• SEC Approves the AMEX Corporate Governance Rules
  • February 8, 2004
  • Law Firm: Blank Rome LLP - Philadelphia Office
  • On December 1, 2003, the Securities and Exchange Commission (the "SEC") approved amendments to the corporate governance rules (the "New AMEX Rules") proposed by the American Stock Exchange LLC ("AMEX"). These rules were adopted in response to the requirements of the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley") and the related rules promulgated by the SEC.

    The New AMEX Rules apply to all companies listed on AMEX. There are exceptions to the New AMEX Rules applicable to certain entities, such as foreign private issuers, limited partnerships and companies to be listed in conjunction with an initial public offering or a transfer from other markets, which are not addressed in this Alert.

    I. Summary

    The New AMEX Rules require, among other things, that:

    • companies have a majority of independent directors; directors of companies be subject to more stringent standards for qualifying as an "independent" director;
    • the board of directors and the audit committee each meet on at least a quarterly basis, and the independent directors on the board of directors meet on a regular basis;
    • the compensation of executive officers, including the chief executive officer (the "CEO"), of companies be determined, or recommended to the board of directors for determination, either by a compensation committee comprised solely of independent directors or by a majority of the independent directors on the board of directors;
    • director nominees of companies be selected, or recommended to the board of directors for selection, either by a nominating committee comprised solely of independent directors or by a majority of the independent directors on the board of directors;
    • companies adopt a charter or board of directors resolution addressing the director nominations process;
    • all related party transactions must be subject to appropriate review and oversight by the audit committee or a comparable body of the board of directors;
    • more stringent standards of independence apply to audit committee members;
    • the audit committee be given significantly increased authority and responsibilities;
    • companies adopt and publicly disclose a code of conduct and ethics;
    • companies provide prompt notification to AMEX upon any material non-compliance with the New AMEX Rules;
    • companies comply with other governance changes, including limits on staggered boards, prohibition on the appointment of AMEX employees as directors, public announcement of changes in board of directors composition and encouraged continuing education and training for directors;
    • companies publish and furnish to security holders an annual report containing audited financial statements prepared in conformity with SEC rules, and disclosure of the number of unoptioned shares available to be granted under option plans and any changes in the exercise price of outstanding options; and
    • public disclosure by companies of the receipt of a "going concern" qualification from their independent auditors.

    II. Director Independence

    The New AMEX Rules require that a majority of the directors of a company1 be "independent directors." AMEX defines an "independent director" as a person other than an officer or employee of the company. No director qualifies as independent unless the board of directors of the company affirmatively determines that the director does not have a material relationship with the company that would interfere with the exercise of independent judgment.

    The New AMEX Rules provide that the following persons will not be considered independent:

    • A director who is, or during the past three years was, employed by the company, other than prior employment as interim chairman or interim CEO;
    • A director who accepts, or has an immediate family member2 who accepts, any payments from the company in excess of $60,000 during the current or any of the past three fiscal years, other than compensation for service on the board of directors, payments arising solely from investments in the company's securities, compensation paid to an immediate family member who is a non-executive employee of the company, compensation received for former service as an interim chairman or interim CEO, benefits under a tax-qualified retirement plan, non-discretionary compensation or loans permitted under Section 13(k) of the Securities Exchange Act of 1934, as amended (the "Exchange Act");
    • A director who is an immediate family member of an individual who is, or has been in any of the past three years, employed by the company as an "executive officer" (as defined in Rule 3b-7 under the Exchange Act);
    • A director who is, or has an immediate family member who is, a partner in, or a controlling shareholder or an executive officer of, any organization to which the company made, or from which the company received, payments (other than those arising solely from investments in the company's securities or payments under non-discretionary charitable contribution programs) that exceed 5% of the organization's consolidated gross revenues for that year, or $200,000, whichever is more, in any of the most recent three fiscal years;
    • A director who is, or has an immediate family member who is, employed as an executive officer of another entity where at any time during the most recent three years any of the company's executive officers served on that entity's compensation committee; and
    • A director who is, or has an immediate family member who is, a current partner of the company's independent auditor, or was a partner or employee of the company's independent auditor who worked on the company's audit at any time during any of the past three years.

    With respect to independent directors who are not members of the audit committee, the "look-back" period will be limited to one year until December 1, 2004. With respect to independent directors who are members of the audit committee, the "look-back" period will be limited to one year until December 1, 2004 for the provisions relating to acceptance of payments from the company, compensation committee interlocks and relationships with the company's independent auditor. The full three-year "look-back" periods will begin to apply on December 1, 2004. If a company chooses to apply only a one-year "look-back" period, it may be required to make changes to its board of directors composition on December 1, 2004. As described below, members of the audit committee will also be required to satisfy several additional independence criteria.

