[Federal Register Volume 64, Number 244 (Tuesday, December 21, 1999)]
[Notices]
[Pages 71529-71534]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-33052]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42233; File No. SR-NYSE-99-39]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the New York Stock Exchange, Inc. Amending the Exchange's 
Audit Committee Requirements and Notice of Filing and Order Granting 
Accelerated Approval of Amendments No. 1 and No. 2 Thereto

December 14, 1999.

I. Introduction

    On September 20, 1999, the New York Stock Exchange, Inc. (``NYSE'' 
or ``Exchange'') submitted to the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change amending the Exchange's audit 
committee requirements.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    The Federal Register published the proposed rule change for comment 
on October 13, 1999.\3\ In response, the Commission received 25 comment 
letters.\4\ On October 15, 1999 and December 8, 1999, the Exchange 
submitted Amendments No. 1 \5\ and No. 2,\6\ respectively, to the 
proposed rule change. This order approves the proposed rule change and 
grants accelerated approval to Amendments No. 1 and No. 2. The 
Commission is also soliciting comment on Amendments No. 1. and No. 2 to 
the proposed rule change.
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    \3\ Securities Exchange Act Release No. 41980 (Oct. 6, 1999), 64 
FR 55514 (Oct. 13, 1999). The Nasdaq Stock Market, Inc. and The 
American Stock Exchange LLC have proposed rule changes relating to 
audit committees. See Securities Exchange Act Release No. 41982 
(Oct. 6, 1999), 64 FR 55510 (Oct. 13, 1999) (``Nasdaq Proposal''), 
and Securities Exchange Act Release No. 41981 (Oct. 6, 1999), 64 FR 
55505 (Oct. 13, 1999) (``Amex Proposal'').
    \4\ The comment letters are discussed in Section III of this 
order.
    \5\ Letter from James E. Buck, Senior Vice President and 
Secretary, NYSE, to Richard Strasser, Assistant Director, Division 
of Market Regulation (``Division''), Commission, dated October 14, 
1999 (``Amendment No. 1''). The Exchange submitted Amendment No. 1 
to require issuers to adopt a formal written audit committee charter 
within six months of the effective date of the proposed rule change. 
As originally filed, the proposed rule change required issuers to 
adopt the charter within eighteen months of the effective date of 
the proposed rule change. Amendment No. 1 also extends the 
definition of ``officer'' in Rule 16a-1(f) under the Act to 
Paragraph 303 of the Exchange's Listed Company Manual. Previously, 
the Exchange permitted each company's by-laws and charter to define 
this term.
    \6\ Letter from James E. Buck, Senior Vice President and 
Secretary, NYSE, to Richard Strasser, Assistant Director, Division, 
Commission, dated December 6, 1999 (``Amendment No. 2''). Amendment 
No. 2 revises proposed rule 303.01(B)(1) to require the board to 
adopt the audit committee charter. Under the original proposal, the 
audit committee adopted the charter, subject to board approval. 
Amendment No. 2 also revises proposed Rule 303.01(B)(1)(c) to 
replace the provision that required the board to take appropriate 
steps to ensure the independence of the outside auditors. The 
revised provision requires the board ``to take appropriate action in 
response to the outside auditors report to satisfy itself of the 
outside auditor's independence.'' Finally, Amendment No. 2 revises 
proposed Rule 303.02 to require companies listing on the Exchange in 
conjunction with an initial public offering to have two qualified 
audit committee members in place within three months of listing, and 
a third qualified member within twelve months of listing.
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II. Description of the Proposed Rule Change

