Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the New York Stock Exchange, Inc. Relating to Shareholder Approval of Stock Option Plans

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40679; File No. SR-NYSE-98-32]

November 13, 1998.

Self-Regulatory Organizations; Notice of Filing of Proposed Rule

Change by the New York Stock Exchange, Inc. Relating to Shareholder

Approval of Stock Option Plans

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934

(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given

that on October 13, 1998, the New York Stock Exchange, Inc. (the

``Exchange'' or the ``NYSE'') filed with the Securities and Exchange

Commission (the ``Commission'' or the ``SEC'') the proposed rule change

as described in Items I, II, and III below, which Items have been

prepared by the self-regulatory organization. The Commission is

publishing this notice to solicit comments on the proposed rule change

from interested persons.

---------------------------------------------------------------------------

\1\ 15 U.S.C. 78s(b)(1).

\2\ 17 CFR 240.19b-4.

---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of

Substance of the Proposed Rule Change

The Exchange is proposing to amend Paragraphs 312.01, 312.03 and

312.04 of its Listed Company Manual (the ``Manual''). The proposed rule

change amends the Exchange's shareholder approval policy (the

``Policy'') with respect to stock option and similar plans (``Plans'').

The text of the proposed rule change is as follows:

Text of the Proposed Rule Change

Italics indicates additions; [brackets] indicate deletions.

312.00 Shareholder Approval Policy

312.01 Shareholders' interest and participation in corporate

affairs has greatly increased. Management has responded by providing

more extensive and frequent reports on matters of interest to

investors. In addition, an increasing number of important corporate

decisions are being referred to shareholders for their approval. This

is

[[Page 64305]]

especially true of transactions involving the issuance of additional

securities.

Good business practice is frequently the controlling factor in the

determination of management to submit a matter to shareholders for

approval even though neither the law nor the company's charter makes

such approvals necessary.The Exchange encourages this growth in

corporate democracy. For example, due to the recent growth of officer

and director equity-based compensation arrangements and the increased

interest of shareholders in this area, companies may determine to

submit stock option and similar plans to shareholders for approval,

whether or not the Exchange requires such approval.

* * * * *

312.03 Shareholder approval is a prerequisite to listing in four

situations: (a) Shareholder approval is required with respect to a

stock option or purchase plan, or any other arrangement, pursuant to

which officers or directors may acquire stock (collectively, a

``Plan'') except:

(1) for warrants or rights issued generally to security holders of

the company;

(2) pursuant to a broadly-based Plan [that includes other employees

(e.g. ESOPs)];

(3) where options or shares are to be issued to a person not

previously employed by the company, as a material inducement to such

person's entering into an employment contract with the company; or

(4) pursuant to a Plan that provides that (i) no single officer or

director may acquire under the Plan more than one percent of the shares

of the issuer's common stock outstanding at the time the Plan is

adopted, and (ii) together with all Plans of the issuer (other than

Plans for which shareholder approval is not required under subsections

(1) to (3) above), does not authorize the issuance of more than five

percent of the issuer's common stock outstanding at the time the Plan

is adopted.

* * * * *

312.04 For the purpose of Para. 312.03:

* * * * *

[(g) Whether a Plan is ``broadly-based'' depends on a variety of

factors, including, but not limited to the number of officers,

directors and other employees covered by the Plan and whether there are

separate compensation arrangements for salaried employees and hourly

employees. The Exchange will deem a Plan to be ``broadly-based'' if at

least 20 percent of the company's employees are eligible to receive

stock or options under the Plan and at least half of those eligible are

neither officers nor directors (the ``20 percent test''). However, this

is a non-exclusive safe harbor and the fact that a Plan does not meet

the 20 percent test does not mean that the Exchange will consider the

Plan to be narrowly-based. The Exchange encourages a listed company

adopting a Plan that does not meet the 20 percent test, but that the

company believes is ``broadly-based,'' to discuss the matter with the

Exchange staff prior to filing a listing application covering the

shares to be issued under the Plan.]

(g) ``Officer'' has the same meaning as defined by the Securities

and Exchange Commission in Rule 16a-1(f) under the Securities Exchange

Act of 1934, or any successor rule.

