SULLIVAN & CROMWELL
TELEPHONE: 1-212-558-4000
FACSIMILE: 1-212-558-3588
WWW.SULLCROM.COM |
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125 Broad Street
New York, NY 10004-2498
LOS ANGELES PALO ALTO WASHINGTON, D.C.
FRANKFURT LONDON PARIS
BEIJING HONG KONG TOKYO
MELBOURNE SYDNEY |
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November 1, 2002
Mr. Jonathan G. Katz,
Secretary,
Securities and Exchange Commission,
450 Fifth Street, N.W.,
Washington, D.C. 20549-0609.
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Re: |
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Proposed Rule Change by the New York Stock Exchange, Inc.
Relating to Shareholder Approval of Equity Compensation Plans
and the Voting of Proxies -- File No. SR-NYSE-2002-46 |
Dear Mr. Katz:
We are responding to Release No. 34-46620 (the Release), in
which the Securities and Exchange Commission (the Commission)
solicited comments on the proposal by the New York Stock Exchange, Inc. (the
NYSE) to amend its rules relating to shareholder approval of
equity-compensation plans and the voting of proxies by member organizations.
We have set forth below specific aspects of the proposal that we
believe, based on our review and on discussion with our clients, can be improved
or clarified.
I. |
The
Shareholder Approval Requirement Should Apply Only to Companies Listing Common
Stock
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The
NYSE proposal from which the Release was excerpted1
clarifies that
the shareholder approval requirements apply to companies listing common
stock on the [NYSE], and to business organizations in non-corporate form such as
limited partnerships, business trusts and REITs, but not to passive
business organizations in the form of trusts, derivative and special purpose
securities or closed-end management companies. The Release does not include this
clarification and therefore lacks guidance as to the applicability of the
proposed shareholder approval requirement. Moreover, it would not appear that
the shareholder approval requirement should apply to entities that do not issue
common stock, such as limited partnerships and business trusts. Because the
stated purpose of the proposal is to protect shareholders from
dilution, it seems evident that the shareholder approval requirement is intended
to apply only to companies listing common stock on the NYSE. The final rule
should make this clear.
II. |
Scope of
Equity-Compensation Plan Definition
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1. |
Plans That Do Not Involve the Delivery of an Equity Security Should Not Be
Equity-Compensation Plans
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The
proposed rule does not define equity-compensation plans. However,
the stated purpose of the proposed approval requirement is to provide
checks and balances on the process of earmarking shares to be used for
equity-based awards, and to provide shareholders a voice regarding the resulting
dilution. Requiring shareholder approval of plans or arrangements that do
not provide for the delivery of equity securities is not consistent with this
stated purpose. Therefore, we suggest that the rule make clear that cash-only
plans even plans where the cash received is linked directly to the stock
price, such as stock appreciation rights that may be settled only in cash
and other plans where equity securities are not deliverable are excluded from
the definition of equity-compensation plans.
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2. |
Non-Compensatory and Deferred Stock Purchase Plans Should Not Be
Equity-Compensation Plans
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The
Release provides that an equity-compensation plan would not include
a plan that merely provides a convenient way (for example, through payroll
deductions) for employees, directors or other service providers to buy shares on
the open market or from the issuer, even if the brokerage and other costs of the
plan are subsidized, so long as the purchasers pay fair market value for
the shares. Statement of Financial Accounting Standards No. 123, issued by the
Financial Accounting Standards Board, treats certain employee stock purchase
plans as non-compensatory if, among other requirements, shares are sold to
employees at a minimal discount, e.g., five percent or less, from market price
at the time of purchase. We suggest that plans that satisfy the criteria set
forth in paragraph 23 of SFAS No. 123 for non-compensatory stock purchase plans
should not be considered equity-compensation plans for the purposes
of the shareholder approval
requirement.2
It
is also common for issuers to permit their employees to acquire stock at market
prices on a pre-tax basis by means of payroll and/or bonus reductions, with the
delivery of the stock and the withholding of taxes deferred until a later date.
The employee receives the benefit, and is subject to the risk, of changes in the
market price of the stock from the time of the pay reduction until delivery of
the stock. It is unclear whether the current carve-out from the definition of
equity-compensation plans covers these plans, because the
tax-deferral aspect may mean that the plan is not merely for
convenience. Because the tax-deferral aspect does not seem to run counter to the
purposes of this exception, we believe that the carve-out should be clarified to
cover such deferred stock purchase plans (e.g., by adding the following words
after subsidized: and even if the plan results in a deferral
of the payment of taxes and/or the delivery of the stock.)
