Proposed Corporate Governance Changes for NYSE and NASDAQ Companies


Please note that this article, “Proposed Corporate Governance Changes for NYSE and NASDAQ Companies,” was written prior to the recent approval of the changes to NASDAQ’s listing standards, the signing into law of the Sarbanes-Oxley Act of 2002, and the adoption by the NYSE Board of Directors of the recommendations of the NYSE Corporate Accountability and Listing Standards Committee, each of which will have a further impact on the subject matter of this article and which are not addressed herein.

It used to be that the phrase “so did you hear about XYZ?” was principally used by Jay Leno in his opening monologue on the Tonight Show. Lately, however, this phrase is being used to discuss yet another financially distressed company that is being investigated by the Securities and Exchange Commission (the “SEC”). In this post-Enron era, it is clear that quite a few regulatory changes are coming that will change the way corporate America conducts its affairs.

On February 12, 2002, SEC Chairman Harvey Pitt sent a letter to the New York Stock Exchange (“NYSE”) and NASDAQ Stock Market Inc. (“NASDAQ”) asking them “to review corporate governance and listing standards, including the important issues of officer and director qualifications and the codes of conduct of public companies.” Separately, Chairman Pitt also commended the Financial Executives International for “reemphasizing its members’ code of ethics,” and asked them “to consider whether there is a need to update the code in light of recent developments.”

In addition to the media attention to “Enron,” the Pitt letters have been a sparkplug that is igniting a series of changes.1  The full extent of these changes remains to be seen. NASDAQ and the NYSE, however, already have proposed corporate governance changes that they would like to integrate into their listing standards — after they ponder comments, issue final proposed rules, and the SEC approves the rule proposals. A number of advisory groups have laid out their recommendations for “best practices” in corporate governance.2  And some notable corporate governance experts have offered new models of corporate governance.

The NASDAQ Approach

On April 11, 2002, the NASDAQ Stock Market announced that its Listing and Hearing Review Council (the “Council”) had developed some tentative recommendations and ideas to enhance corporate governance standards for NASDAQ listed companies. While many of the recommendations are in the form of proposed changes to the NASDAQ listing standards, others set forth a best practice that could be adopted by listed companies. On May 24, 2002, the board of directors of NASDAQ (the “NASDAQ Board”) approved several corporate governance rule changes based upon some of the Council’s recommendations described later in this article. These changes, according to Wick Simmons, chairman and chief executive officer of NASDAQ, are “part of a process that is far from over.” It is important to note that unlike the NYSE, the NASDAQ appears to have adopted a piece-meal approach. Specifically, the changes approved by the NASDAQ Board in May are a first step and NASDAQ will consider further reforms in late June 2002. In that respect, the Council’s recommendations serve as a blue print of changes that the NASDAQ Board expects to consider in the coming months.

The Council’s Recommendations

Option plans. NASDAQ rules generally require shareholder approval of all stock option plans. An exception exists for broad-based plans. Officers and directors can participate in these plans so long as the majority of the options are awarded to non-executive employees. NASDAQ is considering restricting this exception by reducing the level of executive officer participation and requiring the approval of disinterested directors. In fact, it is possible that NASDAQ may eliminate this exemption altogether and require all stock option plans that include officers and directors to be approved by shareholders.

Audit Committee. NASDAQ’s recommendations include several proposed changes for audit committees. With respect to director independence, NASDAQ’s current rule provides that an independent director is a person other than an officer, employee, or a person who, in the opinion of the board of directors, has a relationship that would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. The list of disqualifying relationships with the listed company include: (1) employment for the current year or the past three years; (2) compensation received in excess of $60,000 during the prior fiscal year; (3) familial relationship with an executive officer; (4) payments between the listed company and a company with which the director is associated; and (5) relationships that interlock with another company’s compensation committee.3

In light of recent events, NASDAQ believes that this rule should be amended to address other relationships that may impair independence. For example, NASDAQ expects to address whether a former employee of a company’s auditor should be considered non-independent for a period of time. NASDAQ also believes that executive officers of all listing markets should not serve on boards of their listed companies.