A. Background

    In February 1999, the Blue Ribbon Committee on Improving the 
Effectiveness of Corporate Audit Committees (``Blue Ribbon Committee'') 
issued a report containing recommendations aimed at strengthening the 
independence of the audit committee, making the audit committee more 
effective, and addressing mechanisms for accountability among the audit 
committee, the outside auditors, and management.\7\
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    \7\ Report and Recommendations of the Blue Ribbon Committee on 
Improving the Effectiveness of Corporate Audit Committees (1999). A 
copy of this Report can be found on-line at www.nasdaqnews.com.
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    The Exchange distributed to its listed companies the Exchange 
staff's suggestions for rule changes in response to the Blue Ribbon 
Committee's report. The comments from the Exchange's listed companies 
were generally supportive of the suggestions put forth by the Exchange, 
with some commenters expressing concerns about ``financial literacy'' 
requirement.
    In response to the Blue Ribbon Committee's recommendations, the 
Exchange proposes to revise its listing standards regarding audit 
committees. 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.
    The text of the proposed rule change, as amended by Amendments No. 
1 and No. 2, is as follows. Language deleted by Amendments No. 1 and 
No. 2 is in brackets. Language added by Amendments No. 1 and No. 2 is 
in italics.
NYSE Listed Company Manual
* * * * *
Section 3
Corporate Responsibility
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 Board 
of Directors must adopt and approve a formal written charter for the 
audit committee. 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

[[Page 71530]]

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] in response to the 
outside auditors' report to satisfy itself of the outside auditors' 
independence.
    (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 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 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. See para. 
303.02 for definition of ``Immediate Family.''
303.02 Application 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 such 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)(1) 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.
    (E) ``Officer'' shall have the meaning specified in Rule 16a-1(f) 
under the Securities Exchange Act of 1934, or any successor rule.
    (F) Initial Public Offering. Companies listing in conjunction with 
their initial public offering (including spin-offs and carve outs) will 
be required to have two qualified audit committee members in place 
within three months of listing and a third qualified member in place 
within twelve months of listing.

B. Charter

    The Exchange proposes to require audit committees to adopt a formal 
written charter that is approved by the company's board and to review 
and reassess annually the adequacy of the charter. The charter must 
specify: (i)

[[Page 71531]]

The scope of the audit committee's responsibilities and how they are 
being carried out; (ii) the ultimate accountability of the outside 
auditor to the board and audit committee; (iii) the responsibility of 
the audit committee and board for selection, evaluation and replacement 
of the outside auditor; and (iv) 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.

C. Structure and Membership of the Audit Committee

    The Exchange also proposes to change the structure and membership 
qualifications of the audit committee. Under the proposed rule change, 
each audit committee must have at least three independent directors, 
subject to a board override for one director. The board may override 
the three-year bar for one audit committee member after finding that an 
override is required in the best interests of the company and its 
shareholders. If it exercises the override, the company must disclose 
in its next annual proxy statement the nature of the relationship and 
the reasons for that determination. Potential candidates that are not 
considered independent because of a business relationship with the 
company or a cross compensation committee link may not be the subject 
of a board override.
    As a result of the audit committee's responsibility for a company's 
accounting and financial reporting, the Exchange believes that audit 
committee members should have a basic understanding of financial 
statements. Therefore, the proposed rule change requires each audit 
committee member to be financially literate, or to become financially 
literate within a reasonable period of time after his or her 
appointment to the audit committee, as such qualification is 
interpreted by the company's board in its business judgment. 
Furthermore, in order to further enhance the effectiveness of the audit 
committee, the proposal requires at least one member of each audit 
committee to have accounting or related financial management expertise, 
as the company's board interprets such qualification in its business 
judgment.

D. Independence

    The proposed rule change places four restrictions on audit 
committee members for purposes of determining each member's 
independence. First, 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 employment. 
However, if the relationship is with a former parent or predecessor of 
the company (see definition of ``Affiliate'' described in Subsection F 
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.
    Second, 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 the business relationship.
    Third, 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.
    Fourth, a director who is ``Immediate Family'' (as that term is 
defined by proposed Exchange Rule 303.01(B)(3)(d)) 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.

E. 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 must provide 
the Exchange written confirmation regarding:
    (i) Any determination that the company's board has made regarding 
the independence of directors;
    (ii) The financial literacy of the audit committee members;
    (iii) The determination that at least one of the audit committee 
members has accounting or related financial management expertise; and
    (iv) The annual review and reassessment of the adequacy of the 
audit committee charter.

