Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the New York Stock Exchange, Inc. Amending Audit Committee Requirements of Listed Companies

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41980; File No. SR-NYSE-99-39]

Self-Regulatory Organizations; Notice of Filing of Proposed Rule

Change by the New York Stock Exchange, Inc. Amending Audit Committee

Requirements of Listed Companies

October 6, 1999.

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

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

that on September 22, 1999, the New York Stock Exchange, Inc.

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

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

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

by the Exchange. The Commission is publishing this notice to solicit

comments on the proposed rule change from interested persons.

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

\2\ 17 CFR 240.19b-4.

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

Substance of the Proposed Rule Change

The Exchange proposes to amend Paragraph 303 of its Listed Company

Manual (the ``Manual''). The rule change amends the Exchange's policy

applicable to audit committee requirements of listed companies. The

text of the proposed rule change is as follows.

NYSE Listed Company Manual

* * * * *

Section 3

Corporate Responsibility

[Section 303.00 is being replaced in its entirety with the following

(except the parenthetical reference to outside directors)]

303.00 Corporate Governance Standards

In addition to the numerical listing standards, the Exchange has

adopted certain corporate governance listing standards. These

standards apply to all companies listing common stock on the

Exchange. However, the Exchange does not apply a particular standard

to a non-U.S. company if the company provides the Exchange with a

written certification from independent counsel of the company's

country of domicile stating that the company's corporate governance

practices comply with home country law and the rules of the

principal securities market for the company's stock outside the

United States.

303.01 Audit Committee

(A) Audit Committee Policy. Each company must have a qualified

audit committee.

(B) Requirements for a Qualified Audit Committee.

(1) Formal Charter. Each audit committee must adopt a formal

written charter that is approved by the Board of Directors. The

audit committee must review and reassess the adequacy of the audit

committee charter on an annual basis. The charter must specify the

following:

(a) The scope of the audit committee's responsibilities and how

it carries out those responsibilities, including structure,

processes and membership requirements;

(b) That the outside auditor for the company is ultimately

accountable to the Board of Directors and audit committee of the

company, that the audit committee and Board of Directors have the

ultimate authority and responsibility to select, evaluate and, where

appropriate, replace the outside auditor (or to nominate the outside

auditor to be proposed for shareholder approval in any proxy

statement); and

(c) That the audit committee is responsible for ensuring that

the outside auditor submits on a periodic basis to the audit

committee a formal written statement delineating all relationships

between the auditor and the company and that the audit committee is

responsible for actively engaging in a dialogue with the outside

auditor with respect to any disclosed relationships or services that

may impact the objectivity and independence of the outside auditor

and for recommending that the Board of Directors take appropriate

action to ensure the independence of the outside auditor.

(2) Composition/Expertise Requirement of Audit Committee

Members.

(a) Each audit committee shall consist of at least three

directors, all of whom have no relationship to the company that may

interfere with the exercise of their independence from management

and the company (``Independent'');

(b) Each member of the audit committee shall be financially

literate, as such qualification is interpreted by the company's

Board of Directors in its business judgment, or must become

financially literate within a

[[Page 55515]]

reasonable period of time after his or her appointment to the audit

committee; and

(c) At least one member of the audit committee must have

accounting or related financial management expertise, as the Board

of Directors interprets such qualification in its business judgment.

(3) Independence Requirement of Audit Committee Members. In

addition to the definition of Independent provided above in (2)(a),

the following restrictions shall apply to every audit committee

member:

(a) Employees. A director who is an employee (including non-

employee executive officers) of the company or any of its affiliates

may not serve on the audit committee until three years following the

termination of his or her employment. In the event the employment

relationship is with a former parent or predecessor of the company,

the director could serve on the audit committee after three years

following the termination of the relationship between the company

and the former parent or predecessor.

