December 1, 2005
On November 23, 2005, the New York Stock Exchange filed proposed amendments to its corporate governance listing standards with the Securities and Exchange Commission for approval. Among other things, the proposals would impact the NYSE’s director independence requirements and related proxy disclosures and would mandate notification to the NYSE of any non-compliance with its corporate governance listing standards.
Although the NYSE’s filing states that its Board of Directors approved the proposed amendments in April 2005, the SEC must publish them for comment and approve them before they take effect. An overview of the proposals is below, and the NYSE filing, which includes a mark-up showing the proposed changes to the text of the Listed Company Manual, is available on the NYSE website at http://www.nyse.com/pdfs/NYSE-2005-81.pdf.
The most significant amendments proposed by the NYSE involve its director independence standards. According to the NYSE’s filing, the independence disclosures that many companies provided in their 2005 proxy statements either were "not sufficient to allow investors to adequately assess the quality of the board’s independence determination" or stated that particular directors had relationships with companies without explaining the basis for the board’s determination that these relationships did not preclude independence. In addition, according to the NYSE, many companies were "confused" by the concept of categorical independence standards and often were using the NYSE’s bright-line independence tests as the sole criteria in assessing director independence. To date, the prevailing practice has been to adopt categorical independence standards because the listing standards permit companies to disclose these standards in their proxy statements and make a general disclosure that their independent directors meet the standards "without detailing particular aspects of [any] immaterial relationships between the individual directors and the company."
To clarify the types of disclosure that companies must provide, the NYSE has proposed two alternative disclosure approaches. Under one approach, a company’s board could determine that certain types of relationships are categorically immaterial, and the company could disclose these types of relationships in its proxy statement. For companies that select this alternative, no additional disclosure would be required about individual directors’ relationships that fall within the categories of immaterial relationships established by the board. Importantly, boards would not be permitted to treat as categorically immaterial any relationship that is required to be disclosed as a related party transaction under Item 404 of SEC Regulation S-K. Accordingly, for each independent director, the independence disclosures in a company’s proxy statement would have to include a discussion of any Item 404 related party transactions that the board determined were not material in concluding that the director is independent. In some cases, however, the disclosure thresholds in Item 404 are lower than those in the NYSE’s bright-line independence tests. For example, Item 404 would require disclosure of a transaction between a listed company and an entity where a director is an executive officer if the transaction represented more than 5% the entity’s annual revenues, even if the amount of the transaction were less than $1 million, while under the NYSE’s business relationship test, the transaction would not preclude the director from being independent unless it exceeded a minimum of $1 million.
Under the other approach proposed by the NYSE, a company could disclose in its proxy statement that an independent director has no relationships with the company (other than as a director and/or shareholder) or has only immaterial relationships. If an immaterial relationship exists, the company would have to provide a "specific description" of the relationship and disclose the basis for the board’s determination that the relationship is immaterial and therefore does not preclude a determination of independence.
The proposed amendments also would expressly prohibit companies from summarizing or incorporating disclosures about director independence by reference from another document or a company’s website.
In view of the proposals, companies should revisit their independence standards and consider the independence disclosures to be included in their upcoming proxy statements.
The remaining amendments proposed by the NYSE would address, among other things:
Notification of non-compliance with corporate governance requirements. CEOs would be required to notify the NYSE in writing promptly after an executive officer becomes aware of any non-compliance with the NYSE’s corporate governance listing standards. Currently, notification is required only with respect to a material non-compliance, which also triggers an obligation to file a Form 8-K.
Disclosure of code-of-conduct waivers. Companies would be required to disclose waivers of their codes of conduct that are granted to directors and executive officers within four business days. This is a change from guidance contained in the NYSE’s Frequently Asked Questions, in which the NYSE stated that two to three business days would constitute "prompt" notification to shareholders of a waiver, and is being proposed for consistency with the Form 8-K disclosure requirements. The proposed amendments also would specify that companies must disclose waivers by press release, on their websites, or on a Form 8-K.