(h) A Plan is ``broadly-based'' if, pursuant to the terms of the

Plan:

at least a majority of the company's full-time employees in the

United States, who are ``exempt employees,'' as defined under Fair

Labor Standards Act of 1938, are eligible to receive stock or options

under the Plan; and

at least a majority of the shares of stock or shares of stock

underlying options awarded under the Plan, during the shorter of the

three-year period commencing on the date the Plan is adopted by the

company or the term of the Plan, must be awarded to employees who are

not officers or directors of the company.

II. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

In its filing with the Commission, the Exchange included statements

concerning the purpose of, and basis for, the proposed rule change and

discussed any comments it received on the proposed rule change. The

text of these statements may be examined at the places specified in

Item IV below. The Exchange has prepared summaries, set forth in

section A, B and C below, of the most significant aspects of such

statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

1. Purpose

As a prerequisite to listing, the Policy requires shareholder

approval of stock option or purchase plans or any other arrangement

pursuant to which either officers or directors acquire stock. The

Policy also contains, however, four exemptions from this requirement,

including an exemption for ``broadly-based'' Plans. The purpose of the

proposed rule change is to amend the provisions in the mutual governing

shareholder approval of Plans, including the definition of what

constitutes a ``broadly-based'' Plan.

The Exchange historically had not provided a definition of what

constitutes a ``broadly-based'' Plan other than to state that such a

Plan must include employees other than officers and directors. The one

example in the policy of such a Plan was an employee stock option plan,

or ``ESOP.'' In December of 1997, the Exchange filed a proposed rule

change amending the Policy which was published for public comment \3\

by the Commission as required under Section 19(b)(1) of the Act.\4\ The

Commission received no comments on the proposed rule change, which was

subsequently approved on April 8, 1998.\5\ Among other things, the

Original Proposal codified existing Exchange interpretations regarding

``broadly-based'' plans. Specifically, that proposal stated that the

definition of ``broadly-based'' required a review of a number of

factors, including the number of persons included in the Plan, and the

nature of the company's employees. The Exchange also codified a non-

exclusive safe harbor for Plans in which at least 20 percent of a

company's employees were eligible, provided that the majority of those

eligible were neither officers nor directors.

---------------------------------------------------------------------------

\3\ Exchange Act Release No. 39659 (February 12, 1998), 63 FR

9036 (February 23, 1998).

\4\ 15 U.S.C. 78s(b)(1).

\5\ Exchange Act Release No. 39839 (April 8, 1998), 63 FR 18481

(April 15, 1998) (the ``Original Proposal'').

---------------------------------------------------------------------------

Following the approval and effectiveness of the Original Proposal,

the Exchange and the Commission received a significant number of

inquiries and comments regarding the proposal. These originated

primarily from the institutional investor community and focused on the

definition of ``broadly-based.'' Many commentators were concerned that

the Original Proposal could be a ``loop-hole'' pursuant to which

companies could establish Plans of significant size that included

officers and directors without the need for shareholder approval.

Commentators also expressed general concern regarding the potential

dilutive effects of Plans.

In response to the inquiries and comments, the Exchange issued a

Request for Comment on the definition of ``broadly-based'' Plans. The

Exchange received 166 comments in response to that request. These

comments are discussed in Section II.C., below. The

[[Page 64306]]

Request for Comment indicated the Exchange's intention to establish a

task force (the ``Task Force'') to review the comments and to make

recommendations regarding potential changes to the definition of

``broadly-based'' Plan.

The Exchange thereafter established the Task Force to review the

comments. The Task Force was composed of representatives of the

Exchange's Legal Advisory Committee, Individual Investors Advisory

Committee, Pension Managers Advisory Committee, and Listed Company

Advisory Committee. In addition, members of the Task Force included

representatives of other Exchange constituencies, including a

representative from the Council of Institutional Investors. Following

its deliberations, the Task Force recommended the following:

(1) Retain, but modify the definition of a ``broadly-based'' Plan.

The new definition would classify a Plan as ``broadly-based'' if,

pursuant to the terms of the Plan:

(a) At least a majority of the issuer's full-time, exempt U.S.

employees \6\ are eligible to participate under the plan; and

---------------------------------------------------------------------------

\6\ See 29 U.S.C. 213(a) for the definition of ``exempt

employees.''

