NASD and NYSE Rulemaking:
Relating to Corporate Governance

SECURITIES AND EXCHANGE COMMISSION

(Release No. 34-48745; File Nos. SR-NYSE-2002-33, SR-NASD-2002-77, SR-NASD-2002-80, SR-NASD-2002-138, SR-NASD-2002-139, and SR-NASD-2002-141

November 4, 2003

Self-Regulatory Organizations; New York Stock Exchange, Inc. and National Association of Securities Dealers, Inc.; Order Approving Proposed Rule Changes (SR-NYSE-2002-33 and SR-NASD-2002-141) and Amendments No. 1 thereto; Order Approving Proposed Rule Changes (SR-NASD-2002-77, SR-NASD-2002-80, SR-NASD-2002-138 and SR-NASD-2002-139) and Amendments No. 1 to SR-NASD-2002-80 and SR-NASD-2002-139; and Notice of Filing and Order Granting Accelerated Approval of Amendment Nos. 2 and 3 to SR-NYSE-2002-33, Amendment Nos. 2, 3, 4 and 5 to SR-NASD-2002-141, Amendment Nos. 2 and 3 to SR-NASD-2002-80, Amendment Nos. 1, 2, and 3 to SR-NASD-2002-138, and Amendment No. 2 to SR-NASD-2002-139, Relating to Corporate Governance

I. Introduction

On August 16, 2002, the New York Stock Exchange, Inc. ("NYSE" or "Exchange") filed with the Securities and Exchange Commission ("Commission"), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 ("Exchange Act"),¹ and Rule 19b-4 thereunder,² a proposed rule change (SR-NYSE-2002-33) to amend its Listed Company Manual ("NYSE Manual") to implement significant changes to its listing standards that are aimed to ensure the independence of directors of listed companies and to strengthen corporate governance practices of listed companies ("NYSE Corporate Governance Proposal"). On April 4, 2003, the NYSE submitted Amendment No. 1 to the NYSE Corporate Governance Proposal.³ On April 17, 2003, the proposed rule change, as amended by NYSE Amendment No. 1, was published for comment in the Federal Register.⁴ The Commission received 68 comment letters on the NYSE proposal.⁵ On October 8, 2003, the NYSE filed Amendment No. 2 to the NYSE Corporate Governance Proposal.⁶ On October 20, 2003, the NYSE filed Amendment No. 3 to the NYSE Corporate Governance Proposal.⁷

On October 9, 2002, the NASD, through its subsidiary, The Nasdaq Stock Market, Inc. ("Nasdaq"), filed with the Commission, pursuant to Section 19(b)(1) of the Exchange Act, and Rule 19b-4 thereunder, a proposed rule change (SR-NASD-2002-141) to amend NASD Rules 4200 and 4350(c) and (d) to modify requirements relating to board independence and independent committees ("Nasdaq Independent Director Proposal"). On March 11, 2003, NASD, through Nasdaq, filed Amendment No. 1 to the Nasdaq Independent Director Proposal.⁸ On March 25, 2003, the proposed rule change, as amended by Amendment No. 1 to the Nasdaq Independent Director Proposal, was published for comment in the Federal Register.⁹ The Commission received 24 comment letters on the Nasdaq Independent Director Proposal.¹⁰ On July 16, 2003, Nasdaq filed Amendment No. 2 to the Nasdaq Independent Director Proposal.¹¹ On October 10, 2003, Nasdaq filed Amendment No. 3 to the Nasdaq Independent Director Proposal.¹² On October 16, 2003, Nasdaq filed Amendment No. 4 to the Nasdaq Independent Director Proposal.¹³ On October 30, 2003, Nasdaq filed Amendment No. 5 to the Independent Director Proposal.¹⁴

On June 11, 2002, the NASD, through Nasdaq, filed with the Commission, pursuant to Section 19(b)(1) of the Exchange Act, and Rule 19b-4 thereunder, a proposed rule change (SR-NASD-2002-77) to amend NASD Rule 4350(b) to add a requirement for issuers to announce publicly any audit opinions with going concern qualifications ("Nasdaq Going Concern Proposal"). On July 10, 2003, the NASD Going Concern Proposal was published for comment in the Federal Register.¹⁵ The Commission received no comments on the proposal.

On June 11, 2002, the NASD, through Nasdaq, filed with the Commission, pursuant to Section 19(b)(1) of the Exchange Act, and Rule 19b-4 thereunder, a proposed rule change (SR-NASD-2002-80) to amend NASD Rule 4350(h) to require an issuer's audit committee or another independent body of the board of directors to approve related party transactions ("Nasdaq Related Party Transactions Proposal"). On December 30, 2002, the NASD, through Nasdaq, submitted Amendment No. 1 to the Nasdaq Related Party Transactions Proposal.¹⁶ On July 16, 2003, the proposed rule change, as amended, was published for comment in the Federal Register.¹⁷ The Commission received no comments on the proposal. On October 3, 2003, the NASD, through Nasdaq, submitted Amendment No. 2 to the Nasdaq Related Party Transactions Proposal.¹⁸ On October 6, 2003, the NASD, through Nasdaq, submitted Amendment No. 3 to the Nasdaq Related Party Transactions Proposal.¹⁹

On October 9, 2002, the NASD, through Nasdaq, filed with the Commission, pursuant to Section 19(b)(1) of the Exchange Act, and Rule 19b-4 thereunder, a proposed rule change (SR-NASD-2002-138) to amend NASD Rule 4350(a) to require foreign issuers to disclose any exemptions they may receive from Nasdaq's corporate governance listing standards ("Nasdaq Issuer Applicability Proposal"). On July 10, 2003, the Nasdaq Issuer Applicability Proposal was published for comment in the Federal Register.²⁰ The Commission received one comment letter on the Nasdaq Issuer Applicability Proposal.²¹ On August 15, 2003, the NASD, through Nasdaq, submitted Amendment No. 1 to the Nasdaq Issuer Applicability Proposal.²² On October 10, 2003, the NASD, through Nasdaq, submitted Amendment No. 2 to the Nasdaq Issuer Applicability Proposal.²³ On October 23, 2003, the NASD, through Nasdaq, submitted Amendment No. 3 to the Nasdaq Issuer Applicability Proposal.²⁴

On October 10, 2002, the NASD, through Nasdaq, filed with the Commission, pursuant to Section 19(b)(1) of the Exchange Act, and Rule 19b-4 thereunder, a proposed rule change (SR-NASD-2002-139) to amend NASD Rule 4350(n) to require listed companies to adopt a code of conduct for all directors, officers, and employees ("Nasdaq Code of Conduct Proposal"). On January 15, 2003, the NASD, through Nasdaq, submitted Amendment No. 1 to the Nasdaq Code of Conduct Proposal.²⁵ On July 10, 2003, the proposed rule change, as amended, was published for comment in the Federal Register.²⁶ The Commission received two comment letters on the Nasdaq Code of Conduct Proposal. ²⁷ On October 6, 2003, the NASD, through Nasdaq, submitted Amendment No. 2 to the Nasdaq Code of Conduct Proposal.²⁸

This order approves the NYSE Corporate Governance Proposal, as amended by NYSE Amendment Nos. 1, 2, and 3; the Nasdaq Independent Director Proposal, as amended by Amendment Nos. 1, 2, 3, 4, and 5 to the Nasdaq Independent Director Proposal; the Nasdaq Going Concern Proposal; the Nasdaq Related Party Transactions Proposal, as amended by Amendment Nos. 1, 2, and 3 to that proposal; the Nasdaq Issuer Applicability Proposal, as amended by Amendment Nos. 1, 2, and 3 to that proposal; and the Nasdaq Code of Conduct Proposal, as amended by Amendment Nos. 1 and 2 to that proposal. The Commission is granting accelerated approval to Amendment Nos. 2 and 3 to the NYSE Corporate Governance Proposal, Amendment Nos. 2, 3, 4, and 5 to the Nasdaq Independent Director Proposal, Amendment Nos. 2 and 3 to the Nasdaq Related Party Transactions Proposal, Amendment Nos. 1, 2, and 3 to the Nasdaq Issuer Applicability Proposal, and Amendment No. 2 to the Nasdaq Code of Conduct Proposal, as discussed below, and is soliciting comments from interested persons on these amendments.

II. Description of the NYSE and Nasdaq Proposals

A. History

In 1998, the NYSE and NASD sponsored a committee to study the effectiveness of audit committees. This committee became known as the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees ("Blue Ribbon Committee"). In its 1999 report, the Blue Ribbon Committee recognized the importance of audit committees and issued ten recommendations to enhance their effectiveness.²⁹ In response to these recommendations, the NYSE and the NASD, as well as other exchanges, revised their listing standards relating to audit committees.³⁰ In February 2002, in light of several high-profile corporate failures, the Commission's Chairman at that time requested that the NYSE and NASD, as well as the other exchanges, review their listing standards, with an emphasis this time on all corporate governance listing standards, and not just those provisions relating to audit committees.³¹ After reviewing their corporate governance listing standards, the NYSE and the NASD, through Nasdaq, filed corporate governance reform proposals with the Commission in 2002.³²

In January 2003, pursuant to the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act"),³³ the Commission proposed Rule 10A-3 under the Exchange Act,³⁴ which directs each national securities exchange and national securities association to prohibit the listing of any security of an issuer that is not in compliance with the audit committee requirements specified in Rule 10A-3. Because the provisions concerning audit committees in the NYSE and Nasdaq corporate governance reform proposals, as filed with the Commission, did not conform in all respects with the audit committee requirements set forth in Rule 10A-3 as proposed by the Commission, both the NYSE and Nasdaq revised their proposals.³⁵ In April 2003, the Commission adopted Rule 10A-3.³⁶ In order to conform their proposals to the requirements of final Rule 10A-3, and to incorporate comments from the public and revisions suggested by the Commission's staff, the NYSE and Nasdaq each filed further amendments to their proposals.³⁷ Significant aspects of the proposed rule changes, as amended, are described below.