NASDAQ is considering strengthening the current rules to empower the audit committee with exclusive authority to hire and fire auditors. Under the current rules, both the company and the audit committee have the authority to select or replace the outside directors. This suggestion is in the form of a “best practice” and is coupled with a new NASDAQ-recommended SEC disclosure requirement that a company disclose in its annual report whether the board disagreed with the advice of the audit committee regarding the selection or replacement of the independent auditor.

NASDAQ is taking into account whether companies should be required to ensure that officers and audit committee members possess the requisite level of competence and whether these individuals should be required to obtain continuing education. NASDAQ rules require each member of a listed company’s audit committee to be “able to read and understand fundamental financial statements” and that at least one member of the audit committee have “past employment experience in finance or accounting, requisite professional certification in accounting, or any other comparable experience or background which results in the individual’s financial sophistication.”4

NASDAQ is in the process of surveying disclosure made by listed companies to determine whether the current rules adequately protect the public interest in well-functioning audit committees. NASDAQ also is evaluating whether a best practice regarding continuing education for all board members is appropriate.

Related Party Transactions. NASDAQ’s current rules require companies to conduct an appropriate review of all related party transactions on an ongoing basis and to utilize the audit committee or a comparable body of the board of directors for the review of potential conflict of interest situations. NASDAQ is considering amending this rule by requiring the audit committee and the board to approve all related party transactions. NASDAQ also suggests that the SEC rules be amended to require disclosure of whether related party transactions were approved by the audit committee and the board.

News Dissemination. NASDAQ’s rules require companies to disseminate material information to the public through major wire services, with advance notification to NASDAQ. Since the adoption of Regulation Fair Disclosure (Regulation F-D), however, in which the SEC allows for alternative means of dissemination, such as Web casts , critics have urged NASDAQ to broaden what are acceptable means of information dissemination. NASDAQ expects to harmonize its rules with Regulation F-D to facilitate full and fair disclosure.5

Corporate Governance and Foreign Issuers. NASDAQ is considering amending its listing standards for foreign issuers. Currently, a foreign issuer can obtain a waiver from the corporate governance rules if it can demonstrate that the non-conforming practice is both legal in its home country and in accordance with the generally accepted business practices of the home country. Foreign issuers also are not required to disclose whether they have sought and successfully obtained a waiver of certain corporate governance rules. NASDAQ is considering requiring foreign issuers to provide disclosure when they have received a waiver from the corporate governance standards from NASDAQ. NASDAQ also is considering additional changes to its listing standards to require foreign issuers to comply with the “spirit” of NASDAQ’s corporate governance standards – even if the “letter” of the foreign rules is different.

Code of Conduct. NASDAQ is recommending that listed companies adopt a code of conduct, as a best practice, which addresses, among other items, conflicts of interest and compliance with applicable laws. The company’s board must approve this code of conduct. NASDAQ believes that the company and the board must also approve procedures to monitor compliance. Additionally, NASDAQ suggests that the SEC adopt a rule requiring a company to disclose whether its board has approved a code of conduct.

The NASDAQ Board’s Modifications

Following its meeting in May 2002, the NASDAQ Board approved the following changes to some corporate governance rules.6  According to Edward S. Knight, Executive Vice President and General Counsel of the NASDAQ, these changes represent initiatives that the NASDAQ staff had considered for some time and on which the NASDAQ Board developed consensus. NASDAQ is reviewing other recommendations and is scheduled to consider additional changes in late June 2002.7

Pursuant to the proposed revisions, the current exception available for broad-based plans would be eliminated and all plans in which officers and directors participate would require shareholder approval. This revision also is expected to bump the current de minimis exception.8

The definition of “independence” would be expanded to include a prohibition on receiving any payments in excess of $60,000, including political contributions, and would include payments made to the director’s family members. Additionally, a director would not be considered independent if a company makes payments to a charity in which the director is an executive officer and these payments are greater than $200,000 or 5 percent of either the company’s or the charity’s gross revenues.

