On June 30, 2003, the Securities and Exchange Commission approved changes to listing standards for companies selling stock on the New York Stock Exchange and the Nasdaq Stock Market. The NYSE's new listing standards and the Nasdaq's rule amendments expand the requirement for shareholder approval of equity compensation plans in an effort to restore investor confidence and improve corporate governance practices of companies traded on the U.S. markets. The NYSE standards replace a pilot program, which was also followed by Nasdaq, that allowed companies to avoid a shareholder vote when equity compensation programs were "broadly-based."
Equity Compensation Plans
In general, the new rules require shareholder approval of all equity compensation plans and material revisions to such plans, subject to limited exemptions. Not included in the definition of "equity compensation plans" are plans or arrangements under which employees receive only cash, plans and arrangements that merely allow employees, directors or service providers to buy shares for their current market value, and plans that are made available to shareholders generally, such as dividend reinvestment plans.
Exemptions
As expected, the new rules provide exemptions from the shareholder approval requirement for the following equity plans/arrangements: (a) employment inducement awards, (b) certain grants, plans and amendments in the context of mergers and acquisitions, (c) plans intended to qualify under Section 401(a) or 423 of the Internal Revenue Code, and (d) "parallel excess plans" (or, "parallel nonqualified plans," as they are called by the Nasdaq rules). Any plan or arrangement eligible for an exemption must be approved by a company's independent compensation committee or a majority of all of the company's independent directors.
Material Revisions
As stated above, any material revision to an equity compensation plan will require shareholder approval. It is clear that an increase in the number of shares available under a plan (other than as a result of a reorganization, stock split, merger or similar transaction) will be considered a material revision. Other material revisions include: an expansion of the types of awards available under the plan, a material expansion of the class of employees, directors or other service providers eligible to participate in the plan, a material extension in the term of the plan, a material change to the method of determining the strike price of options under the plan, and the deletion or limitation of any provision prohibiting repricing of options. Both the NYSE and Nasdaq have stated that this is not an exhaustive list of material revisions. However, there will continue to be uncertainty about what constitutes a material amendment as different situations and scenarios arise. Although past experience in requesting interpretive advice from the NYSE about the materiality of an amendment has shown that the NYSE is responsive in providing guidance, it remains to be seen how uniform the NYSE and Nasdaq interpretations will be.
Evergreen plans (i.e., plans providing for automatic increases in the shares available) and plans providing for automatic grants pursuant to a formula are termed "formula plans" under the NYSE listing standards. Each increase in the number of shares available under an evergreen plan and each grant pursuant to an automatic formula are considered material revisions that are subject to shareholder approval unless the plan has a term of not more than ten years. If a company has a shareholder-approved formula plan in place on the date the NYSE listing standards go into effect, but the plan does not have a term of ten years or less, it can continue to be used if it is amended to have a term of ten years or less from the later of the date of its original adoption and the date of the most recent shareholder approval.
The NYSE listing standards also introduced the concept of "discretionary plans." These are plans that contain no limit on the number of shares available and that are not so-called "formula plans." Under the new listing standards, additional grants under discretionary plans, whether or not previously approved by shareholders, may be made without further shareholder approval only during the limited transition period described below, and then only in a manner consistent with past practice.
Transition Rules
Generally, plans adopted prior to the June 30, 2003 effective date of these new rules are "grandfathered" and are not subject to shareholder approval unless and until any "material revisions" are made to such plans. However, special NYSE transition rules apply to formula plans and discretionary plans. These transition rules provide that all pre-existing plans may continue to be used until the first to occur of: (a) the company's next annual meeting at which directors are elected that occurs more than 180 days after the effective date of the listing standard (i.e., after December 27, 2003); (b) the first anniversary of the effective date of the listing standard (i.e., June 30, 2004); and (c) the expiration of the plan.
Despite the fact that the new rules are now effective, there is some indication that additional rules on the topic may be forthcoming. For example, Nasdaq has indicated that it plans to consider further changes to provide greater transparency to investors, including a possible disclosure requirement if a company relies on an exemption from the shareholder approval requirements.
Proxy Disclosure
Companies should note that plans that do not require shareholder approval under the NYSE or Nasdaq rules may, nonetheless, need to be disclosed as non-shareholder approved in the company's equity compensation table, which is now required in the annual proxy statement or Form 10-K.
Broker Voting
The final NYSE listing standards also preclude brokers from giving a proxy to vote on equity compensation plans unless the beneficial owner of the shares has given voting instructions to the broker. This prohibition will be effective for any meeting of shareholders that occurs on or after the 90th day following the date of the SEC's order approving the rule change (i.e., September 28, 2003).