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1. |
Material Revisions Should Be Defined
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The
Release requires shareholder approval of all material revisions to
equity-compensation plans. Material is not defined in the proposed
rule, although numerous examples are given of specific events that would be
deemed material revisions. The absence of a general definition, or
even factors to be considered in making the materiality determination, will make
it difficult for companies to determine when shareholder approval is necessary
outside of the specific situations covered by the provided examples. We suggest
that the final rule specify that materiality be defined by reference
to former Rule 16b-3 under the Securities Exchange Act of 1934 (the
Exchange Act) and the interpretations thereunder. Under this
approach, a revision would be material if the revision:
- materially increased the benefits accruing to participants;
- materially increased the number of securities that may be issued under the plan; or
- materially modified the eligibility requirements of the plan.
This
would work toward harmonizing the NYSE proposal with the similar proposal by the
Nasdaq Stock Market.3
In addition, this approach would permit the
incorporation of the existing SEC interpretations of the above criteria, reduce
the number of interpretational issues that would be presented to the NYSE under
the new rule and focus the requirement on the types of revisions that would be
of concern to shareholders.
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2. |
Option Repricings Should Be Deemed Permitted in the Absence of an Express
Prohibition
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Many
equity-compensation plans are silent on the ability of the listed company to
engage in repricing of options. As a matter of contract interpretation, the
absence of a prohibition on repricings will generally be construed to permit the
company to engage in repricings.4
The proposed rule runs contrary to
this general understanding by indicating just the opposite repricings are
prohibited unless expressly permitted. We believe that it is inappropriate for
the NYSE to change the current contractual expectations of listed companies and,
in effect, to import substantive contractual provisions into existing
equity-compensation plans. We recommend that the issue of the permissibility of
repricings be left to the relevant state contract law.
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3. |
Companies Should Be Permitted to Add a 10-Year Term to Evergreen Plans Without
Shareholder Approval
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Footnote
8 of the Release provides that an automatic increase in the shares available
under a plan pursuant to an evergreen formula will not be considered
a revision if the term of the plan is limited to a specified period
of time not in excess of ten years. Companies that have existing
shareholder-approved evergreen plans with terms of more than 10 years (including
unlimited terms) may wish to amend their plans to conform to the requirements of
the rule. We suggest that the final rule clarify that such an amendment would
not itself be a material revision requiring shareholder approval.
The rule provides that a material extension of the term of a plan would be
deemed a material revision, which implies that a reduction in the term of a plan
would not be a material revision, but we believe it would be helpful for the rule
to state this expressly.
In
addition, the proposed rules do not address whether the 10-year maximum term
must run from the date of effectiveness of the rule, the date of addition of the
10-year term or the date of original adoption or shareholder approval of the
plan. We suggest that the rule clarify that the 10-year term requirement is
satisfied if the specified term ends no more than 10 years from the date that
the term provision is added to the rule.
IV. |
The Parallel Nonqualified Plan Definition Should Be Conformed to the
Rule 16b-3 Definition of Excess Benefit Plan |
The
definition of parallel nonqualified plan in the proposed rule is
similar to, but not identical to, the definition of Excess Benefit Plan
in Rule 16b-3 under the Exchange Act. Rule 16b-3 defines an Excess Benefit Plan
as an employee benefit plan that is operated in conjunction with a
Qualified Plan [e.g., a 401(k) plan], and provides only the benefits or
contributions that would be provided under a Qualified Plan but for any benefit
or contribution limitations set forth in the Internal Revenue Code of 1986, or
any successor provisions thereof. The primary difference between the two
definitions is that the parallel nonqualified plan definition
contains the requirement that the plan cover all or substantially all
employees of an employer who are participants in the related qualified
plan whose annual compensation is in excess of the relevant Internal
Revenue Code provisions.
We
believe that whatever additional shareholder protection is obtained by adding
this requirement to the exception does not outweigh the inefficiencies inherent
in having two different standards for plans operated in conjunction with
tax-qualified plans. The requirements in the Excess Benefit Plan definition that
the plan be operated in conjunction with a 401(k) plan and provide
only the benefits or contributions that would be provided under a 401(k) plan
absent the Internal Revenue Code limitations would, in our view, provide
sufficient protection against abuse of the parallel plan exception. Using the
Rule 16b-3 definition would also permit the NYSE to obtain the benefit of the
Commissions guidance as to the definition of Excess Benefit Plan.
