This article is reprinted with permission
from the
edition of
New York Law Journal.
© 2003 NLP IP Company.
Executive Pay Under Proposed NYSE, NASDAQ Rules
On Oct. 8 and Oct. 9, respectively, the New
York Stock Exchange Inc. [NYSE] and The NASDAQ Stock Market Inc. [NASDAQ]
submitted to the Securities and Exchange Commission [SEC] their latest
proposals [NYSE Proposal and NASDAQ Proposal] with respect to standards for
listed companies' corporate governance practices.1 Both sets of proposals would
require that a majority of the board of directors of a listed company be
"independent directors."2
This column will focus on [i] the role of "independent directors" under the
proposed rules in determining compensation of the CEO and other executives and
[ii] the definition of "independent director" for this purpose.
A. Setting Executive Compensation
Under both the NYSE and the NASDAQ [National
Association of Securities Dealers Automatic Quotation System] Proposals, it is
likely that the compensation committee [which under both proposals must be made
up exclusively of "independent directors" [see Part B below]] will
continue to be the initiator of most board-level actions regarding executive
pay.
1. Setting CEO Pay
a. NYSE Proposal. Under this proposal the
compensation committee3 will have "direct responsibility" to: review
and approve corporate goals and objectives relevant to CEO compensation,
evaluate the CEO's performance in light of those goals and objectives, and,
either as a committee or together with the other independent directors [as
directed by the board], determine and approve the CEO's compensation level
based on this evaluation. ...
The setting of goals and objectives, and the
evaluation of performance against them, appears to be the responsibility of the
compensation committee alone. But the actual setting of the CEO's pay based on
the evaluation of the CEO's performance may, at the direction of the board, be
done by all the independent directors [or left to the committee itself].
The NYSE's explanation accompanying its
latest proposal states, "[W]e also clarified that the board in general is
not precluded from discussing CEO compensation, as we did not intend this
standard to impair communications among all directors."4 There is nothing
in the NYSE Proposal that specifically bars the CEO from attending any meeting
of either the compensation committee or the independent directors at which his
or her compensation is being discussed. This contrasts to the NASDAQ position
as noted below.
b. NASDAQ Proposal. The NASDAQ Proposal reads
as follows:
Compensation of the chief executive officer
of the company must be determined, or recommended to the board for
determination, either by:
[i] a majority of the independent directors, or
[ii] a compensation
committee comprised solely of independent directors.
The chief executive officer may not be
present during voting or deliberations.
Thus, in contrast to the NYSE, NASDAQ would
allow determination of CEO compensation to be made by the board [which may
include insiders except, for this purpose, the CEO] or, on the other hand, by
the compensation committee or by a majority of independent directors.
Unlike the NYSE, as noted above, the NASDAQ
explicitly excludes the CEO from being present during voting or deliberations
on his or her pay, whether by the compensation committee, by a majority of
independent directors or by the board.
2. Setting Non-CEO Pay
a. NYSE Proposal. This proposal gives the
compensation committee "direct responsibility" to "make
recommendations to the board with respect to non-CEO compensation, incentive-compensation
plans and equity-based plans." NYSE Proposed Rule 303A[5][b][i][B]. The implication is that the board, not the
compensation committee, must make the final determination on non-CEO pay. In
its Commentary to Proposed Rule 303A[5], the NYSE
states that "the compensation committee is not precluded from approving
awards [with or without ratification of the board] as may be required to comply
with applicable tax laws [i.e., Rule 162[m]]."
b. NASDAQ Proposal. The NASDAQ Proposal for
setting non-CEO pay is virtually identical to the NASDAQ Proposal for setting
CEO pay [except that there is no exclusion of the CEO from deliberations.]
NASDAQ Proposed Rule 4350[c][3][B]. In contrast to the
NYSE Proposal, the NASDAQ Proposal for non-CEO pay is limited to
"executive officers" [meaning, for this purpose, "executive
officer" as defined in Rule 16a-1[f] under the Securities Exchange Act of
1934 [the "Exchange Act"]].