F. Definitions

    The Exchange proposes to codify two long-standing interpretations 
under the current audit committee requirements as follows:
    (i) ``Immediate Family'' includes a person's spouse, parents, 
children, siblings, mother-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; and
    (ii) ``Affiliate'' includes a subsidiary, sibling company, 
predecessor, parent company, or former parent company.

G. Implementation

    The Exchange proposes to implement a transition period to provide 
its issuers with sufficient time to comply with the proposed rule 
change. Specifically, the Exchange proposes to: (i) ``grandfather'' all 
public company audit committee members qualified under current NYSE 
rules until they are re-elected or replaced; and (ii) give companies 
that have less than three members on their audit committees eighteen 
months from the date of Commission approval of this rule filing to 
recruit the requisite members. Issuers listed on the Exchange as of the 
effective date of the proposed rule change will have six months to 
adopt a formal written audit committee charter.\8\
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    \8\ See Amendment No. 1, supra n. 5.
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III. Comments

    As of December 9, 1999, the Commission received 25 comment letters 
on the proposed rule change.\9\ In

[[Page 71532]]

general, most commenters favored the proposed rule change but 
recommended certain modifications. Three commenters opposed the 
proposed rule change.\10\
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    \9\ See letters from: Ernst & Young LLP (``E&Y'') dated November 
1, 1999; Deloitte & Touche LLP (``Deloitte'') dated November 3, 
1999; Council of Institutional Investors (``CII'') dated November 8, 
1999; Brian T. Borders (on behalf of the National Venture Capital 
Association (``NVCA'')) dated November 12, 1999; Investment Company 
Institute (``ICI'') dated November 3, 1999; PriceWaterhouseCoopers 
LLP (``PWC') dated November 1, 1999; Gary P. Kreider (``Kreider'') 
dated November 5, 1999; Emerson Electric Co. (``Emerson'') dated 
November 1, 1999; Exxon Corporation (``Exxon'') dated November 3, 
1999; McDonald's Corporation (McDonald's) dated November 1, 1999; 
Connectiv (``Connectiv'') dated November 2, 1999; Texas Instruments 
(``TI'') dated November 2, 1999; Dime Bancorp, Inc. (``Dime'') dated 
November 3, 1999; Airlease Management Services, Inc. (``Airlease'') 
dated November 3, 1999; The Dun & Bradstreet Corporation (``D&B'') 
dated November 3, 1999; EMC Corporation (``EMC'') dated November 1, 
1999; Dorsey & Whitney LLP (``Dorsey'') (on behalf of nine closed-
end investment management companies whose stock is listed on the 
Exchange) dated October 28, 1999; Massachusetts Financial Services 
Company (``MFSC'') (on behalf of six closed-end funds advised by 
MFSC) dated November 22, 1999; Meritor Automotive, Inc. 
(``Meritor'') dated November 24, 1999; American Federation of Labor 
and Congress of Industrial Organizations (``AFL-CIO'') dated 
November 29, 1999; Mayer, Brown & Platt on behalf of Morgan Stanley 
Dean Witter (``MSDW'') dated November 29, 1999; Arthur Andersen LLP 
(``Arthur Andersen'') dated December 3, 1999; Association of 
Publicly Traded Companies (``APTC'') dated December 6, 1999; Robert 
A. Profusek (``Profusek'') dated December 3, 1999; Stanley Keller 
and Richard Rowe (``Keller and Rowe'') dated December 7, 1999; and 
The Committee on Securities Regulation of the Business Law Section 
of the New York State Bar Association (``NYSBA'') dated December 1, 
1999.
    \10\ See Kreider Letter at 2; EMC Letter at 2; APTC Letter at 2. 
Kreider stated his belief that the proposed rule change circumvents 
state corporate law. EMC stated that the proposed rule change 
substitutes over-generalized restrictions for the more flexible, 
traditional standards of good faith, candor, care and loyalty that 
underlie the business judgment rule under state law. EMC also stated 
that the independence standards may deprive audit committees of 
valuable financially-expert directors.
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    In particular, the CII supports the new requirements, but stated 
that the proposed board override provision, which allows a company's 
board to include a non-independent director on an audit committee, is 
not appropriate because companies should not have a problem finding 
financially literate, truly independent directors.\11\ In addition, the 
AFL-CIO stated that the restriction period for former employees, or 
relatives of former employees, should be three years instead of five 
years.\12\ MFSC stated that audit committees should not be required to 
describe in their charters how they carry out their 
responsibilities.\13\
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    \11\ CII Letter at 2; see also AFL-CIO Letter at 2.
    \12\ AFL-CIO Letter at 2.
    \13\ MFSC Letter at 1.
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    Many of the commenters pointed to differences between the proposed 
rule change, on the one hand, and the Amex Proposal and Nasdaq 
Proposal, on the other. Specifically, several commenters stated that 
the Exchange should adopt the Amex's and Nasdaq's definitions of 
financial literacy and expertise.\14\ These commenters noted that 
allowing individual companies to define these terms will lead to 
inconsistencies. In addition, several commenters stated that the 
proposed rule change will discourage qualified candidates from serving 
on audit committees.\15\ Moreover, one commenter stated that the 
restriction that prohibits an individual who is an immediate family 
member of an executive officer of the company or any of its affiliates 
from serving on the audit committee should not be limited to executive 
