[Federal Register Volume 64, Number 244 (Tuesday, December 21, 1999)]
[Notices]
[Pages 71529-71534]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-33052]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-42233; File No. SR-NYSE-99-39]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change by the New York Stock Exchange, Inc. Amending the Exchange's
Audit Committee Requirements and Notice of Filing and Order Granting
Accelerated Approval of Amendments No. 1 and No. 2 Thereto
December 14, 1999.
I. Introduction
On September 20, 1999, the New York Stock Exchange, Inc. (``NYSE''
or ``Exchange'') submitted to the Securities and Exchange Commission
(``SEC'' or ``Commission''), pursuant to section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change amending the Exchange's audit
committee requirements.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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The Federal Register published the proposed rule change for comment
on October 13, 1999.\3\ In response, the Commission received 25 comment
letters.\4\ On October 15, 1999 and December 8, 1999, the Exchange
submitted Amendments No. 1 \5\ and No. 2,\6\ respectively, to the
proposed rule change. This order approves the proposed rule change and
grants accelerated approval to Amendments No. 1 and No. 2. The
Commission is also soliciting comment on Amendments No. 1. and No. 2 to
the proposed rule change.
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\3\ Securities Exchange Act Release No. 41980 (Oct. 6, 1999), 64
FR 55514 (Oct. 13, 1999). The Nasdaq Stock Market, Inc. and The
American Stock Exchange LLC have proposed rule changes relating to
audit committees. See Securities Exchange Act Release No. 41982
(Oct. 6, 1999), 64 FR 55510 (Oct. 13, 1999) (``Nasdaq Proposal''),
and Securities Exchange Act Release No. 41981 (Oct. 6, 1999), 64 FR
55505 (Oct. 13, 1999) (``Amex Proposal'').
\4\ The comment letters are discussed in Section III of this
order.
\5\ Letter from James E. Buck, Senior Vice President and
Secretary, NYSE, to Richard Strasser, Assistant Director, Division
of Market Regulation (``Division''), Commission, dated October 14,
1999 (``Amendment No. 1''). The Exchange submitted Amendment No. 1
to require issuers to adopt a formal written audit committee charter
within six months of the effective date of the proposed rule change.
As originally filed, the proposed rule change required issuers to
adopt the charter within eighteen months of the effective date of
the proposed rule change. Amendment No. 1 also extends the
definition of ``officer'' in Rule 16a-1(f) under the Act to
Paragraph 303 of the Exchange's Listed Company Manual. Previously,
the Exchange permitted each company's by-laws and charter to define
this term.
\6\ Letter from James E. Buck, Senior Vice President and
Secretary, NYSE, to Richard Strasser, Assistant Director, Division,
Commission, dated December 6, 1999 (``Amendment No. 2''). Amendment
No. 2 revises proposed rule 303.01(B)(1) to require the board to
adopt the audit committee charter. Under the original proposal, the
audit committee adopted the charter, subject to board approval.
Amendment No. 2 also revises proposed Rule 303.01(B)(1)(c) to
replace the provision that required the board to take appropriate
steps to ensure the independence of the outside auditors. The
revised provision requires the board ``to take appropriate action in
response to the outside auditors report to satisfy itself of the
outside auditor's independence.'' Finally, Amendment No. 2 revises
proposed Rule 303.02 to require companies listing on the Exchange in
conjunction with an initial public offering to have two qualified
audit committee members in place within three months of listing, and
a third qualified member within twelve months of listing.
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II. Description of the Proposed Rule Change
A. Background
In February 1999, the Blue Ribbon Committee on Improving the
Effectiveness of Corporate Audit Committees (``Blue Ribbon Committee'')
issued a report containing recommendations aimed at strengthening the
independence of the audit committee, making the audit committee more
effective, and addressing mechanisms for accountability among the audit
committee, the outside auditors, and management.\7\
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\7\ Report and Recommendations of the Blue Ribbon Committee on
Improving the Effectiveness of Corporate Audit Committees (1999). A
copy of this Report can be found on-line at www.nasdaqnews.com.
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The Exchange distributed to its listed companies the Exchange
staff's suggestions for rule changes in response to the Blue Ribbon
Committee's report. The comments from the Exchange's listed companies
were generally supportive of the suggestions put forth by the Exchange,
with some commenters expressing concerns about ``financial literacy''
requirement.