---------------------------------------------------------------------------

(b) At least a majority of the shares awarded under the Plan (or

shares of stock underlying options awarded under the Plan) during the

shorter of the three year period commencing on the date the Plan is

adopted by the issuer, or the term of the Plan itself, are made to

employees \7\ who are not officers or directors of the issuer.\8\

---------------------------------------------------------------------------

\7\ The Exchange proposes a two part test for determining

whether a plan is broadly-based. In the first prong, a majority of

the company's full-time employees who are ``exempt employees'' must

be eligible to receive stock. As a general matter, ``exempt

employees'' are salaried employees in an executive, administrative

or professional capacity. The Task Force recommended limiting this

prong of the definition to ``exempt employees'' since non-exempt

employees often are covered by compensation arrangements that do not

include stock options.

The second part of the test requires that at least a majority of

the shares awarded under a Plan be awarded to employees who are not

officers or directors of a company. This part of the test is not

limited to ``exempt employees,'' allowing the calculation of the

``majority of shares awarded'' to include both ``exempt employees''

and non-exempt employees who are not officers or directors. The

focus of this requirement is to ensure that a company actually

implements a Plan in a broadly-based fashion. In this regard, it

does not matter whether the awards to persons other than officers or

directors are to ``exempt'' or non-exempt employees. Telephone call

between Michael Simon, Milbank, Tweed, Hadley & McCloy, and Kelly

McCormick, Attorney, Division of Market Regulation, Commission,

dated November 12, 1998.

\8\ In this regard, the Exchange proposes to use the definition

of ``officer'' contained in Commission Rule 16a-1(f) under the Act.

---------------------------------------------------------------------------

(2) Establish the definition of a ``broadly-based'' Plan as an

exclusive test, not a safe harbor.

(3) Revise the Exchange's general policy on shareholder approval

issues to recognize the increased use of Plans as means to compensate

officers and directors and state the Exchange's view that companies

should consider submitting Plans to shareholder whether or not required

by Exchange policy.

(4) Direct the Task Force or other appropriate group to immediately

commence a study to establish a maximum overall dilution listing

standard for all non-tax-qualified Plans that otherwise would be exempt

from shareholder approval. The goal would be to complete this study in

time for Exchange review prior to the year 2000 proxy statement season.

The rule amendments being proposed in this filing implement the

first three Task Force recommendations. In addition, the Exchange has

adopted the fourth recommendation and will direct the Task Force to

consider a possible listing standard regarding a dilution test.

The Exchange believes that the Task Force's recommendations

represent an effective and workable compromise regarding shareholder

approval of Plans. The proposal blends tests based both on Plan

eligibility and Plan awards. In addition, while providing certainty

through the use of an exclusive test, the Exchange believes the

proposed amendments also state a general Exchange policy recognizing

the increased use of Plans by companies and the Exchange's view that

companies should consider submitting Plans to shareholders, whether or

not required under the Policy. The Exchange believes the amendments

also provide consistency in coverage by adopting the Commission's

definition of ``officer,'' as contained in Rule 16a-1(f) under the Act.

Finally, the Task Force recognizes that this proposal may only be an

interim step in addressing this issue, and recommends that the Exchange

consider an overall dilution test. Since the Exchange did not request

comment on this issue in its original Request for Comment, the Exchange

believes that further study of such a test is prudent.

2. Statutory Basis

The NYSE believes that the basis under the Act for this proposed

rule change is the requirement under Section 6(b)(5) \9\ that an

exchange have rules that are designed to prevent fraudulent and

manipulative acts and practices, to promote just and equitable

principles of trade, to foster cooperation and coordination with

persons engaged in regulating, clearing, settling, processing

information with respect to, and facilitating transactions in

securities, to remove impediments to and perfect the mechanism of a

free and open market and a national market system, and, in general, to

protect investors and the public interest.

---------------------------------------------------------------------------

\9\ 15 U.S.C. 78f(b)(5).

