Nasdaq and the New York Stock Exchange Revise Shareholder Approval Requirements for Equity Compensation Plans

On June 30, 2003, the Securities and Exchange Commission (the "SEC") approved changes to the listing requirements of Nasdaq and the New York Stock Exchange (the "SROs") requiring shareholder approval of most equity compensation plans. [fn1] The SEC's approval was the culmination of a protracted year-long effort by the SROs and the SEC to reconcile differences between the SROs' proposals so that both final versions are substantially consistent with one another. As a result, as of June 30, 2003, all equity compensation plans of SRO listed companies ("Companies") (with certain grandfathering exceptions described below) and any material revisions or amendments to plans in existence before or after that date must be approved by the Companies' shareholders. Additionally, the SEC has approved the NYSE's rules to preclude broker-dealers from voting proxies on equity compensation plans unless the beneficial owner of the shares has given voting instructions.

Types of Equity Compensation Plans Affected

The range of equity compensation plans subject to shareholder approval was dramatically expanded by the changes to the SROs' rules. No longer will all "broadly-based plans" (plans where the participation of directors and officers was limited) be exempt from the shareholder approval requirement. In addition, Nasdaq has eliminated the de minimis exception which allowed for grants of the lesser of 1% or 25,000 shares of a Company's common stock without seeking shareholder approval. However, Nasdaq has retained the exception for warrants or rights offered generally to all shareholders.

Generally, any plan or arrangement that provides for grants or awards of the Company's equity to its employees, directors, officers or other service providers as compensation requires shareholder approval. The following examples are types of plans or arrangements that must be approved by a Company's shareholders before awards or grants can be made:

• equity compensation plans pursuant to which stock may be acquired by directors, officers, employees or consultants;
• use of repurchased shares to fund existing plans;
• one-time stock option grants to directors, officers, employees or consultants;
• de minimis grants or awards of equity compensation; and
• warrants with below market exercise prices issued to directors, officers, employees or consultants in connection with a private financing.

Equity Arrangements Exempted from the Shareholder Approval Requirements

The following arrangements are exempted from the shareholder approval requirements under the SROs' rules:

• Tax qualified, non-discriminatory employee benefit plans (e.g., ESOPs);
• Parallel nonqualified or excess plans that fall within the meaning of "pension plan" as defined in the Employee Retirement Income Security Act; [fn2]
• Employee stock purchase plans under Section 423 of the Internal Revenue Code (the "IRC") (these types of plans already are generally required to receive shareholder approval under Section 423 of the IRC, but now when shareholder approval is not required under the IRC, no shareholder approval will be required by the SROs);
• Dividend reinvestment plans;
• Inducement grants or awards to new employees or to previous employees being rehired after a bona fide period of interruption of employment, and to new employees in connection with a merger or acquisition;
• The conversion, replacement or adjustment of outstanding options or other equity compensation awards to reflect a merger or acquisition;
• Certain awards or grants (other than to individuals employed immediately prior to the transaction by the acquiring company) made after a transaction under pre-existing plans previously approved by the target company's shareholders acquired in acquisitions or mergers; [fn3]
• Non-material amendments or revisions to equity compensation plans; and
• Non-U.S. Companies may continue to apply to their respective SRO for specific exemptions from the shareholder approval requirements if they are inconsistent with the requirements of their home jurisdiction.

Amendments to Existing Plans

All "material" revisions (used by the NYSE) or amendments (used by Nasdaq) to existing equity-compensation plans must be approved by the Company's shareholders. The SROs have provided, in response to comments, similar definitions through a non-exhaustive list of what constitutes a material revision or amendment. They include:

• A material increase in the number of shares available under the plan (other than to reflect a reorganization, stock split, merger, spin-off or similar transaction) (also see discussion below regarding evergreen and formula provisions);
• An expansion of the types of awards available under the plan;
• A material expansion of the class of participants eligible to participate in the plan;
• A material extension of the term of the plan;
• A material change to the method of determining the strike price of options under the plan (under the NYSE rule); and
• Repricing of options and the deletion or limitation of any provision prohibiting repricing of options, permitting repricing or decreasing the exercise price of the options.

The final SRO rules do not provide any factors to consider when weighing the materiality of other revisions or amendments to existing plans. Nasdaq has informally indicated that it will continue to consider past SEC Section 16 no action letters in evaluating whether a revision or amendment to a plan is material. [fn4]

Evergreen Provisions, Formula Plans and Discretionary Plans

Under the final SRO rules, if a plan contains a provision for automatic increases in the shares available pursuant to a specified formula (often called an "evergreen plan") or for automatic grants pursuant to a specified formula ("formula plan"), each such increase or grant will be considered a "material revision" to the plan requiring shareholder approval unless the plan has a term of ten years or less. Examples of automatic grants pursuant to a formula include:

• annual grants to directors of restricted stock having a certain dollar value, and
• "matching contributions," whereby stock is credited to a participant's account based upon the amount of compensation the participant elects to defer.