B. NYSE Proposals

According to the NYSE, the NYSE Corporate Governance Proposal is designed to further the ability of honest and well-intentioned directors, officers, and employees of listed issuers to perform their functions effectively. The NYSE believes that the proposal also will allow shareholders to more easily and efficiently monitor the performance of companies and directors in order to reduce instances of lax and unethical behavior.³⁸

1. Independence of Majority of Board Members

NYSE Section 303A(1) of the NYSE Manual would require the board of directors of each listed company to consist of a majority of independent directors.³⁹ Pursuant to NYSE Section 303A(2) of the NYSE Manual, no director would qualify as "independent" unless the board affirmatively determines that the director has no material relationship with the company (either directly or as a partner, shareholder or officer of an organization that has a relationship with the company). The company would be required to disclose the basis for such determination in its annual proxy statement or, if the company does not file an annual proxy statement, in the company's annual report on Form 10-K⁴⁰ filed with the Commission.⁴¹ In complying with this requirement, a board would be permitted to adopt and disclose standards to assist it in making determinations of independence, disclose those standards, and then make the general statement that the independent directors meet those standards.⁴²

2. Definition of Independent Director

In addition, the NYSE proposes to tighten its current definition of independent director as follows. First, a director who is an employee, or whose immediate family member is an executive officer, of the company would not be independent until three years after the end of such employment relationship ("NYSE Employee Provision").⁴³ Employment as an interim Chairman or CEO would not disqualify a director from being considered independent following that employment.⁴⁴

Second, a director who receives, or whose immediate family member receives, more than $100,000 per year in direct compensation from the listed company, except for certain permitted payments,⁴⁵ would not be independent until three years after he or she ceases to receive more than $100,000 per year in such compensation ("NYSE Direct Compensation Provision").⁴⁶

Third, a director who is affiliated with or employed by, or whose immediate family member is affiliated with or employed in a professional capacity by, a present or former internal or external auditor of the company would not be independent until three years after the end of the affiliation or the employment or auditing relationship.⁴⁷

Fourth, a director who is employed, or whose immediate family member is employed, as an executive officer of another company where any of the listed company's present executives serve on that company's compensation committee would not be independent until three years after the end of such service or the employment relationship ("NYSE Interlocking Directorate Provision").⁴⁸

Fifth, a director who is an executive officer or an employee, or whose immediate family member is an executive officer, of a company that makes payments to, or receives payments from, the listed company for property or services in an amount which, in any single fiscal year, exceeds the greater of $1 million, or 2% of such other company's consolidated gross revenues, would not be independent until three years after falling below such threshold ("NYSE Business Relationship Provision").⁴⁹ The NYSE proposes to clarify this proposal with respect to charitable organizations by adding a commentary noting that charitable organizations shall not be considered "companies" for purposes of the NYSE Business Relationship Provision, provided that the listed company discloses in its annual proxy statement, or if the listed company does not file an annual proxy statement, in its annual report on Form 10-K filed with the Commission, any charitable contributions made by the listed company to any charitable organization in which a director serves as an executive officer if, within the preceding three years, such contributions in any single year exceeded the greater of $1 million or 2% of the organization's consolidated gross revenues.⁵⁰

The NYSE also proposes to clarify this proposal by adding commentary explaining that both the payments and the consolidated gross revenues to be measured shall be those reported in the last completed fiscal year, and that the look-back provision applies solely to the financial relationship between the listed company and the director or immediate family member's current employer. A listed company would not need to consider former employment of the director or immediate family member.⁵¹

The NYSE proposes to define "immediate family member" to include a person's spouse, parents, children, siblings, mothers- and fathers-in-law, sons- and daughters-in-law, brothers- and sisters-in-law, and anyone (other than domestic employees) who shares such person's home.⁵² The NYSE also proposes that references to "company" include any parent or subsidiary in a consolidated group with the company.⁵³

The NYSE further proposes to revise the phase-in of the look-back requirement that the NYSE had previously proposed by applying a one-year look-back for the first year after adoption of these new standards.⁵⁴ The NYSE also proposes to change all of the look-back periods from five years to three years.⁵⁵ The three-year look-back would begin to apply from the date that is the first anniversary of Commission approval of the proposed rule change.⁵⁶

3. Separate Meetings for Board Members

NYSE proposes to require the non-management directors of each NYSE-listed company to meet at regularly scheduled executive sessions without management.⁵⁷

In addition, NYSE proposes to require listed companies to disclose a method for interested parties to communicate directly with the presiding director of such executive sessions, or with the non-management directors as a group.⁵⁸ Companies may utilize the same procedures they have established to comply with Rule 10A-3(b)(3).⁵⁹

4. Nominating/Corporate Governance Committee

NYSE proposes to require each listed company to have a nominating/corporate governance committee composed entirely of independent directors.⁶⁰ The NYSE also proposes to require such committee to have a written charter that addresses, among other items, the committee's purpose and responsibilities, and an annual performance evaluation of the nominating/corporate governance committee ("NYSE Nominating/Corporate Governance Committee Provision").⁶¹ The NYSE further proposes to clarify that the committee would be required to identify individuals qualified to become board members, consistent with the criteria approved by the board.⁶²

5. Compensation Committee

NYSE proposes to require each listed company to have a compensation committee composed entirely of independent directors.⁶³ The NYSE also proposes to require the compensation committee to have a written charter that addresses, among other items, the committee's purpose and responsibilities, and an annual performance evaluation of the compensation committee ("NYSE Compensation Committee Provision").⁶⁴ The Compensation Committee also would be required to produce a compensation committee report on executive compensation, as required by Commission rules to be included in the company's annual proxy statement or annual report on Form 10-K filed with the Commission.⁶⁵ Further, the NYSE proposes to (1) delete the previously proposed statement that the compensation committee has the sole authority to determine the compensation of the chief executive officer ("CEO"),⁶⁶ and provide that either as a committee or together with the other independent directors (as directed by the board), the committee would determine and approve the CEO's compensation level based on the committee's evaluation of the CEO's performance;⁶⁷ and (2) add a provision to the commentary on this section indicating that discussion of CEO compensation with the board generally is not precluded.⁶⁸

6. Audit Committee

a. Composition

NYSE Sections 303A(6) and 303A(7) would require each NYSE-listed company to have a minimum three-person audit committee composed entirely of directors that meet the independence standards of both NYSE Section 303A(2) and Rule 10A-3.⁶⁹ The NYSE also proposes to delete the previously proposed commentary relating to NYSE Section 303A(6) and replace it with the following: "The Exchange will apply the requirements of Rule 10A-3 in a manner consistent with the guidance provided by the Securities and Exchange Commission in SEC Release No. 34-47654 (April 1, 2003). Without limiting the generality of the foregoing, the Exchange will provide companies with the opportunity to cure defects provided in Rule 10A-3(a)(3)."⁷⁰

In addition, the Commentary to NYSE Section 303A(7)(a) would require that each member of the audit committee be financially literate, as such qualification is interpreted by the board in its business judgment, or must become financially literate within a reasonable period of time after his or her appointment to the audit committee.⁷¹ In addition, at least one member of the audit committee would be required to have accounting or related financial management expertise, as the company's board interprets such qualification in its business judgment.⁷² The NYSE also proposes to clarify that while the Exchange does not require that a listed company's audit committee include a person who satisfies the definition of audit committee financial expert set forth in Item 401(e) of Regulation S-K, a board may presume that such a person has accounting or related financial management experience.⁷³

If an audit committee member simultaneously serves on the audit committee of more than three public companies, and the listed company does not limit the number of audit committees on which its audit committee members serve, each board would be required to determine that such simultaneous service would not impair the ability of such member to effectively serve on the listed company's audit committee and to disclose such determination.⁷⁴

b. Audit Committee Charter and Responsibilities

NYSE Section 303A(7)(c) would require the audit committee of each listed company to have a written audit committee charter that addresses: (i) the committee's purpose; (ii) an annual performance evaluation of the audit committee; and (iii) the duties and responsibilities of the audit committee ("NYSE Audit Committee Charter Provision").

The NYSE Audit Committee Charter Provision provides details as to the duties and responsibilities of the audit committee that must be addressed. These include, at a minimum, those set out in Rule 10A-3(b)(2), (3), (4) and (5),⁷⁵ as well as the responsibility to annually obtain and review a report by the independent auditor; discuss the company's annual audited financial statement and quarterly financial statements with management and the independent auditor; discuss the company's earnings press releases, as well as financial information and earnings guidance provided to analysts and rating agencies; discuss policies with respect to risk assessment and risk management; meet separately, periodically, with management, with internal auditors (or other personnel responsible for the internal audit function), and with independent auditors; review with the independent auditors any audit problems or difficulties and management's response; set clear hiring policies for employees or former employees of the independent auditors; and report regularly to the board.⁷⁶

7. Internal Audit Function

NYSE Section 303A(7)(d) would require each listed company to have an internal audit function.⁷⁷

8. Corporate Governance Guidelines

NYSE Section 303A(9) would require each listed company to adopt and disclose corporate governance guidelines. The following topics would be required to be addressed: director qualification standards; director responsibilities; director access to management and, as necessary and appropriate, independent advisors; director compensation; director orientation and continuing education; management succession; and annual performance evaluation of the board.⁷⁸ Each company's website would be required to include its corporate governance guidelines and the charters of its most important committees, and the availability of this information on the website or in print to shareholders would need to be referenced in the company's annual report on Form 10-K filed with the Commission.⁷⁹

9. Code of Business Conduct and Ethics

NYSE Section 303A(10) would require each listed company to adopt and disclose a code of business conduct and ethics for directors, officers and employees, and to promptly disclose any waivers of the code for directors or executive officers.⁸⁰ The commentary to this section sets forth the most important topics that should be addressed, including conflicts of interest; corporate opportunities; confidentiality of information; fair dealing; protection and proper use of company assets; compliance with laws, rules and regulations (including insider trading laws); and encouraging the reporting of any illegal or unethical behavior. Each code would be required to contain compliance standards and procedures to facilitate the effective operation of the code. Each listed company's website would be required to include its code of business conduct and ethics, and the availability of the code on the website or in print to shareholders would need to be referenced in the company's annual report on Form 10-K filed with the Commission.⁸¹

10. CEO Certification

NYSE Section 303A(12)(a) would require the CEO of each listed company to certify to the NYSE each year that he or she is not aware of any violation by the company of the NYSE's corporate governance listing standards. This certification would be required to be disclosed in the company's annual report or, if the company does not prepare an annual report to shareholders, in the company's annual report on Form 10-K filed with the Commission.⁸²

In addition, NYSE Section 303A(12)(b) would require the CEO of each listed company to promptly notify the NYSE in writing after any executive officer of the listed company becomes aware of any material non-compliance with any applicable provisions of the new requirements.⁸³

11. Public Reprimand Letter

NYSE Section 303A(13) would allow the NYSE to issue a public reprimand letter to any listed company that violates an NYSE listing standard.⁸⁴

