[Federal Register Volume 67, Number 201 (Thursday, October 17, 2002)]
[Notices]
[Pages 64173-64176]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-26457]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46649; File No. SR-NASD-2002-140]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 Thereto by National Association of 
Securities Dealers, Inc. Relating to Shareholder Approval for Stock 
Option Plans or Other Arrangements

October 11, 2002.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on October 9, 2002, the National Association of Securities Dealers, 
Inc. (``NASD''), through its subsidiary, The Nasdaq Stock Market, Inc. 
(``Nasdaq''), filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by Nasdaq. 
On October 10, 2002, Nasdaq filed Amendment No. 1 to the proposed rule 
change.\3\ The Commission is publishing this notice to solicit comments 
on the proposed rule change, as amended, from interested persons.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from John D. Nachmann, Senior Attorney, Nasdaq, 
to Katherine A. England, Assistant Director, Division of Market 
Regulation, Commission, dated October 10, 2002 (``Amendment No. 
1''). In Amendment No. 1, Nasdaq did the following: (1) made 
technical corrections to its proposed rule language; (2) clarified 
the exceptions to shareholder approval for tax qualified, non-
discriminatory employee benefit plans, parallel nonqualified plans, 
and plans relating to an acquisition or merger; and (3) clarified in 
the purpose section of its filing that it was proposing to make 
conforming changes to NASD Rules 4310(c)(17)(A) and 4320(15)(A).
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of the 
Substance of the Proposed Rule Change

    Nasdaq proposes to amend NASD Rule 4350(i) (``NASD Rule 4350(i)'' 
or ``Rule'') to strengthen listing standards relating to shareholder 
approval for stock option plans or other arrangements, adopt 
interpretative material pertaining to shareholder approval for stock 
option plans or other arrangements, and to make related conforming 
changes to NASD Rules 4310(c)(17)(A) and 4320(15)(A).
    The text of the proposed rule change is below. Proposed new 
language is italicized; proposed deletions are in brackets.
* * * * *

Rule 4310. Qualification Requirements for Domestic and Canadian 
Securities

    (a)-(b) No change.
    (c) In addition to the requirements contained in paragraph (a) or 
(b) above, and unless otherwise indicated, a security shall satisfy the 
following criteria for inclusion in Nasdaq:
    (1)-(16) No change.
    (17) The issuer shall be required to notify Nasdaq on the 
appropriate form no later than 15 calendar days prior to:
    (A) establishing or materially amending a stock option plan, 
purchase plan or other arrangement pursuant to which stock may be 
acquired by officers, [or] directors, employees, or consultants without 
shareholder approval; or
    (B)-(D) No change.
    (18)-(29) No change.
    (d) No change.
* * * * *

Rule 4320. Qualification Requirements for Non-Canadian Foreign 
Securities and American Depositary Receipts

    (a)-(d) No change.
    (e) In addition to the requirements contained in paragraphs (a), 
(b) or (c), and (d), the security shall satisfy the following criteria 
for inclusion in Nasdaq:
    (1)-(14) No change.
    (15) The issuer shall be required to notify Nasdaq on the 
appropriate form no later than 15 calendar days prior to:
    (A) establishing or materially amending a stock option plan, 
purchase plan or other arrangement pursuant to which stock may be 
acquired by officers, [or] directors, employees, or consultants without 
shareholder approval; or
    (B)-(D) No change.
    (16)-(25) No change.
    (f) No change.
* * * * *

Rule 4350. Quantitative Listing Requirements for Nasdaq National Market 
and Nasdaq SmallCap Market Issuers Except for Limited Partnerships