Under the final SRO rules, if a plan contains no limit on the number of shares available and is not a formula plan (a "discretionary plan"), then each grant under the plan will require separate shareholder approval regardless of whether the plan was previously approved by shareholders or has a term of ten years or less. A requirement that grants be made out of treasury shares or repurchased shares will not, in itself, be considered a limit or pre-established formula so as to prevent a plan from being considered a discretionary plan requiring shareholder approval for additional grants. Therefore, the SROs have effectively ended the practice of awarding equity compensation under discretionary plans. The NYSE rule provides for a transition period (see "Grandfather Provisions" section below).

Grandfather Provisions

Generally, pre-existing plans that were adopted prior to June 30, 2003 are "grandfathered" and will not require shareholder approval unless the plans are materially revised or amended.

Though grants of equity compensation under discretionary plans, regardless of whether they were previously approved by shareholders, require shareholder approval, the NYSE rule permits a transition period where approval is not necessary for grants occurring before the earlier of (1) the company's next annual meeting at which directors are elected that occurs on or after December 27, 2003, (2) June 30, 2004, or (3) the expiration of the plan. The Nasdaq rule does not contain such a transition period.

The NYSE rule also provides the same transition period for evergreen/formula plans that either (1) have not been previously approved by shareholders or (2) have a term of greater than ten years. A shareholder approved formula plan that has a term of greater than ten years may continue to be used after the end of the transition period if it is amended so that it has a term of ten years or less (measured from either the date of the plan's initial adoption or shareholder approval). In addition, an evergreen/formula plan not previously approved by shareholders may continue to be used without shareholder approval after the transition period if grants are limited to shares available from formulaic increases that occurred before June 30, 2003. Under the Nasdaq rule, existing evergreen/formula plans may continue to be used without shareholder approval until the end of ten years from the date of adoption or shareholder approval (unless the plan has an earlier expiration date), unless there is a material amendment.

Differences Among the SROs' Rule Changes

Generally, the revised shareholder approval requirements of the SROs were harmonized during the rulemaking process. However, there are some differences.

Issue under the New Rules	NYSE Requirement	Nasdaq Requirement
SRO Notification When Relying on Exemption from Shareholder Approval	The NYSE must be notified in writing	No current requirement. Nasdaq is considering adoption of a similar notification requirement.
Public Disclosure When Relying on Exemption from Shareholder Approval[fn5]	Promptly following an employment inducement award, the Company must issue a press release disclosing the material terms of the award, including the identities of the recipient(s) of the awards and the number of shares involved.	No current requirement. Nasdaq is considering adoption of a similar requirement when a Company relies upon any exemption from shareholder approval.
Transition Periods	A limited transition period for evergreen/formula plans and discretionary plans. Grants under pre-existing discretionary plans may continued during the transition period if grants are made consistent with past practice.	No transition periods for discretionary plans. Each grant under discretionary plan requires shareholder approval. Limited transition period for evergreen/formula plans.

NYSE Broker Non-Vote Rule for Equity Compensation Plans

The final NYSE rule eliminates the ability of broker-dealers to vote proxies on the equity compensation plans of NYSE Companies without the explicit consent and instruction of the beneficial owners. Broker-dealers were already prohibited from voting proxies without explicit instructions from beneficial holders under the Nasdaq's rules. This change will be effective for any meeting of shareholders that occurs on or after September 28, 2003.

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The new rules will have a significant effect on how quickly new equity compensation plans can be adopted. Approval of equity compensation plans will likely become more common place on annual and special meeting proxy statements of Companies.

In addition, any material revision or amendment to a plan will require shareholder approval. Although the SROs' adopting releases provide examples of what will constitute a "material" revision or amendment to a plan, there will be grey areas when making many materiality determinations. Informal telephonic guidance from the staff at the SROs will continue to be important in resolving uncertainty.

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Footnotes

1. The American Stock Exchange has proposed similar rules, which are still pending before the SEC and should be approved by the SEC sometime this summer.

2. The NYSE and Nasdaq are considering limiting this exemption to exclude any plan if the employee-participant in such plan receives employer contributions under the plan in excess of 25% of the participant's cash contributions.

3. Any shares reserved for listing in connection with a merger or acquisition will be counted by the SROs in determining whether the transaction triggers shareholder approval under the SROs' "20% rule."

4. Prior to 1996 before significant changes were made to Section 16, the SEC issued numerous no action letters that focused on whether specific revisions or amendments to employee compensation plans were deemed "material" changes to the plan. Although these letter are no longer relevant for Section 16 purposes, the Nasdaq has continued to consider them when evaluating whether a revision or amendment to an existing equity compensation plan is material and, therefore, would require shareholder approval.

5. SRO disclosure is in addition to the two-business day public disclosure requirements of Section 16(a) of the Securities Exchange Act of 1934.