officers.\16\ Finally, three commenters stated that the Exchange should 
adopt a bright line test for identifying when a director has a 
significant business relationship with the company, as in the Amex 
Proposal and Nasdaq Proposal.\17\ On the other hand, another commenter 
opposed a bright line test and stated that the Exchange should not 
revise its current test to determine if a significant business 
relationship exists.\18\
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    \14\ Dorsey Letter at 7, 9; E&Y Letter at 3; Connectiv Letter at 
2; D&B Letter at 2; Emerson Letter at 2; NYSBA Letter at 5. In 
addition, two commenters stated that the terms financial literacy 
and expertise are too subjective and should be further defined, but 
did not state the Amex/Nasdaq versions should be adopted. See 
McDonald's Letter at 1; MFSC Letter at 2. MFSC Letter at 2. MFSC 
also stated that it is not reasonable to expect a company's board to 
request agreement from a potential audit committee candidate that he 
will become financially literate because there are no accreditation 
criteria or specific timeframes for completing this undertaking. 
MFSC Letter at 2.
    \15\ Dime Letter at 2; NVCA Letter at 2; D&B Letter at 2; MFSC 
at 2.
    \16\ Keller and Rowe Letter at 2.
    \17\ E&Y Letter at 2; Emerson at 2; Arthur Andersen Letter at 1. 
In addition, the AFL-CIO stated that the NYSE should adopt a bright 
line test, but does not think the $60,000 threshold adopted by the 
Amex and Nasdaq is stringent enough. AFL-CIO Letter at 3.
    \18\ Profusek Letter at 2.
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    In addition, one commenter stated that past non-executive 
employment should be treated as a significant business 
relationship.\19\ This commenter also stated that consultants who 
receive from the company more than a de minimis amount of compensation 
should be treated as employees, while consultants who do not should be 
treated as having a business relationship with the company.\20\ 
According to the commenter, the company's board should be permitted to 
determine that the compensation does not impair the director's 
objectivity.\21\ Moreover, the commenter objected to the financial 
expertise requirement and stated that no director will want to be 
designated the financial expert because of the added exposure to 
liability.\22\
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    \19\ Keller and Rowe Letter at 2.
    \20\ Id at 3.
    \21\ Id.
    \22\ Id.; see also NYSBA Letter at 6.
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    APTC stated that the proposed rule change will be counter 
productive to the goal of better audit committees.\23\ In addition, 
APTC stated that the proposed rule change will disadvantage smaller 
companies more than larger companies, but concluded that it is 
appropriate to apply the proposed rule change to all companies, 
regardless of size.\24\ Moreover, APTC is opposed to the proposal's 
financial literacy requirement.\25\ APTC believes that the financial 
literacy requirement may deprive audit committees of the service of 
individuals with ``exceptional character and/or operational 
experience.'' \26\ The commenter suggested that the Exchange replace 
this requirement with a requirement that the committee as a whole 
posses a certain level of financial acumen.\27\
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    \23\ APTC Letter at 2.
    \24\ Id. at 3.
    \25\ Id. at 4-5.
    \26\ Id.
    \27\ Id. at 5.
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    TI stated that to reduce unrealistic expectations, the proposed 
rule change should require or permit a disclaimer in the audit 
committee charter stating that the committee does not provide any 
special assurances with regard to the company's financial statements, 
nor does the audit committee give a professional evaluation of the 
quality of the audits performed by the independent public 
accountants.\28\ Exxon and NYSBA stated that the company's board, not 
the audit committee, should be required to adopt the audit committee 
charter because audit committees are created by the board in its 
discretion and under authority granted by state law.\29\
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    \28\ TI Letter at 1.
    \29\ Exxon Letter at 1; NYSBA Letter at 2.
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    Exxon also stated that proposed Rule 303.01(B)(2)(a), which 
requires audit committees to have at least three directors, all of whom 
must be independent, should provide a business judgment standard for 
independence, as subparts (b) and (c) of this Rule do with respect to 
financial literary and expertise.\30\ Exxon also stated that proposed 
Rule 303.01(B)(1) should not give both the board and the audit 
committee ultimate responsibility to select, evaluate, and replace the 
outside auditor.\31\ Exxon stated that only one body can have ultimate 
authority.\32\ McDonald's stated that a yearly written confirmation 
regarding financial literacy, financial expertise, independence of 
directors, and adequacy of the audit committee's charter is 
unnecessary.\33\
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    \30\ Exxon Letter at 2. The Commission notes that proposed Rule 
303.01(B)(2)(b) and (c) require each company's board to interpret 
the terms ``financial literary'' and ``financial expertise.'' The 
business judgment standard therefore applies to the board's 
interpretation of these terms. Subpart (a) of the rule does not 
require the board to interpret the term ``independence'' and, thus, 
there is no need for a business judgment standard.
    \31\ Exxon Letter at 1.
    \32\ Id.
    \33\ McDonald's Letter at 2.
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    Deloitte and PWC each stated that requiring a company's board or 
audit committee to ``ensure'' the