    (a)-(h) No change.
    (i) Shareholder Approval.
    (1) Each issuer shall require shareholder approval [of a plan or 
arrangement under subparagraph (A) below, or] prior to the issuance of 
designated securities under subparagraph (A), (B), (C), or (D) below:
    (A) when a stock option or purchase plan is to be established or 
materially amended or other arrangement made pursuant to which options 
or stock may be acquired by officers, [or] directors, employees, or 
consultants, except for:
    (i) warrants or rights issued generally to all security holders of 
the company; or
    (ii) [broadly based plans or arrangements including other employees 
(e.g. ESOPs).] tax qualified, non-discriminatory employee benefit plans 
(e.g., plans that meet the requirements of Section 401(a) or 423 of the 
Internal Revenue Code) or parallel nonqualified plans, provided such 
plans are approved by the issuer's compensation committee or a majority 
of the issuer's independent directors; or
    (iii) plans relating to an acquisition or merger as permitted under 
IM-4350-5; or
    (iv) [In a case where the shares are] issuances[ed] to a person not 
previously an employee [d by] or director of the company, as an 
inducement [essential] material to the individual's entering into [an] 
employment [contract] with the company, provided such issuances are 
approved by the issuer's compensation committee or a majority of the 
issuer's independent directors. [shareholder approval will generally 
not be required. The establishment of a plan or arrangement under which 
the amount of securities that may be issued does not exceed the lesser 
of 1% of the number of shares of common stock, 1% of the voting power 
outstanding, or 25,000 shares will not generally require shareholder 
approval.]
    (B)-(D) No change.
    (2)-(6) No change.
    (j)-(l) No change.
* * * * *

[[Page 64174]]

IM-4350-5. Shareholder Approval for Stock Option Plans or Other 
Arrangements

    Employee ownership of company stock can be an effective tool to 
align employee interests with those of other shareholders. Stock option 
plans can also assist in the recruitment and retention of employees, 
which is especially critical to young, growing companies, or companies 
with insufficient cash resources to attract and retain highly qualified 
employees. However, these plans can potentially dilute shareholder 
interests. As such, Rule 4350(i)(1)(A) ensures that shareholders have a 
voice in the use of stock option plans, given this potential for 
dilution.
    Rule 4350(i)(1)(A) provides an exception to the requirement for 
shareholder approval for warrants or rights offered generally to all 
shareholders. In addition, an exception is provided for tax qualified, 
non-discriminatory employee benefit plans as these plans are regulated 
under the Internal Revenue Code and Treasury Department regulations. 
Along with tax qualified, non-discriminatory employee benefit plans, 
the Rule also provides an exception for parallel nonqualified plans.\1\
    Further, there is an exception for inducement grants to new 
employees because in these cases a company has an arm's length 
relationship with the new employees, and its interests are directly 
aligned with the shareholders. Inducement grants for these purposes 
include grants of options or stock to new employees in connection with 
a merger or acquisition.
    In addition, plans involving a merger or acquisition do not require 
shareholder approval in two situations. First, shareholder approval 
will not be required to convert, replace or adjust outstanding options 
or other equity compensation awards to reflect the transaction. Second, 
shares available under certain plans acquired in acquisitions and 
mergers may be used for certain post-transaction grants without further 
shareholder approval. This exception applies to situations where the 
party which is not a listed company following the transaction has 
shares available for grant under pre-existing plans that were 
previously approved by shareholders. These shares may be used for post-
transaction grants of options and other equity awards by the listed 
company (after appropriate adjustment of the number of shares to 
reflect the transaction), either under the pre-existing plan or another 
plan, without further shareholder approval, so long as (1) the time 
during which those shares are available for grants is not extended 
beyond the period when they would have been available under the pre-
existing plan, absent the transaction, and (2) such options and other 
awards are not granted to individuals who were employed by the granting 
company at the time the merger or acquisition was consummated. Nasdaq 
would view a plan adopted in contemplation of the merger or acquisition 
transaction as not pre-existing for purposes of this exception. This 
exception is appropriate because it will not result in any increase in 
the aggregate potential dilution of the combined enterprise.\2\
    Inducement grants, tax qualified non-discriminatory benefit plans, 
and parallel nonqualified plans are subject to approval by either the 
issuer's compensation committee, or a majority of the issuer's 
independent directors. It should also be noted that a company would not 
be permitted to use repurchased shares to fund option plans or grants 
without prior shareholder approval.

