American Bankers Association

Sarah A. Miller
Center for Securities, Trust
and Investments

April 16, 2003

Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549

Re: NASDAQ Proposal Regarding Board Independence and Independent Committees, Release No. 34-47516, File No. SR-NASD-2002-141, 68 Federal Register 14451 (March 25, 2003).

Dear Mr. Katz:

The American Bankers Association ("ABA") welcomes the opportunity to offer its comments on proposed amendments to NASD Rules 4200 and 4350 recently filed by the National Association of Securities Dealers, Inc. ("NASD") through its subsidiary, The NASDAQ Stock Market, Inc. ("NASDAQ"). The proposed amendments to NASD Rules 4200 and 4350 would modify the definition of the term "independent director" and increase the role of independent directors on board committees. These amendments are intended to increase investor confidence in the companies that list on the NASDAQ.

The issues of director independence and corporate governance generally are extremely important to ABA and its members. The ABA brings together all categories of banking institutions to best represent the interests of this rapidly changing industry. Its membership-which includes community, regional and money center banks and holding companies, as well as savings associations, trust companies and savings banks-makes ABA the largest banking trade association in the country. Consistent with its leadership role among banking trade associations and in light of the enactment of the Sarbanes-Oxley Act ("Act"), the ABA commissioned a handbook on corporate governance issues and offered it free of charge to members. In addition, at the direction of Aubrey Patterson, chairman of ABA and chairman and CEO, BancorpSouth, Tupelo, Mississippi, ABA has formed a task force to examine corporate governance issues. Key issues under study by the task force include the make-up and roles of boards of directors and board committees, the definition of "independent" directors and the potential extension of the Act by bank regulators to non-publicly traded banks.

Not surprisingly, the NASDAQ's proposals are of keen interest to our members. Many of our members are listed on the NASDAQ and, thus, are directly impacted by this proposal. Publicly traded banks and bank holding companies not listed on the NASDAQ or any other exchange are also very interested in certain aspects of this proposal as they must disclose in their annual proxy statements whether their audit committee members meet certain exchange listing requirements regarding audit committee independence. Finally, banks and bank holding companies that are not publicly traded are also interested in the NASDAQ's proposal as federal banking laws require banks with assets in excess of $500 million and strongly encourage banks with assets under $500 million to establish independent audit committees. To the extent the NASDAQ, the exchanges and the Securities and Exchange Commission ("SEC") collectively redefine independence as it relates to audit committee membership, all non-publicly traded banks and bank holding companies will likely be impacted.


While the NASDAQ's proposal addresses several issues relating to the roles and responsibilities of independent directors generally and audit committee members specifically, the ABA's comment letter will address only those aspects of the NASDAQ's proposals that define director and audit committee member independence.

Independent Directors

The NASDAQ proposes to amend Rule 4350 to require that a majority of the board of directors of NASDAQ listed companies must be "independent directors" as that term is defined by Rule 4200. Currently, Rule 4350 only requires that listed companies have audit committees comprised solely of independent directors.

Rule 4200 currently requires listed company boards to make an affirmative determination that individuals serving on the board as independent directors not have a relationship with the listed company that would interfere with the exercise of the director's independent judgment in carrying out his or her responsibilities as an independent director. Included in current Rule 4200 is a list of relationships that preclude a board finding of independence. This objective list is intended to provide transparency to investors and companies alike, to facilitate the uniform application of these rules and to ease in their administration. The NASDAQ proposal would amend that list in several ways.

Specifically, proposed Rule 4200 would provide that under the following circumstances listed company directors would NOT be deemed to be independent:

  • Employment. Directors who are, or during the past three years were, employed by the listed company, its parent or a subsidiary will not be deemed to be independent.

  • Receipt of payments in excess of $60,000. Directors and family members that accept payments from the listed company or any parent or subsidiary in excess of $60,000 during the current fiscal year or any part of the last three fiscal years EXCEPT THAT compensation for board service, payments arising solely from investments in the company's securities, compensation paid to a family member who is a non-executive employee of the company, its parent or any subsidiary, benefits under a tax-qualified retirement plan, or non-discretionary compensation will not impair a director's independence.

  • Family members of executives. Directors who are family members of a current executive officer or individuals who in the last three years were executive officers of the company, its parent or any subsidiary will not be deemed to be independent.

  • Payments that exceed the greater of 5% of consolidated gross revenues or $200,00. Directors who are partners in, or controlling shareholders or executive officers of, any for-profit or non-profit organization to which the listed company made, or from which the listed company received, payments that exceed 5% of the recipient's consolidated gross revenues, or $200,000 whichever is more, in the current fiscal year or any of the past three fiscal years will not be deemed to be independent.

  • Interlocking directorships. A director of the listed company who is employed as an executive officer of another entity where any of the executive officers of the listed company serve on the compensation committee of such other entity, or if such relationship existed during the past three years will not be deemed to be independent.