Audit committee review of MD&A. Current NYSE listing standards require that audit committees "meet" to review and discuss the disclosures in the "Management’s Discussion and Analysis of Financial Condition and Results of Operations" section of the company’s annual and quarterly reports. The proposed amendments would clarify that telephonic meetings satisfy the meeting requirement if permitted by state corporate law, but that polling audit committee members in lieu of a meeting is not permitted.
Executive sessions. Current NYSE listing standards require that non-management directors hold regular executive sessions and recommend (but do not require) that the independent directors meet by themselves in executive session at least once per year. In recognition of the fact that some boards have chosen to limit all executive sessions to independent directors, the proposed amendments would clarify that regular executive sessions of the independent (rather than non-management) directors satisfy the NYSE requirement. Similarly, companies could satisfy the requirement to establish procedures for "interested parties" to communicate with the presiding director or the non-management directors as a group through procedures that provide for communication with the independent directors only.
Corporate governance disclosures and webposting of corporate governance documents. Currently, various provisions of the NYSE’s corporate governance listing standards require that companies make specific disclosures about their corporate governance practices in their proxy statements (or annual reports, for companies that do not file proxy statements), and that companies post their corporate governance documents (including their corporate governance guidelines, codes of conduct, and key committee charters) on their websites. The proposed amendments would prohibit companies from incorporating other required proxy disclosures by reference from another document or a company’s website. In addition, the proposals would: (a) eliminate the requirement that companies disclose in their proxy statements that their corporate governance documents are available on their websites; (b) expressly require that companies have and maintain a website; and (c) consolidate the requirements relating to proxy statement and website disclosure in a separate section of the corporate governance listing standards.
CEO and SEC Certifications. Companies would no longer be required to disclose in their annual reports to shareholders (or annual reports on Form 10-K) that they have filed the most recent annual CEO certification mandated by the NYSE (as to compliance with the corporate governance listing standards) and the Section 302 certification required in their most recent annual report. According to the NYSE, this provision caused "significant confusion" because it related to certifications made during a prior year and is no longer necessary in view of SEC disclosure requirements, including the requirement to disclose on a Form 8-K any material non-compliance with NYSE listing standards.
Phase-in requirements for companies listing in connection with IPOs. Companies listing on the NYSE in connection with an IPO would have until the earlier of the date the IPO closes or five business days from the date that trading begins on the NYSE to have one independent director on each of the audit, compensation, and nominating/governance committees. Current listing standards require each of these committees to have one independent committee member as of the date of listing, but according to the NYSE, market practice has been not to appoint independent directors prior to the closing of an IPO due to prospectus liability concerns. Current listing standards also provide a transition period that gives companies listing in connection with an IPO 90 days to have a majority of independent members on their key committees and one year to have fully independent committees. The proposed amendments would extend this transition period to the requirement that companies have a three-person audit committee, giving companies listing in connection with an IPO up to one year after listing to appoint three members to the audit committee. This would avoid the need for companies to appoint directors who are not independent to their audit committees in order to satisfy the three-person minimum.
Controlled companies. The proposed amendments would clarify that a "controlled company" is one in which 50% or more of the voting power for the election of directors is held by an individual, a group, or another company. The proposals also would establish deadlines by which companies that cease to be controlled companies must comply with the requirements for a majority independent board and fully independent compensation and nominating/governance committees. A company would be required to have a majority of independent directors on its board within one year from the date it ceased to be a controlled company. It would be required to have one independent director on each of its compensation and nominating/governance committees on that date, a majority of independent directors within 90 days, and fully independent committees within one year.
Foreign private issuers. Foreign private issuers would be required to disclose on their websites significant differences between their corporate governance practices and NYSE-required practices rather than having the option to provide this disclosure in their annual reports or on their websites.
The proposed amendments must be approved by the SEC before they take effect and will be the subject of a 21-day comment period following publication in the Federal Register.
Gibson, Dunn & Crutcher lawyers are available to assist clients in addressing any questions they may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work, or John F. Olson (202-955-8522, [email protected]),
Amy L. Goodman (202-955-8653, [email protected]),
Ronald O. Mueller (202-955-8671, [email protected]),
or Gillian McPhee (202-955-8230; [email protected]).
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