Footnotes to IM-4350-5

    \1\ The term ``parallel nonqualified plan'' means a plan that is 
a ``pension plan'' within the meaning of the Employee Retirement 
Income Security Act (``ERISA''), 29 U.S.C. Sec.  1002 (1999), that 
is designed to work in parallel with a plan intended to be qualified 
under Internal Revenue Code Section 401(a), to provide benefits that 
exceed the limits set forth in Internal Revenue Code Section 402(g) 
(the section that limits an employee's annual pre-tax contributions 
to a 401(k) plan), Internal Revenue Code Section 401(a)(17) (the 
section that limits the amount of an employee's compensation that 
can be taken into account for plan purposes) and/or Internal Revenue 
Code Section 415 (the section that limits the contributions and 
benefits under qualified plans) and/or any successor or similar 
limitations that may thereafter be enacted. However, a plan will not 
be considered a parallel nonqualified plan unless (1) it covers all 
or substantially all employees of an employer who are participants 
in the related qualified plan whose annual compensation is in excess 
of the limit of Code Section 401(a)(17) (or any successor or similar 
limitation that may hereafter be enacted) and (2) its terms are 
substantially the same as the qualified plan that it parallels 
except for the elimination of the limitations described in the 
preceding sentence.
    \2\ Note that any such shares reserved for listing in connection 
with the transaction would be counted by Nasdaq in determining 
whether the transaction involved the issuance of 20% or more of the 
company's outstanding common stock and thus required shareholder 
approval under Rule 4350(i)(1)(D).
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, Nasdaq 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. Nasdaq 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 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    NASD Rule 4350(i)(1)(A) generally requires shareholder approval for 
all stock option plans or other arrangements in which officers or 
directors participate. However, the Rule contains an exception for 
broadly based plans, that is, plans in which at least a majority of the 
eligible participants are not officers or directors and at least a 
majority of the grants go to employees other than officers and 
directors. Consistent with recent remarks by President Bush and SEC 
Chairman Pitt, and in order to enhance investor confidence, Nasdaq now 
proposes to delete the exception for broadly based plans and expand the 
Rule to generally require that all plans will be subject to shareholder 
approval.
    Nasdaq also proposes to eliminate the de minimis exception to the 
Rule, which allows for the grant of the lesser of 1% of the number of 
shares of common stock or 25,000 shares, without shareholder approval. 
Nasdaq believes that this exception is not in accord with the concept 
of restricting the use of unapproved options.
    The remaining exception for warrants or rights offered generally to 
all shareholders would be retained. In addition, shareholder approval 
would not be required for tax qualified, non-discriminatory benefit 
plans as these plans are regulated under the Internal Revenue Code and 
Treasury Department regulations. Along with tax qualified, non-
discriminatory employee benefit plans, the Rule also proposes an 
exception for parallel nonqualified plans. The Nasdaq represents that 
the proposed amendments to the Rule would have no effect on any 
shareholder approval or other requirements under the Internal Revenue 
Code or other applicable laws or requirements for such plans.

[[Page 64175]]