12. Exceptions to the NYSE Corporate Governance Proposals

The NYSE proposes to exempt any listed company of which more than 50% of the voting power is held by an individual, a group or another company ("Controlled Company") from the requirements that its board have a majority of independent directors, and that the company have nominating/corporate governance and compensation committees composed entirely of independent directors. A company that chose to take advantage of any or all of these exemptions would be required to disclose that choice, that it is a Controlled Company, and the basis for the determination in its annual proxy statement or, if the company does not file an annual proxy statement, in the company's annual report on Form 10-K filed with the Commission.⁸⁵ Limited partnerships and companies in bankruptcy proceedings also would be exempt from requirements that the board have a majority of independent directors and that the issuer have nominating/corporate governance and compensation committees composed entirely of independent directors.⁸⁶

The NYSE considers the requirements of Section 303A to be unnecessary for closed-end and open-end management investment companies that are registered under the Investment Company Act of 1940 ("Investment Company Act")⁸⁷, given the pervasive federal regulation applicable to them. However, the NYSE proposes that registered closed-end management investment companies ("closed-end funds") would be required to: (1) have a minimum three-member audit committee that satisfies the requirements of Rule 10A-3; (2) comply with the requirements of the NYSE Audit Committee Charter Provision; and (3) comply with the certification and notification provisions regarding non-compliance.⁸⁸ Closed-end funds also would be excluded from the disclosure requirement relating to an audit committee member's simultaneous service on more than three audit committees, but would be subject to the requirement for the board to determine that such simultaneous service would not impair the ability of such member to effectively serve on the listed company's audit committee.⁸⁹

The NYSE also proposes to require business development companies, which are a type of closed-end management investment company defined in Section 2(a)(48) of the Investment Company Act⁹⁰ that are not registered under the Investment Company Act, to comply with all of the provisions of NYSE Section 303A applicable to domestic issuers, except that the directors of such companies, including audit committee members, would not be required to satisfy the independence requirements set forth in NYSE Section 303A(2) and 303A(7)(b).⁹¹ For purposes of NYSE Sections 303A(1), (3), (4), (5), and (9), a director of a business development company would be considered to be independent if he or she is not an "interested person" of the company, as defined in Section 2(a)(19) of the Investment Company Act.⁹²

Open-end management investment companies ("open-end funds"), which can be listed as Investment Company Units, and are more commonly known as Exchange Traded Funds or ETFs, would be required to: (1) have an audit committee that satisfies the requirements of Rule 10A-3, and (2) notify the Exchange in writing of any material non-compliance.⁹³

In addition, the NYSE proposes also to require the audit committees of closed-end and open-end funds to establish procedures for the confidential, anonymous submission by employees of the investment adviser, administrator, principal underwriter, or any other provider of accounting related services for the investment company, as well as employees of the investment company, of concerns regarding questionable accounting or auditing matters.⁹⁴ This responsibility would be required to be addressed in the audit committee charter.⁹⁵

NYSE proposes that except as otherwise required by Rule 10A-3, the new requirements also would not apply to passive business organizations in the form of trusts (such as royalty trusts) or to derivatives and special purpose securities (such as those described in NYSE Sections 703.16, 703.19, 703.20, and 703.21). To the extent that Rule 10A-3 applies to a passive business organization, listed derivative, or special purpose security, the requirement to have an audit committee that satisfies the requirements of Rule 10A-3, and the requirement to notify the NYSE in writing of any material non-compliance, also would apply.⁹⁶

The new requirements generally would not apply to companies listing only preferred or debt securities on the NYSE. To the extent required by Rule 10A-3, however, all companies listing only preferred or debt securities on the NYSE would be required to: (1) have an audit committee that satisfies the requirements of Rule 10A-3, and (2) notify the Exchange in writing of any material non-compliance.⁹⁷

13. Application to Foreign Private Issuers

NYSE Section 303A would permit NYSE-listed companies that are foreign private issuers, as such term is defined in Rule 3b-4 under the Exchange Act,⁹⁸ to follow home country practice in lieu of the new requirements, except that such companies would be required to: (1) have an audit committee that satisfies the requirements of Rule 10A-3; (2) notify the NYSE in writing after any executive officer becomes aware of any non-compliance with any applicable provision; and (3) provide a brief, general summary of the significant ways in which its governance differs from those followed by domestic companies under NYSE listing standards.⁹⁹ Listed foreign private issuers would be permitted to provide this disclosure either on their website (provided it is in the English language and accessible from the United States) and/or in their annual report as distributed to shareholders in the United States in accordance with Sections 103.00 and 203.01 of the NYSE Manual.¹⁰⁰ If the disclosure is made available only on the website, the annual report would be required to state this and provide the web address at which the information may be obtained.¹⁰¹

14. Proposed Implementation of New Requirements

In NYSE Amendment No. 2, the NYSE proposes a revised implementation schedule for the new requirements. Pursuant to the new schedule, listed companies would have until the earlier of their first annual meeting after January 15, 2004, or October 31, 2004, to comply with the new standards. However, if a company with a classified board is required to change a director who would not normally stand for election in such annual meeting, the company would be permitted to continue such director in office until the second annual meeting after such date, but no later than December 31, 2005. Notwithstanding the foregoing, foreign private issuers would have until July 31, 2005, to comply with any Rule 10A-3 audit committee requirements.¹⁰²

Companies listing in conjunction with their initial public offering¹⁰³ would be required to have one independent member at the time of listing, a majority of independent members within 90 days of listing, and fully independent committees within one year. They would be required to meet the majority of independent board requirement within 12 months of listing.¹⁰⁴

Companies listing upon transfer from another market would have 12 months from the date of transfer in which to comply with any requirement to the extent the market on which they were listed did not have the same requirement. To the extent the other market has a substantially similar requirement but also had a transition period from the effective date of that market's rule, which period had not yet expired, the company would have the same transition period as would have been available to it on the other market. This transition period for companies transferring from another market would not apply to the audit committee requirements of Rule 10A-3 unless a transition period is available under Rule 10A-3.¹⁰⁵

C. Nasdaq Proposals

According to Nasdaq, the purpose of the Nasdaq Independent Director Proposal is to provide greater transparency regarding certain relationships that would preclude a board of directors from finding that an individual can serve as an independent director, and to increase the role of independent directors on board committees.¹⁰⁶ In Nasdaq's view, the proposal is intended to enhance investor confidence in the companies that list on Nasdaq.¹⁰⁷ According to Nasdaq, the purpose of the Nasdaq Going Concern Proposal is to bring notice of a going concern qualification to investors and potential investors;¹⁰⁸ the purpose of the Nasdaq Related Party Transactions Proposal is to improve investor protection;¹⁰⁹ the purpose of the Nasdaq Issuer Applicability Proposal is to alert investors to the exemptions that may be granted to foreign issuers;¹¹⁰ and the purpose of the Nasdaq Code of Conduct Proposal is to provide further assurance to investors, regulators, and Nasdaq that each of Nasdaq's issuers has in place a system to focus attention throughout the company on the obligation of ethical conduct, encourage reporting of potential violations, and deal fairly and promptly with questionable behavior.¹¹¹

1. Independence of Majority of Board Members

Nasdaq proposes to amend Nasdaq Rule 4200, which sets forth definitions, and Nasdaq Rule 4350, which governs qualitative listing requirements for Nasdaq National Market and Nasdaq SmallCap Market issuers (other than limited partnerships). Under the amendment to NASD Rule 4350(c)(1), a majority of the directors on the board of a Nasdaq-listed company would be required to be independent directors, as defined in NASD Rule 4200. Nasdaq proposes to require each listed company to disclose in its annual proxy (or, if the issuer does not file a proxy, in its Form 10-K or 20-F) those directors that the board has determined to be independent under NASD Rule 4200.¹¹²

If an issuer fails to comply with this requirement due to one vacancy, or one director ceases to be independent due to circumstances beyond their reasonable control, Nasdaq proposes to require the issuer to regain compliance with the requirement by the earlier of its next annual shareholders meeting or one year from the occurrence of the event that caused the failure to comply with this requirement.¹¹³ Nasdaq proposes to require any issuer relying on this provision to provide notice to Nasdaq immediately upon learning of the event or circumstance that caused the non-compliance.¹¹⁴

Pursuant to current NASD Rule 4200(a)(15), a director would not be independent if the director is an officer or employee of the company or its subsidiaries, or any other individual having a relationship which, in the opinion of the company's board, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.¹¹⁵

The NASD proposes to revise NASD Rule 4200(a)(15)(A) through (E) and add subparagraphs (F) and (G). NASD Rule 4200(a)(15) provides a list of relationships that would preclude a board finding of independence. First, a director who is, or at any time during the past three years was, employed by the company or by any parent or subsidiary of the company, would not be deemed independent ("Nasdaq Employee Provision").¹¹⁶

Second, a director who accepts or has a Family Member¹¹⁷ who accepts any payments from the company, or any parent or subsidiary of the company, in excess of $60,000 during the current fiscal year or any of the past three fiscal years, other than certain permitted payments,¹¹⁸ would not be deemed independent ("Nasdaq Payments Provision").¹¹⁹

Nasdaq proposes to state in the interpretive material to its rules ("Interpretive Material") that the Nasdaq Payments Provision is generally intended to capture situations where a payment is made directly to, or for the benefit of, the director or a family member of the director.¹²⁰ For example, consulting or personal service contracts with a director or family member of the director or political contributions to the campaign of a director or a family member of the director would be considered under the Nasdaq Payments Provision.¹²¹

Third, a director who is a Family Member of an individual who is, or at any time during the past three years was, employed by the company or by any parent or subsidiary of the company as an executive officer, would not be deemed independent ("Nasdaq Family of Executive Officer Provision").¹²²

Fourth, a director who is, or has a Family Member who is, a partner in, or a controlling shareholder or an executive officer of, any organization to which the company made, or from which the company received, payments for property or services in the current or any of the past three fiscal years that exceed 5% of the recipient's consolidated gross revenues for that year, or $200,000, whichever is more, other than certain permitted payments,¹²³ would not be deemed independent ("Nasdaq Business Relationship Provision").¹²⁴ In Amendment No. 3 to the Nasdaq Independent Director Proposal, Nasdaq proposes to add Interpretive Material clarifying the application of the Nasdaq Business Relationship Provision. The Interpretive Material states that this proposal is generally intended to capture payments to an entity with which the director or Family Member of the director is affiliated by serving as a partner (other than a limited partner), controlling shareholder or executive officer of such entity.¹²⁵ The Interpretive Material states that under exceptional circumstances, such as where a director has direct, significant business holdings, it may be appropriate to apply the corporate measurements in the Nasdaq Business Relationship Provision, rather than the individual measurements of the Nasdaq Payments Provision, and that issuers should contact Nasdaq if they wish to apply the rule in this manner.¹²⁶ The Interpretive Material further notes that the independence requirements of the Nasdaq Business Relationship Provision are broader than the rules for audit committee member independence set forth in Rule 10A-3(e)(8) under the Exchange Act.¹²⁷