In response to the Blue Ribbon Committee's recommendations, the
Exchange proposes to revise its listing standards regarding audit
committees. The proposed rule change specifies four requirements for a
qualified audit committee and defines the terms ``Immediate Family''
and ``Affiliate'' for purposes of the proposed audit committee
requirements.
The text of the proposed rule change, as amended by Amendments No.
1 and No. 2, is as follows. Language deleted by Amendments No. 1 and
No. 2 is in brackets. Language added by Amendments No. 1 and No. 2 is
in italics.
NYSE Listed Company Manual
* * * * *
Section 3
Corporate Responsibility
303.00 Corporate Governance Standards
In addition to the numerical listing standards, the Exchange has
adopted certain corporate governance listing standards. These standards
apply to all companies listing common stock on the Exchange. However,
the Exchange does not apply a particular standard to a non-U.S. company
if the company provides the Exchange with a written certification from
independent counsel of the company's country of domicile stating that
the company's corporate governance practices comply with home country
law and the rules of the principal securities market for the company's
stock outside the United States.
303.01 Audit Committee
(A) Audit Committee Policy. Each company must have a qualified
audit committee.
(B) Requirements for a Qualified Audit Committee.
(1) Formal Charter. [Each audit committee must adopt a formal
written charter that is approved by the Board of Directors.] The Board
of Directors must adopt and approve a formal written charter for the
audit committee. The audit committee must review and reassess the
adequacy of the audit committee charter on an annual basis. The charter
must specify the following:
(a) The scope of the audit committee's responsibilities and how it
carries out those responsibilities, including structure, processes and
membership requirements;
(b) That the outside auditor for the company is ultimately
accountable to the Board of Directors and audit committee of the
company, that the
[[Page 71530]]
audit committee and Board of Directors have the ultimate authority and
responsibility to select, evaluate and, where appropriate, replace the
outside auditor (or to nominate the outside auditor to be proposed for
shareholder approval in any proxy statement); and
(c) That the audit committee is responsible for ensuring that the
outside auditor submits on a periodic basis to the audit committee a
formal written statement delineating all relationships between the
auditor and the company and that the audit committee is responsible for
actively engaging in a dialogue with the outside auditor with respect
to any disclosed relationships or services that may impact the
objectivity and independence of the outside auditor and for
recommending that the Board of Directors take appropriate action [to
ensure the independence of the outside auditor] in response to the
outside auditors' report to satisfy itself of the outside auditors'
independence.
(2) Composition/Expertise Requirement of Audit Committee Members.
(a) Each audit committee shall consist of at least three directors,
all of whom have no relationship to the company that may interfere with
the exercise of their independence from management and the company
(``Independent'');
(b) Each member of the audit committee shall be financially
literate, as such qualification is interpreted by the company's Board
of Directors in its business judgment, or must become financially
literate within a reasonable period of time after his or her
appointment to the audit committee; and
(c) At least one member of the audit committee must have accounting
or related financial management expertise, as the Board of Directors
interprets such qualification in its business judgment.
(3) Independence Requirement of Audit Committee Members. In
addition to the definition of Independent provided above in (2)(a), the
following restrictions shall apply to every audit committee member.
(a) Employees. A director who is an employee (including non-
employee executive officers) of the company or any of its affiliates
may not serve on the audit committee until three years following the
termination of his or her employment. In the event the employment
relationship is with a former parent or predecessor of the company, the
director could serve on the audit committee after three years following
the termination of the relationship between the company and the former
parent or predecessor.
(b) Business Relationship. A director (i) Who is a partner,
controlling shareholder, or executive officer of an organization that
has a business relationship with the company, or (ii) Who has a direct
business relationship with the company (e.g., a consultant) may serve
on the audit committee only if the company's Board of Directors
determines in its business judgment that the relationship does not
interfere with the director's exercise of independent judgment. In
making a determination regarding the independence of a director
pursuant to this paragraph, the Board of Directors should consider,
among other things, the materiality of the relationship to the company,
to the director, and, if applicable, to the organization with which the
director is affiliated.
``Business relationships'' can include commercial, industrial,
banking, consulting, legal, accounting and other relationships. A
director can have this relationship directly with the company, or the
director can be a partner, officer or employee of an organization that
has such a relationship. The director may serve on the audit committee
without the above-referenced Board of Directors' determination after
three years following the termination of, as applicable, either (1) The
relationship between the organization with which the director is
affiliated and the company, (2) The relationship between the director
and his or her partnership status, shareholder interest or executive
officer position, or (3) The direct business relationship between the
director and the company.