Differences Between the NYSE Listing Standards and the Nasdaq Rules
Unfortunately, the SEC's goal of complete uniformity between the NYSE and Nasdaq rules was not achieved. Although the substance of many of the provisions is similar, the rules are still different. Because there are also some substantive differences between the two rules, in the future it will be necessary to read and interpret the correct rule for your company. Further, the NYSE and Nasdaq may ultimately administer the rules differently, resulting in different interpretations for NYSE and Nasdaq companies.
What Has Changed?
The new rules on shareholder approval of equity plans will necessarily cause a change in the way companies handle the adoption and amendment of equity plans. Since 1996, when the SEC abdicated its role as the arbiter of shareholder approval of equity plans under Rule 16b-3, companies have been increasingly able to adopt plans without consulting shareholders, making it easier to compensate employees and directors with equity. The new rules, however, will cause a shift back to closer scrutiny when adopting and amending equity plans. Other notable changes that will occur as a result of the new rules are:
What Has Stayed the Same?
Equity Compensation Plans
In general, the new rules require shareholder approval of all equity compensation plans and material revisions to such plans, subject to limited exemptions. Not included in the definition of "equity compensation plans" are plans or arrangements under which employees receive only cash, plans and arrangements that merely allow employees, directors or service providers to buy shares for their current market value, and plans that are made available to shareholders generally, such as dividend reinvestment plans.
Exemptions
As expected, the new rules provide exemptions from the shareholder approval requirement for the following equity plans/arrangements: (a) employment inducement awards, (b) certain grants, plans and amendments in the context of mergers and acquisitions, (c) plans intended to qualify under Section 401(a) or 423 of the Internal Revenue Code, and (d) "parallel excess plans" (or, "parallel nonqualified plans," as they are called by the Nasdaq rules). Any plan or arrangement eligible for an exemption must be approved by a company's independent compensation committee or a majority of all of the company's independent directors.
Material Revisions
As stated above, any material revision to an equity compensation plan will require shareholder approval. It is clear that an increase in the number of shares available under a plan (other than as a result of a reorganization, stock split, merger or similar transaction) will be considered a material revision. Other material revisions include: an expansion of the types of awards available under the plan, a material expansion of the class of employees, directors or other service providers eligible to participate in the plan, a material extension in the term of the plan, a material change to the method of determining the strike price of options under the plan, and the deletion or limitation of any provision prohibiting repricing of options. Both the NYSE and Nasdaq have stated that this is not an exhaustive list of material revisions. However, there will continue to be uncertainty about what constitutes a material amendment as different situations and scenarios arise. Although past experience in requesting interpretive advice from the NYSE about the materiality of an amendment has shown that the NYSE is responsive in providing guidance, it remains to be seen how uniform the NYSE and Nasdaq interpretations will be.
Evergreen plans (i.e., plans providing for automatic increases in the shares available) and plans providing for automatic grants pursuant to a formula are termed "formula plans" under the NYSE listing standards. Each increase in the number of shares available under an evergreen plan and each grant pursuant to an automatic formula are considered material revisions that are subject to shareholder approval unless the plan has a term of not more than ten years. If a company has a shareholder-approved formula plan in place on the date the NYSE listing standards go into effect, but the plan does not have a term of ten years or less, it can continue to be used if it is amended to have a term of ten years or less from the later of the date of its original adoption and the date of the most recent shareholder approval.
The NYSE listing standards also introduced the concept of "discretionary plans." These are plans that contain no limit on the number of shares available and that are not so-called "formula plans." Under the new listing standards, additional grants under discretionary plans, whether or not previously approved by shareholders, may be made without further shareholder approval only during the limited transition period described below, and then only in a manner consistent with past practice.
Transition Rules
Generally, plans adopted prior to the June 30, 2003 effective date of these new rules are "grandfathered" and are not subject to shareholder approval unless and until any "material revisions" are made to such plans. However, special NYSE transition rules apply to formula plans and discretionary plans. These transition rules provide that all pre-existing plans may continue to be used until the first to occur of: (a) the company's next annual meeting at which directors are elected that occurs more than 180 days after the effective date of the listing standard (i.e., after December 27, 2003); (b) the first anniversary of the effective date of the listing standard (i.e., June 30, 2004); and (c) the expiration of the plan.
Despite the fact that the new rules are now effective, there is some indication that additional rules on the topic may be forthcoming. For example, Nasdaq has indicated that it plans to consider further changes to provide greater transparency to investors, including a possible disclosure requirement if a company relies on an exemption from the shareholder approval requirements.
Proxy Disclosure
Companies should note that plans that do not require shareholder approval under the NYSE or Nasdaq rules may, nonetheless, need to be disclosed as non-shareholder approved in the company's equity compensation table, which is now required in the annual proxy statement or Form 10-K.
