NASD Rulemaking
Notice of Filing of Proposed Rule Change and Amendment No. 1 Thereto by National Association of Securities Dealers, Inc. Relating to Shareholder Approval for Stock Option Plans or Other Arrangements
SECURITIES AND EXCHANGE COMMISSION
(Release No. 34-46649; File No. SR-NASD-2002-140)
October 11, 2002
Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change and Amendment No. 1 Thereto by National Association of Securities Dealers, Inc. Relating to Shareholder Approval for Stock Option Plans or Other Arrangements
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 ("Act"),1 and Rule 19b-4 thereunder,2 notice is hereby given that on October 9, 2002, the National Association of Securities Dealers, Inc. ("NASD"), through its subsidiary, The Nasdaq Stock Market, Inc. ("Nasdaq"), filed with the Securities and Exchange Commission ("SEC" or "Commission") the proposed rule change as described in Items I, II, and III below, which Items have been prepared by Nasdaq. On October 10, 2002, Nasdaq filed Amendment No. 1 to the proposed rule change.3 The Commission is publishing this notice to solicit comments on the proposed rule change, as amended, from interested persons.
I. Self-Regulatory Organization's Statement of the Terms of the Substance of the Proposed Rule Change
Nasdaq proposes to amend NASD Rule 4350(i) ("NASD Rule 4350(i)" or "Rule") to strengthen listing standards relating to shareholder approval for stock option plans or other arrangements, adopt interpretative material pertaining to shareholder approval for stock option plans or other arrangements, and to make related conforming changes to NASD Rules 4310(c)(17)(A) and 4320(15)(A).
The text of the proposed rule change is below. Proposed new language is italicized; proposed deletions are in brackets.
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Rule 4310. Qualification Requirements for Domestic and Canadian Securities
(a) - (b) No change.
(c) In addition to the requirements contained in paragraph (a) or (b) above, and unless otherwise indicated, a security shall satisfy the following criteria for inclusion in Nasdaq:
(1) - (16) No change.
(17) The issuer shall be required to notify Nasdaq on the appropriate form no later than 15 calendar days prior to:
(A) establishing or materially amending a stock option plan, purchase plan or other arrangement pursuant to which stock may be acquired by officers, [or] directors, employees, or consultants without shareholder approval; or
(B) - (D) No change.
(18) - (29) No change.
(d) No change.
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Rule 4320. Qualification Requirements for Non-Canadian Foreign Securities and American Depositary Receipts
(a) - (d) No change.
(e) In addition to the requirements contained in paragraphs (a), (b) or (c), and (d), the security shall satisfy the following criteria for inclusion in Nasdaq:
(1) - (14) No change.
(15) The issuer shall be required to notify Nasdaq on the appropriate form no later than 15 calendar days prior to:
(A) establishing or materially amending a stock option plan, purchase plan or other arrangement pursuant to which stock may be acquired by officers, [or] directors, employees, or consultants without shareholder approval; or
(B) - (D) No change.
(16) - (25) No change.
(f) No change.
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Rule 4350. Quantitative Listing Requirements for Nasdaq National Market and Nasdaq SmallCap Market Issuers Except for Limited Partnerships
(a) - (h) No change
(i) Shareholder Approval
(1) Each issuer shall require shareholder approval [of a plan or arrangement under subparagraph (A) below, or] prior to the issuance of designated securities under subparagraph (A), (B), (C), or (D) below:
(A) when a stock option or purchase plan is to be established or materially amended or other arrangement made pursuant to which options or stock may be acquired by officers, [or] directors, employees, or consultants, except for:
(i) warrants or rights issued generally to all security holders of the company; or
(ii) [broadly based plans or arrangements including other employees (e.g. ESOPs).] tax qualified, non-discriminatory employee benefit plans (e.g., plans that meet the requirements of Section 401(a) or 423 of the Internal Revenue Code) or parallel nonqualified plans, provided such plans are approved by the issuer's compensation committee or a majority of the issuer's independent directors; or
(iii) plans relating to an acquisition or merger as permitted under IM-4350-5; or
(iv) [In a case where the shares are] issuances[ed] to a person not previously an employee[d by] or director of the company, as an inducement [essential] material to the individual's entering into [an] employment [contract] with the company, provided such issuances are approved by the issuer's compensation committee or a majority of the issuer's independent directors. [shareholder approval will generally not be required. The establishment of a plan or arrangement under which the amount of securities that may be issued does not exceed the lesser of 1% of the number of shares of common stock, 1% of the voting power outstanding, or 25,000 shares will not generally require shareholder approval.]
(B) - (D) No change.
(2) - (6) No change.
(j) - (l) No change.
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IM-4350-5. Shareholder Approval for Stock Option Plans or Other Arrangements
Employee ownership of company stock can be an effective tool to align employee interests with those of other shareholders. Stock option plans can also assist in the recruitment and retention of employees, which is especially critical to young, growing companies, or companies with insufficient cash resources to attract and retain highly qualified employees. However, these plans can potentially dilute shareholder interests. As such, Rule 4350(i)(1)(A) ensures that shareholders have a voice in the use of stock option plans, given this potential for dilution.