(b) Business Relationship. A director (i) who is a partner,

controlling shareholder, or executive officer of an organization

that has a business relationship with the company, or (ii) who has a

direct business relationship with the company (e.g., a consultant)

may serve on the audit committee only if the company's Board of

Directors determines in its business judgment that the relationship

does not interfere with the director's exercise of independent

judgment. In making a determination regarding the independence of a

director pursuant to this paragraph, the Board of Directors should

consider, among other things, the materiality of the relationship to

the company, to the director, and, if applicable, to the

organization with which the director is affiliated.

``Business relationships'' can include commercial, industrial,

banking, consulting, legal, accounting and other relationships. A

director can have this relationship directly with the company, or

the director can be a partner, officer or employee of an

organization that has such a relationship. The director may serve on

the audit committee without the above-referenced Board of Directors'

determination after three years following the termination of, as

applicable, either (1) the relationship between the organization

with which the director is affiliated and the company, (2) the

relationship between the director and his or her partnership status,

shareholder interest or executive officer position, or (3) the

direct business relationship between the director and the company.

(c) Cross Compensation Committee Link. A director who is

employed as an executive of another corporation where any of the

company's executives serves on that corporation's compensation

committee may not serve on the audit committee.

(d) Immediate Family. A director who is an Immediate Family

member of an individual who is an executive office of the company or

any of its affiliates cannot serve on the audit committee until

three years following the termination of such employment

relationship. See para. 303.02 for definition of ``Immediate

Family.''

303.02 Application of Standards

(A) ``Immediate Family'' includes a person's spouse, parents,

children, siblings, mothers-in-law and fathers-in-law, sons and

daughters-in-law, brothers and sisters-in-law, and anyone (other

than employees) who shares person's home.

(B) ``Affiliate'' includes a subsidiary, sibling company,

predecessor, parent company, or former parent company.

(C) Written Affirmation. As part of the initial listing process,

and with respect to any subsequent changes to the composition of the

audit committee, and otherwise approximately once each year, each

company should provide the Exchange written confirmation regarding:

(1) Any determination that the company's Board of Directors has

made regarding the independence of directors pursuant to any of the

subparagraphs above;

(2) The financial literacy of the audit committee members;

(3) The determination that at least one of the audit committee

members has accounting or related financial management expertise;

and

(4) The annual review and reassessment of the adequacy of the

audit committee charter.

(D) Independence Requirement of Audit Committee Members.

Notwithstanding the requirements of subparagraphs (3)(a) and (3)(d)

of para. 303.01, one director who is no longer an employee or who is

an Immediate Family member of a former executive officer of the

company or its affiliates, but is not considered independent

pursuant to these provisions due to the three-year restriction

period, may be appointed, under exceptional and limited

circumstances, to the audit committee if the company's board of

directors determines in its business judgment that membership on the

committee by the individual is required by the best interests of the

corporation and its shareholders, and the company discloses, in the

next annual proxy statement subsequent to such determination, the

nature of the relationship and the reasons for that determination.

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

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

statements.

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

Statutory Basis for, the Proposed Rule Change

1. Purpose

In September 1998, the Blue Ribbon Committee on Improving the

Effectiveness of Corporate Audit Committees (``BRC'') was formed. The

BRC solicited public comments on possible recommendations in November

of the same year. The comment period expired December 1, 1998, and

earlier this year the BRC compiled and published a report that

contained ten specific recommendations (``Recommendations'') to the

Exchange, the National Association of Securities Dealers (``NASD''),

the Commission, and the accounting profession.

The Exchange distributed to its listed companies copies of the

report issued by the BRC. For several months, NYSE staff worked with

listed companies and constituent committees on their comments and views

on the Recommendations. Most of the issues raised during this working

period addressed the four Recommendations made to the Commission and

the accounting profession.