Moreover, the Interpretive Material states that under the Nasdaq Business Relationship Provision, a director who is, or who has a Family Member who is, an executive officer of a charitable organization may not be considered independent if the company makes payments to the charity in excess of the greater of the greater of 5% of the charity's revenues or $200,000.¹²⁸ The Interpretive Material also discusses the treatment of payments from the issuer to a law firm in determining whether a director who is a lawyer may be considered independent.¹²⁹ The Interpretive Material notes that any partner in a law firm that receives payments from the issuer is ineligible to serve on that issuer's audit committee.¹³⁰

Fifth, a director of the listed company who is, or has a Family Member who is, employed as an executive officer of another entity at any time during the past three years where any of the executive officers of the listed company serves on the compensation committee of such other entity, would not be deemed independent ("Nasdaq Interlocking Directorate Provision").¹³¹

Sixth, a director who is, or has a Family Member who is, a current partner of the company's outside auditor, or was a partner or employee of the company's outside auditor, and worked on the company's audit, at any time, during the past three years, would not be deemed independent ("Nasdaq Auditor Relationship Provision").¹³²

Seventh, Nasdaq proposes that, in the case of an investment company, a director would not be considered independent if the director is an "interested person" of the company as defined in Section 2(a)(19) of the Investment Company Act, other than in his or her capacity as a member of the board of directors or any board committee.¹³³ This provision would be in lieu of the other tests for independence specified in the rule.

With respect to the look-back periods referenced in the Nasdaq Employee Provision, the Nasdaq Family of Executive Officer Provision, the Nasdaq Interlocking Directorate Provision, and the Nasdaq Auditor Relationship Provision, Nasdaq proposes to clarify that "any time" during any of the past three years should be considered,¹³⁴ and to add Interpretive Material stating that these three year look-back periods commence on the date the relationship ceases. As an example, the Interpretive Material states that a director employed by the company would not be independent until three years after such employment terminates.¹³⁵

Nasdaq also proposes to add Interpretive Material stating that the reference to a "parent or subsidiary" in the definition of independence is intended to cover entities the issuer controls and consolidates with the issuer's financial statements as filed with the Commission (but not if the issuer reflects such entity solely as an investment in its financial statements). The Interpretive Material also adds that the reference to "executive officer" has the same meaning as the definition in Rule 16a-1(f) under the Exchange Act.¹³⁶

2. Separate Meetings for Board Members

Nasdaq proposes to require independent directors to have regularly scheduled meetings at which only independent directors would be present.¹³⁷

3. Compensation of Officers

Nasdaq proposes to require the compensation of the CEO of a listed company to be determined or recommended to the board for determination either by a majority of the independent directors, or by a compensation committee comprised solely of independent directors ("Nasdaq Compensation of Executives Provision").¹³⁸ In addition, the compensation of all other officers would have to be determined or recommended to the board for determination either by a majority of the independent directors, or a compensation committee comprised solely of independent directors.¹³⁹

Under the Nasdaq proposal, if the compensation committee was comprised of at least three members, one director, who is not independent (as defined in NASD Rule 4200) and is not a current officer or employee or a Family Member of such person, would be permitted to be appointed to the committee if the board, under exceptional and limited circumstances, determines that such individual's membership on the committee is required by the best interests of the company and its shareholders, and the board discloses, in the next annual meeting proxy statement subsequent to such determination (or, if the issuer does not file a proxy, in its Form 10-K or 20-F), the nature of the relationship and the reasons for the determination.¹⁴⁰ A member appointed under such exception would not be permitted to serve longer than two years.

4. Nomination of Directors

Nasdaq proposes to amend NASD Rule 4350(c) to require director nominees to either be selected or recommended for the board's selection either by a majority of independent directors, or by a nominations committee comprised solely of independent directors ("Nasdaq Director Nomination Provision").¹⁴¹

If the nominations committee is comprised of at least three members, one director, who is not independent (as defined in NASD Rule 4200) and is not a current officer or employee or a Family Member of such person, would be permitted to be appointed to the committee if the board, under exceptional and limited circumstances, determines that such individual's membership on the committee is required by the best interests of the company and its shareholders, and the board discloses, in the next annual meeting proxy statement subsequent to such determination (of, if the issuer does not file a proxy, in its Form 10-K or 20-F), the nature of the relationship and the reasons for the determination.¹⁴² A member appointed under such exception would not be permitted to serve longer than two years.

Further, Nasdaq proposes to require each issuer to certify that it has adopted a formal written charter or board resolution, as applicable, addressing the nominations process and such related matters as may be required under the federal securities laws.¹⁴³ Nasdaq also proposes that the Nasdaq Director Nomination Provision would not apply in cases where either the right to nominate a director legally belongs to a third party,¹⁴⁴ or the company is subject to a binding obligation that requires a director nomination structure inconsistent with this provision and such obligation pre-dates the date the provision is approved.¹⁴⁵

5. Controlled Companies Exempt

Nasdaq proposes generally to exempt any Controlled Company from the requirement to have a majority of independent directors and from the compensation and nomination committee requirements discussed above. However, the independent directors would still be required to have regularly scheduled meetings at which only independent directors are present.¹⁴⁶ A Controlled Company would be defined as a company of which more than 50% of the voting power is held by an individual, a group, or another company. A company relying upon the exemption would be required to disclose in its annual proxy statement (or, if the issuer does not file a proxy, in its Form 10-K or 20-F) that it is a Controlled Company and the basis for that determination. To determine whether a group exists for purposes of this exception, the shareholders must have publicly filed a notice that they are acting as a group (e.g., a Schedule 13D).¹⁴⁷

6. Audit Committee Charter and Responsibilities

NASD Rule 4350(d) would retain the requirement that each issuer adopt a formal written audit committee charter, and the proposed amendment to the rule would require the charter to specify the committee's purpose of overseeing the accounting and financial reporting processes and the audits of the financial statements of the issuer.¹⁴⁸ The written charter also would be required to include specific audit committee responsibilities and authority, as set forth in the proposed amendment to Rule 4350(d)(3).¹⁴⁹ Nasdaq also proposes to state in Interpretive Material to Rule 4350(d) that the written charter set forth the scope of the audit committee's responsibilities and the means by which the committee carries out those responsibilities; the outside auditor's accountability to the committee; and the committee's responsibility to ensure the independence of the outside auditors.¹⁵⁰

7. Audit Committee Composition

NASD Rule 4350(d) would retain the requirement that each listed issuer have an audit committee composed of at least three members.¹⁵¹ However, under the proposed requirements, each audit committee member would be required to: (1) be independent, as defined under NASD Rule 4200; (2) meet the criteria for independence set forth in Rule 10A-3 (subject to the exceptions provided in Rule 10A-3(c)); and (3) not have participated in the preparation of the financial statements of the company or any current subsidiary of the company at any time during the past three years, in addition to satisfying the current requirement that the member be able to read and understand fundamental financial statements, including a company's balance sheet, income statement, and cash flow statement ("Nasdaq Audit Committee Provision").¹⁵²

One director who is not independent as defined in NASD Rule 4200 and meets the criteria set forth in Section 10A(m)(3) of the Exchange Act¹⁵³ and the rules thereunder, and is not a current officer or employee of the company or a Family Member of such person, may be appointed to the audit committee if the board, under exceptional and limited circumstances, determines that membership on the committee by the individual is required by the best interests of the company and its shareholders, and the board discloses, in the next annual proxy statement subsequent to such determination (or, if the issuer does not file a proxy, in its Form 10-K or 20-F), the nature of the relationship and the reasons for that determination. A member appointed under this exception would not be permitted to serve longer than two years and would not be permitted to chair the audit committee.¹⁵⁴ Nasdaq proposes to add to Interpretive Material the recommendation that an issuer disclose in its annual proxy (or, if the issuer does not file a proxy, in its Form 10-K or 20-F) if any director is deemed independent but falls outside the safe harbor provisions of Rule 10A-3(e)(1)(ii).¹⁵⁵

In addition, Nasdaq will retain the requirement that at least one member of the audit committee have past employment experience in finance or accounting, requisite professional certification in accounting, or any other comparable experience or background which results in the individual's financial sophistication, including being or having been a chief executive officer, chief financial officer or other senior officer with financial oversight responsibilities.¹⁵⁶

Nasdaq proposes to delete from the Interpretive Material the discussion relating to determining whether a person is an affiliate solely by virtue of stock ownership.¹⁵⁷

8. Cure Periods

Nasdaq proposes to add a cure period provision, as follows: (1) if a listed issuer fails to comply with the audit committee composition requirements under Rule 10A-3 and NASD Rule 4350(d)(2), because an audit committee member ceases to be independent for reasons outside the member's reasonable control, the audit committee member could remain on the committee until the earlier of the issuer's next annual shareholders meeting or one year from the occurrence of the event that caused the failure to comply with the requirements; and (2) if an issuer fails to comply with the audit committee composition requirements due to one vacancy on the audit committee, and the aforementioned cure period is not otherwise being relied upon for another audit committee member, the issuer would have until the earlier of the next annual shareholders meeting or one year from the occurrence of the event that caused the failure to comply with this requirement.¹⁵⁸ An issuer relying on either of these provisions would be required to provide notice to Nasdaq immediately upon learning of the event or circumstance that caused the non-compliance.

9. Notification of Noncompliance

Nasdaq proposes to require that an issuer provide Nasdaq with prompt notification after an executive officer of the issuer becomes aware of any material noncompliance by the issuer with the requirements of NASD Rule 4350.¹⁵⁹

10. Code of Business Conduct and Ethics

In the Nasdaq Code of Conduct Proposal, as amended,¹⁶⁰ Nasdaq proposes NASD Rule 4350(n) and related Interpretive Material, which would require each listed company to adopt a code of conduct applicable to all directors, officers and employees, and to make such code publicly available. The code of conduct would be required to comply with the definition of a "code of ethics" set forth in Section 406(c) of the Sarbanes-Oxley Act and any regulations thereunder. In addition, the code must provide for an enforcement mechanism that ensures prompt and consistent enforcement of the code, protection for persons reporting questionable behavior, clear and objective standards for compliance, and a fair process by which to determine violations. Moreover, any waivers of the code for directors or executive officers must be approved by the board and disclosed in a Form 8-K within five days.

