Self-Regulatory Organizations; New York Stock Exchange, Inc.; Order Approving Proposed Rule Change and Notice of Filing and Order Granting Accelerated Approval of Amendment Nos. 1 and 2 Thereto Relating to Shareholder Approval of Stock Option Plans

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41479; File No. SR-NYSE-98-32]

Self-Regulatory Organizations; New York Stock Exchange, Inc.;

Order Approving Proposed Rule Change and Notice of Filing and Order

Granting Accelerated Approval of Amendment Nos. 1 and 2 Thereto

Relating to Shareholder Approval of Stock Option Plans

June 4, 1999.

I. Introduction

On October 13, 1998, the New York Stock Exchange, Inc. (``NYSE'' or

``Exchange'') submitted to the Securities and Exchange Commission

(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the

Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4

thereunder,\2\ a proposed rule change to amend the Exchange's

shareholder approval policy (``Policy'') with respect to stock option

and similar plans. The proposed rule change was published for comment

in the Federal Register on November 19, 1998.\3\ The Exchange submitted

an amendment to the filing on November 17, 1998.\4\ On December 26,

1998, the Commission extended the comment period until January 25,

1999.\5\ The Commission received 19 comments on the proposal in

response to both the regular and extended comment periods.\6\ On March

12, 1999, the Exchange submitted Amendment No. 2.\7\ This order

approved the proposal, as amended, on a pilot basis until September 30,

2000.

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

\2\ 17 CFR 240.19b-4.

\3\ /Securities Exchange Act Release No. 40679 (November 13,

1998), 63 FR 64304.

\4\ Letter from James E. Buck, Senior Vice President and

Secretary, NYSE to Richard C. Strasser, Assistant Director, Division

of Market Regulation, SEC, dated November 25, 1998 (``Amendment No.

1''). In Amendment No. 1, the Exchange clarified the reason why its

proposed ``broadly-based'' definition is limited to ``exempt

employees'' under the Fair Labor Standards Act of 1938 in the

eligibility part of the definition but not in the participation

part.

\5\ In response to the solicitation of comments, the Commission

received a request to extend the comment period. Letter from Sarah

Teslik, Council of Institutional Investors, to Jonathan G. Katz,

Secretary, SEC, dated November 20, 1998 (``CII Comment Period

Extension Request''). As originally noticed, the comment period

expired on December 10, 1998.

\6\ Letters from Aldo Del Nou to Commissioner (sic) Arthur

Levitt, SEC, dated October 17, 1998; CII Comment Period Extension

Request; Kurt N. Schacht, Chief Legal Officer, State of Wisconsin

Investment Board to Jonathan G. Katz, Secretary, SEC, dated November

30, 1998; Nell Minow, Lens Investment Management, LLC, to Jonathan

G. Katz, Secretary, SEC, dated December 1, 1998; Sarah Teslik,

Council of Institutional Investors, to Jonathan G. Katz, Secretary,

SEC, dated November 30, 1998 (``CII-I''); Howard D. Sherman,

President, Institutional Shareholder Services, to Jonathan G. Katz,

Secretary, SEC, dated December 2, 1998; James E. Heard, Chairman and

Chief Executive Officer, Proxy Monitor, to Jonathan G. Katz,

Secretary, SEC, dated December 4, 1998; Richard Ferlauto, Managing

Director, Proxy Voter Services, to Jonathan G. Katz, Secretary, SEC,

dated December 8, 1998; Linda S. Selbach, Barclays Gloval Investors,

to Jonathan G. Katz, Secretary, SEC, dated December 7, 1998; Lewis

A. Sanders, Sanford C. Bernstein & Co., Inc. to Jonathan G. Katz,

Secretary, SEC, dated December 9, 1998; Kay R.H. Evans, Executive

Director, Maine State Retirement System, to Jonathan G. Katz,

Secretary, SEC, dated December 10, 1998; Jack M. Marco, The Marco

Consulting Group, to Jonathan G. Katz, Secretary, SEC, dated

December 9, 1998; George M. Philip, Executive Director, New York

State Teachers' Retirement System, to Jonathan G. Katz, Secretary,

SEC, dated December 9, 1998; Kayla J. Gillan, General Counsel,

California Public Employees' Retirement System, to Jonathan G. Katz,

Secretary, SEC, dated December 9, 1998 (``Cal PERS''); John J.

Sweeney, President, American Federation of Labor and Congress of

Industrial Organizations, to Jonathan G. Katz, Secretary, SEC, dated

December 10, 1998 (``AFL-CIO''); Bart Naylor, Director, Corporate

Affairs, International Brotherhood of Teamsters, to Jonathan G.

Katz, Secretary, SEC, dated December 10, 1998; Amy B.R. Lancellotta,

Senior Counsel, Investment Company Institute, to Jonathan G. Katz,

Secretary, SEC, dated December 10, 1998; Michelle Edkins, Corporate

Governance Executive, Hermes Investment Management Limited, to

Jonathan G. Katz, Secretary, SEC, dated January 18, 1999; Sarah

Teslik, Council of Institutional Investors, to Jonathan G. Katz,

Secretary, SEC, dated April 14, 1999 (``CII-II'').

\7\ Letter from James E. Buck, Senior Vice President and

Secretary, NYSE to Jonathan G. Katz, Secretary, SEC, dated March 11,

1999 (``Amendment No. 2''). In Amendment No. 2, the Exchange

submitted a sunset provision pursuant to which the proposed rule

change will expire on September 30, 2000. Amendment No. 2 also

contained the Exchange's response to the comment letters.

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II. Background

The Exchange proposes to amend paragraphs 312.01, 312.03, and

312.04 of the Listed Company Manual (``Manual''). The proposal amends

the Exchange's Policy with respect to stock option and similar plans

(``Plans'').

