Effective June 30, 2003, the Securities and Exchange Commission (SEC) approved new rules of the New York Stock Exchange (NYSE) and of the Nasdaq Stock Market (Nasdaq) that significantly broaden shareholder approval requirements for equity-based compensation plans, including material revisions to such plans, subject to certain limited exceptions described below.[1] Among other things, the new rules eliminate exceptions formerly available for broadly based plans and certain de minimis equity grants. In addition, the NYSE rule prohibits brokers holding shares on behalf of customers from voting such shares on equity compensation plan matters without specific voting instructions from the customers.
This advisory summarizes and compares the new NYSE and Nasdaq rules and discusses how they apply to existing and future equity compensation plans. Because the final NYSE and Nasdaq rules are significantly similar, the following discussion applies to both the NYSE and the Nasdaq rules, except as otherwise noted.
What "equity compensation plans" are subject to the shareholder approval requirements?
The NYSE rule defines "equity-compensation plan" as a plan or other arrangement that provides for the delivery of equity securities (either newly issued or treasury shares) to any employee, director or other service provider as compensation for services (including compensatory grants of options or other equity securities that are not made under a plan). The Nasdaq rule states that shareholder approval is required when a stock option or stock purchase or other equity compensation plan or arrangement is to be established or materially amended pursuant to which options or stock may be acquired by officers, directors, employees or consultants.[2] Neither the NYSE rule nor the Nasdaq rule permits companies to avoid the shareholder approval requirements by funding options with repurchased or treasury shares.
Under the NYSE and Nasdaq rules, the following plans or arrangements are either excluded from the definition of "equity-compensation plans" or are specifically exempted from the shareholder approval requirement:
- Plans that are made available to shareholders generally (such as dividend reinvestment plans or plans involving the distribution of shares or purchase rights to all shareholders);
- Plans that merely allow employees, directors and other service providers to purchase shares on the open market or from the company at fair market value (regardless of whether shares are delivered immediately or on a deferred basis or whether payments for shares are made directly or through deferral of compensation); and
- Arrangements under which employees receive cash payments based on the value of the company's stock (such as phantom stock payable in cash).
What are the exceptions to the shareholder approval requirement?
In addition to the excluded types of plans described above, the following arrangements are exempt from the NYSE and Nasdaq shareholder approval requirements, provided they are made with the approval of the company's compensation committee or a majority of the company's independent directors.
- Employment Inducement Awards. Shareholder approval is not required for the grant of options or other equity-based compensation as a material inducement to a person being hired, or being rehired after a bona fide period of employment interruption (including grants to new employees in connection with a merger or acquisition), by a company or any of its subsidiaries. The NYSE rule requires that, promptly following the grant of an inducement award, a company must disclose the material terms of the award in a press release.
- Plans or Arrangements Relating to a Merger or Acquisition. Shareholder approval is not required for:
- Options and other awards that are made or adopted to convert, replace or adjust outstanding options or other equity-compensation awards of another company in connection with the acquisition of that other company; and
- Shares available under pre-existing plans [3] of a company acquired in a merger or acquisition by a listed company that are used for certain post-transaction grants, provided: (i) the plan originally was approved by the shareholders of the target company; (ii) the number of shares available for grants is adjusted to reflect the transaction; (iii) the time during which those shares are available is not extended; and (iv) the options or other awards are not granted to individuals who were employed by the acquiring company or its subsidiaries at the time the merger or acquisition was consummated. [4]
- Plans Intended to Meet the Requirements of Sections 401(a) or 423 of the Internal Revenue Code and Parallel Excess Plans. [5] Shareholder approval is not required for these plans as such plans are regulated by the Internal Revenue Code and Treasury Department regulations.
NYSE listed companies must notify the NYSE in writing when relying on one of the foregoing exceptions to the shareholder approval requirement. [6]
What is a material revision or amendment to a plan?
Material revisions to equity-compensation plans and arrangements require shareholder approval. The NYSE and Nasdaq rules provide that a material revision includes, but is not limited to, the following:
- A material increase in the number of shares available under the plan (other than solely to reflect a reorganization, stock split, merger, spinoff or similar transaction);
- 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; and
- A material extension of the term of the plan.
