minimum must be to:
  –identify qualified board member candidates;
  –select or recommend that the board select director nominees for the next annual meeting of shareholders; and
  –develop and recommend to the board a set of Corporate Governance Guidelines.
• Duties and responsibilities–which at a minimum must reflect:
  –the board's criteria for selecting new directors; and
  –oversight of the evaluation of the board and management.

The charter should also address: member qualifications; member appointment and removal; committee structure and operations (including authority to delegate to subcommittees); and committee reporting to the board. The charter should give the committee sole authority to retain and terminate any search firm to be used to identify director candidates, including sole authority to approve the search firm's fees and other retention terms.

• Responsibility to perform an annual performance evaluation of the committee.

Compensation Committee

Also within six months of SEC approval of the rules, all listed companies must have a compensation committee. Controlled companies need not comply with this rule.

Member Independence
The committee must have at least one independent director within 12 months, and it must be composed entirely of independent directors within 24 months.

Committee Charter
The committee must have a written charter that specifies the committee's:

• Purpose–which at a minimum must be to:
  –discharge the board's responsibilities relating to compensation of the company's executives; and
  –produce an annual report on executive compensation for inclusion in the company's proxy statement.
• Duties and responsibilities–which at a minimum must be to:
  –review and approve corporate goals and objectives relevant to the CEO's compensation;
  –evaluate the CEO's performance in light of those goals and objectives;
  –set the CEO's compensation level based on this evaluation; and
  –make recommendations to the board with respect to incentive-compensation plans and equity-based plans.
  
  The charter should also address: member qualifications; member appointment and removal; committee structure and operations (including authority to delegate to subcommittees); and committee reporting to the board. Additionally, if a compensation consultant is to assist in the evaluation of director, CEO or senior executive compensation, the compensation committee charter should give that committee sole authority to retain and terminate the consulting firm, including sole authority to approve the firm's fees and other retention terms.
• Responsibility to perform an annual performance evaluation of the committee.

Internal Audit Function

Within six months of SEC approval of the rules, a listed company must establish an internal audit function. The company need not establish a separate internal audit department or have full-time internal audit employees. "It is enough for a company to have in place an appropriate control process for reviewing and approving its internal transactions and accounting." Companies may outsource this function to a firm other than its independent auditor.

Shareholder Approval of Equity-Compensation Plans

Effective immediately upon SEC approval of the rules, shareholders must approve all equity-compensation plans, and any material revisions to the terms of such plans (including the repricing of existing options). This requirement will not apply to employment inducement awards, option plans acquired in corporate acquisitions and mergers and certain tax-qualified plans. The compensation committee must approve plans not subject to shareholder approval. In addition, brokers may no longer vote on equity-compensation plans unless the beneficial owner of the shares has given the broker voting instructions.

Corporate Governance Guidelines

Within six months of SEC approval of the rules, a listed company must adopt and disclose Corporate Governance Guidelines. The Guidelines, as well as the company's Code of Ethics/Business Conduct and the charters of its most important committees (including at least the audit, compensation and nominating committees) must be posted on the company's website. The company's annual report must state that the information is available on its website and also available in print to any shareholder who requests it.

Corporate Governance Guidelines must address:

• director qualification and independence standards;
• director responsibilities;
• director access to management and independent advisors;
• director compensation;
• director orientation and continuing education;
• management succession; and
• annual performance evaluation of the board of directors.

Code of Ethics/Business Conduct

Also within six months of SEC approval of the rules, listed companies must adopt and disclose a Code of Ethics/Business Conduct for directors, officers and employees, and promptly disclose any waivers of the Code for directors or executive officers.

The Code should address:

• conflicts of interest;
• corporate opportunities;
• confidentiality;
• fair dealing;
• protection and proper use of company assets;
• compliance with laws, rules and regulations (including insider trading laws); and
• reporting of any illegal or unethical behavior.

CEO Certification

Within six months of SEC approval of the rules, each listed company CEO must certify to NYSE each year that he or she is not aware of any violation by the company of NYSE's corporate governance listing standards and rules. NYSE reduced the scope of its proposed certification to be harmonious with the certifications required by the SEC and the Sarbanes-Oxley Act. A listed company must disclose the certifications in its annual report to shareholders.

Public Reprimand Letters

Effective immediately upon the SEC's approval of the rules, NYSE may issue a public reprimand letter to a company that it determines has violated any NYSE listing standard. For companies that repeatedly or flagrantly violate NYSE listing standards, suspension and delisting remain the ultimate penalties.

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