SEC Approves AMEX Corporate Governance Reforms

Summary

On December 1, 2003, the SEC approved the American Stock Exchange's proposed corporate governance reforms. The new rules are available at http://www.amex.com/. The publication of these reforms marks the latest step in a process that began on June 23, 2003 when AMEX initially filed its proposed rule changes with the SEC. The key requirements for AMEX-listed companies are as follows:

  • A majority of the company's board of directors and each member of its audit committee must be independent under enhanced independence standards;

  • The audit committee must meet at least quarterly;

  • All related party transactions are to be reviewed by a listed company's audit committee or a comparable body of the board of directors;

  • A listed company must publicly disclose changes and vacancies in its board of directors or the receipt of an audit opinion that contains a going concern qualification;

  • Meetings of the board of directors must occur on at least a quarterly basis and an executive session of the independent members of the board must be held at least annually outside of the presence of the non-independent directors and management;

  • A listed company must adopt a formal written charter or board resolution addressing the nominations process;

  • All nominees to a listed company's board of directors must be selected, or recommended to the board of directors for selection, by a nominating committee composed entirely of independent directors or by a majority of the company's independent directors;

  • Compensation of all officers must be determined, or recommended to the board of directors for determination, by a compensation committee composed entirely of independent directors or by a majority of the company's independent directors; and

  • A code of conduct and ethics must be adopted and be applicable to all directors, officers and employees.

The new listing standards generally apply to all AMEX-listed companies. There are exceptions to certain of these requirements for controlled companies, limited partnerships, asset-backed issuers and other passive business organizations, registered investment management companies, business development companies, companies with only listed preferred stock or debt securities, foreign private issuers and small business filers.


Effective Dates

The rules relating to director independence, boards of directors, audit committees (other than audit committee reforms mandated by SEC rules), director nominations and executive compensation are expected to become effective for most companies by the earlier of the company's first annual shareholders meeting after March 15, 2004 or October 31, 2004. For foreign private issuers and small business filers, the rules relating to director independence, boards of directors, audit committees (other than audit committee reforms mandated by SEC rules), director nominations and executive compensation are expected to take effect on July 31, 2005. However, if a company has a staggered board, and a change is required with respect to a director whose term does not expire until after the applicable effective date referred to above, the company may continue such director in office until the second annual meeting after such date, but not later than December 31, 2005. The code of ethics requirements are expected to become effective on June 1, 2004 . The rules related to public announcements and related party transactions requirements are expected to become effective on December 31, 2003.

Board Independence Requirements

A Majority of the Board of Directors Must Be Independent

A listed company's board of directors must affirmatively determine that directors comprising at least a majority of the company's board have no material relationship with the listed company that would interfere with the exercise of independent judgment.

Disqualifying Conditions

To assist boards with their assessment of director independence, the new listing standards include five "bright line" conditions that disqualify a director from being independent. The board cannot waive these conditions.

In certain cases, these disqualifying conditions apply not only to the director, but also to any immediate family member of the director. "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).

In many cases, the disqualifying conditions contain a three-year look-back. The new rules limit the look-back period for all directors who are not audit committee members to one-year for the first year after the proposals are adopted. Directors who are members of the audit committee may also rely on a one-year look-back period for certain relationships and transactions for the first year after the proposals are adopted – the applicable transactions and relationships are described below in the bulleted items "Compensation...", "Compensation Committee Interlocks" and "Auditor Relationship". The three-year look-back will apply to all directors commencing December 1, 2004.

The following disqualifying conditions are not applicable to investment companies. Instead, a director of an investment company will not be considered independent if he or she is an "interested person" of the company as determined pursuant to the Investment Company Act of 1940, as amended.

The disqualifying conditions are:

  • Employment. A director who is, or during the past three years was, an employee of the company or any parent or subsidiary of the company or an immediate family member of an individual who is, or in the past three years has been, employed by the company or any parent or subsidiary of the company as an executive officer. Prior service as an interim Chairman or CEO will not disqualify an otherwise independent director.

  • Compensation Other Than Board Fees, Pensions, etc. A director who accepts or has an immediate family member who accepts any payments from the company or any parent or subsidiary of the company in excess of $60,000 during the current or any of the past three fiscal years. This disqualification does not apply to (i) compensation for board service, (ii) payments arising solely from investments in the company's securities, (iii) compensation to an immediate family member who is a non-executive employee of the company or of a parent or subsidiary of the company, (iv) compensation for prior service as an interim Chairman or CEO, (v) benefits under a tax-qualified retirement plan, (vi) non-discretionary compensation, or (vii) personal loans to executives permitted by the Securities Exchange Act of 1934, as amended.

  • Business Relationships. A director who is, or who 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 payments arising solely from investments in the company's securities or payments under non-discretionary charitable contribution matching programs) that exceed the greater of 5% of the recipient's gross revenues for that year or $200,000, in any of the most recent three fiscal years.