The Policy requires, as a prerequisite to listing, shareholder

approval of Plans or any other arrangement pursuant to which either

officers or directors acquire stock. There are, however, four

exemptions from this requirement, one of which is an exemption for

Plans that are ``broadly-based.'' Historically, the Exchange had not

provided a definition of what constituted a ``broadly-based'' Plan

other than to state that such a Plan must include employees other than

officers and directors. The only example in the Policy of such a Plan

was an employee stock option plan, or ``ESOP.''

In December 1997, the Exchange filed a proposed rule change

amending the Policy. The proposal was amended on January 28, 1998 and

was then published for public comment by the Commission (``Original

Proposal'').\8\ The Original Proposal codified, among other things,

existing Exchange interpretations regarding ``broadly-based'' Plans.

Specifically, the Original Proposal stated that the determination of

whether a Plan was ``broadly-based'' required the review of a number of

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

nature of the company's employees, such as whether there were separate

compensation arrangements for salaried and hourly employees. The

proposal 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.\9\ The Commission did not receive any comments on the

proposal, and subsequently approved it, as amended, on April 8,

1998.\10\

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\8\ Securities Exchange Act Release No. 39659 (February 12,

1998), 63 FR 9036 (February 23, 1998).

\9\ According to the NYSE, the 20% test was based upon the

``rule of thumb'' the Exchange had historically used in determining

whether a Plan was ``broadly-based.'' See Request for Comment on

NYSE Shareholder Approval Requirement for Broadly-Based Stock Option

Plans at 2 (``Request for Comment'').

\10\ Securities Exchange Act Release No. 39839, 63 FR 18481

(April 15, 1998).

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Following the Commission's approval of the Original Proposal, the

Exchange and the Commission received a significant number of inquiries

and comments regarding the Original Proposal. Many of these inquiries

and comments originated from the institutional investor community and

focused on the definition of ``broadly-based.'' Commenters expressed

general concern that, without shareholder approval, companies could

dilute the value of existing shares by creating new Plans.

[[Page 31668]]

In response, the Exchange issued the Request for Comment regarding

the definition of ``broadly-based'' Plans. The Exchange received 166

comments in response to that request.\11\ According to the NYSE, the

listed company community favored retaining the new Policy, while the

institutional investor community favored a narrower definition of what

constituted a ``broadly-based'' Plan, and suggested that such

definition be an exclusive test instead of a non-exclusive safe harbor.

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\11\ Interested persons are directed to the public file located

at the Commission's Public Reference Room, 450 Fifth Street, N.W.

Washington, D.C. 20549 to review the comments received by the NYSE.

The public file contains: (1) a Summary of Comment Letters (Exhibit

B); (2) the NYSE Request for Comment (Exhibit 2A); (3) the Comment

Letters in Response to the Request for Comment (Exhibit 2B); and (4)

the Report of the NYSE Task Force (Exhibit 2C). The public file may

also be inspected at the principal office of the NYSE.

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A Stockholder Approval Policy Task Force (``Task Force'') was

subsequently established to review the comments and to make

recommendations concerning possible changes to the Policy. The Task

Force was composed of representatives of the Exchange's Legal Advisory

Committee, Individual Investor Committee, Pension Manager Advisory

Committee, and Listed Company Advisory Committee. In addition, member

of other Exchange constituencies, including the Council of

Institutional Investors, were represented on the Task Force.

Following its deliberations, the Task Force recommended that

certain changes be made to the definition of a ``broadly-based''

Plan.\12\ In addition, the Task Force recommended that the Exchange

actively consider setting an overall dilution maximum for all non-tax

qualified Plans that otherwise would be exempt from shareholder

approval requirements. The Task Force recommended that the Exchange

direct it or another appropriate group to immediately consider this

issue with a target date of the NYSE's September 1999 Board meeting.

The Task Force further stated that the goal should be to complete this

study in time for Exchange review prior to the year 2000 proxy

statement season.

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\12\ See Report of the Special Task Force on Stockholder

Approval Policy.

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This proposed rule change implements the first three Task Force

recommendations to change the existing rule.\13\ The proposed rule

change amends the definition of what constitutes a ``broadly-based''

Plan and adds some general language concerning approval of Plans under

the Policy. In addition, in its filing, the Exchange stated that it had

adopted the Task Force's final recommendation and had convened a new

task force (``Dilution Task Force'') to consider a possible listing

standard that would include a dilution test.

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\13\ Id.

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III. Description of Proposal

The proposed rule change amends the definition of ``broadly-based''

which is used to determine whether a Plan is exempt from shareholder

approval. 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 \14\ are eligible to

participate under the Plan; and (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 \15\ who are not officers or directors of

the issuer.\16\ The new definition is an exclusive test, not a safe

harbor as in the current rule.

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\14\ See 29 U.S.C. 213(a) for the definition of ``exempt''

employees.

\15\ In Amendment No. 1, the Exchange explained that the

proposed definition of ``broadly-based'' would be a two-part test.

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. According to

the NYSE, the Task Force recommended limiting this prong of the

definition to ``exempt employees'' because non-exempt employees are

often 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 the Plan be awarded to employees who are

not officers or directors. This part of the test is not limited to

``exempt'' employees, allowing the calculation of the ``majority of

shares awarded'' to include both ``exempt'' and non-exempt employees

who are not officers or directors. According to the NYSE, 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.

\16\ In this regard, the Exchange proposes to use the definition

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

17 CFR 240.16a-1(f).

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The proposed rule change also expresses the Exchange's general

policy towards Plans. The Exchange recognized the increased use of

Plans by companies and expressed its view that companies should

consider submitting Plans to shareholders, whether or not required

under the Exchange's Policy.