    Further, the exception for inducement grants to new employees would 
be retained because in these cases a company has an arm's length 
relationship with the new employees, and its interests are directly 
aligned with the shareholders. Inducement grants for these purposes 
would include grants of options or stock to new employees in connection 
with a merger or acquisition.
    In addition, the proposed amendments to the Rule would make clear 
that plans involving a merger or acquisition would not require 
shareholder approval in two situations. First, shareholder approval 
will not be required to convert, replace or adjust outstanding options 
or other equity compensation awards to reflect the transaction. Second, 
shares available under certain plans acquired in acquisitions and 
mergers may be used for certain post-transaction grants without further 
shareholder approval. This exception applies to situations where the 
party which is not a listed company following the transaction has 
shares available for grant under pre-existing plans that were 
previously approved by shareholders. These shares may be used for post-
transaction grants of options and other equity awards by the listed 
company (after appropriate adjustment of the number of shares to 
reflect the transaction), either under the pre-existing plan or another 
plan, without further shareholder approval, so long as (1) the time 
during which those shares are available for grants is not extended 
beyond the period when they would have been available under the pre-
existing plan, absent the transaction, and (2) such options and other 
awards are not granted to individuals who were employed by the granting 
company at the time the merger or acquisition was consummated. Nasdaq 
would view a plan adopted in contemplation of the merger or acquisition 
transaction as not pre-existing for purposes of this exception. Nasdaq 
believes that this exception is appropriate because it believes that it 
will not result in any increase in the aggregate potential dilution of 
the combined enterprise.
    Under the proposed amendments to the Rule, inducement grants, tax 
qualified, non-discriminatory benefit plans, and parallel nonqualified 
plans are subject to approval by either the issuer's compensation 
committee, or a majority of the issuer's independent directors. It 
should also be noted that a company would not be permitted to use 
repurchased shares to fund options without prior shareholder approval.
    The proposed amendments to the Rule also clarify that material 
amendments to plans will require shareholder approval. Nasdaq will 
continue to provide guidance as to what constitutes a material 
amendment to a plan. Nasdaq currently determines the existence of a 
material amendment to a plan consistent with the Commission's position 
under former Rule 16b-3 of the Act. In particular, Nasdaq looks to 
whether there is a material change to: (1) The benefits available to 
potential recipients under the plan; (2) the number of shares available 
under the plan; or (3) the class of eligible participants under the 
plan. Nasdaq is considering whether these factors can be refined, and 
may provide further guidance following this consideration.
    With respect to implementation of the proposed amendments to the 
Rule, Nasdaq proposes that the amended Rule become effective upon SEC 
approval, and that existing plans be grandfathered. Nasdaq represents 
that any material modification to plans in place or adopted after the 
effective date of the Rule would require shareholder approval.
    Lastly, Nasdaq proposes to make conforming changes to NASD Rules 
4310(c)(17)(A) and 4320(e)(15)(A). These proposed changes will require 
issuers to notify Nasdaq on the appropriate form no later than 15 
calendar days prior to establishing or materially amending a stock 
option plan, purchase plan or other arrangement pursuant to which stock 
may be acquired by officers, directors, employees, or consultants 
without shareholder approval.
2. Statutory Basis
    Nasdaq believes that the proposed rule change, as amended, is 
consistent with the provisions of Section 15A of the Act,\4\ in general 
and with Section 15A(b)(6) of the Act,\5\ in particular, in that the 
proposed rule change is designed to prevent fraudulent and manipulative 
acts and practices, to promote just and equitable principles of trade, 
to remove impediments to and perfect the mechanism of a free and open 
market, and a national market system, and in general, to protect 
investors and the public interest. As previously noted, Nasdaq believes 
that the proposed rule change will strengthen shareholder approval 
requirements with respect to stock option plans.
---------------------------------------------------------------------------

    \4\ 15 U.S.C. 78o-3.
    \5\ 15 U.S.C. 78o-3(6).
---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on Competition

    Nasdaq does not believe that the proposed rule change will result 
in any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act, as amended.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received from Members, Participants, or Others

    Written comments were neither solicited nor received.

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 self-regulatory organization 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, as amended, in 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 NASD. All submissions should refer to file 
number SR-NASD-2002-140 and should be submitted by November 7, 2002.


[[Page 64176]]


    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\6\
---------------------------------------------------------------------------

    \6\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-26457 Filed 10-16-02; 8:45 am]
BILLING CODE 8010-01-P