Finally,
using the Excess Benefit Plan definition would permit the exception to the
shareholder approval requirement to be available to top hat plans.
Most nonqualified plans operated in parallel with qualified plans are top
hat plans, which are plans that are exempted from some requirements of the
Employee Retirement Income Security Act of 1974 (ERISA) because they
apply only to a select group of management or highly compensated
employees.5
These plans generally qualify as Excess Benefit
Plans and also would qualify as parallel nonqualified plans but for
the fact that the select group subject to the plan may exclude some
employees who are participants in the underlying tax-qualified plans and whose
compensation exceeds the applicable compensation limitations. Consequently, to
avail itself of the parallel nonqualified plan exception, a listed
company may be required to expand coverage under its plans in a manner that
jeopardizes their qualification as top hat plans under ERISA.
Failing the top hat plan exemption would make it impossible to deliver the
tax-deferred benefits that these plans are designed and intended to provide, and
defeat their purpose of operating in conjunction with the underlying
tax-qualified plan as contemplated and recognized under Rule 16b-3. We see no
policy reason to force NYSE-listed companies to forgo the benefits of the ERISA
exemptions in order to qualify for the shareholder approval exception.
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1. |
A Transition Period Should Apply for the Approval of Existing Evergreen Plans
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The
proposed rule provides that any plan including an evergreen formula
that was not previously approved by shareholders would need to be approved
before the next increase in shares pursuant to the evergreen formula that
occurs on or after the effective date of this rule. Many evergreen
provisions are triggered based on year-end data (for example, the number of
outstanding shares). If the proposed rule becomes effective before December 31,
2002, companies with such plans would, as a practical matter, be unable to
schedule a special meeting of shareholders to approve the formulaic increase.
This would require these issuers to forego the increase at the risk of
disrupting their system for compensating
employees,6
or to condition
grants on shareholder approval (which could have adverse financial accounting
and employee relations consequences). This problem also arises for plans that
have no express share limitation, but instead contain a blanket authorization
for the issuance of shares in accordance with the terms of the plan; if such
plans are deemed to contain an inherent evergreen provision, then a company runs
the risk of being in violation of the rule upon the first issuance of shares
under the plan following the effective date of the rule, because this would
arguably be an increase in the shares available under the plan.
We
suggest that the rule be modified so that an evergreen plan adopted before the
effective date would not be required to be submitted to shareholders for
approval until the next annual meeting of shareholders.
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2. |
Existing Plans of Newly-Listed Companies Should Be Grandfathered
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The
proposed rule provides that it will apply to a plan adopted before the effective
date of the rule only upon any subsequent material revision of the
plan. The proposed rule does not address the treatment of plans adopted
after the effective date of the rule but before the companys stock is
listed on the NYSE. We believe that the grandfathering provisions of the
proposed rule should apply equally to such plans. The purpose of the proposed
rule is to give shareholders a voice in preventing potential dilution of their
interest through the establishment of new equity-compensation plans and the
material amendment of existing plans. There is no reason consistent with this
purpose to require purchasers of shares of a newly-listed company to be given
the ability to ratify or eliminate the equity-compensation plans underlying the
companys existing compensation structure. In fact, requiring newly-listed
companies to subject all of their existing equity-compensation plans to a
shareholder vote would, at a minimum, create a new financial and administrative
burden to the listing process and could even result in the disruption of the
companys existing compensation system.
VI. |
Neither Compensation Committee Nor Board Approval Should Be Required for All
Plans and Amendments Not Voted on by Shareholders |
The
proposed rule provides that, [i]n circumstances in which equity
compensation plans and amendments thereto are not subject to shareholder
approval, the plans and amendments still must be subject to the approval of the
companys compensation committee or a majority of the companys
independent directors. The use of the phrase subject to the
approval suggests that the approval of the compensation committee or
independent directors must occur prior to the adoption or amendment at issue.