The NASDAQ has proposed to amend its related party transactions review requirement to require the audit committee or a comparable body of the board to review and approve all related party transactions. The NASDAQ rules also are proposed to include an explicit prohibition on misrepresenting information to NASDAQ and to require the issuance of a press release on the receipt of a “going concern” qualification in an auditor’s opinion.9

The NYSE Approach

On February 13, 2002, NYSE appointed a special committee of its board of directors to review listing requirements and matters involving corporate governance. On June 6, 2002, the NYSE Corporate Accountability and Listing Standards Committee (the “NYSE Special Committee”) submitted its report to the NYSE Board of Directors (the “NYSE Board”).10  The report is designed to “strengthen checks and balances and give the legions of diligent directors better tools to empower them and encourage excellence.” The report contains proposed changes that (1) focus on the operations of a listed company’s board of directors; (2) require shareholder approval of equity-based compensation plans; and (3) establish new control and enforcement mechanisms.

Of note, the NYSE Special Committee explicitly rejected imposing “additional liability on directors, or reducing the protections currently available through directors and officer liability insurance and state law exculpation provisions” and “repealing the Private Securities Litigation Reform Act.” The report also contains suggested reforms that should be undertaken by the SEC and Congress.11  The proposed changes are subject to a two-month public comment period before the NYSE Board will consider them at its August 2002 meeting.

The proposed changes have been well received by the SEC12  and members of both political parties. Certain aspects of the NYSE proposals, however, have been criticized and the NYSE should expect to receive some heated comments. For example, there have been some rumblings from the issuer community about the NYSE proposal to require shareholder approval for all option plans. During its consideration, the NYSE Special Committee received several suggestions from advisory groups including a special study group of the Committee on Federal Regulation of Securities of the Section of Business Law of the American Bar Association (ABA Committee), the American Society of Corporate Secretaries (ASCS), the Council of Institutional Investors (CII), Institutional Shareholder Services, the Teachers Insurance and Annuity Association – College Retirement Equity Fund (TIAA-CREF), and Fidelity Investments.13

Changes to Board Operations

The NYSE believes that listed companies should have a majority of independent directors because “a majority of independent directors will increase the quality of board oversight and lessen the possibility of damaging conflicts of interest.”14  This “simple majority” requirement is unlike the “substantial majority” standard that most other groups have supported. Under the NYSE proposal, companies would be given two years after the listing standard is adopted to comply with this requirement. Additionally, a company would be required to publicly disclose when it meets this requirement.

The NYSE’s current definition of “independent” directors excludes directors employed by the company within the past three years, immediate family members of executives, and certain interlocking directorships.15  A director with business relationships with the company or its executives can be deemed independent if the board decides, in its business judgment that the director’s membership on the committee is in the best interest of the company and its shareholders. The company is required to disclose the nature of the relationship and the reasons for the determination in its next annual proxy statement. The board’s absolute discretion to determine whether certain relationships may impair a director’s independence has been criticized. According to the CII, “(S)ome relationships, no matter how small, may compromise a director’s objectivity and loyalty to shareholders.”16  TIAA-CREF has suggested that the current NYSE definition of independence does not meet the definition called for by the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees.17

The NYSE proposes to tighten the definition of “independent” by requiring a company’s board to affirmatively determine that the director has no material relationship with the listed company. Companies would be required to disclose the board’s determination regarding each director. The current three year cooling-off period would be extended to five years and would apply to: (1) former employees; (2) affiliates or employees of the company’s auditor; (3) former employees of any company whose compensation committee includes an officer of the listed company; and (4) immediate family members of the foregoing categories.

The NYSE intends to empower non-management directors by requiring them to schedule executive sessions without management participation. The company would be required to disclose the name of the director who presides at these meetings in its annual proxy statement – arguably akin to interjecting a de facto “lead director” requirement.