    III. Annual Proxy Statement Disclosure

    As described below in the sections of this Alert titled "Compensation and Compensation Committee Requirements," "Nomination of Directors and Nominating Committee Requirements" and "Audit Committee Requirements," the board of directors may appoint a non-independent director to serve on any of the compensation, nominating or audit committees, provided the board of directors under "exceptional and limited circumstances" determines that membership on the particular committee is required by the best interests of the company and its shareholders (subject also to other requirements as more fully described in this Alert). In this event, the company must disclose in its next annual meeting proxy statement (or in its next annual report on Form 10-K or equivalent, if the company does not file an annual proxy statement) following this determination, the nature of the relationship and the reason for such determination.

    IV. Meetings of Directors

    The board of directors must meet on at least a quarterly basis. The audit committee must also meet on at least a quarterly basis. The independent directors on the board of directors must meet on a regular basis as often as necessary to fulfill their responsibilities, including at least annually in executive session without the presence of non-independent directors and management.

    V. Compensation and Compensation Committee Requirements

    Compensation of the CEO and all other officers must be determined, or recommended to the board of directors for determination, either by a compensation committee comprised solely of independent directors or by a majority of the independent directors on the board of directors. The CEO may not be present during voting or deliberations relating to his or her compensation.

    If a company's compensation committee is comprised of at least three members, the board of directors under "exceptional and limited circumstances" may appoint to the compensation committee one director who is not independent, provided that the director is not a current officer or employee of the company or an immediate family member of a current officer or employee of the company and the board of directors determines that membership on the compensation committee is required by the best interests of the company and its shareholders. The board of directors must disclose in the company's next annual meeting proxy statement (or in its next annual report on Form 10-K or equivalent, if the company does not file an annual proxy statement) following this determination, the nature of the relationship and the reasons for that determination. A member appointed pursuant to this exception may not serve for in excess of two years.

    VI. Nomination of Directors and Nominating Committee Requirements

    Director nominations must either be selected, or recommended for the board of directors' selection, either by a nominating committee comprised solely of independent directors or by a majority of independent directors.3 Each company must adopt a formal written charter or board of directors resolution, as applicable, addressing the nominations process and all related matters as may be required under federal securities laws; the SEC's recently proposed rules for additional disclosure regarding the nominating process will be applicable to this charter and board of directors resolutions.

    If a company's nominating committee is comprised of at least three members, the board of directors under "exceptional and limited circumstances" may appoint to the nominating committee one director who is not independent, provided that the director is not a current officer or employee of the company or an immediate family member of a current officer or employee of the company and the board of directors determines that membership on the nominating committee is required by the best interests of the company and its shareholders. The board of directors must disclose in the company's next annual meeting proxy statement (or in its next annual report on Form 10-K or equivalent, if the company does not file an annual proxy statement) following this determination, the nature of the relationship and the reasons for such determination. A member appointed pursuant to this exception may not serve longer than two years.

    VII. Audit Committee Requirements

    A company must have, and must certify that it has and will continue to have, an audit committee comprised of at least three members. Each member of the audit committee must meet the requirements of an independent director outlined above and meet the independence criteria set forth in Exchange Act Rule 10A-3 (subject to the applicable exceptions), which provide that an audit committee member cannot accept, directly or indirectly, any consulting, advisory or other compensatory fee from the company other than fees for service on the board of directors and committees of the board of directors, or be an "affiliated person" (as defined in Exchange Act Rule 10A-3) of the company (except as a director of an affiliate of the company if the director is otherwise independent).

    In addition, the company must have, and certify that it has and will continue to have, an audit committee comprised of directors who are each able to read and understand fundamental financial statements, including the company's balance sheet, income statement and cash flow statement. The company must also certify that it has and will continue to have at least one member of the audit committee who is financially sophisticated, in that he or she has past employment experience in finance or accounting, requisite professional certification in accounting, or any other comparable experience or background which results in the individual's financial sophistication, including being or having been a CEO, chief financial officer or other senior officer with financial oversight responsibilities.4

    Notwithstanding the requirement that each member meet the independent director criteria applicable to directors generally under the New AMEX Rules, the board of directors may appoint to the audit committee one director who is not independent under the New AMEX Rules criteria, but is independent under Exchange Act Rule 10A-3, if the board of directors under "exceptional and limited circumstances" determines that membership on the committee is required by the best interests of the company and its shareholders and the director is not a current officer or employee or a family member of a current officer or employee. The board of directors must disclose in the company's next annual meeting proxy statement (or in its next annual report on Form 10-K or equivalent, if the company does not file a proxy statement) following this determination, the nature of the relationship and the reasons for that determination. A member appointed pursuant to this exception may not serve for in excess of two consecutive years and may not chair the audit committee.