(c) Cross Compensation Committee Link. A director who is employed
as an executive of another corporation where any of the company's
executives serves on that corporation's compensation committee may not
serve on the audit committee.
(d) Immediate Family. A director who is an Immediate Family member
of an individual who is an executive officer of the company or any of
its affiliates cannot serve on the audit committee until three years
following the termination of such employment relationship. See para.
303.02 for definition of ``Immediate Family.''
303.02 Application Standards
(A) ``Immediate Family'' includes 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.
(B) ``Affiliate'' includes a subsidiary, sibling company,
predecessor, parent company, or former parent company.
(C) Written Affirmation. As part of the initial listing process,
and with respect to any subsequent changes to the composition of the
audit committee, and otherwise approximately once each year, each
company should provide the Exchange written confirmation regarding:
(1) Any determination that the company's Board of Directors has
made regarding the independence of directors pursuant to any of the
subparagraphs above;
(2) The financial literacy of the audit committee members;
(3) The determination that at least one of the audit committee
members has accounting or related financial management expertise; and
(4) The annual review and reassessment of the adequacy of the audit
committee charter.
(D) Independence Requirement of Audit Committee Members.
Notwithstanding the requirements of subparagraphs (3)(1) and (3)(d) of
para. 303.01, one director who is no longer an employee or who is an
Immediate Family member of a former executive officer of the company or
its affiliates, but is not considered independent pursuant to these
provisions due to the three-year restriction period, may be appointed,
under exceptional and limited circumstances, to the audit committee if
the company's board of directors determines in its business judgment
that membership on the committee by the individual is required by the
best interests of the corporation and its shareholders, and the company
discloses, in the next annual proxy statement subsequent to such
determination, the nature of the relationship and the reasons for that
determination.
(E) ``Officer'' shall have the meaning specified in Rule 16a-1(f)
under the Securities Exchange Act of 1934, or any successor rule.
(F) Initial Public Offering. Companies listing in conjunction with
their initial public offering (including spin-offs and carve outs) will
be required to have two qualified audit committee members in place
within three months of listing and a third qualified member in place
within twelve months of listing.
B. Charter
The Exchange proposes to require audit committees to adopt a formal
written charter that is approved by the company's board and to review
and reassess annually the adequacy of the charter. The charter must
specify: (i)
[[Page 71531]]
The scope of the audit committee's responsibilities and how they are
being carried out; (ii) the ultimate accountability of the outside
auditor to the board and audit committee; (iii) the responsibility of
the audit committee and board for selection, evaluation and replacement
of the outside auditor; and (iv) The responsibility of the audit
committee for ensuring the independence of the outside auditor by
reviewing, and discussing with the board if necessary, any
relationships between the auditor and the company or any other
relationships that may adversely affect the independence of the
auditor.
C. Structure and Membership of the Audit Committee
The Exchange also proposes to change the structure and membership
qualifications of the audit committee. Under the proposed rule change,
each audit committee must have at least three independent directors,
subject to a board override for one director. The board may override
the three-year bar for one audit committee member after finding that an
override is required in the best interests of the company and its
shareholders. If it exercises the override, the company must disclose
in its next annual proxy statement the nature of the relationship and
the reasons for that determination. Potential candidates that are not
considered independent because of a business relationship with the
company or a cross compensation committee link may not be the subject
of a board override.
As a result of the audit committee's responsibility for a company's
accounting and financial reporting, the Exchange believes that audit
committee members should have a basic understanding of financial
statements. Therefore, the proposed rule change requires each audit
committee member to be financially literate, or to become financially
literate within a reasonable period of time after his or her
appointment to the audit committee, as such qualification is
interpreted by the company's board in its business judgment.
Furthermore, in order to further enhance the effectiveness of the audit
committee, the proposal requires at least one member of each audit
committee to have accounting or related financial management expertise,
as the company's board interprets such qualification in its business
judgment.
D. Independence
The proposed rule change places four restrictions on audit
committee members for purposes of determining each member's
independence. First, Employees (including non-employee executive
officers) of the company or its affiliates may not serve on the audit
committee until three years following the termination of employment.