Under the NASDAQ Proposal the full Board
[including the CEO and other insiders] can make final determinations on the pay
of other executive officers [based on recommendations by the compensation
committee or a majority of independent directors] or such determinations may be
made by the compensation committee itself or by a majority of the independent
directors.
Following, in Table 1, is a comparison of
NYSE and NASDAQ proposals regarding the role of different parties in setting
CEO and non-CEO compensation.
B. Definition of 'Independent' Directors
The NYSE and the NASDAQ proposals both
provide for an affirmative determination by the Board of a listed company as to
the directors designated as "independent." In the case of the NYSE
Proposal, if the director is not automatically disqualified under the specific
standards of "non-independence," the board of the listed company must
affirmatively determine that a director has no "material
relationship" with the company in order for that director to be deemed
independent. NYSE Proposed Rule 303A[2][a]. The commentary
to this NYSE Proposal notes that "[m]aterial
relationships can include commercial, industrial, banking, consulting, legal,
accounting, charitable and familial relationships, among others." In the
case of the NASDAQ Proposal, the board must make a determination that the
director does not have a relationship "which, in the opinion [of the
board] would interfere with the exercise of independent judgment in carrying
out the responsibilities of a director." NASDAQ Proposed Rule 4200[a][15].
Both NYSE and NASDAQ Proposals require that a
determination by the board that a director is independent within the meanings
noted above must be made in the proxy statement, or if a proxy statement is not
filed for the applicable period, then in the annual report as filed with the
SEC.6 Commentary to NYSE Proposed Rule 303A[2][a] and
NASDAQ Proposed Rule 4350[c][1].
In addition to the required findings by the
board as to the status of a director as "independent," the proposed
NYSE and NASDAQ rules provide specific circumstances in which a director cannot
be designated as "independent." These circumstances are as follows:
[a] Employment by
the listed company or any parent or subsidiary;
[b] Compensation [with exceptions noted in
the chart below] received from the listed company;
[c] Affiliation with the listed company's
auditor;
[d] Serving as executive officer of another
company under certain circumstances; and
[e] Affiliation with another company with
significant business dealings with the listed company.
More specific detail, including phase-in
rules, for the above-listed circumstances in which a director cannot be treated
as independent and the differences between the NYSE and NASDAQ proposed rules
in this regard are set forth in the chart at the end of the column.
C. Comments:
On Certain Relationships with a Listed
Company That Do Not Prevent a Director from Being Considered
"Independent."
There are certain relationships with a listed
company that do not prevent treatment of a director as "independent"
under the proposals. These include:
[a] In the case of
the NYSE Proposal, employment as an interim chairman or CEO once such
employment ceases. Commentary to NYSE Proposed Rule 303A[2][b][i].
[b] In the case of both NYSE and NASDAQ
proposals, receipt of a pension. NYSE Proposed Rule 303A[2][b][ii];
NASDAQ Proposed Rule 4200[a][15][B][iv].
[c] In the case of both NYSE and NASDAQ
proposals, ownership of stock, by itself. Commentary to NYSE Proposed Rule 303A[2][a]; Interpretative Material to NASDAQ Proposed Rule
4200[a][15].
In all events, a board of a listed company
subject to the new NYSE and NASDAQ rules will need to weigh carefully the
totality of relationships between the issuer and a director in making a
determination [not already precluded by a specific rule] that a director is
independent.7
D. Notification, Certification
Both the NYSE and NASDAQ would require their
listed companies [the CEO in the case of the NYSE] to provide them with
"prompt" notification after any executive officer becomes aware of
any material non-compliance with the new corporate governance standards. NYSE
Proposed Rule 303A[12][b] and NASDAQ Proposed Rule
4350[m]. In addition, the NYSE proposes that each listed company's CEO must
certify to the NYSE each year that he or she is not aware of any violation by
the company of NYSE corporate governance standards and such certification
[along with Sarbanes-Oxley CEO and CFO
certifications] must be disclosed in the company's annual report. NYSE Proposed
Rule 303A[12][a]. Please see Table 2.