Rule 4350(i)(1)(A) provides an exception to the requirement for shareholder approval for warrants or rights offered generally to all shareholders. In addition, an exception is provided for tax qualified, non-discriminatory employee benefit plans as these plans are regulated under the Internal Revenue Code and Treasury Department regulations. Along with tax qualified, non-discriminatory employee benefit plans, the Rule also provides an exception for parallel nonqualified plans.1
Further, there is an exception for inducement grants to new employees because in these cases a company has an arm's length relationship with the new employees, and its interests are directly aligned with the shareholders. Inducement grants for these purposes include grants of options or stock to new employees in connection with a merger or acquisition.
In addition, plans involving a merger or acquisition do not require shareholder approval in two situations. First, shareholder approval will not be required to convert, replace or adjust outstanding options or other equity compensation awards to reflect the transaction. Second, shares available under certain plans acquired in acquisitions and mergers may be used for certain post-transaction grants without further shareholder approval. This exception applies to situations where the party which is not a listed company following the transaction has shares available for grant under pre-existing plans that were previously approved by shareholders. These shares may be used for post-transaction grants of options and other equity awards by the listed company (after appropriate adjustment of the number of shares to reflect the transaction), either under the pre-existing plan or another plan, without further shareholder approval, so long as (1) the time during which those shares are available for grants is not extended beyond the period when they would have been available under the pre-existing plan, absent the transaction, and (2) such options and other awards are not granted to individuals who were employed by the granting company at the time the merger or acquisition was consummated. Nasdaq would view a plan adopted in contemplation of the merger or acquisition transaction as not pre-existing for purposes of this exception. This exception is appropriate because it will not result in any increase in the aggregate potential dilution of the combined enterprise.2
Inducement grants, tax qualified non-discriminatory benefit plans, and parallel nonqualified plans are subject to approval by either the issuer's compensation committee, or a majority of the issuer's independent directors. It should also be noted that a company would not be permitted to use repurchased shares to fund option plans or grants without prior shareholder approval.
Footnotes to IM-4350-5:
1 The term "parallel nonqualified plan" means a plan that is a "pension plan" within the meaning of the Employee Retirement Income Security Act ("ERISA"), 29 U.S.C. §1002 (1999), that is designed to work in parallel with a plan intended to be qualified under Internal Revenue Code Section 401(a), to provide benefits that exceed the limits set forth in Internal Revenue Code Section 402(g) (the section that limits an employee's annual pre-tax contributions to a 401(k) plan), Internal Revenue Code Section 401(a)(17) (the section that limits the amount of an employee's compensation that can be taken into account for plan purposes) and/or Internal Revenue Code Section 415 (the section that limits the contributions and benefits under qualified plans) and/or any successor or similar limitations that may thereafter be enacted. However, a plan will not be considered a parallel nonqualified plan unless (1) it covers all or substantially all employees of an employer who are participants in the related qualified plan whose annual compensation is in excess of the limit of Code Section 401(a)(17) (or any successor or similar limitation that may hereafter be enacted) and (2) its terms are substantially the same as the qualified plan that it parallels except for the elimination of the limitations described in the preceding sentence.
2 Note that any such shares reserved for listing in connection with the transaction would be counted by Nasdaq in determining whether the transaction involved the issuance of 20% or more of the company's outstanding common stock and thus required shareholder approval under Rule 4350(i)(1)(D).
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II. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, Nasdaq included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. Nasdaq has prepared summaries, set forth in Sections A, B, and C below, of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change
1. Purpose
NASD Rule 4350(i)(1)(A) generally requires shareholder approval for all stock option plans or other arrangements in which officers or directors participate. However, the Rule contains an exception for broadly based plans, that is, plans in which at least a majority of the eligible participants are not officers or directors and at least a majority of the grants go to employees other than officers and directors. Consistent with recent remarks by President Bush and SEC Chairman Pitt, and in order to enhance investor confidence, Nasdaq now proposes to delete the exception for broadly based plans and expand the Rule to generally require that all plans will be subject to shareholder approval.
Nasdaq also proposes to eliminate the de minimis exception to the Rule, which allows for the grant of the lesser of 1% of the number of shares of common stock or 25,000 shares, without shareholder approval. Nasdaq believes that this exception is not in accord with the concept of restricting the use of unapproved options.
The remaining exception for warrants or rights offered generally to all shareholders would be retained. In addition, shareholder approval would not be required for tax qualified, non-discriminatory benefit plans as these plans are regulated under the Internal Revenue Code and Treasury Department regulations. Along with tax qualified, non-discriminatory employee benefit plans, the Rule also proposes an exception for parallel nonqualified plans. The Nasdaq represents that the proposed amendments to the Rule would have no effect on any shareholder approval or other requirements under the Internal Revenue Code or other applicable laws or requirements for such plans.
Further, the exception for inducement grants to new employees would be retained because in these cases a company has an arm's length relationship with the new employees, and its interests are directly aligned with the shareholders. Inducement grants for these purposes would include grants of options or stock to new employees in connection with a merger or acquisition.