However, if the relationship is with a former parent or predecessor of
the company (see definition of ``Affiliate'' described in Subsection F
below), the three-year bar applies to the time period following the
severance of the relationship between the company and the former parent
or predecessor.
Second, a director: (i) who is a partner, controlling shareholder,
or executive officer of an organization that has a business
relationship with the company, or (ii) who has a direct business
relationship with the company (e.g., a consultant), may serve on the
audit committee only if the company's board determines in its business
judgment that the relationship does not interfere with the director's
exercise of independent judgment. Business relationships can include
commercial, industrial, banking, consulting, legal, accounting and
other relationships. A director can have this relationship directly
with the company, or the director can be a partner, officer or employee
of an organization that has the business relationship.
Third, a director who is employed as an executive of another
corporation where any of the company's executives serves on that
corporation's compensation committee may not serve on the audit
committee.
Fourth, a director who is ``Immediate Family'' (as that term is
defined by proposed Exchange Rule 303.01(B)(3)(d)) of an individual who
is an executive officer of the company or any of its affiliates cannot
serve on the audit committee until three years following the
termination of such employment relationship.
E. Written Affirmation
To monitor compliance with the proposed rule change, the Exchange
proposes to incorporate an ongoing written affirmation requirement. In
this regard, as part of the initial listing process, and with respect
to any subsequent changes to the composition of the audit committee,
and otherwise approximately once each year, each company must provide
the Exchange written confirmation regarding:
(i) Any determination that the company's board has made regarding
the independence of directors;
(ii) The financial literacy of the audit committee members;
(iii) The determination that at least one of the audit committee
members has accounting or related financial management expertise; and
(iv) The annual review and reassessment of the adequacy of the
audit committee charter.
F. Definitions
The Exchange proposes to codify two long-standing interpretations
under the current audit committee requirements as follows:
(i) ``Immediate Family'' includes a person's spouse, parents,
children, siblings, mother-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; and
(ii) ``Affiliate'' includes a subsidiary, sibling company,
predecessor, parent company, or former parent company.
G. Implementation
The Exchange proposes to implement a transition period to provide
its issuers with sufficient time to comply with the proposed rule
change. Specifically, the Exchange proposes to: (i) ``grandfather'' all
public company audit committee members qualified under current NYSE
rules until they are re-elected or replaced; and (ii) give companies
that have less than three members on their audit committees eighteen
months from the date of Commission approval of this rule filing to
recruit the requisite members. Issuers listed on the Exchange as of the
effective date of the proposed rule change will have six months to
adopt a formal written audit committee charter.\8\
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\8\ See Amendment No. 1, supra n. 5.
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III. Comments
As of December 9, 1999, the Commission received 25 comment letters
on the proposed rule change.\9\ In
[[Page 71532]]
general, most commenters favored the proposed rule change but
recommended certain modifications. Three commenters opposed the
proposed rule change.\10\
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\9\ See letters from: Ernst & Young LLP (``E&Y'') dated November
1, 1999; Deloitte & Touche LLP (``Deloitte'') dated November 3,
1999; Council of Institutional Investors (``CII'') dated November 8,
1999; Brian T. Borders (on behalf of the National Venture Capital
Association (``NVCA'')) dated November 12, 1999; Investment Company
Institute (``ICI'') dated November 3, 1999; PriceWaterhouseCoopers
LLP (``PWC') dated November 1, 1999; Gary P. Kreider (``Kreider'')
dated November 5, 1999; Emerson Electric Co. (``Emerson'') dated
November 1, 1999; Exxon Corporation (``Exxon'') dated November 3,
1999; McDonald's Corporation (McDonald's) dated November 1, 1999;
Connectiv (``Connectiv'') dated November 2, 1999; Texas Instruments
(``TI'') dated November 2, 1999; Dime Bancorp, Inc. (``Dime'') dated
November 3, 1999; Airlease Management Services, Inc. (``Airlease'')
dated November 3, 1999; The Dun & Bradstreet Corporation (``D&B'')
dated November 3, 1999; EMC Corporation (``EMC'') dated November 1,
1999; Dorsey & Whitney LLP (``Dorsey'') (on behalf of nine closed-
end investment management companies whose stock is listed on the
Exchange) dated October 28, 1999; Massachusetts Financial Services
Company (``MFSC'') (on behalf of six closed-end funds advised by
MFSC) dated November 22, 1999; Meritor Automotive, Inc.