The NYSE expects to revise its listing standards to increase the authority and responsibility of the audit committee by granting the committee sole authority to hire and fire the company’s independent auditors and to approve any significant non-audit relationship with the independent auditors. For audit committees, the NYSE also anticipates: (1) requiring the audit committee chair to possess either accounting or related financial management expertise; (2) restricting the director fees an audit committee member can receive as compensation; and (3) limiting the ability of a director who holds 20 percent or more of the company’s stock to serve on the audit committee.

The NYSE’s current listing standards do not require a nominating or a compensation committee. The NYSE suggests that listed companies create these separate committees, each composed entirely of independent directors. Each committee would have its own separate charter that addresses that committee’s purpose and responsibilities.

Equity-Based Compensation Plan Changes

In 1999, the NYSE Task Force on Stock Option Plans and Shareholder Voting Rights suggested that the NYSE amend its listing standards to give shareholders the right to vote on most stock option plans, regardless if they are limited to officers or directors or broadened to include non-officer employees. The NYSE did not adopt this suggestion because, among other issues, NASDAQ did not agree to adopt similar changes.

The NYSE proposes that all equity-based compensation plans, and any material revisions to the terms of these plans, including the repricing of existing options, should be submitted for a shareholder vote. The NYSE also suggests that the SEC amend its proxy rules to require additional qualitative disclosure on the potential valuation of awards that may be made under such plans.

Currently, brokers who hold stock in “street name” can cast uninstructed votes on behalf of beneficial owners on routine matters – including many compensation plans. Brokers generally tend to follow the management’s recommendations. In many instances, this block of votes determines whether a particular proposal fails or succeeds. The NYSE is considering prohibiting brokers from voting on equity compensation plans unless they have specific instructions from the beneficial owners. Removing uninstructed broker votes is expected to reduce the ability of management to adopt compensation plans without significant shareholder support.

New Control and Enforcement Mechanisms

The NYSE is considering imposing an annual CEO certification for listed companies. Under this proposal, a company’s CEO would have to certify each year to the NYSE that:

[T]he company has established procedures for verifying the accuracy and completeness of the information provided to investors; that those procedures have been carried out, and that based upon the CEO’s assessment of the adequacy of those procedures and of the diligence of those carrying them out, the CEO has no reasonable cause to believe that the information provided to investors is not accurate and complete in all material respects.

The CEO must certify that he or she has reviewed those procedures with the board and that the company complies with the procedures. The CEO must also certify that he or she is not aware of any violation of NYSE listing standards by the company.

The NYSE recommends that companies adopt and disclose codes for corporate governance and business conduct and ethics. Each company’s annual report must indicate that these codes are available on its Web site, and that on request, the codes are available in print to any shareholder. Listed foreign private issuers must disclose any significant ways in which their home-country corporate governance practices vary from the practices followed by domestic companies under the NYSE listing standards. The NYSE intends to issue a public reprimand letter if a company violates a NYSE listing standard. Companies that repeatedly or flagrantly violate NYSE listing standards may face suspension or delisting from the NYSE. The NYSE also urges listed companies to establish an orientation program for new board members.

The Call for a Corporate Governance Board – the Comply or Explain Model

In addition to the proposed reforms discussed previously, John C. Whitehead and Ira M. Millstein18  have suggested the creation of a Federal Corporate Governance Board (Governance Board).19  The members of the Governance Board would be representative of the corporate governance constituency: shareholders, corporate management, investment banks and institutions, the NYSE and NASDAQ. The Governance Board would be responsible for developing a voluntary corporate governance code (the “Code”).

The Code would, among other matters, address issues, such as the composition/independence of the board, audit, compensation, and nomination/governance committee.20  Adhering to the standards of the Code itself would be voluntary, but for listed companies, the SEC would be responsible for requiring reporting companies to disclose, on an annual basis, whether the company complies with each element of the Code or for explaining any areas of non-compliance (hence, the “Comply or Explain” model). This disclosure could be made in a listed company’s annual report, proxy statement, or other public filing.