In addition, the NYSE rule states that a material revision includes any material change to the method of determining the strike price of options under the plan and any deletion or limitation of any provision prohibiting repricing of options. Similarly, the Nasdaq rule provides that a material amendment would include any material increase in benefits to participants, including any reduction in the exercise price of outstanding options or the price at which shares or options to purchase shares may be offered.
Under the NYSE rule, if a plan has an "evergreen" provision that provides for automatic increases in the number of shares available under the plan, or the plan provides for automatic formula grants [7] (in either case, a "formula plan"), each increase or grant will be considered a revision requiring shareholder approval unless the plan has a term of not more than 10 years. Under the Nasdaq rule, a formula plan cannot have a term in excess of 10 years unless shareholder approval is obtained every 10 years.
If a plan has no limit on the number of shares available and is not a formula plan (a "discretionary plan"), then under both the NYSE and Nasdaq rules each grant under the plan will be considered a material amendment requiring separate shareholder approval regardless of whether the plan has a term of not more than 10 years. Needless to say, discretionary plans will likely become a thing of the past as a result of this requirement.
What do the rules say about repricings?
In addition to treating a repricing as a material revision or amendment requiring shareholder approval, the NYSE rule provides that a plan that does not contain a provision specifically permitting the repricing of options will be considered to prohibit repricing. [8] Moreover, according to the NYSE rule, any actual repricing of options will be considered a material revision of a plan even if the plan itself is not revised. Repricings commenced prior to June 30, 2003 are not subject to shareholder approval (unless shareholder approval is otherwise required under existing NYSE rules).
As described in the response to the preceding question, the Nasdaq rule treats repricings as material amendments requiring shareholder approval. However, the Nasdaq rule does not contain these additional provisions regarding repricings.
How will the new rules affect existing plans?
As a general rule, under both the NYSE and Nasdaq rules, plans that were adopted before June 30, 2003 will be grandfathered and will not require shareholder approval unless and until they are materially revised or amended. Equity compensation plans and arrangements adopted (or materially revised or amended) on or after June 30, 2003 will be subject to the new rules regarding shareholder approval.
Under the NYSE rule, each increase in the number of shares available under an evergreen provision, and each grant pursuant to an automatic formula, is considered a revision requiring shareholder approval, unless the plan has a term of not more than ten years. Under the Nasdaq rule, a formula plan cannot have a term in excess of ten years unless shareholder approval is obtained every ten years.
The NYSE rule provides special transition rules for formula plans and discretionary plans. Additional grants under a formula plan that has either not been previously approved by shareholders or does not have a term of 10 years or less may be made on or after June 30, 2003 without further shareholder approval for a limited transition period ending on the first to occur 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.
A shareholder-approved formula plan may be used after the transition period without further shareholder action if amended to provide for a term of 10 years or less from the date of its original adoption or most recent shareholder approval. Such an amendment may be made on or after June 30, 2003 and would not itself be considered a material revision requiring shareholder approval.
A formula plan that has not been approved by shareholders may continue to be used without shareholder approval to the extent grants on or after June 30, 2003 are based on formulaic increases that occurred prior to June 30, 2003.
Under the NYSE transition rules, additional grants under a discretionary plan, whether or not previously approved by shareholders, may be made on or after June 30, 2003 without further shareholder approval only for the limited transition period described above and in a manner consistent with past practice. The transition rules state that if a plan can be separated into a discretionary plan portion and a portion that is not discretionary, the non-discretionary portion of the plan can continue to be used separately. For example, if a shareholder-approved plan permits both grants pursuant to a provision that makes available a specific number of shares, and grants pursuant to a provision authorizing the use of treasury shares without regard to the specific share limit, the former provision (but not the latter) may continue to be used after the transition period.
