GEORGIA NORTH CAROLINA SOUTH CAROLINA VIRGINIA WASHINGTON, DC
SEC APPROVES NYSE AND NASDAQ SHAREHOLDER APPROVAL RULES FOR EQUITY COMPENSATION PLANS July 15, 2003 On June 30, 2003, the Securities and Exchange Commission (the “SEC”) approved rules proposed and adopted by the New York Stock Exchange (“NYSE”) and the Nasdaq Stock Market, Inc. (“Nasdaq”), requiring shareholder approval of most equity compensation plans and material plan amendments, subject to certain limited exceptions.1 While the NYSE rule (the “NYSE Rule”) and the Nasdaq rule (the “Nasdaq Rule”) are similar, they are not identical. For instance, the NYSE Rule requires shareholder approval of certain existing discretionary and formula plans (subject to certain interim rules), while the Nasdaq Rule grandfathers most prior plans, and the NYSE Rule requires disclosure of a company’s reliance on certain exceptions, while the Nasdaq Rule does not require such disclosure. The NYSE Rule and Nasdaq Rule became effective June 30, 2003 (except for certain transition rules applicable to NYSE companies). The new rules were originally proposed in October of 2002 as part of both the NYSE’s and the Nasdaq’s corporate governance reform initiatives; other corporate governance proposals, including proposals relating to director independence and committee functions, have not yet been finalized by the SEC.2 I. NYSE Rule
Summary The NYSE Rule requires shareholder approval for all equity-based compensation plans, including any material revisions to the terms of such plans, except for inducement awards, certain plans relating to mergers or acquisitions, and tax qualified and parallel excess plans. Prior NYSE standards required shareholder approval for equity compensation plans in which officers and directors participated, subject to certain limited exceptions, including an exception for broadly-based plans in which a majority of the participants were not officers or directors.
Release No. 34-48108, Self-Regulatory Organizations; New York Stock Exchange, Inc. and National Association of Securities Dealers, Inc.; Order Approving NYSE and Nasdaq Proposed Rule Changes and Nasdaq Amendment No. 1 and Notice of Filing and Order Granting Accelerated Approval to NYSE Amendments No. 1 and 2 and Nasdaq Amendments No. 2 and 3 Thereto Relating to Equity Compensation Plans (June 30, 2003). The release may be found at http://www.sec.gov/rules/sro/34-48108.htm. 2 See Corporate Governance Rule Proposals Reflecting Recommendations from the NYSE Corporate Accountability and Listing Standards Committee As Approved by the NYSE Board of Directors August 1, 2002 (available at http://www.nyse.com/pdfs/corp_gov_pro_b.pdf), Amendment No. 1 to the NYSE’s Corporate Governance Rule Proposals (available at http://www.nyse.com/pdfs/amend1-04-09-03.pdf) and Summary of Nasdaq Corporate Governance Proposals as of February 26, 2003 (available at http://www.nasdaq.com/about/Web_Corp_ Gov_Summary%20Feb-revised.pdf).
1
RTP 70493v7
Definition of Equity Compensation Plan The NYSE Rule defines the term “equity compensation plan” to include a plan or other arrangement that provides for the delivery of equity securities (either newly issued or treasury shares) of the listed company to any employee, director or other service provider as compensation for services. This definition includes a compensatory grant of options or other equity securities not made under a plan (for instance, an individual option agreement). However, the term excludes (1) any plan that is made available to shareholders generally (such as a typical dividend reinvestment plan), (2) plans that do not provide for the delivery of issuer securities (such as cash-only phantom stock plans), (3) deferred compensation plans pursuant to which employees pay the full current market value of deferred shares, and (4) broad-based plans that merely provide a convenient way (e.g., through payroll deductions) for employees, directors or other service providers to buy shares at fair market value, even if the brokerage and other costs of the plan are subsidized. Exceptions to the Shareholder Approval Requirement The NYSE Rule exempts certain limited types of plans and awards from the shareholder approval requirement, such as inducement awards, certain awards made in connection with mergers, and certain types of tax-qualified and “parallel excess plans.”3 However, even if equity compensation plans and related amendments are not subject to shareholder approval, under the NYSE Rule, the plans and amendments are still subject to the approval of the company’s independent compensation committee or a majority of the company’s independent directors. Companies must notify the NYSE in writing when they rely on one of these exceptions. The NYSE Rule also eliminates its existing exception for plans funded by treasury shares (rather than newly issued shares). Employment inducement awards. Employment inducement awards are grants of options or other equity awards that are intended to serve as a material inducement to a person’s first becoming an employee of the issuer (or to a person rehired following a bona fide period of interruption of employment) and are exempt from the shareholder approval requirement. Awards granted to new employees in connection with a merger or acquisition are also exempt. The NYSE Rule requires a listed company to promptly disclose in a press release the material terms of such an award, including the recipient(s) of the award and the number of shares involved, following the grant of an inducement award in reliance on this exemption. Mergers and acquisitions. In the case of corporate acquisitions and mergers, two exceptions to the rule apply. First, shareholder approval is not required to convert, replace or
