June 16, 2003
RE: File No. SR-NYSE-2002-33
This is a letter of comment on the New York Stock Exchange's proposal1 to amend its Listed Company Manual to "implement significant changes to its listing standards aimed at helping to restore investor confidence by empowering and ensuring the independence of directors and strengthening corporate governance practices." Briefly, this is a very weak proposal misleadingly cast in the guise of a very strong proposal. The proposal is very weak for two different reasons: First, some of the proposed rules are substantively weak and indeed highly questionable. Second, some of the proposed rules that are not substantively weak are largely gutted by the transition provisions.
Because I am sure that you are intimately acquainted with the proposed rules, I will not set them out in detail. Instead, I will refer to various aspects of the NYSE proposal by subject.
1. "Independence." The treatment of director independence raises both substantive and timing issues.
Substantively, the definition of "independence" in the proposed rules is much too weak. In particular, the rules provide that a director who is employed by the corporation is only presumed to be non-independent. This is simply not credible. A director who is actually employed by the corporation cannot reasonably be considered independent.
The timing issue is twofold.
First, under the proposed transition rules, the independence rules will not become effective until eighteen months after the SEC has approved the proposal. Accordingly, if, for example, the SEC approves the proposal on October 31, 2003-a date contemplated by the Exchange2-the independence provisions will not become effective until two years from now. In the corporate area today, two years is like half of a lifetime. There is no sufficient reason for such a long delay in making the independence rules effective. The NYSE proposal and the report on which it was based have already been in circulation for many months. All NYSE firms have had more than enough time to line up new independent directors to the extent required.3
Second, the proposed rules provide that a director will not be considered independent if he or she has had certain relationships with the corporation within the previous five years. The five-year hiatus from such relationships is sometimes referred to as a "cooling off" period, on the ground that these relationships are deemed to have an influence on the director until after they have cooled off for that period. However, the transition provisions provide that the cooling-off provisions will not become fully effective even when the proposed rules become effective. Under these transition provisions, during the five-year period immediately following the effective date of the rules-which, recall, may be two years from now-the cooling-off period will begin to run only from the effective date of the rules. Accordingly, if, for example, the SEC approves the rules on October 31, 2003, the cooling-off period will not be in full effect for about seven years from now, or about eight years after the proposal began to be circulated. A seven-year period for the proposed independence rules to become fully effective-eight years counting back to when the report and proposed rules began to be circulated-is ludicrous.
2. The role of independent directors. It is widely recognized that good corporate governance requires the independent directors to meet regularly. In contrast, the proposed rules require meetings of "non-management" rather than "independent" directors. "Non-management" is specifically defined in the Comment to include directors who are not independent for any reason other than being an officer. Accordingly, the proposed rules fall distressingly short of good corporate governance, by completely failing to give a special role to independent directors. Instead, the rules specifically inject, into the meetings of the true independent directors, an infectious element of nonindependent directors. This rule completely guts the important element of corporate governance, that independent directors should meet regularly.
3. Lead independent director. Good corporate governance also requires that the board include either an independent chair or an independent lead director. In the absence of an independent chair, a lead independent director is necessary to facilitate and chair meetings of the independent directors. Such a director also plays a focal-point role, since he or she is someone to whom the other independent directors-or, for that matter, persons other than directors-can communicate their concerns between meetings of the independent directors. The proposed rules make no provision for such a director. This is a grievous flaw, because a lead independent director is an extremely important element in making the independent directors effective as a group. The failure to require a lead independent director in the absence of an independent choice goes hand in hand with the failure to require meetings of independent directors. In both cases, the NYSE proposal has the cosmetics of doing something and the reality of doing nothing.
4. Oversight Committees. The NYSE proposal requires an Audit Committee, a Compensation Committee, and a Nominating Committee, each consisting entirely of "independent directors." However, the independence standards applicable to the oversight committees would not be effective for around two years from now. Even then, the cooling-off elements of the independence standards would not be fully effective for around seven years from now. These transition rules effectively gut the "requirement" that oversight committees consist of independent directors. This "requirement" is further gutted by the fact that under the NYSE proposals a director who is an employee of the corporation can be considered independent.
5. Compensation. The proposed rules require shareholder approval for stock option plans. However, the proposed rules do not require shareholder approval for equity compensation that is not issued under a stock option plan. This is a major shortcoming, because corporations have issued huge amounts of stock as compensation without having adopted a prior plan.
6. Conclusion. The NYSE proposals are misleading. The Exchange states that the proposed rules "implement significant changes to [the Exchange's] listing standards aimed at . . . empowering and ensuring the independence of directors and strengthening corporate governance practices." In fact, they do not. Given the weak and misleading nature of the NYSE proposal, I urge the SEC not approve the proposal unless it is revised to provide that: (i) Directors employed by the corporation are not independent. (ii) The independent directors should meet separately as a group. (iii) There should be a lead independent director where the corporation does not have an independent chair. (iv) Shareholder approval should be required for all equity compensation of the five highest-paid senior executives. (v) The new rules will become fully effective in all respects no more than one year after SEC approval.
Cc: Harvey Goldschmid