In its filing, the Exchange stated that the proposed changed blend

tests based both on Plan eligibility and awards. Furthermore, the

Exchange expects that the proposed rule change will provide certainty

because it is an exclusive test applicable to all Plans and because it

adopts the Commission's definition of ``officer.'' \17\

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\17\ See supra note 16.

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IV. Summary of Comments

The Commission received 19 comments on the proposed rule

change.\18\ Of the 19 comment letters, 13 letters opposed the proposed

rule change,\19\ three comment letters offered qualified support for

the proposal,\20\ one comment letter supported the proposed rule

change,\21\ and one comment requested an extension of the comment

period.\22\ One letter did not address the issues raised in the

proposed rule change.\23\

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\18\ See supra note 6.

\19\ See letters from State of Wisconsin Investment Board; Lens

Investment Management; CII-I; Institutional Shareholder Services;

Proxy Monitor; Proxy Voter Services; Barclays Global Investors;

Maine State Retirement System; Marco Consulting Group; AFL-CIO;

Teamsters; Hermes Investment Management; and CII-II.

\20\ See letters from Sanford C. Bernstein; NY State Teachers'

Retirement System; and Cal PERS. Cal PERS, while not specifically

addressing the substance of the proposed amendments, suggested that

they should only be approved for one year while a dilution test is

developed. As discussed below, Cal PERS also supported disclosure.

\21\ See letter from Investment Company Institute urging

adoption of the proposed rule change and stating that the proposed

definition addresses many of their previouis concerns with the

existing rule.

\22\ See CII Comment Period Extension Request letter. This

letter did not address the proposed rule change's substantive

issues.

\23\ See letter from Mr. Del Nou. Mr. Del Nou's letter requested

that shareholders be offered stock options and raised purported

constitutional issues regarding shareholder voting rights.

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These comment letters raised a number of concerns regarding the

amendment to the Policy. The Exchange submitted a written response to

the issues raised in the comment letters in Amendment No. 2.\24\ The

following discussion summarizes the issues raised by the commenters and

the Exchange's response.

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\24\ See supra note 7.

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A. Dilution

A majority of the comment letters expressed concern over the lack

of a dilution test.\25\ Dilution refers to the diminished value of a

shareholder's investment that can occur when stock options are granted.

These commenters believe that the expanded definition of ``broadly-

based'' Plans will essentially permit unlimited dilution to occur and

[[Page 31669]]

allow unlimited amounts of equity to be given to Plan participants

without share holder approval.\26\ Many of these commenters questioned

why any Plan that has a dilutive effect on a shareholder's investment

should be exempt from a shareholder vote. For example, one commenter

observed that shareholders are concerned with the cost of equity-based

Plans and not the business decision of who can (or does) receive

equity-based compensation.\27\ Another commenter suggested that the

grant of stock options may also have the effect of a stealth hostile

takeover from within the company be diluting shareholders' voting

power.\28\ Several commenters stated that the definition of ``broadly-

based'' Plans should only be adopted in conjunction with adoption of a

dilution test and were opposed to the NYSE's decision to consider a

dilution test at a later date.\29\ Other commenters believe there

should be no exemption for ``boardly-based'' Plans and that a dilution

commenters believe there should be no exemption for ``broadly-based''

Plans and that a dilution test should be the sole standard.\30\

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\25\ See letters from State of Wisconsin Investment Board; Lens

Investment Management; CII-I; Institutional Shareholder Services;

Proxy Monitor; Barclays Global Investors; Sanford C. Bernstein;

Maine State Retirement System; NY State Teachers' Retirement System;

Cal PERS; AFL-CIO; Investment Company Institute Hermes Investment

Investment Management; and CII-II.

\26\ See letters from State of Wisconsin Investment Board; Lens

Investment Management; Institutional Shareholder Services; Proxy

Monitor; Cal PERS; Hermes Investment Investment Management; and CII-

II.

\27\ See letter from Institutional Shareholder Services.

\28\ See letter from Lens Investment Management.

\29\ See, e.g., letters from Lens Investment Management stating

that ``under no circumstances should the Exchange be permitted to

bifurcate the rulemaking in this way'' and letter from Institutional

Shareholder Services stating that ``the proposed listing standard,

absent a meaningful ``dilution'' test, is fundamently flawed.'' See

also letter from State of Wisconsin Investment Board; and CII-II.

\30\ See letters from State of Wisconsin Investment Board;

Barclays Global Investors; Sanford C. Bernstein; Maine State

Retirement System; Marco Consulting Group; and Hermes Investment

Management.

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In Amendment No. 2, the Exchange responded to the comments on

dilution. The Exchange stated that while it agrees that it is

appropriate to consider a dilution test and is committed to doing so, a

dilution test raises numerous policy issues that it was unable to

consider in time for the 1999 proxy season. Moreover, the Exchange did

not originally seek comment on this issue in the Request for Comment.

The Exchange further expressed its commitment to review this issue by

amending its proposal to be effective only until September 30, 2000.

The Exchange stated that while it expects to propose a dilution test to

replace the revised stockholder approval test in advance of the year

2000 proxy season, it proposes to make the current changes to the

``broadly-based'' test effective through the 2000 proxy season in the

event there is any unforseen delay in this schedule.