The term “parallel excess plan” means a plan that is a “pension plan” within the meaning of the Employee Retirement Income Security Act of 1972, as amended (“ERISA”), and that is designed to work in parallel with a plan intended to be qualified under Section 401(a) of the Internal Revenue Code of 1986, as amended (the “Code”), to provide benefits that exceed certain Code limitations on employee contributions and covered compensation. However, a plan will not be considered a parallel nonqualified plan unless (1) it covers all or substantially all employees of an employer who are participants in the related qualified plan whose annual compensation is in excess of certain Code limitations, (2) its terms are substantially the same as the qualified plan that it parallels except for the elimination of the contribution and covered compensation limitations, and (3) no participant receives employer equity contributions under the plan in excess of 25% of the participant’s cash compensation.
3
RTP 70493v7
2
adjust outstanding options or other equity compensation awards to reflect the transaction. Second, shares available under certain plans acquired in corporate acquisitions and mergers can be used for certain post-transaction grants without further shareholder approval. This exception applies to situations where the acquired company (which is not a listed company after the transaction) had shares available for grant under pre-existing plans that were previously approved by shareholders. These shares may be used for post-transaction grants by the surviving listed company, either under the pre-existing plan or another plan, without further shareholder approval, so long as (1) appropriate adjustment of the number of shares is made to reflect the transaction, (2) the time during which those shares are available for grants is not extended beyond the period when they would have been available under the pre-existing plan, absent the transaction, and (3) such awards are not granted to individuals who were employed by the surviving listed company or its subsidiaries immediately before the merger or acquisition. Thus, such shares apparently could only be used for the grant of awards to employees of the particular target or to persons who become employees of the listed company (or its subsidiaries) after the merger or acquisition was completed. A plan adopted in contemplation of a merger or acquisition transaction will not be considered pre-existing for purposes of this exception. Shares reserved for listing on the NYSE in connection with transactions in reliance on this exemption must, however, be counted in determining whether the transaction involves the issuance of 20% or more of the acquirer’s outstanding common stock, which may require acquirer shareholder approval under other NYSE rules. Tax qualified and “parallel excess” plans. Plans, such as employee stock ownership plans (“ESOPs”) and 401(k) plans, which are intended to meet the requirements of Section 401(a) of the Code, certain parallel excess plans, and employee stock purchase plans (“ESPPs”) intended to meet the requirements of Section 423 of the Code are exempt from the shareholder approval requirement. Plans such as Section 401(a) plans and Section 423 plans are already regulated under the Code and U.S. Treasury Department regulations (including, in the case of ESPPs, shareholder approval requirements). Equity compensation plans for non-U.S. employees that would qualify for this exception but for features necessary to comply with foreign tax law are also exempt from the shareholder approval requirement. Definition of Material Revision Under the NYSE Rule, a “material revision” to equity compensation plans also requires shareholder approval. A material revision includes, but is not limited to, the following: (1) a material increase in the number of shares available under the plan (other than an increase solely to reflect a reorganization, stock split, merger, spin-off or similar transaction),4 (2) an expansion (whether or not material) of the types of awards available under the plan, (3) a material expansion of the class of persons eligible to participate in the plan, (4) a material extension of the terms of the plan, (5) a material change to the method of determining the strike price of options under the plan, and (6) the deletion or limitation of any provision prohibiting repricing.