---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden Competition

The proposed rule change does not impose any burden on competition

that is not necessary or appropriate in furtherance of the purposes of

the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed

Rule Change Received From Members, Participants or Others

As discussed, the Exchange issued a Request for Comment on the

definition of a ``broadly-based'' plan. The Exchange received 166

comment letters in response to that solicitation.\10\ As a general

matter, the listed company community favored retaining the current

shareholder approval policy with respect to stock option plans. In

contrast, the institutional investor community generally favored a

narrower definition of what constitutes a ``broadly-based'' plan, and

suggested that such a definition be an exclusive test, not a non-

exclusive safe harbor. The Task Force considered these comments in

proposing the compromise position the Exchange is proposing in this

filing.

---------------------------------------------------------------------------

\10\ Interested persons are directed to the public file, located

at the places specified in Item IV below, to review the comments

received by the NYSE. The public file contains: (1) a Summary of the

Comment Letters (Exhibit B); (2) the NYSE Request for Comment

(Exhibit 2A); (3) the Comment Letters in Response to the Request

(Exhibit 2B); and (4) the Report of the NYSE Task Force (Exhibit

2C).

---------------------------------------------------------------------------

III. Date of Effectiveness of the Proposed Rule Change and Timing

for Commission Action

Within 35 days of the date of publication of this notice in the

Federal Register or within such longer period (i) as the Commission may

designate up to 90 days of such date if it finds such longer period to

be appropriate and publishes its reasons for so finding or (ii) as to

which the self-regulatory organization consents, the Commission will:

(A) By order approve such proposed rule change, or

(B) Institute proceedings to determine whether the proposed rule

change should be disapproved.

[[Page 64307]]

IV. Solicitation of Comments

Interested persons are invited to submit written data, views and

arguments concerning the foregoing, including whether the proposed rule

change is consistent with the Act. In particular, the Commission

requests comment on whether the ``actual participation'' standard of

paragraph 312.03(h) of the Manual (which states that at least a

majority of the shares of stock or shares underlying options awarded

under the Plan, during the shorter of the three-year period commencing

on the date the Plan was adopted by the company or the term of the

plan, must be awarded to employees who are not officers or directors),

in conjunction with the ``eligibility'' portion of proposed paragraph

312.03(h), adequately addresses commenters' concerns regarding non-

executive participation, as well as eligibility, in a Plan. The

Commission requests comment on whether a company could meet the

definition of a broadly-based plan by nominally complying with the

participation prong and the thereby avoid the shareholder approval

requirements. In particular, could a company either issue grants to

non-executive employees in the first three years of the Plan but

reserve a majority of the shares actually available under a Plan for

executives and directors once the three years has elapsed?

Alternatively, could a company not issue any grants during the first

three years of the Plan but reserve all shares available under the Plan

for grants only to executives and directors once the three years has

elapsed? The Commission also requests comment on whether Section 162(m)

of the Internal Revenue Code,\11\ (which requires shareholder approval

of applicable employee remuneration in excess of one million dollars

for covered employees for the remuneration to be eligible for deduction

as a trade or business expense) provides shareholders with additional

protection by affording shareholders an adequate opportunity to vote on

certain stock option plans.

---------------------------------------------------------------------------

\11\ 26 U.S.C. 162(m).

---------------------------------------------------------------------------

Persons making written submissions should file six copies thereof

with the Secretary, Securities and Exchange Commission, 450 Fifth

Street, N.W., Washington, D.C. 20549. Copies of the submission, all

subsequent amendments, all written statements with respect to the

proposed rule change that are filed with the Commission, and all

written communications relating to the proposed rule change between the

Commission and any person, other than those that may be withheld from

the public in accordance with the provisions of 5 U.S.C. 552, will be

available for inspection and copying in the Commission's Public

Reference Room, 450 Fifth Street, N.W., Washington, D.C. 20549. Copies

of such filing will also be available for inspection and copying at the

principal office of the NYSE. All submissions should refer to File No.

SR-NYSE-98-32 and should be submitted by December 10, 1998.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\12\

---------------------------------------------------------------------------

\12\ 17 CFR 200.30-3(a)(12).

---------------------------------------------------------------------------

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 98-30948 Filed 11-18-98; 8:45 am]

BILLING CODE 8010-01-M