B. Conflict of Interest

Another area of concern for commenters was the apparent conflict of

interest of officers and directors.\31\ The commenters remarked on the

inherent conflict of interest that arises because officers and

directors themselves benefit from the Plans they cause a company to

establish without shareholder approval and oversight. The comment

letters expressed concern over the removal of shareholder oversight and

suggested that where officers and directors are allowed to participate

in a Plan, the Plan should not be allowed to be considered ``broadly-

based.'' \32\

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\31\ See letters from Lens Investment Management; CII-I; Proxy

Voter Services; Sanford C. Bernstein; NY State Teachers' Retirement

System; Cal PERS; Teamsters; and Hermes Investment Management. See

also letter from AFL-CIO, which was concerned about Plans that allow

board member participation.

\32\ See letter from Proxy Voter Services. See also letter from

Cal PERS stating that ``to the extent those who participate in the

decision to approve a plan also may personally benefit from it, and

obvious conflict of interest exists.''

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The Exchange contends that ``broadly-based'' Plans have long been

exempt from shareholder approval requirements. The Exchange explained

that the ``broadly-based'' exemption originally was adopted

requirements. The Exchange explained that the ``broadly-based''

exemption originally was adopted because the NYSE believed that any

potential concerns regarding preferential treatment of officers or

directors would be mitigated if a Plan was boardly available to a

company's employees. The Exchange, however, did reiterate its plan to

examine whether to continue to rely on the concept of ``broadly-based''

Plans as a basis for exemption from the shareholder approval

requirement or whether to abandon that standard in a favor of a

dilution test.

C. The Use of an ``Exempt'' Employee Test

Several commenters expressed concerns about the proposed

eligibility standard in the proposed rule.\33\ As discussed above, the

eligibility standard provides that in determining if a Plan is

``broadly-based,'' the Exchange will look at the number of ``exempt''

employees eligible to participate in the Plan. The term ``exempt''

employee is based upon the definition found in the Fair Labor Standards

Act of 1934.\34\ The commenters believe that limiting the eligibility

requirement to require only a majority of a company's full-time

``exempt'' employees could potentially exclude a majority of a

company's workforce. Many of the commenters quoted Department of Labor

statistics showing that only about 25 percent of the overall U.S.

workforce is classified as ``exempt.'' \35\ According to these figures,

on average, only 12.5 percent of a company's workforce would need to be

eligible to participate for a Plan to be considered ``broadly-based''

under the NYSE proposed rule--and thus avoid a shareholder vote.\36\

Several of these commenters also expressed concern over excluding low

level workers from eligibility because they believed the proposed rule

change could be interpreted as a disincentive to grant non-exempt

employees stock options, or conversely as an incentive to make stock

options available only to a privileged few.\37\ Finally, commenters

asserted that the NYSE's rationale for excluding non-exempt employees

because they are covered by other compensation arrangements is not

correct.\38\

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\33\ See letters from Lens Investment Management; CII-I;

Institutional Shareholder Services; Proxy Voter Services; AFL-CIO;

Marco Consulting Group; and Teamsters.

\34\ See supra note 14.

\35\ See letter from CII-I; Institutional Shareholder Services;

Proxy Voter Services; AFL-CIO; and Marco Consulting Group.

\36\ For example, the AFL-CIO stated that the ``definition

effectively assures that ``broadly-based' plans will not be truly

`broadly-based.' ''

\37\ See letters from Proxy Voter Services; AFL-CIO; and

Teamsters.

\38\ See letters from Proxy Voter Services; and AFL-CIO. In

their letter, Proxy Voter Services stated that ``a growing number of

companies include grant options and other types of stock awards to

`non-exempt' employees as part of their total compensation

packages.''

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In response, the Exchange states that it continues to believe that

limiting the proposal to ``exempt'' employees is appropriate. NYSE

states that the Task Force, which included representatives of listed

companies, leading investor groups, and institutional investors,

unanimously proposed the ``exempt'' employee distinction. The Task

Force believed that stock options are primarily used to compensate

``exempt'' employees. Moreover, the Task Force expressed its belief

that non-exempt employees generally seek other forms of compensation or

benefits, such as cash, medical benefits, or retirement packages. The

NYSE notes that the Task Force was aware that some parties thought that

limiting this prong of the test to ``exempt'' employees was too narrow.

Despite these contentions, the Task Force unanimously accepted the

``exempt'' employee distinction.

The Task Force's recommendations were further reviewed and

considered by the Exchange's Board. In approving the proposal, the

Board accepted the Task Force's recommendation and also

[[Page 31670]]

endorsed limiting the test to ``exempt'' employees. According to the

NYSE, the Board expressed its concern that not limiting the test to

``exempt'' employees could result in companies structuring their

compensation programs to offer non-exempt employees stock options

instead of other benefits that may be preferred by those employees

simply to comply with the Exchange's shareholder approval policy, and

not because it was an appropriate compensation policy. The Board

believed that management should establish compensation policies based

on what management believes is best for its company.

D. Participation Test

One commenter supported the participation prong of the proposed

rule change.\39\ The commenter stated that, by requiring review of

awards granted during the first three years of a Plan, the Exchange

recognized the importance of implementing a Plan in a truly ``broadly-

based'' fashion.

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\39\ See letter from Investment Company Institute.

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Three commenters argued that the participation prong of the

``broadly-based'' test does not sufficiently prevent companies from

granting a majority of options awarded under a Plan to executives after

the three-year time period.\40\ These commenters pointed out that a

company could reserve a majority of shares to be awarded under a Plan

and grant them to officers and directors after the three-year time

period had elapsed.\41\ Moreover, a company could either grant no

awards during the initial time period or only a nominal amount and then

make the remaining grants to executives after the three-year time

period expires. In either of these scenarios, the commenters noted, the

company would be in compliance with the proposed rule although

shareholders would not have been provided the opportunity to approve

the awards to executives. To resolve this, one commenter recommended

limiting Plans to three years.\42\ Another commenter suggested changing

the test so that a majority of the shares must be awarded to

nonofficers and directors over the entire life of the Plan or over a

rolling three-year period.\43\

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\40\ See letters from Institutional Shareholder Services; Marco

Consulting Group; and NY State Teachers' Retirement System.