If a plan contains a formula (1) for automatic increases in the shares available (i.e. an “evergreen” formula) or (2) for automatic grants, each such increase or grant will be considered a material revision unless the term of the plan is limited to a specified period of time not in excess of 10 years. The NYSE Rule designates these types of plans as “formula plans.” If a plan does not limit the number of shares available for grant and is not a formula plan, then each grant under the plan will require separate shareholder approval even if the term of the plan is limited to a specified period not in excess of 10 years. The NYSE Rule refers to this type of plan as a “discretionary plan.”
4
RTP 70493v7
3
With respect to repricings,5 if, as is the case with many plans, a plan does not contain a provision that specifically permits repricing of options, the plan would be considered for this purpose as prohibiting repricing, and any actual repricing of options would be considered a material revision of the plan, thus requiring shareholder approval, even if the plan itself is not revised. This mandate does not apply to repricings through an exchange offer that commenced before June 30, 2003. Transition Rules Generally, any plan adopted prior to June 30, 2003 will not be subject to shareholder approval unless the plan is materially revised. However, special transition rules apply to discretionary plans and formula plans that were adopted prior to June 30, 2003. Discretionary plans. Additional grants may be made under discretionary plans after June 30, 2003 – regardless of whether the plan was previously approved – without obtaining further shareholder approval, for a limited transition period (the “transition period”), in a manner consistent with past practices, only until the first to occur of the following: (1) the listed company’s next annual meeting at which directors are elected that occurs after December 27, 2003, (2) June 30, 2004, or (3) the expiration of the plan. If a plan can be divided into a discretionary portion and a non-discretionary portion, the non-discretionary portion can be used separately (subject to the applicable transition rules). Formula plans. Additional grants under formula plans that (1) have not been approved by shareholders or (2) do not have a term of 10 years or less may be made after June 30, 2003 without further shareholder approval only for the transition period applicable to discretionary plans. A formula plan may continue to be used beyond the transition period if the plan is amended to limit the term of the plan to a specified period of time not in excess of 10 years; such an amendment will not be considered a material revision of the plan. Summary of the NYSE Rule Prohibiting Broker Voting on Equity Compensation Proposals
The NYSE Rule also amends NYSE Rule 452 to provide that a broker may vote on proposals for equity compensation plans only pursuant to customer instructions. This rule means that an equity compensation plan proposal is no longer treated as an ordinary matter for which a broker can vote on its own. This rule may make it more difficult for companies to obtain shareholder approval of equity compensation plans. The Amended Rule 452 is effective for any meeting of shareholders that occurs on or after September 28, 2003.
5
A “repricing” means any of the following (or any other action that has the same effect as any of the following): (1) lowering the strike price of an option after it is granted; (2) any other action that is treated as a repricing under generally accepted accounting principles (“GAAP”); or (3) canceling an option at a time when its strike price exceeds the fair market value of the underlying stock, in exchange for another option, restricted stock or other equity, unless the cancellation and exchange occurs in connection with a merger, acquisition, spin-off or other similar corporate transaction.
RTP 70493v7
4
II.
Nasdaq Rule
Summary of the Nasdaq Rule for Shareholder Approval of Equity Compensation Plans Like the NYSE Rule, the Nasdaq Rule requires shareholder approval for the adoption or material amendment of any equity compensation plan in which officers, directors, employees or consultants may acquire options or stock, subject to certain limited exceptions. The Nasdaq Rule eliminates (1) the exception from shareholder approval for broadly-based plans and (2) the de minimis exception, which permitted the grant of the lesser of 1% of the number of outstanding shares of common stock or 25,000 shares without shareholder approval. In addition, shareholder approval is required in order for a company to use repurchased shares to fund option plans or grants. Exceptions to the Shareholder Approval Requirement
The Nasdaq Rule exempts certain types of plans and awards from the shareholder approval requirement, such as warrants or rights issued to all shareholders, tax qualified and parallel nonqualified plans, inducement grants and plans adopted in connection with mergers. However, inducement grants and tax qualified and parallel nonqualified plans are subject to approval by the company’s compensation committee or a majority of the company’s independent directors.