  • Compensation Committee Interlocks. A director who is, or has an immediate family member who is, employed as an executive officer of another company at any time during the most recent three fiscal years at which any of the listed company's officers serve on such other company's compensation committee.

  • Auditor Relationship. A director who is, or has an immediate family member who is, a current partner of the company's outside auditor, or was a partner or employee of the company's outside auditor who worked on the company's audit engagement at any time during the past three fiscal years.
Other Governance Changes

In addition to satisfying the independence requirements, a listed company's board of directors must comply with the following additional requirements.

  • Quarterly Board Meetings. The board of directors as a whole must meet on at least a quarterly basis.

  • Regular Meetings of Independent Directors. The independent directors must meet on a regular basis as often as necessary to fulfill their responsibilities, including at least annually in executive session outside of the presence of the non-independent directors and management.

  • Limits on Staggered Boards. The board of directors may not be divided into more than three classes. All classes should be of approximately equal size and each term of office for each director should not exceed three years.

  • Director Training. Listed companies are also urged to develop and implement continuing education programs for all directors, including orientation and training programs for new directors.

Audit Committees

AMEX has made limited revisions to its existing standards for audit committees, principally to implement the audit committee standards mandated by the SEC and the Sarbanes-Oxley Act of 2002. In addition to the required changes, the new AMEX rules will require audit committees to meet a minimum of once per quarter.

The SEC mandates impose two basic audit committee member independence requirements:

  • No Compensatory Fees. Audit committee members may not accept, directly or indirectly, any consulting, advisory or other compensatory fees from the company or any subsidiary of the company, other than (i) for service as a member of the board of directors and any board committee, (ii) fixed retirement payments or deferred compensation for prior service with the company that is not contingent in any way on continued service or (iii) dividends or other payments on account of securities owned by a committee member, if they are made to all shareholders as a class. This prohibition precludes all payments to a committee member as an officer or employee. There is no de minimus exception to this requirement.

    "Indirect" compensatory payments include payments to spouses, minor children or stepchildren, or children or stepchildren sharing a home with the member. In addition, indirect payments include those made to an entity (i) in which the audit committee member is a partner, a member, an officer such as a managing director occupying a comparable position or executive officer, or occupies a similar position (but not that of limited partner, non-managing member and those occupying similar positions who, in each case, have no active role in providing services to the entity) and (ii) which provides accounting, consulting, legal, investment banking, or financial advisory services to the company or any of its subsidiaries.

  • No Affiliated Persons. A member of the audit committee may not be an "affiliate" of the company or any subsidiary of the company due to any relationship (including stock ownership) other than as a result of his or her capacity as a member of the board and any board committee of the company. The SEC's rules specifically provide that an executive officer, a director who is also an employee and a general partner or a managing member of an entity that is an affiliate of the company is an affiliate of the company for purposes of the audit committee independence rules and may not serve on a listed company's audit committee.

    One effect of this requirement under the SEC's standard "control" test for affiliate status may be to disqualify representatives of significant shareholders from membership on the audit committee. To provide some clarity on this issue, the SEC adopted a safe harbor to the effect that a person who is not an executive officer or the direct or indirect beneficial owner of 10% or more of any class of voting equity securities of the listed company or of an entity that controls, is controlled by or is under common control with the listed company, will be deemed not to be an affiliated person. This is only a safe harbor, however, meaning that a director who is not an executive officer but beneficially owns (directly or indirectly) more that 10% of the listed company's voting equity securities can still be determined not to be an affiliate under a facts-and-circumstances analysis of actual control.

In addition to satisfying the SEC's requirements, members of an audit committee will still be required to meet AMEX's general independence standards described in "Board Independence Requirements" above.

Unlike the revised AMEX independence standards, there are no look-back periods under the SEC's additional independence requirements. The SEC prohibitions apply only to current relationships between the audit committee member and the listed company. The AMEX rules also retain the "exceptional and limited circumstances" exemption that will permit a director who is not independent under AMEX's revised independence criteria but who satisfies the SEC's independence requirements to serve on the audit committee for up to two consecutive years as long as such person is not the chair of the audit committee and provided that the board of directors discloses such determination in the company's next proxy statement (or Form 10-K if the company does not file an annual proxy statement).

Related Party Transactions

Under the new rules, a listed company must subject all related party transactions to appropriate review and oversight by the company's audit committee or a comparable body of the board of directors.

Disclosure of Material Events

The new rules will require a listed company to promptly publicly announce any changes in the composition of the board of directors, including vacancies. Listed companies will also be required to promptly publicly announce the receipt of an audit opinion that contains a going concern qualification.