\41\ See, e.g., letter from Marco Consulting Group, which stated

that most stock option Plans last for 10 years.

\42\ See letter from NY State Teachers' Retirement System.

\43\ See letter from Institutional Shareholder Services.

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The Exchange recognizes that the three-year test could, in theory,

allow a company to administer a Plan in a non-broadly-based manner

after the initial three years. The Exchange stated, however, that it

anticipates that companies will act in good faith, and it has no reason

to believe that companies will drastically change their compensation

policies in the later years of a Plan.

According to the Exchange, the Task Force specifically considered

this issue and determined that if a Plan is to be exempt from

shareholder approval, it is critical not only to require a broad group

of employee eligibility, but also to require that a company administer

a Plan in a ``broadly-based'' manner. However, when considering how to

best measure a company's administration of a Plan, the Task Force

decided that a three-year period was realistic. The Exchange expressed

the Task Force's concern that imposing a one-year test could result in

companies structuring their Plans to comply with Exchange rules instead

of promoting sound compensation policies. For these reasons, the NYSE

determined that the Task Force recommendation was reasonable,

recognizing that is was a package of compromises, and that the Exchange

needed to consider this recommendation in the context of the full Task

Force report. Moreover, the Exchange noted that this issue may well be

moot if the Exchange later implements a dilution test.\44\

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\44\ Plans approved under the rules approved today, however,

will continue to be subject to the participation test. If a Plan is

not administered in a ``broadly-based'' fashion during the first

three years, shareholder approval will be required for any shares

that the company later seeks to add to the Plan. The Exchange will

review all listing applications seeking to add additional shares to

any Plan approved under the rules approved today. Telephone call

between Steven Walsh, NYSE, Michael Simon, Milbank, Tweed, Hadley &

McCloy, and Kelly McCormick, SEC, on March 30, 1999.

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E. Disclosure

Seven commenters requested that the Commission require full

disclosure to shareholders of all Plans implemented without shareholder

approval.\45\ One commenter observed that shareholders have diminished

access to important information regarding issues that are not approved

by shareholder votes.\46\

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\45\ See letters from State of Wisconsin Investment Board; Lens

Investment Management; CII-I; NY State Teachers' Retirement System;

Cal PERS; Teamsters; and Hermes Investment Management; and CII-II.

\46\ See letter from Teamsters.

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F. Other Issues \47\

Three commenters suggested that the Commission should decide the

issues on which shareholders can vote because of the competition

between exchanges is gaining listed companies.\48\ One commenter

suggested that a uniform standard be applied to all exchanges to

safeguard shareholder interests in this area.\49\ Finally, several

commenters argued that all Plans should be subject to shareholder

approval.\50\

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\47\ One comment letter, Sanford C. Bernstein, addressed

concerns regarding key employee Plans (i.e., non-broadly-based Plans

that (a) provide that no single officer or director may acquire more

than 1 percent of the issuer's common stock and (b) together with

all non-broadly-based Plans of the issuer, do not authorize the

issuance of more than 5 percent of the issuer's common stock at the

time the Plan is adopted. The key employee exemptions were at issue

in the Original Proposal and were not considered or amended in the

current proposed rule change.

\48\ See letters from CII-I; AFL-CIO and Cal PERS.

\49\ See letter from Cal PERS, which argues that shareholder

voting is a national issue and ``urges the Commission to take steps

necessary to ensure that a uniform standard is applied to safeguard

shareholders' interests in this area.'' See also letter from CII-II.

\50\ See letters from State of Wisconsin Investment Board;

Barclays Global Investors; Sanford C. Bernstein; Maine State

Retirement System; Marco Consulting Group; and Hermes Investment

Management. In addition, Lens Investment Management asserted that

the Exchange had not adequately justified the exemption for

``broadly-based'' Plans.

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One commenter supported the proposed rule change as an exclusive

test, rather than a non-exclusive safe harbor as under the existing

rule.\51\ This commenter believed it should ensure shareholder

protection and provide greater certainty to the process.

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\51\ See letter from investment Company Institute.

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V. Discussion

After careful review, the Commission finds that the proposed rule

change is consistent with the requirements of the Act and the rules and

regulations thereunder applicable to a national securities

exchange.\52\ In particular, the Commission believes the proposal is

consistent with the requirement of section 6(b)(5) of the Act.\53\

Section 6(b)(5) requires, among other things, that the rules of an

exchange be designed to prevent fraudulent and manipulative acts and

practices, to promote just and equitable principles of trade, and, in

general, to protect investors and the public interest, and not be

designed to permit unfair discrimination between issuers.

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\52\ In reviewing this proposal, the Commission has considered

its impact on efficiency, competition, and capital formation. 15

U.S.C. 78c(f).

\53\ 15 U.S.C. 78f(b)(5).

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The Commission has carefully considered the proposed rule change

and believes the amended proposed rule change to be consistent with the

requirements of the Act. In approving the proposal, the Commission

recognizes that the majority of the

[[Page 31671]]

commenters opposed the proposal and believed a dilution standard would

be more appropriate. Nevertheless, the Commission believes that, by

including a specific test to ensure that Plans are actually implemented

in a ``broadly-based'' fashion, the proposed rule change is an

improvement over the existing rule. Moreover, the proposed rule change

amends the definition of ``broadly-based'' by making it an exclusive

test instead of the current non-exclusive safe harbor. By providing

issuers with an exclusive rule, all Plans reviewed by the Exchange will

be subject to the same standards. This standardization of review should

enable issuers to more easily comply with the Exchange's listing

standards and prevent uneven application of the rule. Accordingly, this

aspect of the proposed rule will help to ensure that, consistent with

the Act, the rule is not designed to permit unfair discrimination among

issuers.