[[Page 71533]]

independence of the outside auditor goes beyond what can reasonably be 
expected of the board and the audit committee in their oversight 
role.\34\ Deloitte suggested that the Exchange replace the word 
``ensure'' with ``monitor'' or ``actively oversee.'' \35\ E&Y supports 
the proposed rule change overall, but stated that Small Business Filers 
should not be exempt from the financial literacy and expertise 
requirements and that the Exchange should expand its definition of 
immediate family member to include sons-in-law and daughters-in-
law.\36\ Airlease stated that smaller companies should not be required 
to have three independent auditors on their audit committees.\37\
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    \34\ Deloitte Letter at 1; PWC Letter at 1; Meritor Letter at 2.
    \35\ Id. at 2.
    \36\ E&Y Letter at 4. In addition, the NVCA stated that the 
exemption for Small Business Filers should be expanded to apply to 
companies with less than $50 million in revenue. NVCA Letter at 4. 
The Commission notes, unlike the Nasdaq Proposal and the Amex 
Proposal, there is no exemption for Small Business Filers under the 
NYSE's proposed rule change.
    \37\ Airlease Letter at 1.
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    In addition, the NVCA stated that the proposed rule change should 
exclude venture capital investors from the independence 
qualifications.\38\ The NVCA also stated that the proposed rule change 
should give companies that have just completed an initial public 
offering (``IPO'') eighteen months to comply with the new 
requirements.\39\
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    \38\ NVCA Letter at 5.
    \39\ Id at 4.
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    Three commenters stated that the proposed rule change should not 
apply to closed-end investment companies.\40\ ICI and MSDW noted that 
closed-end investment companies are adequately regulated under the 1940 
Act.\41\ These two commenters also stated that the potential abuses 
that the proposed rule change is designed to address do not exist with 
respect to closed-end investment funds because the assets of closed-end 
funds, consist exclusively of investment securities and thus there is 
no opportunity to ``manage'' earnings or results through the selective 
application of accounting policies.\42\
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    \40\ ICI Letter at 2; MSDW Letter at 1; Keller and Rowe Letter 
at 3. In addition, Keller and Rowe stated that the proposed rule 
change should exempt all investment companies because their audit 
committee members are already required not to be ``interested 
persons'' as that term is defined in Section 2(a)(9) of the 
Investment Company Act of 1940 (``1940 Act''). Keller and Rowe 
Letter at 5. Moreover, Dorsey supported the application of the 
proposed rule change to investment companies. Dorsey Letter at 3.
    \41\ ICI Letter at 3-4; MSDW Letter at 2.
    \42\ ICI Letter at 3; MSDW Letter at 1. ICI and MSDW also noted 
that the independent accountants of investment funds are selected by 
the independent directors of the fund.
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IV. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities exchange,\43\ and, in 
particular, the requirements of section 6(b)(5) of the Act.\44\ The 
Commission believes that the proposed rule change will protect 
investors by improving the effectiveness of audit committees of 
companies listed on the Exchange. The Commission also believes that the 
new requirements will enhance the reliability and credibility of 
financial statement of companies listed on the Exchange by making it 
more difficult for companies to inappropriately distort their true 
financial performance.
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    \43\ In approving the proposal, the Commission has considered 
its impact on efficiency, competition, and capital formation. 15 
U.S.C. 78c(f).
    \44\ 15 U.S.C. 78f(b)(5).
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    Specifically, the Commission believes that the proposed definition 