FOOTNOTES:
[1] All references to NYSE Listed Company Manual Proposed Rule 303A are to the
proposed rules in the NYSE's Oct. 8, 2003 filing with the SEC [the NYSE
Proposal] and all references to NASDAQ Proposed Rules 4200 and 4350 are to the
proposed rules in the NASDAQ's Oct. 9, 2003 filing with the SEC [the
"NASDAQ Proposal"]. The NYSE and NASDAQ are proposing that the
required effective date for compliance with their new listing standard rules
would generally be the earlier of a listed company's first annual meeting after
Both the NYSE and NASDAQ propose delays in
applicability of the new rules in specific situations which are not discussed
in the column. Also, exceptions and exemptions from the rules are provided
[e.g., in the case of the NYSE Proposal, "foreign private issuers"
are provided certain exceptions and under both the NYSE and NASDAQ Proposals
"controlled companies" [those in which more than 50 percent of the
voting power is held by an individual, group or another company] are provided
certain exceptions.] These exceptions are not discussed in the column.
The American Stock Exchange submitted to the
SEC proposals to enhance the corporate governance requirements applicable to
its listed companies. These proposals are not discussed in the column.
[2] See NYSE Proposed Rule 303A[1];
NASDAQ Proposed Rule 4350[c][1].
[3] The NYSE proposed rule would allow a
committee "denominated" by some name other than the compensation
committee to make the determinations described in the text, provided it is
comprised solely of independent directors and has a published charter
[presumably containing the provisions required as to a compensation committee].
[4] The commentary to the NYSE proposal also
states "[n]othing in this provision should be
construed as precluding discussion of CEO compensation with the board
generally, as it is not the intent of this standard to impair communication
among members of the board." Commentary to NYSE Proposed Rule 303A[5].
[5] Under the NASDAQ Proposal, if the
compensation committee consists of at least three members, a nonindependent director [so long as he is not a current
officer or employee and does not have a family member who is a current officer
or employee of the company] may serve on the compensation committee for no more
than two years if the board determines it is in the best interests of the
company and shareholders. This arrangement and the reasons for it must be
disclosed in the company's proxy statement for its next annual meeting
subsequent to such determination. NASDAQ Proposed Rule 4350[c][3][C].
[6] To assist in making this determination,
the board can adopt and disclose categorical standards and make a general
disclosure if a director meets these standards. See Commentary to NYSE Proposed
Rule 303A[2][a].
[7] The NYSE urges boards to "consider
all relevant facts and circumstances" and to "consider the issue not
merely from the standpoint of the director, but also from that of persons or
organizations with which the director has an affiliation." Commentary to
NYSE Proposed Rule 303A[2][a].
[8] The NYSE Proposal defines "immediate
family member" to mean a person's spouse, parents, children, siblings,
in-laws [parents, children and siblings], and anyone else [other than domestic
employees] who shares such person's home. General Commentary to NYSE Proposed
Rule 303A[2][b]. The NASDAQ Proposal defines family
members to mean a person's spouse, parents, children and siblings, including
in-laws, or anyone residing in such person's home. NASDAQ Proposed Rule 4200[a][14].
[9] Unlike the corresponding NYSE threshold
test [which refers to more than $100,000 in "direct compensation"],
the latest NASDAQ proposal deletes a reference to "compensation" and
adopts instead the broader term of "payments." NASDAQ's
Interpretative Material notes that the use of the broader term
"payments" is intended to capture payment under arrangements such as
consulting or personal service contracts and political contributions.
[10] According to the NYSE's commentary, even
though charitable organizations are not "companies" for purposes of
this test, proxy disclosure is required if the listed company makes
contributions to any charity in which a director serves as an executive officer
if, within the prior three years, contributions in any single fiscal year
exceeded the greater of $1 million or 2 percent of such charity's consolidated
gross revenues. And, the commentary goes on to observe, in affirmatively
determining director "independence," boards are required to consider
the materiality of a director's relationship with any such charity in
determining whether that director has any material relationship with the listed
company. Commentary to NYSE Proposed Rule 303A[2][b][v].
Under the NASDAQ Proposal payments to a charitable organization would be
subject to the payment limit of Proposed Rule 4200[a][15][D].
See Interpretative Material to NASDAQ Proposed Rule 4200[a][15][D].