The Commission is approving the rule change on a pilot basis until

September 30, 2000 in order to give the NYSE time to develop a dilution

test. Based on the task force's recommendations, the Exchange has

established the Dilution Task Force to study the dilution issue and has

stated that it currently expects to propose a dilution test to replace

the revised ``broadly-based'' test by the year 2000 proxy season.\54\

Accordingly, the Commission is satisfied, for the reasons discussed

more fully below, that the proposed rule change should address concerns

raised by commenters to the Original Proposal, while also satisfying

the requirements of section 6(b)(5) of the Act.\55\

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\54\ Because there may be slippage in its schedule, the Exchange

is proposing to extend the pilot through the year 2000 proxy season.

\55\ The Commission notes that under Section 19(b)(2) of the

Act, the Commission must approve a proposed rule change of a self-

regulatory organization if it finds that such proposed rule change

is consistent with the requirements of the Act and the rules

thereunder. The Commission must disapprove a proposed rule change

only if it does not make such a finding. The Commission's standard

of review for the proposed rule changes of self-regulatory

organizations is determined by, among other things, Section 6(b) of

the Act.

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A. Conflict of Interest

A number of the commenters raised concerns about exempting from

shareholder approval any Plan in which officers and directors can

participate, because of the apparent conflict of interest. Upon careful

review, however, the Commission is satisfied that this aspect of the

proposed rule change is consistent with the requirements of section

6(b)(5) of the Act for the reasons discussed below.

NYSE current rules and proposed rules will continue to require

shareholders to vote on Plans pursuant to which officers and directors

may acquire stock unless a Plan meets one of four exemptions set forth

in the NYSE Manual.\56\ As noted by the Exchange, one of these

exemptions, the ``broadly-based'' exemption, has been recognized by the

Exchange for many years and was implemented because of the belief that

Plans available to a broad group of employees would alleviate concerns

that the Plan could give preferential treatment to officers and

directors. The Commission believes that it is reasonable for the NYSE

to determine that Plans that are ``broad-based'' should be eligible for

the exemption even though officers and directors may participate in the

Plan because Plans that are truly ``broadly-based'' should provide

sufficient protection to shareholders from officer and director

conflicts of interest and self-dealing.

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\56\ See NYSE Manual Paragraph 312.03.

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While the NYSE could decide to eliminate the ``broadly-based''

exemption, the Act does not dictate how a self-regulatory organization

should regulate in this area. Rather, the Commission must find that a

self-regulatory organization's proposed rules are consistent with the

Act before they can be adopted.\57\ The Commission believes that the

rationale behind the ``broadly-based'' exemption is sound and will

protect investors from self-dealing by officers and directors,

consistent with the requirements of section 6(b)(5) of the Act.

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\57\ See supra note 55.

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B. Definition of ``Broadly-Based''

The proposal defines a ``broadly-based'' Plan as one in which at

least a majority of the issuer's full-time ``exempt'' employees are

eligible to participate.\58\ In contrast, the current definition

provides that a Plan would be considered ``broadly-based'' if at least

20 percent of all of a company's employees are eligible to receive

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

neither officers nor directors. In other words, the proposal limits the

eligibility prong of the test to ``exempt'' employees while the current

rule does not. Some comment letters suggested that the proposal

unfairly limits the number and classification of employees eligible to

participate in a Plan. Several commenters also were critical of

limiting the eligibility prong to ``exempt'' employees because this

excludes a large part of the workforce and could result in companies

not offering such Plans to low level workers.

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\58\ See supra notes 14 and 15.

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Upon review, however, the Commission notes that the proposal is not

a significant change from the current approved standards. The current

rule requires that 20 percent of a company's workforce be eligible, but

only requires that 10 percent of those eligible be non-officers and

directors. The proposed rule change requires that at least half of an

issuer's full-time ``exempt'' workforce be eligible to participate. A

number of comment letters cited to Department of Labor statistics,

which state that 25 percent of the U.S. workforce is exempt. If this

number is correct, the majority of employees eligible to participate

should be approximately 12.5 percent, on average, which could result in

a slight increase in required eligibility over the current rule.

Although it is difficult to precisely compare these two measures, on

the whole, the number of eligible employees measured to determine if a

Plan is ``broadly-based'' under the proposed rule change is not

significantly different from the existing approved rule. Accordingly,

limiting eligibility to ``exempt'' employees does not appear to

significantly alter the number of employees currently being offered

participation in a Plan.

Several factors also minimize concerns about the eligibility prong

of the proposed test. First, the Commission notes that nothing in the

NYSE rules prevents companies from offering a Plan to more than

``exempt'' employees. The eligibility prong is the minimum required for

a Plan to be eligible for the ``broadly-based'' exemption. Second,

companies currently offering Plans to all employees except officers and

directors already are not required to submit these Plans to a

shareholder vote. The Commission believes it is unlikely that companies

will change these Plans to comply with the minimum requirements of the

rules approved today. Finally, the Commission notes that certain

companies may need to expand the base of employees eligible for a Plan

in order to meet the participation prong of the ``broadly-based''

definition. Thus, the proposed change to the eligibility prong appears

to include a reasonable number of employees eligible to participate in

Plans which should help to protect investors, pursuant to section

6(b)(5) of the Act.