  • Employees of outside auditors. Directors who are or were a partner or an employee of the listed company's outside auditor, and worked on the company's audit, during the past three years will not be deemed independent.

In addition, the NASDAQ proposes to expand significantly the definition of "family member" to include any person who is a relative by blood, marriage or adoption or who has the same residence.

The ABA strongly supports the requirement that all NASDAQ listed companies have a majority of independent directors seated on their boards. We also support the requirement that the board affirmatively determine that directors are, in fact, independent. We are, however, concerned that two of the situations listed where an affirmative determination of independence would be precluded would disproportionately impact the banking industry. Unlike other corporations that manufacture specific products, banks are in the business of making loans, taking deposits, providing trust services, and managing customers' assets, among other things. We believe that the NASDAQ's proposal should be revised to reflect the unique nature of our industry.

Specifically, we are concerned that the term "payments" as used in the proposed amendments to Rule 4200 would preclude banks from engaging in ordinary course of business transactions with both directors and their affiliated companies. Any ban on directors receiving payments in excess of $60,000 or directors' companies from receiving payments in excess of 5% of the company's consolidated gross revenues or $200,000 whichever is greater will have a significant impact on the ability of banks to continue to engage in the business of banking, i.e., extending credit and taking deposits.1

It is very common for directors to obtain home mortgage loans, home equity lines of credit, credit cards, checking accounts, savings accounts, certificates of deposit or personal and company lines of credit through the same bank on whose board they sit. In addition, firms affiliated with bank directors may use the bank to provide services such as cash management, payroll processing, travel agency, and employee benefit trusteeships.

Providing credit and other services to board members and their companies is not a new phenomenon. Banks have been providing these services to board members for well over a century and because board members are usually drawn from the bank's local community, the benefits of these bank-provided services generally inure to the benefit of that local community.

Suggesting that extending credit or paying interest on deposits involves a payment that would a render a director "not independent" will force our members into a "Catch-22" situation: either lose valuable and legitimate business by driving directors and their companies to seek to have their individual and company financial services needs met by competing organizations or, alternatively, have the pool of qualified business leaders available to sit on banking organization boards significantly reduced. In today's increasingly complex financial services world, it is more important than ever that boards of banking organizations have the benefit of financially savvy directors experienced in the issues of today's commerce.

Because we believe very strongly that banking organizations are different, the ABA would suggest that the NASDAQ define "payments" not to include extensions of credit to directors and their affiliated companies that are in accordance with the non-preferential lending requirements set out in the Federal Reserve Board's Regulation O. In addition, we would suggest that all other banking or financial transactions with a director or any company affiliated with a director involving the payment of money, including the payment of interest on deposits, not be included within the meaning of the term "payment" if the transaction is entered into in the ordinary course of business and was made on substantially the same terms as those prevailing at the time for comparable transactions with other non-affiliated persons.

Regulation O requires that extensions of credit made to directors and other insiders be on substantially the same terms and conditions as comparable extensions to comparable borrowers. Interest rates, collateral requirements, credit underwriting standards and repayment terms cannot be more favorable for insider borrowers. Violations of Regulation O can result in severe sanctions, including civil penalties of more than $1 million per day per violation, being assessed against the offending banking organization.

In addition to the severe penalties associated with violations of Regulation O, the NASDAQ should take comfort from the fact that Regulation O is construed most broadly. For example, Regulation O applies to directors of not only banks but also bank subsidiaries, any company, including a bank holding company that owns a bank, as well as certain affiliates of the bank holding company. Any extensions of credit made to companies that are related interests of the director are also subject to Regulation O. Finally, extensions of credit are defined broadly to include not only loans of money but also repurchase agreements, standby letters of credit, and advances against unearned salary in excess of 30 days.

Moreover, where it is permissible to engage in non-preferential lending with insiders, stringent lending limits apply. These lending limits are applied both individually to directors and other insiders, but also in the aggregate to all insiders. Regulation O also requires, under certain circumstances, significant recordkeeping, reporting and disclosure requirements.

Non-credit business transactions between a bank and a director or director-affiliated company that is made both in the ordinary course of business and on non-preferential terms and conditions also should not be deemed to impair a director's independence. Specifically, interest paid on corporate deposits regardless of whether the amount exceeds 5% of the recipient's consolidated gross revenues or $200,000 whichever is greater should not impair a director's independence.

Banks and bank holding companies are subject to strict and frequent examination by both federal and state banking authorities. For example, many of our larger banks (the ones most likely to be publicly-traded and thus, subject to NASDAQ or other exchange listing standards) have on-site examiners and it is not uncommon for banks and bank holding companies to be examined by more than one bank regulator in any calendar year.

