[Federal Register Volume 64, Number 197 (Wednesday, October 13, 1999)]
[Notices]
[Pages 55514-55517]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-26623]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-41980; File No. SR-NYSE-99-39]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the New York Stock Exchange, Inc. Amending Audit Committee
Requirements of Listed Companies
October 6, 1999.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rules 19b-4 thereunder,\2\ notice is hereby given
that on September 22, 1999, the New York Stock Exchange, Inc.
(``Exchange'' or ``NYSE'') filed with the Securities and Exchange
Commission (``Commission'' or ``SEC'') the proposed rule change as
described in Items I, II, and III below, which Items have been prepared
by the Exchange. The Commission is publishing this notice to solicit
comments on the proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
The Exchange proposes to amend Paragraph 303 of its Listed Company
Manual (the ``Manual''). The rule change amends the Exchange's policy
applicable to audit committee requirements of listed companies. The
text of the proposed rule change is as follows.
NYSE Listed Company Manual
* * * * *
Section 3
Corporate Responsibility
[Section 303.00 is being replaced in its entirety with the following
(except the parenthetical reference to outside directors)]
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
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.
(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
[[Page 55515]]
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 office 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 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.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the Exchange included statements
concerning the purpose of, and basis for, the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. The Exchange has prepared summaries, set forth in
sections A, B and C below, of the most significant aspects of such
statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and the
Statutory Basis for, the Proposed Rule Change
1. Purpose
In September 1998, the Blue Ribbon Committee on Improving the
Effectiveness of Corporate Audit Committees (``BRC'') was formed. The
BRC solicited public comments on possible recommendations in November
of the same year. The comment period expired December 1, 1998, and
earlier this year the BRC compiled and published a report that
contained ten specific recommendations (``Recommendations'') to the
Exchange, the National Association of Securities Dealers (``NASD''),
the Commission, and the accounting profession.
The Exchange distributed to its listed companies copies of the
report issued by the BRC. For several months, NYSE staff worked with
listed companies and constituent committees on their comments and views
on the Recommendations. Most of the issues raised during this working
period addressed the four Recommendations made to the Commission and
the accounting profession.
On June 3, 1998, the Exchange Board reviewed the suggested rule
changes and authorized the Exchange staff to distribute to its listed
companies the Exchange staff's suggestions for rule changes in response
to the Recommendations. The comments from the Exchange's listed
companies were generally supportive of the suggestions put forth by the
Exchange, with limited concerns addressing the concept of ``financial
literacy.'' Furthermore, during that time period, the Exchange staff
met with staff at the Commission and the NASD regarding uniformity
among the markets in standards governing issuer audit committees.
As a result of comments from the issuers ad conversations with
staff at the Commission and the NASD, the Exchange slightly modified
the proposed audit committee requirements and obtained Board approval
on September 2, 1999 to file the proposed rule change with the
Commission. The Exchange proposes to revise Paragraph 303 of the
Manual. 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.
Audit Committee Requirements:
1. Formal Charter: The Exchange proposes to adopt the
Recommendations to require audit committees to adopt a formal written
charter that is approved
[[Page 55516]]
by the company's board and to review and reassess annually the adequacy
of the charter. In addition, the charter must specify: (a) The scope of
the audit committee's responsibilities and how they are being carried
out, (b) the ultimate accountability of the outside auditor to the
board and audit committee, (c) the responsibility of the audit
committee and board for selection, evaluation and replacement of the
outside auditor, and (d) 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.
2. Composition/Expertise Requirement of Audit Committee Members:
Three requirements suggested by the BRC, with one slight modification
from the Recommendations as noted below, are part of the proposed rule
change:
(a) Each audit committee must have at least three Independent
directors, as described in item 3 below, subject to a board
``override'' for one director. The ``override'' may be exercised by the
board in the event that it determines in its business judgment that a
director who is no longer an Employee of the company or its affiliates,
or who is an Immediate Family member of a former executive officer of
the company or its affiliates, but is otherwise not eligible due to the
three-year bar, should serve on the audit committee because such
service is required in the best interests of the corporation and its
shareholders. In exercising such discretion, the company would be
required to disclose in its next annual proxy statement the nature of
the relationship and the reasons for that determination. The Exchange
notes that the BRC suggested that the ``override'' provision apply to
all four restrictions regarding Independence; however, the Exchange
proposes to limit it to the two instances referenced above, and to
codify its existing interpretations and policies with respect to
analysis of business relationships between organizations and directors.