On June 3, 1998, the Exchange Board reviewed the suggested rule

changes and authorized the Exchange staff to distribute to its listed

companies the Exchange staff's suggestions for rule changes in response

to the Recommendations. The comments from the Exchange's listed

companies were generally supportive of the suggestions put forth by the

Exchange, with limited concerns addressing the concept of ``financial

literacy.'' Furthermore, during that time period, the Exchange staff

met with staff at the Commission and the NASD regarding uniformity

among the markets in standards governing issuer audit committees.

As a result of comments from the issuers ad conversations with

staff at the Commission and the NASD, the Exchange slightly modified

the proposed audit committee requirements and obtained Board approval

on September 2, 1999 to file the proposed rule change with the

Commission. The Exchange proposes to revise Paragraph 303 of the

Manual. The proposed rule change specifies four requirements for a

qualified audit committee and defines the terms ``Immediate Family''

and ``Affiliate'' for purposes of the proposed audit committee

requirements.

Audit Committee Requirements:

1. Formal Charter: The Exchange proposes to adopt the

Recommendations to require audit committees to adopt a formal written

charter that is approved

[[Page 55516]]

by the company's board and to review and reassess annually the adequacy

of the charter. In addition, the charter must specify: (a) The scope of

the audit committee's responsibilities and how they are being carried

out, (b) the ultimate accountability of the outside auditor to the

board and audit committee, (c) the responsibility of the audit

committee and board for selection, evaluation and replacement of the

outside auditor, and (d) the responsibility of the audit committee for

ensuring the independence of the outside auditor by reviewing, and

discussing with the board if necessary, any relationships between the

auditor and the company or any other relationships that may adversely

affect the independence of the auditor.

2. Composition/Expertise Requirement of Audit Committee Members:

Three requirements suggested by the BRC, with one slight modification

from the Recommendations as noted below, are part of the proposed rule

change:

(a) Each audit committee must have at least three Independent

directors, as described in item 3 below, subject to a board

``override'' for one director. The ``override'' may be exercised by the

board in the event that it determines in its business judgment that a

director who is no longer an Employee of the company or its affiliates,

or who is an Immediate Family member of a former executive officer of

the company or its affiliates, but is otherwise not eligible due to the

three-year bar, should serve on the audit committee because such

service is required in the best interests of the corporation and its

shareholders. In exercising such discretion, the company would be

required to disclose in its next annual proxy statement the nature of

the relationship and the reasons for that determination. The Exchange

notes that the BRC suggested that the ``override'' provision apply to

all four restrictions regarding Independence; however, the Exchange

proposes to limit it to the two instances referenced above, and to

codify its existing interpretations and policies with respect to

analysis of business relationships between organizations and directors.

The Exchange further believes that the potential conflicts presented by

the cross-compensation committee link are such that it should not be a

subject of board override.

(b) Each audit committee member must be financially literate, as

such qualification is interpreted by the company's board in its

business judgment, or must shortly attain such status.

(c) At least one member of each audit committee must have

accounting or related financial management expertise, as the company's

board interprets such qualification in its business judgment.

3. Independence: In keeping with the spirit of the Recommendations,

the following restrictions will apply to each audit committee member

for the purpose of determining such member's Independence:

(a) Employees. Employees (including non-employee executive

officers) of the company or its affiliates may not serve on the audit

committee until three years following the termination of such

employment. However, if such relationship is with a former parent or

predecessor of the company (see definition of Affiliate described in

item 4 below), the three-year bar applies to the time period following

the severance of the relationship between the company and the former

parent or predecessor.

(b) Business Relationship. A director (i) who is a partner,

controlling shareholder, or executive officer of an organization that

has a business relationship with the company, or (ii) who has a direct

business relationship with the company (e.g., a consultant), may serve

on the audit committee only if the company's board determines in its

business judgment that the relationship does not interfere with the

director's exercise of independent judgment. ``Business relationships''

can include commercial, industrial, banking, consulting, legal,

accounting and other relationships. A director can have this

relationship directly with the company, or the director can be a

partner, officer or employee of an organization that has such a

relationship. The director may serve on the audit committee without the

above-referenced board determination after three years following the

termination of, as applicable, either (1) the relationship between the

organization with which the director is affiliated and the company, (2)

the relationship between the director and his or her partnership

status, shareholder interest or executive officer position, or (3) the

direct business relationship between the director and the company.