In the Interpretive Material, Nasdaq proposes that the requirement of a publicly available code of conduct applicable to all directors, officer and employees of an issuer is intended to demonstrate to investors that the board and management of Nasdaq issuers have carefully considered the requirement of ethical dealing and have put in place a system to ensure that they become aware of and take prompt action against any questionable behavior. Nasdaq states that, for company personnel, a code of conduct with enforcement provisions provides assurance that reporting of questionable behavior is protected and encouraged, and fosters an atmosphere of self-awareness and prudent conduct.

11. Public Announcement of Audit Opinions with Going Concern Qualifications

In the Nasdaq Going Concern Proposal,¹⁶¹ Nasdaq proposes to amend NASD Rule 4350(b) to require each Nasdaq-listed company that receives an audit opinion that contains a going concern qualification to make a public announcement through the news media disclosing the receipt of such qualification. Under the proposal, the issuer, prior to the release of the public announcement, would be required to provide the text of the public announcement to the StockWatch section of Nasdaq's MarketWatch Department. The public announcement must be provided to Nasdaq StockWatch and released to the media not later than seven calendar days following the filing of the audit opinion in a public filing with the Commission.¹⁶²

12. Related Party Transactions

In the Nasdaq Related Party Transactions Proposal, as amended,¹⁶³ Nasdaq proposes to amend NASD Rule 4350(h) to specify that each issuer shall conduct an appropriate review of all related party transactions for potential conflict of interest situations on an ongoing basis and all such transactions would have to be approved by the listed company's audit committee or another independent body of the board of directors. For purposes of the rule, "related party transactions" would refer to transactions required to be disclosed pursuant to Commission Regulation S-K, Item 404.¹⁶⁴ Nasdaq proposes that the Related Party Transactions Proposal become operative on January 15, 2004.¹⁶⁵

13. Application to Foreign Issuers and Certain Other Issuers

NASD Rule 4350 currently provides that foreign issuers are not required to do any act that is contrary to a law, rule or regulation of any public authority exercising jurisdiction over such issuer or that is contrary to generally accepted business practices in the issuer's country of domicile. Currently, Nasdaq may provide exemptions from the requirements of NASD Rule 4350 as may be necessary or appropriate to carry out this intent. In the Nasdaq Issuer Applicability Proposal, as amended,¹⁶⁶ Nasdaq proposes to amend this rule and add Interpretive Material to clarify that the authority to grant exemptions from the corporate governance standards applies only to foreign private issuers and does not apply to the extent that such exemption would be contrary to the federal securities laws, including, without limitation, Section 10A(m) of the Exchange Act and Rule 10A-3 thereunder. Nasdaq also proposes to provide that a foreign issuer that receives an exemption from NASD Rule 4350 would be required to disclose in its annual reports filed with the Commission each requirement from which it is exempted and describe the home country practice, if any, followed by the issuer in lieu of these requirements. In addition, a foreign issuer making its initial public offering or first U.S. listing on Nasdaq would be required to disclose any such exemptions in their registration statement.

In addition, Nasdaq proposes that management investment companies (including business development companies) would be subject to all of the requirements of NASD Rule 4350, except that management investment companies registered under the Investment Company Act would be exempt from the requirements of NASD Rule 4350(c) and (n), which pertain to board and key committee independence requirements and codes of conduct.¹⁶⁷ Nasdaq proposed these exemptions in light of the fact that registered management investment companies are already subject to a pervasive system of federal regulation.

Finally, Nasdaq proposes that cooperative entities, such as agricultural cooperatives that are structured to comply with relevant state law and federal tax law and that do not have a publicly traded class of common stock would be exempt from NASD Rule 4350(c); however, such entities would be required to comply with all federal securities laws, including, without limitation, Section 10A(m) of the Exchange Act and Rule 10A-3 thereunder.¹⁶⁸

Nasdaq proposes that asset-backed issuers and other passive issuers,¹⁶⁹ such as unit investment trusts, would be exempt from NASD Rule 4350(c) and (n), which pertain to board and key committee independence requirements and codes of conduct, and the audit committee requirements of NASD Rule 4350(d).¹⁷⁰ Nasdaq noted that these revisions are commensurate with provisions contained in Rule 10A-3.

14. Proposed Implementation of New Requirements

In Amendment No. 3 to the Nasdaq Issuer Applicability Proposal,¹⁷¹ Nasdaq proposed to set out in NASD Rule 4350(a)(5) the proposed dates by which listed companies would be required to comply with the rule changes to NASD Rules 4200 and 4350 that are the subject of this Order. In order to allow companies to make necessary adjustments in the course of their regular annual meeting schedule, and consistent with Exchange Act Rule 10A-3, the rule would establish the deadlines for compliance listed below. During the transition period between the date of approval of the rule filing by the Commission and the deadline indicated for each rule change, companies that have not brought themselves into compliance with the new rules would be required to comply with the previously existing rules, as applicable.¹⁷²

Companies would be required to be in compliance with the new rules by the following dates:

The provisions of Rule 4200(a) and Rule 4350(c), (d) and (m) regarding director independence, independent committees, and notification of noncompliance would be required to be implemented by:

• July 31, 2005 for foreign private issuers¹⁷³ and small business issuers (as defined in Rule 12b-2¹⁷⁴); and
   
• For all other listed issuers, by the earlier of: (1) the listed issuer's first annual shareholders meeting after January 15, 2004; or (2) October 31, 2004.

In the case of an issuer with a staggered board, with the exception of the audit committee requirements, the issuer would have until its second annual meeting after January 15, 2004, but not later than December 31, 2005, to implement all new requirements relating to board composition, if the issuer would be required to change a director who would not normally stand for election at an earlier annual meeting. Such issuers would be required to comply with the audit committee requirements pursuant to the implementation schedule noted above.

Issuers that have listed or will be listed in conjunction with their initial public offering would be afforded exemptions from all board composition requirements consistent with the exemptions afforded in Rule 10A-3(b)(1)(iv)(A). That is, for each committee that the company adopts, the company would be required to have one independent member at the time of listing, a majority of independent members within 90 days of listing, and all independent members within one year. The rule would note, however, that investment companies are not afforded the exemptions in Rule 10A-3(b)(1)(iv)(A). Issuers could choose not to adopt a compensation or nomination committee and could instead rely upon a majority of the independent directors to discharge responsibilities under the rules. These issuers would be required to meet the majority independent board requirement within one year of listing.

Companies transferring from other markets with a substantially similar requirement would be afforded the balance of any grace period afforded by the other market. Companies transferring from other listed markets that do not have a substantially similar requirement would be afforded one year from the date of listing on Nasdaq. The rule would stipulate that this transition period is not intended to supplant any applicable requirements of Rule 10A-3 under the Exchange Act.

Compliance with the limitations on corporate governance exemptions to foreign private issuers would be required by July 31, 2005. However, the requirement that a foreign issuer disclose the receipt of a corporate governance exemption from Nasdaq would apply to new listings and filings made after January 1, 2004.

Compliance with proposed Rule 4350(n), requiring issuers to adopt a code of conduct,¹⁷⁵ would be required six months after approval by the Commission. Proposed Rule 4350(h), requiring audit committee approval of related party transactions, would be operative January 15, 2004. The remainder of Proposed Rules 4350(a) and 4350(b) would be effective upon approval by the Commission.

III. Summary of Comments on NYSE and Nasdaq Proposals

The Commission received a total of 90 comment letters on the NYSE and Nasdaq proposals.¹⁷⁶ Many of the commenters expressed their support for the goals of the proposals.¹⁷⁷ While some commenters praised specific provisions of the proposals,¹⁷⁸ other commenters argued that specific provisions of the proposals were too restrictive or too lenient.¹⁷⁹ Many commenters believed that certain aspects of the proposals needed clarification.¹⁸⁰ The commenters generally addressed issues falling into one or more of the categories discussed below.

A. Independence of Majority of Board Members

General

Many commenters supported the proposals by NYSE and Nasdaq to require each listed company to have a majority of independent directors on its board,¹⁸¹ to tighten the definition of independent director,¹⁸² and to require the board to affirmatively determine that directors are independent.¹⁸³ There were some who disagreed, however. One commenter argued, in general, that boards should not be required to have a majority of independent directors.¹⁸⁴ With respect to NYSE's proposal to tighten the definition of independent director, one commenter expressed disapproval for what it described as an "expanding list of defined relationships."¹⁸⁵ With respect to Nasdaq's proposal to tighten the definition of independent director, another commenter stated its concern that the proposed standards would lead to smaller boards or to boards composed of individuals that might not have the best or most valuable experience.¹⁸⁶

With respect to the NYSE proposal regarding the manner in which boards may disclose determinations of independence, one commenter stated its belief that permitting boards to adopt categorical standards of independence and to disclose generally that directors meet these standards would ensure that privacy is maintained concerning the specifics of private financial matters.¹⁸⁷ Another commenter requested that, with respect to the barrier to independence of individuals having specified affiliations with "organizations" having a material relationship with the company, the NYSE clarify what "organization" means.¹⁸⁸ With respect to Nasdaq's proposed definition of independence, one commenter requested that Nasdaq clarify that "employee" does not include independent contractors and employees of other goods and service providers.