Elimination of Broker Voting
Under amended NYSE Rule 452, brokers holding shares for the accounts of customers will no longer be permitted to vote those shares with respect to equity-compensation plan matters unless the beneficial owner of the shares (i.e., the customer) has given the broker specific voting instructions. [9] This change is effective for shareholder meetings occurring on or after September 28, 2003. This change could make it more burdensome for NYSE-listed companies to obtain the requisite shareholder approval than it has been in the past.
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FOOTNOTES
1. Self-Regulatory Organizations; New York Stock Exchange, Inc. and National Association of Securities Dealers, Inc.; Order Approving NYSE and Nasdaq Proposed Rule Changes and Nasdaq Amendment No. 1 and Notice of Filing and Order Granting Accelerated Approval to NYSE Amendments No. 1 and 2 and Nasdaq Amendments No. 2 and 3 Thereto Relating to Equity Compensation Plans, http://www.sec.gov/rules/sro/34-48108.htm (June 30, 2003). For background on the proposed rules, see Alston & Bird LLP Securities Law Advisory, "NASDAQ and NYSE Propose New and More Stringent Standards for Listed Companies," http://www.alston.com/articles/Nasdaq%20and%20NYSE.pdf (June 27, 2002).
2. It is not clear whether the NYSE's term "service provider" is intended to have a broader scope than the Nasdaq's term "consultant." For example, it is not clear whether the NYSE's rule is intended to require stockholder pre-approval of a grant of warrants to a "strategic alliance" partner in consideration of the provision of services by the partner to the issuer.
3. For purposes of this exemption, a plan adopted by the acquired company in contemplation of a merger or acquisition transaction would not be considered "pre-existing."
4. Any additional shares available for issuance under a plan or arrangement acquired in connection with a merger or acquisition would be counted by NYSE or Nasdaq, as applicable, in determining whether the transaction involved the issuance of 20 percent or more of the company's outstanding common stock, thus triggering the shareholder approval requirements under NYSE Listed Company Manual Section 312.03(c) and Nasdaq Rule 4350(i)(1)(C).
5. The NYSE rule uses the term "parallel excess plan," and the Nasdaq rule uses the term "parallel nonqualified plan," both of which are defined to mean a plan that is a "pension plan" within the meaning of the Employee Retirement Income Security Act that is designed to work in parallel with a plan intended to be qualified under Internal Revenue Code Section 401(a) to provide benefits that exceed the limits set forth in Internal Revenue Code Section 402(g) (the section that limits an employee's annual pre-tax contributions to a 401(k) plan), Internal Revenue Code Section 401(a)(17) (the section that limits the amount of an employee's compensation that can be taken into account for plan purposes) and/or Internal Revenue Code Section 415 (the section that limits the contributions and benefits under qualified plans) and/or any successor or similar limitations that may be enacted. A plan will not be considered a parallel excess plan unless: (1) it covers all or substantially all employees of an employer who are participants in the related qualified plan whose annual compensation is in excess of the limit of Internal Revenue Code Section 401(a)(17) (or any successor or similar limits that may be enacted); (2) its terms are substantially the same as the qualified plan that it parallels except for the elimination of the limits described in the preceding sentence and the limitation described in clause (3); and (3) no participant receives employer equity contributions under the plan in excess of 25 percent of the participant's cash compensation.
6. The SEC's release indicates that Nasdaq is considering whether to impose a disclosure requirement when a Nasdaq listed company relies upon any of these exceptions to the shareholder approval requirements.
7. The NYSE rule provides examples of formula plans, which include annual grants to directors of restricted stock having a certain dollar value, and company "matching contributions" whereby stock is credited to a participant's account based upon the amount of compensation a participant elects to defer. The Nasdaq rule describes formula plans as providing for automatic grants pursuant to a dollar-based formula, such as annual grants based on a certain dollar value, or company matching contributions based upon compensation a participant elects to defer.
8. A "repricing" is defined in the NYSE rule to include any of the following or any other action that has the same effect: (i) lowering the strike price of an option after it is granted; (ii) any other action that is treated as a repricing under GAAP; or (iii) canceling an underwater option in exchange for another option, restricted stock, or other equity, unless in connection with a merger, acquisition, spin-off or similar transaction.