(c) Cross Compensation Committee Link. A director who is employed

as an executive of another corporation where any of the company's

executives serves on that corporation's compensation committee may not

serve on the audit committee.

(d) Immediate Family. A director who is an Immediate Family member

of an individual who is an executive officer of the company or any of

its affiliates cannot serve on the audit committee until three years

following the termination of such employment relationship.

4. Written Affirmation. To monitor compliance with the proposed

rule change, the Exchange proposes to incorporate an ongoing written

affirmation requirement. In this regard, as part of the initial listing

process, and with respect to any subsequent changes to the composition

of the audit committee, and otherwise approximately once each year,

each company should provide the Exchange written confirmation

regarding:

(a) Any determination that the company's board has made regarding

the independence of directors described above;

(b) The financial literacy of the audit committee members;

(c) The determination that at least one of the audit committee

members has accounting or related financial management expertise; and

(d) The annual review and reassessment of the adequacy of the audit

committee charter.

Definitions: The Exchange proposes to codify two long-

standing interpretations under the current audit committee requirements

as follows:

1. ``Immediate Family'' includes a person's spouse, parents,

children, siblings, mothers-in-law and fathers-in-law, sons and

daughters-in-law, brothers and sisters-in-law, and anyone (other than

employees) who shares such person's home.

2. ``Affiliate'' includes a subsidiary, sibling company,

predecessor, parent company, or former parent company.

Finally, the Exchange proposes to implement a transition period in

order to provide its issuers with sufficient time to come into

compliance with the proposed rule change. Specifically, the Exchange

proposes (1) to ``grandfather'' all public company audit committee

members qualified under current NYSE rules until they are re-elected or

replaced and (2) give companies that have less than three members on

their audit committees eighteen months from the date of SEC approval of

this rule filing to recruit the requisite members.

2. Statutory Basis

The Exchange believes that the proposed rule change is consistent

with Section 6(b)(5) of the Act,\3\ which requires, among other things,

the Exchange's rules to be designed to prevent fraudulent and

manipulative

[[Page 55517]]

acts and practices and, in general, to protect investors and the public

interest.

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\3\ 15 U.S.C. 78f(b)(5).

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

The Exchange does not believe that the proposed rule change will

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

The Exchange circulated the report issued by the BRC and the

Exchange staff's proposed responses to it to its issuers. As a general

matter, those responding agreed with the proposed rule change. The

relevant comments were focused in three general areas. The primary

issue raised was the element of ``financial literacy,'' with a small

proportion of responses suggesting that only a majority of members need

be financially literate. In addition, issuers were concerned that the

proposed concept of a ``financial literacy'' requirement for all audit

committee members was not adequately defined and is potentially

limiting with regard to the expertise of an audit committee member.

Second, some issuers felt the definition of independence was too

restrictive and that the board should be given more authority over the

determination of the independence of a director. Finally, a number of

companies thought the recommendations put forth by the BRC, which are

substantially analogous to the proposed rule change, will not

meaningfully help to prevent fundamental problems such as fraud and

financial reporting failures. In addition to the foregoing, some

companies thought the thrust of the Recommendations is to transfer some

of the traditional responsibilities of the outside auditors to the

board and audit committee, possibly increasing litigation exposure for

issuers.

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 Exchange 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.

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. 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 in the

Commission's Public Reference Room. Copies of such filing will also be

available for inspection and copying at the principal office of the

Exchange. All submissions should refer to the File No. SR-NYSE-99-39

and should be submitted by November 3, 1999.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\4\

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\4\ 17 CFR 200.30-3(a)(12).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 99-26623 Filed 10-12-99; 8:45 am]

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