Proposals Regarding Prohibited Compensation for Independent Directors

With respect to the kinds of compensation received by a director or family member that would preclude a finding of independence, one commenter described the NYSE Direct Compensation Provision as a "reasonable approach,"¹⁸⁹ while another commenter thought the proposal was too rigid because it would disqualify employees who were paid more than $100,000 and did not have significant decision-making authority.¹⁹⁰ Some commenters requested clarification of this proposal. For example, one of these commenters asked whether "compensation" had a similar meaning to that given by the Commission in Rule 10A-3,¹⁹¹ and whether any of the following could be excluded: gains from investments in securities and dividends,¹⁹² restricted stock received by directors as part of their compensation for service as directors,¹⁹³ payments from banking transactions in the ordinary course of business,¹⁹⁴ and deferred compensation.¹⁹⁵ One commenter expressed its preference for the NYSE Direct Compensation Provision over the Nasdaq Payments Provision because the Nasdaq Payments Provision excluded individuals who received "payments," which the commenter believed was too broad.¹⁹⁶ One commenter argued that either the $100,000 threshold of the NYSE Direct Compensation Provision should be increased for larger companies, or the board should have the discretion to establish the appropriate threshold.¹⁹⁷

With respect to the Nasdaq Payments Provision, one commenter argued that an indication of non-independence based on the threshold amounts of payments received should be a rebuttable presumption as in the NYSE Direct Compensation Provision, rather than a bright line test.¹⁹⁸ Commenters advocated that the following should be excluded from these amounts: indirect payments, such as payments to related organizations,¹⁹⁹ payments from banking or brokerage transactions in the ordinary course of business,²⁰⁰ other items excluded from disclosure per Commission rules such as Item 404 of Form S-K,²⁰¹ and compensation for service on board committees.²⁰² In contrast, one commenter stated that director's fees should be the only compensation an independent director could receive from the company.²⁰³ In addition, one commenter stated its belief that the three-year look back should not apply to the Nasdaq Payments Provision because the board would already be required to consider previous employment in making an affirmative determination of director independence.²⁰⁴

One commenter expressed its strong support for the exception in the NYSE Direct Compensation Provision for compensation received by a director for former service as an interim Chairman or CEO, and recommended that Nasdaq include this exception in its proposal.²⁰⁵

Business Relationship Provisions

One commenter supported the NYSE Business Relationship Provision and represented that members of its corporate governance task force (which consists of representatives from both large and small, public and non-public banking organizations) were confident that the majority of directors sitting on the boards of banking organizations impacted by these listing standards would be able to satisfy this requirement.²⁰⁶ Other commenters argued that the NYSE Business Relationship Provision would be difficult to implement and would not, in many cases, be the most accurate measure of the materiality of a business relationship.²⁰⁷ Likewise, commenters argued that NYSE's threshold of 2% was too low,²⁰⁸ the proposal was not appropriate for smaller companies,²⁰⁹ the proposal was ambiguous,²¹⁰ and that the existence of a commercial relationship should give rise only to a rebuttable presumption of lack of independence.²¹¹ Commenters were also concerned about the application of the proposal to family members.²¹² In addition, commenters argued that the proposal should not apply to the following: executive officers or employees of a company making the payments who seek to be independent directors of the company that is on the receiving end of the payments,²¹³ certain loans,²¹⁴ non-executive employees,²¹⁵ disqualification due to consolidation accounting principles,²¹⁶ and gross revenues received in certain competitively bid and public utility transactions.²¹⁷

With respect to the Nasdaq Business Relationship Provision, one commenter recommended defining "controlling shareholder."²¹⁸

Interlocking Directorate Provisions

Two commenters supported the NYSE and Nasdaq Interlocking Directorate Provisions.²¹⁹ One commenter does not believe that the look-back provisions of the NYSE and Nasdaq Interlocking Directorate Provisions should apply because independence would seem to be compromised only if the listed company's executives had the current ability to participate in determining the director's compensation as an executive officer of the other entity.²²⁰ The commenter suggests that if the NYSE and Nasdaq look-back provisions are applied, then the service of the listed company's executive, and the employment of the listed company's director, at the other company should be required to have occurred at the same time during that five-year period.²²¹

Relationships of a Director with the Company's Auditors

With respect to the NYSE's proposal concerning relationships with an auditor, one commenter did not believe that the NYSE had sufficiently explained why a director's affiliation with a company's auditor would compromise the director's independence.²²² In addition, several commenters argued that applying the proposals to family members would be too burdensome, given the small number of accounting firms that provide audit services to large publicly traded companies, and would be difficult to monitor. These commenters suggested limiting the scope of the proposal.²²³ Furthermore, commenters requested clarification of the terms "external auditors,²²⁴ "internal auditors,"²²⁵ "affiliated with,"²²⁶ and "executives."²²⁷ One commenter supported this proposal.²²⁸

With respect to the Nasdaq proposal on the same topic, one commenter suggested limiting the scope of the proposal by excluding from its prohibition partners or employees that provide only a minimal amount of work on the company's audit or who are brought in to assist on technical or industry-specific issues.²²⁹

Definition of Family Member

In general, many commenters criticized the proposed NYSE and Nasdaq definitions of family members for being too broad and impractical to apply.²³⁰ One commenter expressed its preference for NYSE's proposed definition,²³¹ and another commenter stated that NYSE's proposed definition is reasonable.²³²

Look-Back Periods and their Phase-In

With respect to the look-back periods proposed by the NYSE and Nasdaq to disqualify former employees, auditor personnel, interlocking directors and their families, as applicable, for a specified time, two commenters argued that no look-back periods were necessary.²³³ One of these commenters recommended that Nasdaq clarify that the look-back would apply to any time within the three-year period, not the entire three-year period.²³⁴ Two commenters²³⁵ approved of NYSE's proposal to phase-in the look-back periods but, along with other commenters,²³⁶ argued that a five-year look-back period would be too long. Some commenters argued that Nasdaq's look-back provisions should be phased-in as in the NYSE's proposal.²³⁷

Affiliates

With respect to how NYSE proposes to define independent directors, two commenters asked, absent other disqualifying factors, if a director that sits on the board of a company's affiliate could be an independent director with respect to that company.²³⁸

Application to Investment Companies

With respect to how Nasdaq proposes to define independent director, one commenter stated that whether a director of an investment company is independent should be determined exclusively under the provisions of Section 2(a)(19) of the Investment Company Act.²³⁹

Banks and Banking Transactions

Several commenters stated their concern about the impact of both the NYSE and Nasdaq proposals on small community banks and the disqualification of otherwise independent directors due to ordinary course of business banking transactions.²⁴⁰ These commenters recommended that Nasdaq and NYSE amend their proposals accordingly. However, one of these commenters expressed its support for the NYSE proposal and represented that members of its corporate governance task force (which consists of representatives from both large and small, public and non-public banking organizations) were confident that the majority of directors sitting on the boards of banking organizations impacted by these listing standards would be able to satisfy the proposed requirements.²⁴¹

Charities

One commenter argued that both companies and the charities they support would benefit from a bright line uniform rule that would apply to all charitable contributions without regard to the market on which a company is traded. The commenter stated its belief that Nasdaq's Business Relationship Provision would be a reasonable standard for assessing the effect of charitable contributions on a director's independence, and expressed its concern that NYSE-listed companies would be more likely to discontinue giving to charities than to expend the time and effort necessary to craft the categorical standards that would be needed under the NYSE proposal. ²⁴²

Other Comments on Independence Proposals

Some commenters recommended strengthening the independence standards. For example, two commenters recommended that a former CEO should never be eligible to serve as an independent director.²⁴³ One of these commenters argued that the board should be required to take into account a director's relationship with senior management and other directors in making a determination of independence.²⁴⁴ Another commenter recommended barring investment institutions from having board seats in companies they have investments in.²⁴⁵ Three commenters recommended adding considerations such as ethnic and gender diversity of the board to the discussion of independence.²⁴⁶

With respect to the Nasdaq proposal, one commenter suggested defining "executive officer" - - which appears in the Nasdaq Payments Provision, the Nasdaq Family of Executive Officer Provision, and the Nasdaq Business Relationship Provision - - as defined in Rule 16a-1(f) of the Exchange Act, to prevent these proposals from disqualifying employees who have no policy-making role at the corporate level.²⁴⁷ The same commenter also recommended clarifying the meaning of "subsidiary," which appears in the Nasdaq Employee Provision, the Nasdaq Payments Provision, and the Nasdaq Family of Executive Officer Provision.

One commenter expressed its strong support for the position taken by both the NYSE and Nasdaq not to disqualify independent directors for ownership of even a significant amount of stock.²⁴⁸

Two commenters recommended that NYSE and Nasdaq apply a more lenient independence standard to smaller companies.²⁴⁹

With respect to the NYSE proposal, one commenter recommended that NYSE adopt the provision permitted by Rule 10A-3 that would allow a listed issuer to have one audit committee member that ceases to be independent for reasons outside the member's reasonable control for a limited amount of time, and to extend such provision to all independent directors and the other non-Rule 10A-3 independence requirements.²⁵⁰ Another commenter recommended adding a provision relating to appropriate procedures for a company to cure any defects in its compliance with the proposed new independence standards.²⁵¹

B. Separate Meetings for Independent Directors

Several commenters were in favor of the NYSE proposal to require separate executive sessions for non-management directors.²⁵² One commenter stated that it regarded this requirement as among the most important in improving the independence of the board.²⁵³ Another commenter criticized the proposal because it believes that it could lead to decisions being made without critical information available to management, and could raise liability issues for the non-management directors under state law if their decisions are determined to be harmful to the company or not in its best interest.²⁵⁴ The commenter suggested that the NYSE encourage these meetings, but not make them mandatory, so that each company could determine if the sessions would be productive. A third commenter stated its belief that requiring executive sessions would have a divisive effect within boards of listed companies and would deprive directors of guidance by management.²⁵⁵ Another commenter argued that independent directors, not non-management directors, should be required to attend executive sessions, and that an independent director should be required to preside over the executive sessions.²⁵⁶

With respect to the Nasdaq proposal to require separate sessions for independent directors, one commenter stated its view that such a requirement could be burdensome, and recommended requiring regular meetings of non-management directors.²⁵⁷ Another commenter recommended that Nasdaq clarify what would be expected to occur at these meetings.²⁵⁸

C. Communications with Independent Directors

Commenters recommended that NYSE clarify its proposal that interested parties should have the ability to freely communicate with a company's non-management directors with respect to the identity of "interested parties;"²⁵⁹ how they should communicate with independent directors;²⁶⁰ what topics would be appropriate to direct to independent directors, instead of the entire board;²⁶¹ and whether management could be involved in screening communications and in reviewing and responding to concerns.²⁶² Another commenter recommended limiting the proposal to employees.²⁶³ With respect to the Nasdaq proposal, one commenter advocated that companies ensure that employees know that they would not be retaliated against for reports made in good faith.²⁶⁴