Warrants or rights. Shareholder approval is not required for warrants or rights issued generally to all shareholders of an issuer. Tax qualified and parallel nonqualified plans. Nasdaq excepts from the shareholder approval requirement tax qualified, nondiscriminatory employee benefit plans and parallel nonqualified plans. Plans that facilitate the purchase of shares on the open market or from the issuer at fair market value are also excepted. Inducement Grants. Inducement grants are not subject to the shareholder approval requirement because in these cases a company is viewed as having an arm’s length relationship with the new employees (or with persons previously employed by the issuer following a bona fide period of non-employment), and the company’s interests are viewed as directly aligned with those of the company’s shareholders. Inducement grants include equity grants to new employees in connection with mergers and acquisitions. Mergers and acquisitions. As is the case under the NYSE Rule, plans involving a merger or acquisition do not require shareholder approval under the Nasdaq Rule in two situations. First, shareholder approval is not required to convert, replace or adjust outstanding options or other equity compensation awards to reflect the transaction. Second, shares available under certain plans acquired in corporate acquisitions and mergers may be used for certain post-transaction grants without further shareholder approval. This exception applies to situations where the acquired company (which is no longer a listed company after the transaction) had shares available for grant under pre-existing plans that were previously approved by shareholders. These shares may be used for post-transaction grants of options and other equity awards by the acquiring/listed company (after appropriate adjustment of the number of shares to reflect the transaction), either under the pre-existing plan or another plan, without further shareholder
RTP 70493v7
5
approval, so long as (1) the time during which those shares are available for grants is not extended beyond the period when they would have been available under the pre-existing plan, absent the transaction, and (2) such options and other awards are not granted to individuals who were employed by the surviving company at the time the merger or acquisition was consummated. A plan adopted in contemplation of a merger or acquisition transaction is not considered pre-existing for purposes of this exception. Material Amendments The Nasdaq Rule provides a non-exclusive list of “material” amendments which are subject to shareholder approval. This list of material amendments is similar to the NYSE Rule and includes all of the following: • Any material increase in the number of shares to be issued under the plan (other than an increase solely to reflect a reorganization, stock split, merger, spinoff or similar transaction). Any material increase in benefits to participants, including any material change to (1) permit a repricing (or decrease in exercise price) of outstanding options, (2) reduce the price at which shares or options to purchase shares may be offered or (3) extend the duration of a plan. Any material expansion of the class of participants eligible to participate in the plan. Any expansion in the types of options or awards provided under the plan.
•
• • Formula Plans
If a plan contains a formula (1) for automatic increases in the shares available (i.e. an “evergreen” formula) or (2) for automatic grants, such plans cannot have a term in excess of 10 years unless shareholder approval is obtained every 10 years. However, when a plan does not impose a share limit on the number of shares available for grant, shareholder approval is required for each grant under the plan. Grants made out of treasury or repurchased shares will not exempt a plan from the additional shareholder approval requirements. Transition Rules The Nasdaq Rule grandfathers prior plans unless they are materially modified. The Nasdaq Rule also requires notification to Nasdaq 15 calendar days prior to establishing or materially amending an equity compensation plan pursuant to which stock may be acquired by officers, directors, employees or consultants without shareholder approval.
RTP 70493v7
6
III.
Practical Considerations
Since the NYSE Rule and Nasdaq Rule became effective on June 30, 2003, companies must begin to prepare for compliance right away. At a minimum, companies should consider taking the following actions: • Companies should review their compensation plans to assess how their plans may be impacted by the new shareholder approval rules. This review should include not only equity compensation plans but also other plans such as deferred compensation and “parallel” nonqualified plans, since equity issued under those plans will be exempt from shareholder approval only if the conditions of the applicable rule are met. In addition, in reviewing their equity compensation plans, companies should focus on those plans which have evergreen provisions, formula terms or which do not impose a share limit since such plans either will need to be amended to impose a 10-year term (for evergreen and formula plans) or will need shareholder approval for each grant. Companies should revise their compliance programs to ensure that prompt disclosure of the grant of equity awards in reliance on an exception to the new rules is made to the NYSE or Nasdaq, as appropriate, and, in the case of NYSE companies, that press releases are timely provided where required. Companies should ensure that either their compensation committees or a majority of their independent directors give the requisite approval to equity awards made in reliance on an exception to the shareholder approval requirements.
•
•
If you have any questions about the new rules and amendments discussed in this memorandum or if we can be of further assistance, please contact the Womble Carlyle attorney with whom you work.
This memorandum is a summary for general information only. It is not a full analysis of the matters presented and may not be relied upon as legal advice.
RTP 70493v7
7