Nominating and Compensation Committees

The new AMEX rules do not necessarily require the establishment of independent nominating and compensation committees. The rules do require that each listed company adopt a formal written charter or board resolution, as applicable, addressing the nominations process and such related matters as may be required under the federal securities laws.

In addition, the rules require that all nominations to the board of directors be selected, or recommended for the board's selection, by either a majority of the company's independent directors or a nominating committee composed solely of independent directors.

One director that does not meet the AMEX independence requirements described above may be appointed to the nominating committee in exceptional and limited circumstances if (i) the nominating committee is composed of at least three members, (ii) the director is not a current officer or employee or an immediate family member of such person, and (iii) the board of directors determines that the director's membership on the committee is required by the best interest of the company shareholders, and the board of directors discloses such determination in the company's next proxy statement (or Form 10-K if the company does not file an annual proxy statement). A director appointed to the nominating committee pursuant to this exception may not serve for in excess of two years.

With respect to compensation, the rules require that a majority of the company's independent directors or a compensation committee composed solely of independent directors determine, or recommend to the board of directors for determination, the compensation of a listed company's chief executive officer. The chief executive officer may not be present during voting or deliberations concerning his or her compensation. Compensation for all other officers must be determined, or recommended to the board of directors for determination, either by the compensation committee or a majority of the company's independent directors. The new rules contain an exemption, which may be relied upon in exceptional and limited circumstances, for one non-independent director to serve on the compensation committee similar to the one described above for nominating committees.

Code of Conduct and Ethics

Listed companies must adopt a Code of Conduct and Ethics applicable to all directors, officers and employees that complies with the SEC rules concerning codes of ethics for senior financial officers. The Code of Conduct and Ethics must be publicly available. In commentary to the new rules, AMEX indicated that all Codes of Conduct and Ethics must promote:

  • Honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest that arise in personal and professional relationships;

  • Full, fair, accurate, timely, and understandable disclosure in periodic reports and documents required to be filed by the company;

  • Compliance with applicable exchange and governmental rules and regulations;

  • Prompt internal reporting of violations of the Code to the appropriate person; and

  • Accountability for adherence to the Code.

Application to Certain Companies

The AMEX proposal includes special provisions for a variety of listed companies, several of which are summarized below. Other provisions not summarized in this Advisory apply to limited partnerships, companies in bankruptcy, registered management investment companies, business development companies, asset-backed issuers and other passive business organizations.

Controlled Company Exception

Companies whose voting securities are more than 50% held by an individual, group or another company do not need to comply with the requirement that a majority of the board be independent and the requirements applicable to compensation and nominating committees. However, a controlled company that elects to take advantage of this exception would need to disclose in its proxy statement that it is a controlled company and the basis for that determination.

Foreign Listed Companies

Foreign listed companies may generally follow the practices of their home countries to the extent that such practices are not contrary to federal securities laws. Foreign listed companies must disclose any significant differences between their home country corporate governance practices and those required by AMEX listing standards.

Preferred and Debt Securities

Companies that have only preferred stock or debt securities listed on AMEX are required to comply only with the SEC's rules governing minimum standards for audit committee members described above.

Small Business Filers

Small business filers will be subject to the new corporate governance requirements, except that they will only be required to have a board of directors composed of at least 50% independent directors and an audit committee of at least two directors.

Look-Back Period and Transition Period Issues

Potential Loss of Independence Due to Passage of Time

When the new AMEX director independence standards become applicable on the compliance date described above, the look-back period will include the company's prior fiscal year. However, the full three-year look-back period provided in the AMEX standards will become applicable on December 1, 2004. As a result, a transaction or relationship that would not affect a director's independence in 2004 because it occurred or existed during 2002 (in the case of calendar year companies) could affect that director's independence in 2005. This timing issue is significant as a director's independence may be compromised as a result of a past transaction or relationship merely by the passage of time.

Audit Committee Independence Requirements

The extended compliance date does not extend the deadline for audit committee members to satisfy AMEX and SEC independence requirements.

Initial Public Offerings

Companies listing in conjunction with their initial public offerings will be required to phase in their independent nomination and compensation committees on the same schedule as Rule 10A-3 mandates for audit committees, namely, one independent director at the time of listing, a majority within 90 days and fully independent committees within one year.


The Corporate Governance, Securities Litigation and M&A attorneys at Goodwin Procter keep current on these matters. We are available to help advise public companies and their officers and directors on specific issues as well as to provide educational presentations to help them understand and meet their responsibilities under both current and proposed rules and regulations. Please contact us either directly or through your regular Goodwin Procter contact if we may be of assistance.

Scott F. Duggansduggan@goodwinprocter.com212.813.8972
James A. Mataresejmatarese@goodwinprocter.com617.570.1865
Ettore A. Santucci, P.C.esantucci@goodwinprocter.com617.570.1531

Stephen A. Boyko contributed to the preparation of this Advisory.

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