(``Meritor'') dated November 24, 1999; American Federation of Labor
and Congress of Industrial Organizations (``AFL-CIO'') dated
November 29, 1999; Mayer, Brown & Platt on behalf of Morgan Stanley
Dean Witter (``MSDW'') dated November 29, 1999; Arthur Andersen LLP
(``Arthur Andersen'') dated December 3, 1999; Association of
Publicly Traded Companies (``APTC'') dated December 6, 1999; Robert
A. Profusek (``Profusek'') dated December 3, 1999; Stanley Keller
and Richard Rowe (``Keller and Rowe'') dated December 7, 1999; and
The Committee on Securities Regulation of the Business Law Section
of the New York State Bar Association (``NYSBA'') dated December 1,
1999.
\10\ See Kreider Letter at 2; EMC Letter at 2; APTC Letter at 2.
Kreider stated his belief that the proposed rule change circumvents
state corporate law. EMC stated that the proposed rule change
substitutes over-generalized restrictions for the more flexible,
traditional standards of good faith, candor, care and loyalty that
underlie the business judgment rule under state law. EMC also stated
that the independence standards may deprive audit committees of
valuable financially-expert directors.
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In particular, the CII supports the new requirements, but stated
that the proposed board override provision, which allows a company's
board to include a non-independent director on an audit committee, is
not appropriate because companies should not have a problem finding
financially literate, truly independent directors.\11\ In addition, the
AFL-CIO stated that the restriction period for former employees, or
relatives of former employees, should be three years instead of five
years.\12\ MFSC stated that audit committees should not be required to
describe in their charters how they carry out their
responsibilities.\13\
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\11\ CII Letter at 2; see also AFL-CIO Letter at 2.
\12\ AFL-CIO Letter at 2.
\13\ MFSC Letter at 1.
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Many of the commenters pointed to differences between the proposed
rule change, on the one hand, and the Amex Proposal and Nasdaq
Proposal, on the other. Specifically, several commenters stated that
the Exchange should adopt the Amex's and Nasdaq's definitions of
financial literacy and expertise.\14\ These commenters noted that
allowing individual companies to define these terms will lead to
inconsistencies. In addition, several commenters stated that the
proposed rule change will discourage qualified candidates from serving
on audit committees.\15\ Moreover, one commenter stated that the
restriction that prohibits an individual who is an immediate family
member of an executive officer of the company or any of its affiliates
from serving on the audit committee should not be limited to executive
officers.\16\ Finally, three commenters stated that the Exchange should
adopt a bright line test for identifying when a director has a
significant business relationship with the company, as in the Amex
Proposal and Nasdaq Proposal.\17\ On the other hand, another commenter
opposed a bright line test and stated that the Exchange should not
revise its current test to determine if a significant business
relationship exists.\18\
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\14\ Dorsey Letter at 7, 9; E&Y Letter at 3; Connectiv Letter at
2; D&B Letter at 2; Emerson Letter at 2; NYSBA Letter at 5. In
addition, two commenters stated that the terms financial literacy
and expertise are too subjective and should be further defined, but
did not state the Amex/Nasdaq versions should be adopted. See
McDonald's Letter at 1; MFSC Letter at 2. MFSC Letter at 2. MFSC
also stated that it is not reasonable to expect a company's board to
request agreement from a potential audit committee candidate that he
will become financially literate because there are no accreditation
criteria or specific timeframes for completing this undertaking.
MFSC Letter at 2.
\15\ Dime Letter at 2; NVCA Letter at 2; D&B Letter at 2; MFSC
at 2.
\16\ Keller and Rowe Letter at 2.
\17\ E&Y Letter at 2; Emerson at 2; Arthur Andersen Letter at 1.
In addition, the AFL-CIO stated that the NYSE should adopt a bright
line test, but does not think the $60,000 threshold adopted by the
Amex and Nasdaq is stringent enough. AFL-CIO Letter at 3.
\18\ Profusek Letter at 2.