In addition, the proposed amendments to the Rule would make clear that plans involving a merger or acquisition would not require shareholder approval in two situations. First, shareholder approval will not be required to convert, replace or adjust outstanding options or other equity compensation awards to reflect the transaction. Second, shares available under certain plans acquired in acquisitions and mergers may be used for certain post-transaction grants without further shareholder approval. This exception applies to situations where the party which is not a listed company following the transaction has shares available for grant under pre-existing plans that were previously approved by shareholders. These shares may be used for post-transaction grants of options and other equity awards by the listed company (after appropriate adjustment of the number of shares to reflect the transaction), either under the pre-existing plan or another plan, without further shareholder approval, so long as (1) the time during which those shares are available for grants is not extended beyond the period when they would have been available under the pre-existing plan, absent the transaction, and (2) such options and other awards are not granted to individuals who were employed by the granting company at the time the merger or acquisition was consummated. Nasdaq would view a plan adopted in contemplation of the merger or acquisition transaction as not pre-existing for purposes of this exception. Nasdaq believes that this exception is appropriate because it believes that it will not result in any increase in the aggregate potential dilution of the combined enterprise.
Under the proposed amendments to the Rule, inducement grants, tax qualified, non-discriminatory benefit plans, and parallel nonqualified plans are subject to approval by either the issuer's compensation committee, or a majority of the issuer's independent directors. It should also be noted that a company would not be permitted to use repurchased shares to fund options without prior shareholder approval.
The proposed amendments to the Rule also clarify that material amendments to plans will require shareholder approval. Nasdaq will continue to provide guidance as to what constitutes a material amendment to a plan. Nasdaq currently determines the existence of a material amendment to a plan consistent with the Commission's position under former Rule 16b-3 of the Act. In particular, Nasdaq looks to whether there is a material change to: (1) the benefits available to potential recipients under the plan; (2) the number of shares available under the plan; or (3) the class of eligible participants under the plan. Nasdaq is considering whether these factors can be refined, and may provide further guidance following this consideration.
With respect to implementation of the proposed amendments to the Rule, Nasdaq proposes that the amended Rule become effective upon SEC approval, and that existing plans be grandfathered. Nasdaq represents that any material modification to plans in place or adopted after the effective date of the Rule would require shareholder approval.
Lastly, Nasdaq proposes to make conforming changes to NASD Rules 4310(c)(17)(A) and 4320(e)(15)(A). These proposed changes will require issuers to notify Nasdaq on the appropriate form no later than 15 calendar days prior to establishing or materially amending a stock option plan, purchase plan or other arrangement pursuant to which stock may be acquired by officers, directors, employees, or consultants without shareholder approval.
2. Statutory Basis
Nasdaq believes that the proposed rule change, as amended, is consistent with the provisions of Section 15A of the Act,4 in general and with Section 15A(b)(6) of the Act,5 in particular, in that the proposed rule change is designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to remove impediments to and perfect the mechanism of a free and open market, and a national market system, and in general, to protect investors and the public interest. As previously noted, Nasdaq believes that the proposed rule change will strengthen shareholder approval requirements with respect to stock option plans.
B. Self-Regulatory Organization's Statement on Burden on Competition
Nasdaq does not believe that the proposed rule change will result in any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act, as amended.
C. Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received from Members, Participants, or Others
Written comments were neither solicited nor received.
III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action
Within 35 days of the date of publication of this notice in the Federal Register or within such longer period (i) as the Commission may designate up to 90 days of such date if it finds such longer period to be appropriate and publishes its reasons for so finding or (ii) as to which the self-regulatory organization consents, the Commission will:
A. by order approve such proposed rule change, or
B. institute proceedings to determine whether the proposed rule change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change, as amended, in consistent with the Act. Persons making written submissions should file six copies thereof with the Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission's Public Reference Room. Copies of such filing will also be available for inspection and copying at the principal office of the NASD.
All submissions should refer to file number SR-NASD-2002-140 and should be submitted by [insert date 21 days from the date of publication].
For the Commission, by the Division of Market Regulation, pursuant to delegated authority.6
Margaret H. McFarland
Deputy Secretary
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| 1 | 15 U.S.C. 78s(b)(1).
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| 2 | 17 CFR 240.19b-4.
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| 3 | See letter from John D. Nachmann, Senior Attorney, Nasdaq, to Katherine A. England, Assistant Director, Division of Market Regulation, Commission, dated October 10, 2002 ("Amendment No. 1"). In Amendment No. 1, Nasdaq did the following: (1) made technical corrections to its proposed rule language; (2) clarified the exceptions to shareholder approval for tax qualified, non-discriminatory employee benefit plans, parallel nonqualified plans, and plans relating to an acquisition or merger; and (3) clarified in the purpose section of its filing that it was proposing to make conforming changes to NASD Rules 4310(c)(17)(A) and 4320(15)(A).
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| 4 | 15 U.S.C. 78o-3.
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| 5 | 15 U.S.C. 78o-3(6).
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| 6 | 17 CFR 200.30-3(a)(12).
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