D. Compensation of Officers

Many commenters disapproved of the NYSE Compensation Committee Provision because the compensation committee would be given the sole authority to determine CEO compensation.²⁶⁵ Commenters argued that the full board should have a role in making CEO compensation decisions,²⁶⁶ or that all independent directors should have a role in making CEO compensation decisions, perhaps even by deciding how CEO compensation decisions would be made.²⁶⁷ One commenter stated that the board should be permitted to allocate this responsibility to other committees or other groups of directors, as long as all members are independent, and that the compensation committee should be permitted to make a recommendation to be approved by all of the independent directors.²⁶⁸ Another commenter recommended that the NYSE make clear that the compensation committee could be given the discretion to make other decisions.²⁶⁹ Other commenters supported the proposal.²⁷⁰ One commenter provided recommendations for how the compensation committee should evaluate CEO performance.²⁷¹

With respect to the Nasdaq Compensation of Executives Provision, one commenter argued that it would not be necessary or appropriate to apply this proposal to investment companies.²⁷² With respect to both the NYSE Compensation Committee Provision and the Nasdaq Compensation of Executives Provision, two commenters asked how other compensation would be determined.²⁷³

E. Nomination of Directors

Several commenters supported the NYSE Nominating/Corporate Governance Committee Provision,²⁷⁴ and one commenter supported the exception that provides that nominating committee approval is not required where the right to nominate a director legally belongs to a third party.²⁷⁵ However, one commenter argued that the NYSE should permit director nomination responsibilities to be allocated to other committees or other groups of directors so long as all members are independent.²⁷⁶

With respect to the role of board committees generally, one commenter recommended that the proposed listing standards explicitly recognize the oversight role and the responsibilities of the board of directors as a whole.²⁷⁷

While one commenter supported the Nasdaq Director Nomination Provision,²⁷⁸ another commenter believed that the full board should be involved in the director nomination process, because otherwise all the independent directors may be friends and may not be independent in thought from one another.²⁷⁹ One commenter recommended clarifying that the proposal's exception for cases where the right to nominate a director legally belongs to a third party includes arrangements other than contractual arrangements.²⁸⁰ Another commenter recommended changing the 20% shareholder exception that had been included in Nasdaq's original proposal by deleting the phrase, "and is not independent as defined in Rule 4200 because that director is also an officer."²⁸¹ In addition, another commenter argued that the proposal should not apply to investment companies whose independent directors are nominated by independent directors.²⁸²

F. Controlled Company Exemption

While one commenter supported both the NYSE and Nasdaq proposals to exempt controlled companies from some of the independent director requirements,²⁸³ two commenters did not support the NYSE proposal.²⁸⁴ One of these commenters argued that it would disenfranchise minority shareholders,²⁸⁵ and the other commenter argued that the exemption should apply only where the measure of "control" is both voting and economic control, because corporations with two-tier classes of voting stock, where the minority economic interests exercise voting control because of supermajority voting rights, are particularly subject to the potential for abuse.²⁸⁶ With respect to the Nasdaq proposal, one commenter recommended adding language to make clear that controlled companies choosing not to rely on the exemption need not include any special disclosures about their controlled status.²⁸⁷

G. Audit Committee Charter

In general, several commenters supported increasing the authority and responsibility of the audit committee.²⁸⁸ However, one commenter argued that final authority over audit committee issues should rest with all the independent directors.²⁸⁹ With respect to the NYSE Audit Committee Charter Provision, several commenters were concerned with the extent of the audit committee's proposed new responsibilities.²⁹⁰ For example, one of these commenters argued that the audit committee should be permitted to delegate non-financial risk management activities to other committees so long as such committee reports to the audit committee.²⁹¹ Another commenter argued that the audit committee should not be responsible for legal and regulatory compliance, and that investing a single committee with an overload of functions may dilute resources of the committee that should be available to its accounting and financial oversight role.²⁹² A third commenter argued that there were too many items for the audit committee to discuss and that the audit committee needs the flexibility to set its agenda to focus on the company's most significant financial reporting and corporate governance issues.²⁹³ One of the commenters also argued that financial statements are the representations and responsibility of management, not the audit committee.²⁹⁴

Further, one commenter requested clarification of whether advance discussion of quarterly financial statements would be required and, if so, argued that the audit committee should be permitted to decide whether this requirement should apply to the earnings release or the quarterly financial statements.²⁹⁵ Another commenter recommended excluding investment companies from the proposed requirement that audit committee members discuss earnings press releases as well as financial information and earnings guidance provided to analysts and rating agencies.²⁹⁶

With respect to the Nasdaq Audit Committee Charter Provision, the same commenter supported the proposed requirements regarding complaints, particularly their flexibility; and favored the proposal to grant the audit committee the authority to engage and fund outside advisors.²⁹⁷ However, the commenter also argued that the Nasdaq proposal should be revised to make clear that each Nasdaq-listed company would be required to provide appropriate funding to the audit committee.²⁹⁸ Another commenter argued that the Nasdaq proposal should be revised to require audit committee charters to state that one of the audit committee's purposes must be to assist the board in oversight of the company's compliance with laws and regulations, which would be consistent with the NYSE Audit Committee Charter Provision.²⁹⁹

Several commenters, writing before the NYSE and Nasdaq filed amendments to the proposals, pointed out that the NYSE and Nasdaq Audit Committee Charter Provisions should be revised so that the responsibilities required of the audit committee would comply with the requirements of Rule 10A-3.³⁰⁰

H. Audit Committee Independence

With respect to the NYSE proposal on audit committee independence, two commenters supported the proposal to require an independent audit committee.³⁰¹ However, several commenters were concerned about the interplay between the proposal and the requirements of Rule 10A-3. For example, one commenter argued that the proposal should incorporate the various exceptions and accommodations codified in Rule 10A-3.³⁰² Another commenter recommended clarifying whether the Commission's Rule 10A-3 definition of impermissible compensation should be applied.³⁰³ A third commenter asked: (1) which definition of "immediate family member" should be used; (2) whether NYSE intends to apply a five-year look-back; (3) whether NYSE intends to consider payments made in any period prior to board service; and (4) whether NYSE intends to consider whether payments are made to a family member or to a firm providing advisory or professional services to the listed company with which a director is or was associated in the capacities referred to in Rule 10A-3(e)(8).³⁰⁴

Another commenter requested that NYSE determine that banking transactions in the ordinary course of business between banks and their directors and their affiliated companies would not constitute a material relationship that would impair an audit committee member's independence.³⁰⁵

With respect to the Nasdaq proposal on audit committee independence, one commenter disapproved of the application of a three-year look back, and was concerned that this provision would deprive a company of a high-quality audit committee member who has an appreciation for the operational aspect of the business.³⁰⁶ The commenter argued that no look-back was necessary because directors have a legal duty to act independently of previous allegiances. Although the commenter opposed any look-back, it commented that shortening the look-back to one year would significantly mitigate the adverse effect.

Two commenters approved of the provisions in Nasdaq's original proposal to include a bright line test that would bar directors who own or control 20% or more of a company's stock.³⁰⁷ One commenter requested further clarification of this provision.³⁰⁸ Another commenter argued that directors who own more than 20% of a company's stock are the directors who are most independent of management because they have a stake in the firm apart from the compensation they receive as directors, and often there is no indicia whatsoever of control.³⁰⁹ The same commenter argued that the proposed standard could be highly disruptive, expensive and counterproductive.³¹⁰

Other commenters requested clarification of who Nasdaq would consider to be an affiliate.³¹¹ For example, one of these commenters requested more guidance as to what factors ought to be considered in determining whether an individual is an affiliate.³¹² Another commenter asked whether a director could serve on both the board of a holding company and the board of a subsidiary of the holding company.³¹³ Two other commenters expressed concern about the effect of banking relationships.³¹⁴

Although one commenter supported Nasdaq's proposal to allow certain leniencies in exceptional and limited circumstances, it argued that a company should not be required to disclose its use of these exceptions in a proxy because that would discourage use of the exceptions. The commenter stated that, instead, a company should be required to disclose its use of these exceptions in a report to Nasdaq.³¹⁵ Another commenter stated that it would be helpful for Nasdaq to clarify the relationship between the Nasdaq proposal and the requirements of Rule 10A-3, such as whether the same definition of family member and application of a look-back applies to both.³¹⁶

One commenter requested clarification of the relationship between current Nasdaq rules addressing audit committees and the Nasdaq Audit Committee Provision.³¹⁷

I. Financial Background of Audit Committee Members

With respect to the NYSE and Nasdaq proposals on the requisite background of audit committee members, two commenters recommended harmonizing the two proposals.³¹⁸ One of these commenters recommended modifying the NYSE proposal to require audit committee members to be financially literate at the time they join the audit committee.³¹⁹ The other commenter recommended modifying the Nasdaq proposal to provide that an individual who satisfies the Commission's definition of an audit committee financial expert would be qualified to be an audit committee member.³²⁰

With respect to the NYSE and Nasdaq proposals to require at least one member of the audit committee to have accounting or related financial management expertise, one commenter requested confirmation that past and current employment as a venture capitalist would allow a director to meet this requirement on a per se basis.³²¹ The commenter also recommended that the NYSE make clear that "accounting or related financial management experience" does not require any particular background, certification or education.³²²

J. NYSE Audit Committee Member Simultaneous Service Provision

With respect to the NYSE proposal limiting the permissibility of simultaneous service on more than three audit committees, one commenter recommended moving this proposal to a different section of the NYSE proposal because it does not relate to independence.³²³ Another commenter questioned whether the proposed requirement would be mandatory because it appears in the commentary, and argued that because it is difficult to generalize about which directors are likely to have adequate time to carry out the duties of the committee, it should apply only to directors who are currently functioning in active senior executive roles of listed companies.³²⁴ A third commenter strongly recommended that in application of the proposed requirement to investment companies, a "fund complex" should be treated as one company because: (1) it is common practice in the investment company industry for the same directors to serve on the audit committee of one or more funds in a complex; (2) an investment company's financial statements are less complicated and therefore audit committee oversight requires less time; and (3) all funds in a fund complex typically rely on the same accounting system and are subject to the same internal controls and policies.³²⁵

K. Internal Audit Function

With respect to the NYSE proposal to require an internal audit function at all listed companies, one commenter recommended evaluating whether this requirement would be identical to the requirements of Rule 10A-3. ³²⁶ If the rules were not identical, the commenter recommended delaying the imposition of additional requirements until those required by federal law have been adopted and implemented, and their efficacy evaluated after a reasonable amount of time.³²⁷ Two commenters argued that investment companies should be excluded from the internal audit requirement.³²⁸ A third commenter strongly recommended that Nasdaq implement the same requirement.³²⁹