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In addition, one commenter stated that past non-executive
employment should be treated as a significant business
relationship.\19\ This commenter also stated that consultants who
receive from the company more than a de minimis amount of compensation
should be treated as employees, while consultants who do not should be
treated as having a business relationship with the company.\20\
According to the commenter, the company's board should be permitted to
determine that the compensation does not impair the director's
objectivity.\21\ Moreover, the commenter objected to the financial
expertise requirement and stated that no director will want to be
designated the financial expert because of the added exposure to
liability.\22\
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\19\ Keller and Rowe Letter at 2.
\20\ Id at 3.
\21\ Id.
\22\ Id.; see also NYSBA Letter at 6.
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APTC stated that the proposed rule change will be counter
productive to the goal of better audit committees.\23\ In addition,
APTC stated that the proposed rule change will disadvantage smaller
companies more than larger companies, but concluded that it is
appropriate to apply the proposed rule change to all companies,
regardless of size.\24\ Moreover, APTC is opposed to the proposal's
financial literacy requirement.\25\ APTC believes that the financial
literacy requirement may deprive audit committees of the service of
individuals with ``exceptional character and/or operational
experience.'' \26\ The commenter suggested that the Exchange replace
this requirement with a requirement that the committee as a whole
posses a certain level of financial acumen.\27\
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\23\ APTC Letter at 2.
\24\ Id. at 3.
\25\ Id. at 4-5.
\26\ Id.
\27\ Id. at 5.
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TI stated that to reduce unrealistic expectations, the proposed
rule change should require or permit a disclaimer in the audit
committee charter stating that the committee does not provide any
special assurances with regard to the company's financial statements,
nor does the audit committee give a professional evaluation of the
quality of the audits performed by the independent public
accountants.\28\ Exxon and NYSBA stated that the company's board, not
the audit committee, should be required to adopt the audit committee
charter because audit committees are created by the board in its
discretion and under authority granted by state law.\29\
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\28\ TI Letter at 1.
\29\ Exxon Letter at 1; NYSBA Letter at 2.
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Exxon also stated that proposed Rule 303.01(B)(2)(a), which
requires audit committees to have at least three directors, all of whom
must be independent, should provide a business judgment standard for
independence, as subparts (b) and (c) of this Rule do with respect to
financial literary and expertise.\30\ Exxon also stated that proposed
Rule 303.01(B)(1) should not give both the board and the audit
committee ultimate responsibility to select, evaluate, and replace the
outside auditor.\31\ Exxon stated that only one body can have ultimate
authority.\32\ McDonald's stated that a yearly written confirmation
regarding financial literacy, financial expertise, independence of
directors, and adequacy of the audit committee's charter is
unnecessary.\33\
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\30\ Exxon Letter at 2. The Commission notes that proposed Rule
303.01(B)(2)(b) and (c) require each company's board to interpret
the terms ``financial literary'' and ``financial expertise.'' The
business judgment standard therefore applies to the board's
interpretation of these terms. Subpart (a) of the rule does not
require the board to interpret the term ``independence'' and, thus,
there is no need for a business judgment standard.
\31\ Exxon Letter at 1.
\32\ Id.
\33\ McDonald's Letter at 2.
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Deloitte and PWC each stated that requiring a company's board or
audit committee to ``ensure'' the
[[Page 71533]]
independence of the outside auditor goes beyond what can reasonably be
expected of the board and the audit committee in their oversight
role.\34\ Deloitte suggested that the Exchange replace the word
``ensure'' with ``monitor'' or ``actively oversee.'' \35\ E&Y supports
the proposed rule change overall, but stated that Small Business Filers
should not be exempt from the financial literacy and expertise
requirements and that the Exchange should expand its definition of
immediate family member to include sons-in-law and daughters-in-
law.\36\ Airlease stated that smaller companies should not be required
to have three independent auditors on their audit committees.\37\
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\34\ Deloitte Letter at 1; PWC Letter at 1; Meritor Letter at 2.
\35\ Id. at 2.
\36\ E&Y Letter at 4. In addition, the NVCA stated that the
exemption for Small Business Filers should be expanded to apply to
companies with less than $50 million in revenue. NVCA Letter at 4.
The Commission notes, unlike the Nasdaq Proposal and the Amex
Proposal, there is no exemption for Small Business Filers under the
NYSE's proposed rule change.
\37\ Airlease Letter at 1.
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In addition, the NVCA stated that the proposed rule change should
exclude venture capital investors from the independence
qualifications.\38\ The NVCA also stated that the proposed rule change
should give companies that have just completed an initial public
offering (``IPO'') eighteen months to comply with the new
requirements.\39\
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\38\ NVCA Letter at 5.