of independence will promote the quality and reliability of a company's 
financial statements. The Commission believes that directors without 
financial, familial, or other material personal ties to management will 
be more likely to objectively evaluate the propriety of management's 
accounting, internal control, and financial reporting practices. The 
Commission also believes that the proposal's prohibition against 
employees serving on the audit committee is appropriate and that the 
Exchange should not be required to distinguish between executive and 
non-executive employees.\45\ In addition, the Commission considers that 
the proposed provision permitting a company to appoint one non-
independent director to its audit committee, if the board determines 
that membership on the committee by the individual is required by the 
best interests of the corporation and its shareholders, adequately 
balances the need for objective, independent directors with the 
company's need for flexibility in exceptional and unusual 
circumstances. The Commission believes that the proposal's requirement 
that the company disclose in its next annual proxy statement the nature 
of the relationship and the board's reasons for determining that the 
appointment was in the best interests of the corporation will 
adequately guard against abuse of the proposed exception to the 
independence requirement.\46\
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    \45\ See Keller and Rowe Letter at 2.
    \46\ The Commission does not believe that the Exchange should 
require its listed companies to adopt a separate provision on 
consultants. See Keller and Rowe Letter at 3.
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    The Commission does not believe that venture capital investors 
should be excluded from the Exchange's definition of independence. The 
Commission does not view the proposed rule change as posing an undue 
hardship on venture capital firms or companies listed on the NYSE. The 
Commission notes that the proposed rule change will only prohibit 
venture capital investors from sitting on a company's audit committee 
if the investor does not fall within the Exchange's definition of 
independence. The proposed rule change will not prohibit previously 
eligible investors from serving on the company's board.
    In addition, the Commission believes that requiring boards of 
directors of listed companies to adopt formal written charters 
specifying the audit committee's responsibilities, and how it carries 
out those responsibilities, will help the audit committee, management, 
investors, and the company's auditors recognize, and understand the 
function of the audit committee and the relationship among the parties. 
Moreover, the Commission believes that the proposal's requirement that 
companies provide yearly written confirmation regarding the 
independence, financial literacy, and financial expertise of directors, 
as well as the adequacy of the audit committee charter, will help the 
Exchange to ensure that listed companies are complying with the 
proposed rule change.
    The Commission believes that the proposed rule change's requirement 
that each issuer have an audit committee composed of three independent 
directors who are able to read and understand fundamental financial 
statements will enhance the effectiveness of the audit committee and 
help to ensure that audit committee members are able to adequately 
fulfill their responsibilities. The Commission believes that requiring 
each audit committee member to satisfy this standard will help to 
ensure that the committee as a whole is financially literate.\47\ 
Moreover, the Commission believes that requiring one member of the 
audit committee to have past employment experience in financial or 
accounting, requisite professional certification in accounting, or any 
other comparable experience or background that indicates the 
individual's financial sophistication, will further enhance the 
effectiveness of the audit committee in carrying out its financial 
oversight responsibilities. The Commission does