L. NYSE Corporate Governance Guidelines

With respect to the NYSE proposal relating to corporate governance guidelines, one commenter strongly supported the proposal, particularly the concept of requiring director orientation for new directors and continuing education for all directors.³³⁰ Two other commenters also supported requiring director orientation.³³¹ Another commenter strongly supported requiring annual evaluations by the board,³³² and one commenter supported requiring board and committee assessments.³³³ Two of the commenters also recommended that evidentiary protection be provided in connection with any evaluations or assessments made by the board or its committees.³³⁴

While two other commenters supported requiring corporate governance guidelines, they argued that such guidelines should promote ethical guidelines for conducting core business, and that director orientation should include social and environmental risk management, as well as training on corporate social responsibility.³³⁵

Another commenter stated that the reference to charitable contributions in the proposed commentary to the guideline topic relating to director compensation was too vague. ³³⁶ This commenter recommended deleting the reference in its entirety or revising it to cover only the situation in which a director is permitted, as a perk of his or her position, to recommend a corporate gift to a favorite charity.³³⁷

M. Code of Business Conduct and Ethics

With respect to the NYSE proposal regarding codes of business conduct and ethics, one commenter supported the proposal and stated that it will help companies manage conflicts of interest.³³⁸ Five other commenters also supported the proposal,³³⁹ but four of these commenters argued that it should deal with a broader scope of issues including environmental and social practices.³⁴⁰ Two of these commenters promoted the Global Reporting Initiative, which provides a uniform disclosure policy and extends the reach of corporate social responsibility to economically, environmentally and socially sustainable business practices.³⁴¹ In addition, one commenter recommended that the NYSE require that CEOs endorse the codes with their signatures.³⁴²

One commenter supported the proposal to require companies to disclose waivers.³⁴³ Another commenter argued that the NYSE should require companies to disclose only a waiver of material terms of their codes because requiring disclosure of any waivers would be too burdensome and would discourage companies from adopting comprehensive codes.³⁴⁴

With respect to the Nasdaq Code of Conduct Proposal, one commenter supported the proposal, but recommended that Nasdaq require its listed companies to publish a summary of the compliance processes in place to support the code.³⁴⁵ Another commenter also supported the proposal, but recommended that Nasdaq limit the proposed disclosure requirement to waivers of material terms of the code, because requiring disclosure of any waivers would be too burdensome and would discourage companies from adopting comprehensive codes.³⁴⁶ The commenter also stated that the proposal should address "implicit waivers," which would occur when a company fails to take action against a violation of the code. The commenter also recommended that Nasdaq permit waivers to be approved either by the board or a committee of the board to give listed companies the flexibility to place the oversight of a company's code of conduct within the jurisdiction of a particular committee if that structure would be more effective and appropriate.

Another commenter recommended that Nasdaq modify its proposal to provide that investment companies that are already subject to code of ethics and other requirements pursuant to rules under the Investment Company Act would be deemed to satisfy any new Nasdaq requirements regarding codes of conduct.³⁴⁷ The commenter argued that this modification would be consistent with Nasdaq's intentions and the NYSE proposal.

N. Noncompliance

One commenter urged the NYSE and Nasdaq to modify their proposals to permit transitional periods of noncompliance, distinct from any similar procedures for other listing standards.³⁴⁸

O. CEO Certification

Several commenters supported the NYSE proposal to require a company's CEO to certify annually that he or she is not aware of any violation of the Exchange's corporate governance rules.³⁴⁹ One of these commenters claimed that requiring CEO certification has caused many companies to engage in better due diligence about their financial statements.³⁵⁰ Other commenters disapproved of the proposal.³⁵¹ One of the commenters opposing the proposal argued that requiring CEO certification is too high of a standard given the myriad of rules and standards facing listed companies, and recommended requiring a representation from the CEO, rather than a certification.³⁵² The other commenter argued that the NYSE proposal should be modified to require notification of material noncompliance with the new standards by the company, and not the CEO in his or her individual capacity, for the following reasons: (1) certification could still be made if the CEO was unavailable or unwilling to make the certification; (2) the proposal adds an element of personal liability to the CEO that the commenter believes is unduly burdensome and is not contemplated by Rule 10A-3, which only applies to non-compliance with audit-related matters; and (3) the requirement is more onerous and time-consuming than the annual certification requirement.³⁵³ The commenter also recommended that the NYSE make clear that the event that triggers the reporting requirement would not create a private cause of action against the company or the CEO.

One commenter recommended that the proposal be modified to provide that the CEO certify that he or she is not aware of any "material and ongoing" violations, and that the NYSE should clarify what is not material or ongoing.³⁵⁴

Another commenter asked whether a company would be required to include a full text of these certifications, or a statement that the certifications have been made in its annual report.³⁵⁵

P. NYSE Public Reprimand Provision

Two commenters supported the NYSE proposal to permit the Exchange to issue public reprimand letters to non-compliant companies.³⁵⁶ One commenter recommended that the NYSE specify that any new NYSE corporate governance rules should not create a private right of action for non-compliance.³⁵⁷ Another commenter recommended that the NYSE research and revise this proposal separately from the remainder of the corporate governance reforms.³⁵⁸ The commenter also stated that a provision for due process prior to issuance of a reprimand letter would be necessary for fact checking and an opportunity to remedy the company's non-compliance.³⁵⁹

Q. Other Exemptions

One commenter strongly concurred with NYSE's exemption for closed-end funds.³⁶⁰ Another commenter approved of the NYSE exemption for companies in bankruptcy and urged Nasdaq to adopt a similar exemption.³⁶¹

R. Application of Rules to Foreign Private Issuers

Several commenters supported the NYSE proposal regarding private foreign issuers.³⁶² A few commenters recommended that the NYSE modify the proposal to clarify that foreign issuers would be permitted to take advantage of the accommodations for foreign issuers set forth in Rule 10A-3.³⁶³

With respect to the Nasdaq proposal regarding foreign private issuers, one commenter argued that, consistent with the NYSE proposal, the Nasdaq proposal should be amended to: (1) automatically exempt foreign private issuers from the proposed corporate governance requirements (except for Rule 10A-3 requirements); (2) synchronize its effective date with Rule 10A-3 requirements; and (3) require disclosure of exemptions and alternative measures in a company's first annual report covering the fiscal year ending on or after July 31, 2005.³⁶⁴

S. Implementation Schedule

With respect to the NYSE's proposed implementation schedule, one commenter criticized what it viewed as a long delay in implementation of the new requirements.³⁶⁵ Another commenter recommended coordinating the effective dates and transition periods with Rule 10A-3 requirements.³⁶⁶

With respect to Nasdaq's proposed implementation schedule for its Independent Director Proposal, one commenter recommended that Nasdaq adopt transition periods for compliance for newly-listed companies similar to the transition periods outlined in the NYSE proposal.³⁶⁷ Two commenters recommended that Nasdaq adopt transition periods for compliance for companies with classified boards similar to the transition periods outlined in the NYSE proposal.³⁶⁸ Another commenter recommended granting small business issuers additional time to come into compliance.³⁶⁹

IV. Amendments to NYSE and Nasdaq Proposals

The discussion in Sections II.B. and C. above reflects revisions proposed in the amendments to the NYSE and Nasdaq proposals that were submitted by the NYSE and Nasdaq following publication of the NYSE Notice and the Nasdaq Notice. The discussion below summarizes those revisions.

In Amendment No. 2 to its Corporate Governance Proposal, the NYSE proposed revisions in a number of areas. The proposed revisions in Amendment No. 2 would:

• conform the compliance dates and transition periods with those mandated for audit committees by Rule 10A-3 under the Exchange Act;
   
• provide phase-in periods with respect to certain requirements for companies listing in conjunction with an initial public offering, companies emerging from bankruptcy, and companies that ceased to be Controlled Companies;
   
• revise the "look-back" periods so that the independence tests would have a one year look-back during the first year after Commission approval of the new standards, with the full look-back period becoming applicable after the end of that first year, and would shorten the periods from five years to three years;
   
• clarify that when applying look-back provisions to family members, listed companies need not consider individuals who are no longer family members due to separation or divorce, or individuals who have died or become incapacitated;
   
• indicate that references to "company" would include any parent or subsidiary in a consolidated group with the company;
   
• clarify the NYSE Employee Provision to provide that a director who is an employee, or whose immediate family member is an executive officer, of the company would not be considered independent until three years after the end of such employment relationship;
   
• provide that employment as an interim Chairman or CEO would not disqualify a director from being considered independent following that employment;
   
• revise the NYSE Direct Compensation Provision to be a bright-line test, rather than a rebuttable presumption and clarify that immediate family member compensation would need only to be considered if the family member is an executive officer of the listed company;
   
• revise the NYSE Business Relationship Provision to test all payments (whether to or from the listed company) against the consolidated gross revenues of the director's company, rather than also testing them against the listed company;
   
• apply the look-back period in the NYSE Business Relationship Provision only to the financial relationship between the listed company and the current employer of the director, and not require the listed company to consider former employment of the director or family member;
   
• clarify in the Commentary to the NYSE Business Relationship Provision that listed companies must disclose contributions to a charity of which a director serves as an executive officer, if the contributions satisfy the proposal's threshold test;
   
• recommend that listed companies should hold an executive session limited solely to independent directors at least once a year;
   
• revise the NYSE Compensation Committee Provision to clarify that all independent directors may be involved in approving the CEO's compensation and that the board in general is not precluded from discussing CEO compensation;
   
• restructure the audit committee provisions to clearly define the audit committee requirements applicable to listed companies pursuant to Rule 10A-3;
   
• exclude closed-end funds from specified provisions of Section 303A, in recognition of the additional regulation to which closed-end funds are subject under the Investment Company Act;
   
• require open-end funds to comply with the requirements of Section 303A(6), which implement Rule 10A-3 under the Exchange Act;
   
• require business development companies to comply with all of the provisions of Section 303A applicable to domestic issuers, but use the "interested person" standard under Section 2(a)(19) of the Investment Company Act for purposes of determining director independence; and
   
• require the audit committees of open-end and closed-end funds to establish procedures for the confidential, anonymous submission of concerns regarding questionable accounting or auditing matters by employees of the investment adviser, administrator, principal underwriter, or any other provider of accounting related services for the fund, as well as employees of the fund.

In Amendment No. 3 to its Corporate Governance Proposal, NYSE proposed to require that the audit committee charter of a closed-end or open-end fund address the responsibility of the audit committee to establish pro