The Comply or Explain model has several benefits. It provides a light-handed and flexible mechanism that encourages public companies to either adopt the best practices reflected by the Code or explain why the company does not, or cannot, comply with the Code provisions.21  Such an approach does not smack of federalism, with the SEC, the NYSE, or NASDAQ mandating the adoption of certain rules.22  Rather, it uses the SEC’s disclosure power to encourage the adoption of recommended practices reflected in the Code, while giving each company the ability to explain its particular circumstances.23

Adoption of the Code would also bring uniformity to the market. Amendments to the listing standards have several inherent limitations. Historically, the stock exchanges do not appear to have the personnel, the will, or the tools to monitor or enforce these standards once a company is listed. The only “penalty” for violating the corporate governance provisions of NASDAQ and the NYSE has been delisting an offending company’s securities from the market – a drastic penalty that is rarely used. The exchangesmust be more willing to impose sanctions for listing-standards violations to be considered part of an effective corporate governance framework.

Whitehead and Millstein are not alone in suggesting this type of approach. The ABA Committee and the National Association of Corporate Directors have made similar proposals.24  In addition, the Comply or Explain model has been adopted in countries, such as United Kingdom and Canada. Therefore, companies listed on the London Stock Exchange and the Toronto Stock Exchange, respectively, are required to disclose whether they comply with the specified code.25


Most companies are not waiting for the SEC, the NYSE, or NASDAQ to make changes to their corporate governance cultures. These companies started by making a “gut check” to ensure that they are not the next “Enron.” For example, The Walt Disney Company, frustrated by persistent criticism of its corporate governance, announced that it was making changes to ensure the independence of its board members. The company also hired Millstein to conduct a review of its governance practices.

Regardless of the form in which the proposed changes to the corporate governance landscape are adopted, one thing is certain – corporate governance, as we know it, will be different. Modifications could come in the form of changes to the SEC disclosure rules, changes to the NASDAQ and NYSE listing requirements, the creation of a Governance Board, or new federal regulations. While the final reforms are not expected to become operational for some time, the changes discussed above do, however, provide a good road map of what may be required of public companies. Companies are well advised to consult with their legal advisors to start thinking about the actions that will be required in the coming days. In the meantime, the proposed changes are generating thought provoking debates as companies look closely at their corporate governance practices and disclosure policies, auditors examine their independence and thoroughness, and boards review their attitudes and relationships with management.

© 2002 Sanjay M. Shirodkar. Sanjay M. Shirodkar was a Special Counsel in the Division of Corporation Finance at the Securities and Exchange Commission and can be reached at Portions of this article were previously published in The Corporate Governance Advisor (July/August 2002)



