[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