    If a member of the company's audit committee ceases to be independent under the New AMEX Rules and Exchange Act Rule 10A-3 for reasons outside of the member's reasonable control, that person, with prompt notice to AMEX, may remain an audit committee member until the earlier of the company's next annual shareholders meeting or one year from the occurrence of the event that caused the member to be no longer independent.

    VIII. Audit Committee Charter Requirements

    The company must certify that it has adopted a formal written audit committee charter and that the audit committee has reviewed and assessed the adequacy of the charter on an annual basis. The audit committee charter must specify the scope of the audit committee's responsibilities (which must include all responsibilities specified under Exchange Act Rule 10A-3 as set forth below) and how the audit committee carries out those responsibilities, including structure, processes and membership requirements. The charter must also specify the audit committee's responsibility for ensuring its receipt from the independent auditors of a formal written statement delineating all relationships between the auditor and the company (consistent with Independence Standards Board Standard 1), actively engaging in a dialogue with the auditor with respect to any disclosed relationships or services that may impact the objectivity and independence of the auditor and taking, or recommending that the full board of directors take, appropriate action to oversee the independence of the independent auditor.

    The audit committee's charter must also specify the audit committee's purpose of overseeing the accounting and financial reporting processes of the company and the audits of the financial statements of the company, and must also include the specific audit committee responsibilities and authority mandated by Exchange Act Rule 10A-3, which implements the audit committee minimum standards set forth in Section 301 of Sarbanes-Oxley. Exchange Act Rule 10A-3 prohibits AMEX from listing any security of a company that does not have an audit committee comprised of independent directors and that is not in compliance with the following standards:

    • The audit committee must be directly responsible for the appointment, compensation, retention and oversight of the work of any independent auditor (including resolution of disagreements between management and the auditor regarding financial reporting) engaged for the purpose of preparing or issuing an audit report or performing other audit, review or attest services for the company, and the independent auditor must report directly to the audit committee;
    • The audit committee must establish procedures for the receipt, retention and treatment of complaints received by the company regarding accounting, internal accounting controls or auditing matters, including procedures for the confidential, anonymous submission by employees of concerns regarding questionable accounting or auditing matters;
    • The audit committee must have the authority to engage independent counsel and other advisors, as it determines necessary to carry out its duties; and
    • The company must provide appropriate funding, as determined by the audit committee, for payment of:

      • compensation to any independent auditor engaged for the purpose of preparing or issuing an audit report or performing other audit, review or attest services for the company,
      • compensation to any advisors employed by the audit committee, and
      • ordinary administrative expenses of the audit committee.

    IX. Code of Conduct and Ethics

    The company must adopt a code of conduct and ethics applicable to all directors, officers and employees, which must be publicly available and must comply with the "code of ethics" definition set forth in Section 406(c) of Sarbanes-Oxley, which includes such standards as are reasonably necessary to promote honest and ethical conduct, including the ethical handling of conflicts of interest, full and fair disclosure and compliance with laws, rules and regulations. Under the New AMEX Rules and Item 406 of Regulation S-K, the code of conduct and ethics must also provide for prompt internal reporting of violations of the code of conduct and ethics to an appropriate person or persons identified in the code of conduct and ethics and accountability for adherence to the code of conduct and ethics.

    Any waivers of the code of conduct and ethics for directors or executive officers must be approved by the board of directors and disclosed in a current report on Form 8-K within five days.

    X. Related Party Transactions

    Related party transactions must be subject to appropriate review and oversight by the company's audit committee or a comparable body of the board of directors.

    XI. Notification of Non-Compliance

    The company must promptly notify AMEX after an executive officer becomes aware of any material non-compliance by the company with the applicable corporate governance requirements of the New AMEX Rules.

    XII. Other Governance Changes

    Companies must also comply with the following additional governance requirements:

    • The board of directors may not be divided into more than three classes. All classes should be of approximately equal size and tenure and directors' terms of office should not exceed three years.5
    • AMEX employees and floor members are not permitted to serve on a company's board of directors.
    • Companies must provide a prompt announcement to the public of any changes in or vacancies on the board of directors.
    • Companies are urged to develop and implement continuing education programs for all directors, including orientation and training programs for new directors.