\39\ Id at 4.
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Three commenters stated that the proposed rule change should not
apply to closed-end investment companies.\40\ ICI and MSDW noted that
closed-end investment companies are adequately regulated under the 1940
Act.\41\ These two commenters also stated that the potential abuses
that the proposed rule change is designed to address do not exist with
respect to closed-end investment funds because the assets of closed-end
funds, consist exclusively of investment securities and thus there is
no opportunity to ``manage'' earnings or results through the selective
application of accounting policies.\42\
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\40\ ICI Letter at 2; MSDW Letter at 1; Keller and Rowe Letter
at 3. In addition, Keller and Rowe stated that the proposed rule
change should exempt all investment companies because their audit
committee members are already required not to be ``interested
persons'' as that term is defined in Section 2(a)(9) of the
Investment Company Act of 1940 (``1940 Act''). Keller and Rowe
Letter at 5. Moreover, Dorsey supported the application of the
proposed rule change to investment companies. Dorsey Letter at 3.
\41\ ICI Letter at 3-4; MSDW Letter at 2.
\42\ ICI Letter at 3; MSDW Letter at 1. ICI and MSDW also noted
that the independent accountants of investment funds are selected by
the independent directors of the fund.
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IV. Discussion
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a national securities exchange,\43\ and, in
particular, the requirements of section 6(b)(5) of the Act.\44\ The
Commission believes that the proposed rule change will protect
investors by improving the effectiveness of audit committees of
companies listed on the Exchange. The Commission also believes that the
new requirements will enhance the reliability and credibility of
financial statement of companies listed on the Exchange by making it
more difficult for companies to inappropriately distort their true
financial performance.
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\43\ In approving the proposal, the Commission has considered
its impact on efficiency, competition, and capital formation. 15
U.S.C. 78c(f).
\44\ 15 U.S.C. 78f(b)(5).
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Specifically, the Commission believes that the proposed definition
of independence will promote the quality and reliability of a company's
financial statements. The Commission believes that directors without
financial, familial, or other material personal ties to management will
be more likely to objectively evaluate the propriety of management's
accounting, internal control, and financial reporting practices. The
Commission also believes that the proposal's prohibition against
employees serving on the audit committee is appropriate and that the
Exchange should not be required to distinguish between executive and
non-executive employees.\45\ In addition, the Commission considers that
the proposed provision permitting a company to appoint one non-
independent director to its audit committee, if the board determines
that membership on the committee by the individual is required by the
best interests of the corporation and its shareholders, adequately
balances the need for objective, independent directors with the
company's need for flexibility in exceptional and unusual
circumstances. The Commission believes that the proposal's requirement
that the company disclose in its next annual proxy statement the nature
of the relationship and the board's reasons for determining that the
appointment was in the best interests of the corporation will
adequately guard against abuse of the proposed exception to the
independence requirement.\46\
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\45\ See Keller and Rowe Letter at 2.
\46\ The Commission does not believe that the Exchange should
require its listed companies to adopt a separate provision on
consultants. See Keller and Rowe Letter at 3.
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The Commission does not believe that venture capital investors
should be excluded from the Exchange's definition of independence. The
Commission does not view the proposed rule change as posing an undue
hardship on venture capital firms or companies listed on the NYSE. The
Commission notes that the proposed rule change will only prohibit
venture capital investors from sitting on a company's audit committee
if the investor does not fall within the Exchange's definition of
independence. The proposed rule change will not prohibit previously
eligible investors from serving on the company's board.
In addition, the Commission believes that requiring boards of
directors of listed companies to adopt formal written charters
specifying the audit committee's responsibilities, and how it carries
out those responsibilities, will help the audit committee, management,
investors, and the company's auditors recognize, and understand the
function of the audit committee and the relationship among the parties.
Moreover, the Commission believes that the proposal's requirement that
companies provide yearly written confirmation regarding the
independence, financial literacy, and financial expertise of directors,
as well as the adequacy of the audit committee charter, will help the
Exchange to ensure that listed companies are complying with the
proposed rule change.