Broker Voting
The final NYSE listing standards also preclude brokers from giving a proxy to vote on equity compensation plans unless the beneficial owner of the shares has given voting instructions to the broker. This prohibition will be effective for any meeting of shareholders that occurs on or after the 90th day following the date of the SEC's order approving the rule change (i.e., September 28, 2003).
Differences Between the NYSE Listing Standards and the Nasdaq Rules
Unfortunately, the SEC's goal of complete uniformity between the NYSE and Nasdaq rules was not achieved. Although the substance of many of the provisions is similar, the rules are still different. Because there are also some substantive differences between the two rules, in the future it will be necessary to read and interpret the correct rule for your company. Further, the NYSE and Nasdaq may ultimately administer the rules differently, resulting in different interpretations for NYSE and Nasdaq companies.
What Has Changed?
The new rules on shareholder approval of equity plans will necessarily cause a change in the way companies handle the adoption and amendment of equity plans. Since 1996, when the SEC abdicated its role as the arbiter of shareholder approval of equity plans under Rule 16b-3, companies have been increasingly able to adopt plans without consulting shareholders, making it easier to compensate employees and directors with equity. The new rules, however, will cause a shift back to closer scrutiny when adopting and amending equity plans. Other notable changes that will occur as a result of the new rules are:
- The treasury share loophole has been closed. The NYSE has indicated that any new equity compensation plan adopted following the effective date of the new listing standards, whether it provides for the delivery of newly issued or treasury shares, will require shareholder approval. Existing treasury share plans that contain a limit on the number of shares available will be grandfathered. If, however, an existing treasury share plan does not contain a limit on the number of shares available, it can be used only during the transition period described above.
- The Nasdaq 1% de minimus exception has been eliminated. Even if a plan or arrangement provides for the issuance of less than 1% of the company's common stock, it will still require shareholder approval under the new Nasdaq rules.
- All-employee option plans now require shareholder approval. This feature of the new rules demonstrates that shareholder approval is not merely a means of addressing conflicts of interest among executives and directors, but a means of enhancing shareholder control over dilution.
- There is now a special category for parallel excess plans. Any such plan that fails to meet the tests required for exemption will need shareholder approval. In addition, it is worth noting that some plans that qualify under the exchanges' standards may not be treated as "excess plans" under Rule 16b-3 of the Securities Exchange Act of 1934. As a result, the issuance of equity pursuant to some parallel excess plans that are exempt from shareholder approval may still be required to be reported on a two-day basis under Section 16.
- Equity issued in connection with a merger or acquisition is addressed by a specific rule. The prior NYSE and Nasdaq rules regarding shareholder approval of equity plans did not specifically address equity issued in the context of corporate acquisitions and mergers. The new rules, however, specifically provide that shareholder approval will not be required to convert or adjust outstanding options or other awards to reflect the transaction.
- Option repricings are now specifically addressed in the rules. The NYSE and Nasdaq, however, treat repricings differently. The NYSE listing standards provide that if a plan does not contain a provision that specifically permits repricing of options, it will be considered to prohibit repricing. Thus, any subsequent repricing is a material amendment to the plan, which will in turn require shareholder approval. The Nasdaq rules do not clearly address whether a proposed repricing will require shareholder approval if a plan is silent on whether or not repricings are permitted. Under the Nasdaq rules, an amendment to an existing plan to permit repricing will be considered a material amendment requiring shareholder approval.
- NYSE listed companies must now notify the Exchange in writing when an exemption is relied upon in not obtaining shareholder approval. Nasdaq has indicated that it will make further changes to its rules, which will require companies to notify Nasdaq prior to establishing or amending an equity compensation arrangement without shareholder approval. Nasdaq has also indicated that it may require public disclosure of reliance on an exemption from the shareholder approval requirement.
- Plans or arrangements under which employees receive only cash (even if the amount of the cash payment is based on the value of common stock) are still not subject to shareholder approval. Thus, awards of cash-settled phantom stock would not require shareholder approval.
- Most deferred compensation plans and arrangements can continue to operate without shareholder approval. However, as described above, deferral plans that are parallel excess plans and that provide for an employer equity contribution in excess of 25% of the participant's cash compensation will not be exempt from the shareholder approval requirement. Note that the percentage limit relates to the cash compensation of participants, not to the matching percentage under the plan.
- Plans that are intended to qualify under certain provisions of the Internal Revenue Code (e.g., 401(k) plans and Section 423 plans) continue to be exempt from the shareholder approval requirements.
- Plans and arrangements that allow employees, directors or service providers to buy shares for their current market value and plans that are made available to shareholders generally (dividend reinvestment plans) also remain exempt from the shareholder approval requirements.