The participation prong of the ``broadly-based'' definition

requires that at least a majority of the shares awarded under a Plan

during the shorter of the three-year period commencing on the Plan

adoption date or the term of the

[[Page 31672]]

Plan be made to employees who are not officers or directors of the

issuer. In contrast, the current rule does not have any requirements

regarding actual awards or grants under a Plan. The Commission believes

that this portion of the proposal should help to ensure that Plans are

``broadly-based.'' To comply with the participation prong of the test,

companies will need to monitor the awards granted to officers and

directors under ``broadly-based'' Plans to ensure that officers and

directors are not the primary recipients of such awards. Participation

under ``broadly-based'' Plans also will be monitored by the Exchange to

ensure compliance with the Exchange rules.\59\ This should provide

protection to investors, consistent with section 6(b)(5) of the Act, by

ensuring that companies do not take advantage of the exemption by

merely allowing non-executives to be eligible for awards under Plans

without actually granting them awards.

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\59\ See supra note 44.

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While the participation prong is an improvement over the current

rule in that it requires that Plans actually be administered in a

``broadly-based'' manner, the Commission recognizes that, as proposed,

the participation requirement will only apply for the first three years

of a Plan (or the term of the Plan if it is shorter than three years).

Accordingly, as some commenters argued, for Plans that are longer than

three years, companies could nominally comply with the participation

requirement by granting no, or a small amount of, awards during the

first three years of the Plan to non-executives and reserve the

majority of shares to be awarded to officers and directors after the

three years have elapsed.

In response to these concerns, the NYSE stated that it recognized

that ``in theory a company could administer a Plan in a non-broadly

based manner.'' \60\ Nevertheless, the NYSE stated that it expects

companies to act in good faith and has no reason to believe that a

company will drastically change its compensation policy in later years

of a Plan. The Commission agrees with the NYSE but expects the NYSE to

monitor whether companies are continuing to administer Plans in a

``broadly-based'' manner after the initial three-year period to

determine if changes need to be made to the participation prong of the

test. While the Commission recognizes that the NYSE is working on a

dilution standard that may replace the ``broadly-based'' standard by

the next proxy season, the NYSE should monitor and notify those

companies that are subject to this rule if it believes that they are

not complying with the spirit of the rule by delaying actual awards

under a Plan until the three-year period has expired.

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\60\ See Amendment No. 2, supra note 7.

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If the NYSE proposes to retain the participation prong of the

``broadly-based'' test long with a dilution standard, the Commission

requests further information on actual awards made by issuers to comply

with the participation prong. The NYSE also should address whether the

development of a rolling three-year period would give companies the

flexibility they need to make awards under Plans while at the same time

ensuring that Plans are administered in a ``broadly-based'' manner or

some other alternative to address the concerns discussed above. In

approving the participation prong with the three-year limit, the

Commission has considered the need to provide companies with

flexibility in administering awards under the Plan. The Commission

believes that the sixteenth-month pilot period, along with the NYSE's

monitoring of Plans complying with the ``broadly-based'' exemption,

should help to ensure that any necessary changes will be made to the

rule if companies violate the spirit of the rule by offering a majority

of shares to offices and directors after the three-year period has

lapsed.

C. Dilution Standard and Pilot

The Exchange has committed to study a dilution standard for

determining when shareholder approval is necessary for Plans. As noted

above, a substantial majority of comments expressed concern about the

potential dilution of shareholder's equity upon the grant of stock

options under a Plan. These commenters were generally critical of the

NYSE's decision to consider dilution at a later date. While some of

these commenters believed that a dilution test should replace the

``broadly-based'' exemption immediately, other believed the definition

of ``broadly-based'' Plans should only be adopted along with a dilution

test.

While the majority of commenters believe that dilution is a

preferable standard over the current proposal, the Commission's

standards for reviewing the NYSE's proposal is whether it is consistent

with the Act. For the reasons discussed above, the Commission believes

that, until such time as a dilution standard is developed, the proposal

is a reasonable effort to clarify which Plans are ``broadly-based'' and

therefore except from shareholder approval. Accordingly, the adoption

of he proposed rule for the pilot period should protect investors in

accordance with section 6(b)(5) of the Act by helping to ensure that

only ``broadly-based'' Plans will be exempted from shareholder

approval. In making this finding, as noted above, the Commission does

have some questions about how certain portions of the two prong test

will be implemented. The pilot period should provide the NYSE with

necessary time to monitor the changes approved today and to address

these questions if the NYSE determines that the ``broadly-based'' test

should continue to be applied together with a dilution standard.\61\

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\61\ We note that nay extension of the current proposal would

have to be approved by the Commission pursuant to Section 19(b)(2)

of the Act. Of course, as detailed above, NYSE has indicated its

intention to submit a proposal, pursuant to Section 19(b)(2) of the

Act, to replace or supplement the pilot with a dilution standard.

See infra note 62.

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The pilot period also should provide the NYSE with the necessary

time to formulate a dilution standard. We note that one commenter

suggested a one-year pilot and another commenter was critical of the

proposed sixth-month sunset provisions, suggesting that it would unduly

delay the adoption of a dilution standard.

The Commission believes, however, that it is appropriate to approve

the proposed rule so that it is effective until September 30, 2000. The

NYSE has shown its commitment to be responsive to the comments on

dilution by immediately establishing the Dilution Task Force to

consider this issue. The NYSE represents that it intends to consider

adopting a dilution standard to be place prior to he next proxy season

in the year 2000. Because the Commission recognizes that matters

involving shareholder voting rights are extremely important and involve

a wide variety of interested parties, the Commission believes that

adoption of the proposed rule change until September 30, 2000 will

ensure that the NYSE is given adequate time to consider and implement

and alternative to the proposal. Further this schedule would not

prevent the NYSE from replacing the proposal being approved today with

a dilution standard prior to the pilot's expiration, assuming

Commission approval pursuant to section 19(b) of the Act.\62\

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\62\ We note that the Commission would expeditiously publish for

comment and review any proposal submitted by the NYSE to adopt a

dilution standard so that such a standard could be put in place as

soon as possible.