In
certain cases, a prior approval requirement would be impracticable. For example,
as the proposed rule recognizes, employment inducement awards often need to be
granted on an urgent basis, and compensation committee or director pre-approval
would necessarily delay this process and place NYSE-listed companies at a
disadvantage in the hiring process. In any event, we agree with the statement in
the proposed rule that inducement awards and mergers and acquisitions are
not likely to be abused and accordingly believe that compensation
committee pre-approval is unnecessary. In addition, in our experience, technical
amendments are often made to equity-compensation plans particularly
tax-qualified plans due to changes in laws or regulations or to ease or
expedite administrative matters. These amendments are often adopted without the
prior approval of the compensation committee or independent directors, and we
believe that it is not necessary to involve the compensation committee or the
independent directors in this type of corporate housekeeping.
We
believe that the responsibility of the compensation committee with respect to
equity-compensation plans should be that set forth in the NYSEs August 16,
2002 proposal relating to compensation committee functions: to make
recommendations to the board with respect to incentive-compensation plans and
equity-based plans. This oversight function, together with the shareholder
approval requirement and the Commissions disclosure
rules,7
will adequately protect and inform shareholders. To the extent that the
Commission and the NYSE believe it appropriate to heighten committee oversight
in this area, the compensation committee could be charged with the
responsibility of reviewing periodically non-shareholder-approved plans and
amendments adopted by the company. Alternatively, if it is determined that the
compensation committee or independent directors should be responsible for
pre-approving non-shareholder-approved plans and amendments, we recommend that
the final rule specify that the compensation committee or independent directors
are permitted to delegate this responsibility to others within the company, at
least with respect to tax-qualified plans, which are strictly regulated under
the tax laws.
VII. |
Technical Revisions Should Be Made to the Existing NYSE Voting Requirements |
Existing
Section 312.07 of the NYSE Listed Company Manual provides for minimum voting
requirements where shareholder approval is a prerequisite to the listing
of any additional or new securities of a listed company. These
requirements apply to existing Section 312.03(a), which the proposed rule will
replace, and presumably are intended to continue to apply to the proposed rule.
However, because the proposed rule is not technically a prerequisite to
listing, Section 312.07 will need to be modified to make clear that it
also applies to the new shareholder approval requirement.
* * *
We
appreciate the opportunity to comment to the Commission on the proposed NYSE
rules, and would be happy to discuss any questions the Commission may have with
respect to this letter. Any questions about this letter may be directed to
Robert W. Reeder (212-558-3755), Max Schwartz (212-558-3936) or Marc R. Trevino
(212-558-4239).
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Very truly yours,
SULLIVAN & CROMWELL |
Endnotes
1 |
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The original proposal was filed with the Commission on August 16, 2002.
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2 |
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See SFAS No. 123, Accounting for Stock-Based Compensation, paragraph 23
(October 1995), which provides as follows: If an
employee stock purchase plan satisfies all of the following criteria, the plan
is not compensatory. . . .
- The plan incorporates no
option features other than the following, which may be incorporated:
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- Employees are permitted a short period of timenot exceeding 31
daysafter the purchase price has been fixed to enroll in the plan.
- The purchase price is based solely on the stocks market price at date of
purchase, and employees are permitted to cancel participation before the
purchase date and obtain a refund of amounts previously paid (such as those paid
by payroll withholdings).
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- The discount from the market price does not exceed the greater of (1) a
per-share discount that would be reasonable in a recurring offer of stock to
stockholders or others or (2) the per-share amount of stock issuance costs
avoided by not having to raise a significant amount of capital by a public
offering. A discount of 5 percent or less from the market price shall be
considered to comply with this criterion without further justification.
- Substantially all
full-time employees that meet limited employment qualifications may participate
on an equitable basis.
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3 |
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See Notice of Filing of Proposed Rule Change and Amendment No. 1 Thereto by
National Association of Securities Dealers, Inc. Relating to Shareholder
Approval of Stock Option Plans or Other Arrangements, Release No. 34-46649,
Rule No. SR-NASD-2002-140 (October 11, 2002) (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 Commissions 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.)
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4 |
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We believe
that this is generally the result a court would reach under New York and
California law.
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5 |
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See ERISA §§201(2), 301(a)(3) and 401(a)(1).
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6 |
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In fact, it is unclear from the current materiality discussion in the proposed
rules whether a decision by the company to forgo a scheduled increase under an
evergreen plan would itself be a material amendment to the plan requiring
shareholder approval.
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7 |
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See Final Rule: Disclosure of Equity Compensation Plan Information,
Release No. 34-45189 (December 21, 2001).
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