The Exchange further believes that the potential conflicts presented by
the cross-compensation committee link are such that it should not be a
subject of board override.
(b) Each audit committee member must be financially literate, as
such qualification is interpreted by the company's board in its
business judgment, or must shortly attain such status.
(c) At least one member of each audit committee must have
accounting or related financial management expertise, as the company's
board interprets such qualification in its business judgment.
3. Independence: In keeping with the spirit of the Recommendations,
the following restrictions will apply to each audit committee member
for the purpose of determining such member's Independence:
(a) Employees. 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 such
employment. However, if such relationship is with a former parent or
predecessor of the company (see definition of Affiliate described in
item 4 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.
(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 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 such a
relationship. The director may serve on the audit committee without the
above-referenced board 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.
4. 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 should provide the Exchange written confirmation
regarding:
(a) Any determination that the company's board has made regarding
the independence of directors described above;
(b) The financial literacy of the audit committee members;
(c) The determination that at least one of the audit committee
members has accounting or related financial management expertise; and
(d) The annual review and reassessment of the adequacy of the audit
committee charter.
Definitions: The Exchange proposes to codify two long-
standing interpretations under the current audit committee requirements
as follows:
1. ``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.
2. ``Affiliate'' includes a subsidiary, sibling company,
predecessor, parent company, or former parent company.
Finally, the Exchange proposes to implement a transition period in
order to provide its issuers with sufficient time to come into
compliance with the proposed rule change. Specifically, the Exchange
proposes (1) to ``grandfather'' all public company audit committee
members qualified under current NYSE rules until they are re-elected or
replaced and (2) give companies that have less than three members on
their audit committees eighteen months from the date of SEC approval of
this rule filing to recruit the requisite members.
2. Statutory Basis
The Exchange believes that the proposed rule change is consistent
with Section 6(b)(5) of the Act,\3\ which requires, among other things,
the Exchange's rules to be designed to prevent fraudulent and
manipulative
[[Page 55517]]
acts and practices and, in general, to protect investors and the public
interest.
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\3\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition
The Exchange does not believe that the proposed rule change will
impose any burden on competition that is not necessary or appropriate
in furtherance of the purposes of the Act.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
The Exchange circulated the report issued by the BRC and the
Exchange staff's proposed responses to it to its issuers. As a general
matter, those responding agreed with the proposed rule change. The
relevant comments were focused in three general areas. The primary
issue raised was the element of ``financial literacy,'' with a small
proportion of responses suggesting that only a majority of members need
be financially literate. In addition, issuers were concerned that the
proposed concept of a ``financial literacy'' requirement for all audit
committee members was not adequately defined and is potentially
limiting with regard to the expertise of an audit committee member.
Second, some issuers felt the definition of independence was too
restrictive and that the board should be given more authority over the
determination of the independence of a director. Finally, a number of
companies thought the recommendations put forth by the BRC, which are
substantially analogous to the proposed rule change, will not
meaningfully help to prevent fundamental problems such as fraud and
financial reporting failures. In addition to the foregoing, some
companies thought the thrust of the Recommendations is to transfer some
of the traditional responsibilities of the outside auditors to the
board and audit committee, possibly increasing litigation exposure for
issuers.
III. Date of Effectiveness of the Proposed Rule Change and Timing
for Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the Exchange consents, the Commission will:
(A) By order approve such proposed rule change, or
(B) Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. 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, NW, Washington, DC 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
Exchange. All submissions should refer to the File No. SR-NYSE-99-39
and should be submitted by November 3, 1999.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\4\
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\4\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-26623 Filed 10-12-99; 8:45 am]
BILLING CODE 8010-01-M