  1. 1.     On April 4, 2002, Chairman Pitt delivered a speech at Northwestern Law School. In this speech, Chairman Pitt discussed the need for better corporate governance standards and for stricter control on the issuance of stock options to senior management.
  2. 2.     The Business Roundtable (BRT) recently updated its corporate governance best practices. A copy of the BRT’s “Principles of Corporate Governance” is at
  3. 3.     NASD Manual Rule 4200(14).
  4. 4.     NASD Manual Rule 4350(d)(2)(A).
  5. 5.     Currently, the NYSE and NASDAQ do not recognize Web casts as an acceptable form of dissemination, but the SEC does under Regulation F-D.
  6. 6.     Text of the proposed NASDAQ rules changes is available on It is important to note that these rules have not been published for public comment and may be changed by the NASDAQ.
  7. 7.     These changes include: (1) requiring a majority of independent directors on corporate boards; (2) imposing a cooling-off period before a former auditor can serve on an audit committee; (3) expanding the scope of the audit committee authority; (4) mandating that the compensation committee be comprised solely of independent directors; (5) establishing continuing education requirements for directors; (6) increasing the use of corporate codes of conduct; and (7) implementing new disclosure rules regarding the governance of non-U.S. companies.
  8. 8.     The de minimis exception is available under NASD Manual Rule 4350(i)(1)(A).
  9. 9.     Recently, NASDAQ conducted corporate governance summits in San Jose and New York City, with over 130 senior executives of NASDAQ listed companies. These summits were designed to solicit the views of NASDAQ listed companies. NASDAQ expects to distill the thoughts of the participants and prepare a report in the coming months. This report will be sent to the SEC and Congress.
  1. Report of the NYSE Corporate Accountability and Listing Standards Committee, June 6, 2002 ( NYSE Report) (available at
  2. Suggested changes by the SEC include creating a new private sector organization governed and funded independently of the accounting industry, recommending companies report information based upon GAAP standards before discussing “pro-forma” or “adjusted” financial information, improving MD&A disclosure, accelerating disclosure of insider transactions, and evaluating the impact of Regulation FD on corporate behavior and corporate markets. The NYSE Special Committee also suggests that Congress give the SEC the authority to bar officers and directors through an administrative process, allocate additional resources to the SEC, and create a panel to review concentration in 401(k) plans.
  3. In a statement issued on June 6, 2002, SEC Chairman Harvey Pitt stated that “the steps proposed by the NYSE represent an important first step, but improvement of corporate governance is a work in progress, and we look forward to continuing to work with the NYSE and all other interested parties toward that end.” (available at
  4. See Memorandum of a Special Study Group of the Committee on Federal Regulation of Securities of the Section of Business Law of the American Bar Association (Mar. 13, 2002); Comments by the American Society of Corporate Secretaries to the New York Stock Exchange Special Committee on Corporate Accountability and Listing Standards (NYSE Special Committee) (April 2002) (available at; Testimony of the Council of Institutional Investors (CII Testimony) (April 15, 2002); Letter from Peter C. Clapman, Senior Vice President and Chief Counsel, Corporate Governance of the Teachers Insurance and Annuity Association of America College Retirement and Equities Fund to the NYSE Special Committee (TIAA-CREF) (April 10, 2002) and Letter from Eric D. Roiter, Senior Vice President and General Counsel, Fidelity Management and Research Company to the NYSE Special Committee (May 8, 2002).
  5. The NYSE Report at 6.
  6. NYSE Listed Company Manual § 303.01(B)(2)(a) and 303.01(B)(3) currently define “independent” only for audit committee members.
  7. CII Testimony at 2.
  8. See n. 18 for a description of the Blue Ribbon Committee.
  9. Millstein and Whitehead co-chaired the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees, which was sponsored by the NYSE, NASDAQ and the SEC. For a thorough discussion on the Blue Ribbon Committee and its report, see 54 The Business Lawyer 1067, May 1999.
  10. Memorandum from Whitehead and Millstein to the Senate Committee on Banking, Housing and Urban Affairs dated April 2002 (Whitehead/Millstein memorandum).
  11. Id. at 2 and 3. The Whitehead/Millstein memorandum contains a detailed list of recommended practices.
  12. Id. at 2.
  13. It is important to note that the authority of the SEC, the NYSE and the NASDAQ to adopt corporate governance measures as listing standards is not free from doubt. See The Business Roundtable v. SEC, 905 F.2d 406, 408 (1990) (noting that the SEC did not have the authority to adopt a rule prohibiting exchanges from listing stock that restrict or disparately reduce per share voting rights of common shareholders). Under the tenets of this case, further study may be required before the Comply or Explain model could be adopted.
  14. See the Whitehead/Millstein memorandum on p. 2.
  15. The ABA Committee is scheduled to publish a report with its analysis and recommended alternatives sometime this month. The NACD suggests that the NYSE and NASDAQ endorse a set of general governance practices and that the SEC require public companies to disclose whether they meet these practices. Some suggested NACD practices include the formal designation of an independent director as chairman or lead director, regular evaluation by the board of the company’s CEO and other senior officers, and director orientation programs for new directors. See Recommendations from the National Association of Corporate Directors (May 3, 2002) (available on
  16. The Combined Code in the United Kingdom and the Dey Report in Canada

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