Because banking organizations are subject to extensive regulation and oversight and are subject to strict regulation requiring many banking services to be provided to customers on an arm's length, non-preferential basis, we urge the NASDAQ to conclude that director independence is not impaired when credit is extended in accordance with Regulation O or other payments are made in the ordinary course of business between a banking organization and a director or a director's company.

Audit Committee Independence

Consistent with the Sarbanes-Oxley Act, the NASDAQ has proposed heightened independence requirements for audit committees of NASDAQ-listed companies. Specifically, the NASDAQ proposes to amend the current requirement in Rule 4350(d) that all audit committee members must be independent to provide that audit committee members will not be deemed to be independent unless they not only meet the general independence requirements of Rule 4200 discussed above, but that they also meet the criteria for independence set forth in section 10(a)(m)(3) of the Act, and do not own or control 20% or more of the listed company's voting securities.2

Section 10(a)(m)(3) provides that in order to be considered independent for purposes of membership on an issuer audit committee, the member must satisfy two criteria. First, he or she may not, other than in his or her capacity as a member of the audit committee, accept directly or indirectly any consulting, advisory or other compensatory fee from the issuer. Second, the member must not be an affiliated person of the issuer or any subsidiary of the issuer.

Newly adopted SEC Rule 10A-3 implements Section 10(a)(m)(3). In adopting Rule 10A-3, the SEC made clear that while the prohibition on compensation reaches fees paid in connection with accounting, consulting, legal, investment, banking or financial advisory services, it does not prohibit compensation received for other non-advisory financial services, including lending, check clearing, maintaining customer accounts, stock brokerage services or custodial and cash management services. We encourage the NASDAQ to follow the SEC's direction and determine that non-advisory, ordinary course of business transactions between banking organizations and their directors and their affiliated companies do not impair an audit committee member's independence.

Definition of Family Member

Rule 4200 is proposed to be amended to define "Family Member" as any person who is a relative by blood, marriage or adoption or who has the same residence. We believe the proposed definition is overly broad as it, presumably, includes very distant relatives including second and third cousins, and could lead to NASDAQ listed companies inadvertently violating the requirement to have a majority board of independent directors. Under the NASDAQ's current proposal, second or third cousins of current or former executive officers would not be deemed independent. The ABA would submit that it is not uncommon for individuals not to know the identity of their second and third cousins. We believe a better definition would be to borrow from the New York Stock Exchange's proposal and define "Family Member" to include a person's spouse, parents, children, siblings, mothers-in-law and fathers-in-law, sons and daughters-in-law, brothers and sisters-in-law, and anyone (other than employees) who shares such person's home.

Effective Date and Look-back Provisions

The proposal provides that those provisions of Rules 4200 and 4350 that call for an adjustment to the composition of the company's board or committees would be required to be implemented by the company's annual meeting occurring after January 1, 2004. As the majority of publicly traded banks and bank holding companies are calendar year reporting companies, the proposal, if approved by the SEC, would be effective for next year's spring proxy season.

Several of the situations listed in Rule 4200 that would preclude a finding of independence contain three-year look-back provisions. We request clarification that Rule 4200 will only apply on a going forward basis with respect to director independence and that the three-year look-back provisions will be phased-in as the amendments to Rule 4200 age. For example, in 2004, director independence would be determined by looking at existing transactions, if any, between the listed company and the director. For 2005, director independence would be determined by looking at transactions in 2004 and 2005 and so on, until 2007, when director independence would be determined by looking at all current transactions, as well as transactions occurring in the past three fiscal years, between the company and the director. As we have stated before, banks and bank holding companies currently have a difficult time finding qualified directors. Without a suitable phase-in of these new independent requirements, we could anticipate wholesale turnover of bank and bank holding company boards. The loss of a vast number of knowledgeable and qualified directors from bank and bank holding company boards would, we would submit, have a very deleterious impact on the safety and soundness of the banking system.


In conclusion, the ABA appreciates the opportunity to comment on the NASDAQ's proposed revisions to Rules 4200 and 4350. We strongly urge the NASDAQ to recognize the unique nature of banking and provide that non-preferential, ordinary course of business transactions between banks and directors and director-affiliated companies do not impair a director's independence. It is most imperative that banks be permitted to make loans on

a non-preferential basis to directors and their affiliated firms. Should you wish to discuss these matters further, please do not hesitate to contact the undersigned.

Sincerely yours,

Sarah A. Miller

1 We are cognizant that Rule 4200 currently precludes a finding of independence when a director's company receives payments in excess of 5% of the company's consolidated gross revenues or $200,000, whichever is greater. This ban currently applies only to independence determinations as they relate to audit committee membership. The expansion of the ban to determine independence for the rest of the board is what gives us particular concern.
2 Ownership of listed company's voting securities will not impair a director's general independence requirements under Rule 4200. See discussion at IM-4200 Definition of Independence-Rule 4200(a)(15).