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Finally, we note that several commenters stated that disclosure of

Plans adopted without shareholder

[[Page 31673]]

approval should be required. The Division of Corporation Finance is

presently reviewing Commission rules requiring disclosure of executive

and director compensation (Item 402 of Regulations S-K; Item 10 of

Schedule 14A) and director and director nominee qualifications and

relationships (Items 401 and 404 of Regulation S-K), with a view toward

determining whether to recommend changes to the Commission. One of the

issues to be examined is the extent to which additional disclosure

should be provided in registrant filings about non-shareholder approved

Plans.

D. Conclusion

In summary, the Commission believes that the current proposal helps

to address some of the earlier concerns raised by the NYSE's Original

Proposal for determining when a Plan including officers and directors

is ``broadly-based'' enough to be exempt from the shareholder approval

requirements. The Original Proposal merely intended to codify the

NYSE's existing policy interpreting the ``broadly-based'' exemption,

which it had used for many years. While the Original Proposal was

submitted to a full notice and comment period, no comments were

received on the rule prior to its approval. Nevertheless, after

Commission approval of the NYSE's rule, several commenters,

particularly those representing institutional investors, raised

concerns over the Commission's approval process as well as the NYSE's

role in developing its definition of a ``broadly-based'' Plan.

Both the NYSE and the Commission have taken these concerns

seriously. While the Original Proposal provided the NYSE with more

flexibility in determining when a Plan was ``broadly-based'' and

entitled to the exemption, the current proposal has the benefit of

providing a clear bright line test. This should provide benefits to

both investors and issuers consistent with section 6(b)(5) of the Act.

The NYSE has indicated its strong commitment to develop a dilution

standard that potentially could replace the current proposal by the

next proxy season. The Commission requests that any proposal by the

NYSE to adopt a dilution standard be submitted to the Commission by

October 15, 1999. This should provide the Commission with sufficient

time to review and solicit comment on the proposal prior to the

beginning of the proxy season in 2000. If the NYSE is unable to submit

a proposal by this date, the Exchange must submit a status report by

October 15, 1999 on the NYSE's progress in developing a dilution

standard.\63\

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\63\ The Commission recognizes that the NYSE could decide, as

some commenters suggested, to keep the ``broadly-based'' exemption

in its rules and adopt a dilution standard as part of the test. Any

request by the NYSE to change or extend the standard being adopted

in this order must be submitted to the Commission no later than May

18, 2000 along with a monitoring report about the Plans utilizing

the revised ``broadly-based'' exemption. Any new proposal containing

the new definition approved today should also address the questions

noted above about the three-year limit in the participation prong.

Further, the monitoring report should include, at a minimum,

information on the types and number of employees who are eligible to

participate under a Plan, as well as information concerning actual

awards being made under the Plans.

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The Commission finds good cause to approve Amendment No. 1 to the

proposed rule change prior to the thirtieth day after the date of

publication of notice thereof in the Federal Register. The Exchange

submitted Amendment No. 1 to clarify the use of the ``exempt'' employee

definition in the eligibility prong of the test and not in the

participation prong of the test. As discussed earlier, the Commission

is satisfied that the use of ``exempt'' employees in determining the

level of eligibility does not unfairly exclude a large number of

employees. Because the amendment only serves to clarify and does not

change the meaning or intent of the proposed rule, it does not raise

any new regulatory issues. Therefore, the Commission believes good

cause exists, consistent with section 6(b)(5) \64\ and section 19(b)

\65\ of the Act, to approve Amendment No. 1 to the proposed rule change

on an accelerated basis.

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\64\ 15 U.S.C. 78f(b)(5).

\65\ 15 U.S.C. 78s(b).

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The Commission also finds good cause for approving Amendment No. 2

to the proposed rule change prior to the thirtieth day after the date

of publication of notice thereof in the Federal Register. Amendment No.

2 amends the proposal so that it would be effective for a pilot period

until September 30, 2000. As discussed above, this pilot period seems

reasonable and should provide the NYSE with adequate time to monitor

the rule as well as provide the NYSE with time to develop a dilution

test. Amendment No. 2 does not substantially change the meaning or

intent of the proposed rule change. Because Amendment No. 2 further

explains the Exchange's commitment regarding the development of a

dilution test and raises no new issues or regulatory concern regarding

the proposed rule change, the Commission believes that good cause

exists, consistent with section 6(b)(5) \66\ and section 19(b) \67\ of

the Act, to approve the amendment on an accelerated basis.

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\66\ 15 U.S.C. 78f(b)(5).

\67\ 15 U.S.C. 78s(b).

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VI. Solicitation of Comments

Interested persons are invited to submit written data, views, and

arguments concerning Amendment Nos. 1 and 2, including whether they are

consistent with the Act. Persons making written submissions should file

six copies thereof with the Secretary, Securities and Exchange

Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. 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 at the Commission's

Public Reference Room, 450 Fifth Street, NW., Washington, DC 20549.

Copies of such filings also will 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 July 2,

1999.

VII. Conclusion

It is therefore ordered, pursuant to section 19(b)(2) of the

Act,\68\ that the amended proposed rule change (SR-NYSE-98-32) is

approved on a pilot basis until September 30, 2000.

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\68\ 15 U.S.C. 78s(b)(2).

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\69\

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\69\ 17 CFR 200.30-3(a)(12).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 99-14871 Filed 6-10-99; 8:45 am]

BILLING CODE 8010-01-M