[[Page 71534]]

not believe that these requirements will discourage qualified 
candidates from serving on audit committees. Rather, the Commission 
believes that these requirements will better enable companies to 
identify and select qualified directors. In addition, the Commission 
does not believe that companies will experience undue difficulty 
recruiting an audit committee member that satisfies the financial 
expertise requirements.
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    \47\See APTC Letter at 5.
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    Moreover, the Commission considers the Exchange's decision to 
exempt Small Business Filers as appropriate.\48\ The Commission notes 
that relatively few companies that qualify for listing on the Exchange 
would also qualify as Small Business Filers under SEC Regulation S-
B.\49\
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    \48\ See NVCA and Airlease Letters.
    \49\ Small Business Filer is defined by Regulation S-B as an 
issuer that: (i) has revenue of less than $25,000,000; (ii) is a 
U.S. or Canadian issuer; and (iii) if a majority owned subsidiary, 
the parent corporation is a small business issuer. 17 CFR 
228.10(a)(1).
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    Furthermore, the Commission does not believe that the Exchange 
should be required to adopt the Amex and Nasdaq proposed definitions of 
financial literacy and expertise or the test to determine when a 
potential director has a significant business relationship with the 
company. The Commission notes that the proposed rule change is not 
inconsistent with the Act.
    Moreover, the Commission has concluded that the Exchange's decision 
to include investment companies in the proposed rule change is 
warranted. While the Commission recognizes that the opportunity for 
some types of financial reporting abuses may be limited by the nature 
of fund assets,\50\ it believes that audit committees do play an 
important role in overseeing the financial reporting process for 
investment companies.
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    \50\ See Keller and Rowe Letter at 5; ICI Letter at 3; MSDW 
Letter at 1.
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    Finally, the Commission does not view the proposed rule change as 
circumventing state law.\51\ The Commission notes that the Exchange is 
amending its own listing standards, which is a function within the 
Exchange's discretion, as long as those changes are consistent with the 
Act.
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    \51\ Kreider Letter at 2.
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    The Commission finds good cause for approving Amendments No. 1 and 
No. 2 to the proposed rule change prior to the thirtieth day after 
publication in the Federal Register. The Commission notes that 
Amendment No. 1 revises the implementation time periods for the 
proposed rule change solely to provide greater clarity to issuers and 
to investors. The Commission believes that Amendment No. 1 will enable 
issuers to determine when they must comply with the new requirements 
and will enable investors to determine when to reply on the protections 
afforded by the proposed rule change. The Commission notes that 
Amendment No. 2 simply codifies the Exchange's existing policy on the 
timing of audit committee requirements for IPO's; clarifies that the 
company's board must take appropriate action to satisfy itself of the 
outside auditor's independence, and is not intended to provide an 
absolute guarantee of independence; and requires the board to adopt the 
audit committee charter, rather than approving the charter adopted by 
the audit committee. The Commission believes that accelerated approval 
will allow the Exchange to simultaneously make all relevant 
modifications to its Listed Company Manual and will avoid potential 
confusion. Accordingly, the Commission finds good cause to accelerate 
approval of Amendments No. 1 and No. 2 to the proposed rule change, 
consistent with the Sections 6(b)(5)\52\ and 19(b)\53\ of the Act.
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    \52\ 15 U.S.C. 78f(b)(5).
    \53\ 15 U.S.C. 78s(b).
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V. 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 witheld 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 January 11, 2000.

VI. Conclusion

    For the foregoing reasons, the Commission finds that the Exchange's 
proposal to amend its audit committee requirements is consistent with 
the requirements of the Act and the rules and regulations thereunder.

    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\54\ that the amended proposed rule change (SR-NYSE-99-39) is 
approved.

    \54\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\55\
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    \55\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-33052 Filed 12-20-99; 8:45 am]
BILLING CODE 8010-01-M