    XIII. Publication of Annual Report

    A company is required to publish and furnish to its shareholders (or to holders of any other listed security when its common stock is not listed on a national securities exchange) an annual report containing audited financial statements prepared in conformity with the requirements of the SEC.

    The company must disclose in its annual report to security holders, for the year covered by the report: the number of unoptioned shares available at the beginning and at the close of the year for the granting of options under an option plan; and any changes in the exercise price of outstanding options, through cancellation and reissuance or otherwise, except price changes resulting from the normal operation of anti-dilution provisions of the options. Three copies of the report must be filed with AMEX.

    XIV. Going Concern Qualifications

    The New AMEX Rules require that a company that receives an audit opinion from its independent auditor with a going concern qualification make a public announcement through the news media disclosing the receipt of the qualified opinion. Prior to the release of the public announcement, the company must provide the announcement to AMEX's StockWatch and Listing Qualifications Departments. The public announcement must be made as promptly as possible, but not more than seven calendar days after the filing of the audit opinion in a public filing with the SEC.

    XV. Effective Dates/Transition Periods

    Companies (other than small business issuers (as defined in Exchange Act Rule 12b-2)) have until the earlier of October 31, 2004, or their first annual shareholders meeting after March 15, 2004, to comply with the New AMEX Rules regarding director independence, boards of directors, executive compensation, director nominations and audit committees (other than audit committee reforms mandated by Exchange Act Rule 10A-3). Small business issuers will have until July 31, 2005 to comply with these rules.

    The New AMEX Rules relating to codes of conduct and ethics become effective on June 1, 2004. The provisions relating to public announcements, going concern qualifications, review of related party transactions and publication of annual report are effective as of December 31, 2003.

    In the case of a company with a staggered board of directors, if timely compliance would require a change in a director who would normally not stand for election at the first annual meeting after March 15, 2004, the New AMEX Rules provide that the director may continue in office until the second annual meeting after March 15, 2004, but no later than December 31, 2005.

    XVI. Exceptions

    Exceptions to these requirements exist for foreign private issuers, limited partnerships, companies to be listed in conjunction with an initial public offering or a transfer from other markets, companies in bankruptcy, asset-backed issuers and other passive business organizations (such as royalty trusts), issuers of derivatives and special purpose securities and management investment companies registered under the Investment Company Act of 1940 (including closed-end and open-end funds) that are not addressed in this Alert. The New AMEX Rules also include special provisions for "controlled companies," small business issuers and companies listing only preferred or debt securities on AMEX (including cooperative entities that are structured to comply with relevant state law and federal tax law and do not have a publicly traded class of common stock), which are summarized below.

    A "controlled company" is a company in which more than 50% of the voting power is held by an individual, a group or another company. A controlled company is not required to comply with the requirement that a majority of the board of directors be independent and the provisions relating to director nominations and executive compensation. A controlled company electing to take advantage of any or all of these exemptions must disclose in its annual meeting proxy statement (or in its annual report on Form 10-K or equivalent, if it does not file an annual proxy statement) its election and how it qualifies as a controlled company.

    Small business issuers (as defined in Exchange Act Rule 12b-2) must comply with the New AMEX Rules, except they are only required to maintain a board of directors comprised of at least 50% independent directors and an audit committee of at least two directors. Companies listing only preferred or debt securities on AMEX are required to comply with the independence standards relating to the board of directors and audit committee requirements to the extent required by Exchange Act Rule 10A-3, which is discussed above.

    1References to a "company" include any parent, subsidiary or other entity that is consolidated with the company's financial statements.
    2An "immediate family member" includes a person's spouse, parents, children, siblings, mother-in-law, father-in-law, brother-in-law, sister-in-law, son-in-law, daughter-in-law and anyone who resides in such person's home (other than domestic employees).
    3Where the company is legally required by contract or otherwise to provide third parties with the ability to nominate and/or appoint directors, the selection and nomination of such directors is not subject to approval by the nominating committee or by a majority of the independent directors. The new requirements relating to director nominations and nominating committees will not apply in cases where the company is already subject to a binding obligation that requires a director nomination structure inconsistent with the rule.
    4Although AMEX does not require an audit committee to have a member who qualifies as an "audit committee financial expert," a person qualifying as such (as defined in Item 401(h) of Regulation S-K) is presumed to qualify as financially sophisticated.
    5This provision is not intended to restrict the number of terms of office that a director may serve, whether consecutive or otherwise.