The Commission believes that the proposed rule change's requirement
that each issuer have an audit committee composed of three independent
directors who are able to read and understand fundamental financial
statements will enhance the effectiveness of the audit committee and
help to ensure that audit committee members are able to adequately
fulfill their responsibilities. The Commission believes that requiring
each audit committee member to satisfy this standard will help to
ensure that the committee as a whole is financially literate.\47\
Moreover, the Commission believes that requiring one member of the
audit committee to have past employment experience in financial or
accounting, requisite professional certification in accounting, or any
other comparable experience or background that indicates the
individual's financial sophistication, will further enhance the
effectiveness of the audit committee in carrying out its financial
oversight responsibilities. The Commission does
[[Page 71534]]
not believe that these requirements will discourage qualified
candidates from serving on audit committees. Rather, the Commission
believes that these requirements will better enable companies to
identify and select qualified directors. In addition, the Commission
does not believe that companies will experience undue difficulty
recruiting an audit committee member that satisfies the financial
expertise requirements.
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\47\See APTC Letter at 5.
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Moreover, the Commission considers the Exchange's decision to
exempt Small Business Filers as appropriate.\48\ The Commission notes
that relatively few companies that qualify for listing on the Exchange
would also qualify as Small Business Filers under SEC Regulation S-
B.\49\
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\48\ See NVCA and Airlease Letters.
\49\ Small Business Filer is defined by Regulation S-B as an
issuer that: (i) has revenue of less than $25,000,000; (ii) is a
U.S. or Canadian issuer; and (iii) if a majority owned subsidiary,
the parent corporation is a small business issuer. 17 CFR
228.10(a)(1).
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Furthermore, the Commission does not believe that the Exchange
should be required to adopt the Amex and Nasdaq proposed definitions of
financial literacy and expertise or the test to determine when a
potential director has a significant business relationship with the
company. The Commission notes that the proposed rule change is not
inconsistent with the Act.
Moreover, the Commission has concluded that the Exchange's decision
to include investment companies in the proposed rule change is
warranted. While the Commission recognizes that the opportunity for
some types of financial reporting abuses may be limited by the nature
of fund assets,\50\ it believes that audit committees do play an
important role in overseeing the financial reporting process for
investment companies.
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\50\ See Keller and Rowe Letter at 5; ICI Letter at 3; MSDW
Letter at 1.
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Finally, the Commission does not view the proposed rule change as
circumventing state law.\51\ The Commission notes that the Exchange is
amending its own listing standards, which is a function within the
Exchange's discretion, as long as those changes are consistent with the
Act.
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\51\ Kreider Letter at 2.
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The Commission finds good cause for approving Amendments No. 1 and
No. 2 to the proposed rule change prior to the thirtieth day after
publication in the Federal Register. The Commission notes that
Amendment No. 1 revises the implementation time periods for the
proposed rule change solely to provide greater clarity to issuers and
to investors. The Commission believes that Amendment No. 1 will enable
issuers to determine when they must comply with the new requirements
and will enable investors to determine when to reply on the protections
afforded by the proposed rule change. The Commission notes that
Amendment No. 2 simply codifies the Exchange's existing policy on the
timing of audit committee requirements for IPO's; clarifies that the
company's board must take appropriate action to satisfy itself of the
outside auditor's independence, and is not intended to provide an
absolute guarantee of independence; and requires the board to adopt the
audit committee charter, rather than approving the charter adopted by
the audit committee. The Commission believes that accelerated approval
will allow the Exchange to simultaneously make all relevant
modifications to its Listed Company Manual and will avoid potential
confusion. Accordingly, the Commission finds good cause to accelerate
approval of Amendments No. 1 and No. 2 to the proposed rule change,
consistent with the Sections 6(b)(5)\52\ and 19(b)\53\ of the Act.
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\52\ 15 U.S.C. 78f(b)(5).
\53\ 15 U.S.C. 78s(b).
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V. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change is 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 witheld 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
Exchange. All submissions should refer to the File No. SR-NYSE-99-39
and should be submitted by January 11, 2000.
VI. Conclusion
For the foregoing reasons, the Commission finds that the Exchange's
proposal to amend its audit committee requirements is consistent with
the requirements of the Act and the rules and regulations thereunder.
It Is Therefore Ordered, pursuant to Section 19(b)(2) of the
Act,\54\ that the amended proposed rule change (SR-NYSE-99-39) is
approved.
\54\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\55\
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\55\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-33052 Filed 12-20-99; 8:45 am]
BILLING CODE 8010-01-M
