This article is reprinted with permission from the
October 30, 2003
edition of
New York Law Journal.
2003 NLP IP Company.


Executive Pay Under Proposed NYSE, NASDAQ Rules

By Joseph E. Bachelder


On Oct. 8 and Oct. 9, respectively, the New York Stock Exchange Inc. [NYSE] and The NASDAQ Stock Market Inc. [NASDAQ] submitted to the Securities and Exchange Commission [SEC] their latest proposals [NYSE Proposal and NASDAQ Proposal] with respect to standards for listed companies' corporate governance practices.1 Both sets of proposals would require that a majority of the board of directors of a listed company be "independent directors."2

This column will focus on [i] the role of "independent directors" under the proposed rules in determining compensation of the CEO and other executives and [ii] the definition of "independent director" for this purpose.

A. Setting Executive Compensation

Under both the NYSE and the NASDAQ [National Association of Securities Dealers Automatic Quotation System] Proposals, it is likely that the compensation committee [which under both proposals must be made up exclusively of "independent directors" [see Part B below]] will continue to be the initiator of most board-level actions regarding executive pay.

1. Setting CEO Pay

a. NYSE Proposal. Under this proposal the compensation committee3 will have "direct responsibility" to: review and approve corporate goals and objectives relevant to CEO compensation, evaluate the CEO's performance in light of those goals and objectives, and, either as a committee or together with the other independent directors [as directed by the board], determine and approve the CEO's compensation level based on this evaluation. ...

The setting of goals and objectives, and the evaluation of performance against them, appears to be the responsibility of the compensation committee alone. But the actual setting of the CEO's pay based on the evaluation of the CEO's performance may, at the direction of the board, be done by all the independent directors [or left to the committee itself].

The NYSE's explanation accompanying its latest proposal states, "[W]e also clarified that the board in general is not precluded from discussing CEO compensation, as we did not intend this standard to impair communications among all directors."4 There is nothing in the NYSE Proposal that specifically bars the CEO from attending any meeting of either the compensation committee or the independent directors at which his or her compensation is being discussed. This contrasts to the NASDAQ position as noted below.

b. NASDAQ Proposal. The NASDAQ Proposal reads as follows:

Compensation of the chief executive officer of the company must be determined, or recommended to the board for determination, either by:

[i] a majority of the independent directors, or

[ii] a compensation committee comprised solely of independent directors.

The chief executive officer may not be present during voting or deliberations.

Thus, in contrast to the NYSE, NASDAQ would allow determination of CEO compensation to be made by the board [which may include insiders except, for this purpose, the CEO] or, on the other hand, by the compensation committee or by a majority of independent directors.

Unlike the NYSE, as noted above, the NASDAQ explicitly excludes the CEO from being present during voting or deliberations on his or her pay, whether by the compensation committee, by a majority of independent directors or by the board.

2. Setting Non-CEO Pay

a. NYSE Proposal. This proposal gives the compensation committee "direct responsibility" to "make recommendations to the board with respect to non-CEO compensation, incentive-compensation plans and equity-based plans." NYSE Proposed Rule 303A[5][b][i][B]. The implication is that the board, not the compensation committee, must make the final determination on non-CEO pay. In its Commentary to Proposed Rule 303A[5], the NYSE states that "the compensation committee is not precluded from approving awards [with or without ratification of the board] as may be required to comply with applicable tax laws [i.e., Rule 162[m]]."

b. NASDAQ Proposal. The NASDAQ Proposal for setting non-CEO pay is virtually identical to the NASDAQ Proposal for setting CEO pay [except that there is no exclusion of the CEO from deliberations.] NASDAQ Proposed Rule 4350[c][3][B]. In contrast to the NYSE Proposal, the NASDAQ Proposal for non-CEO pay is limited to "executive officers" [meaning, for this purpose, "executive officer" as defined in Rule 16a-1[f] under the Securities Exchange Act of 1934 [the "Exchange Act"]].

Under the NASDAQ Proposal the full Board [including the CEO and other insiders] can make final determinations on the pay of other executive officers [based on recommendations by the compensation committee or a majority of independent directors] or such determinations may be made by the compensation committee itself or by a majority of the independent directors.

Following, in Table 1, is a comparison of NYSE and NASDAQ proposals regarding the role of different parties in setting CEO and non-CEO compensation.

B. Definition of 'Independent' Directors

The NYSE and the NASDAQ proposals both provide for an affirmative determination by the Board of a listed company as to the directors designated as "independent." In the case of the NYSE Proposal, if the director is not automatically disqualified under the specific standards of "non-independence," the board of the listed company must affirmatively determine that a director has no "material relationship" with the company in order for that director to be deemed independent. NYSE Proposed Rule 303A[2][a]. The commentary to this NYSE Proposal notes that "[m]aterial relationships can include commercial, industrial, banking, consulting, legal, accounting, charitable and familial relationships, among others." In the case of the NASDAQ Proposal, the board must make a determination that the director does not have a relationship "which, in the opinion [of the board] would interfere with the exercise of independent judgment in carrying out the responsibilities of a director." NASDAQ Proposed Rule 4200[a][15].

Both NYSE and NASDAQ Proposals require that a determination by the board that a director is independent within the meanings noted above must be made in the proxy statement, or if a proxy statement is not filed for the applicable period, then in the annual report as filed with the SEC.6 Commentary to NYSE Proposed Rule 303A[2][a] and NASDAQ Proposed Rule 4350[c][1].

In addition to the required findings by the board as to the status of a director as "independent," the proposed NYSE and NASDAQ rules provide specific circumstances in which a director cannot be designated as "independent." These circumstances are as follows:

[a] Employment by the listed company or any parent or subsidiary;

[b] Compensation [with exceptions noted in the chart below] received from the listed company;

[c] Affiliation with the listed company's auditor;

[d] Serving as executive officer of another company under certain circumstances; and

[e] Affiliation with another company with significant business dealings with the listed company.

More specific detail, including phase-in rules, for the above-listed circumstances in which a director cannot be treated as independent and the differences between the NYSE and NASDAQ proposed rules in this regard are set forth in the chart at the end of the column.

C. Comments:

On Certain Relationships with a Listed Company That Do Not Prevent a Director from Being Considered "Independent."

There are certain relationships with a listed company that do not prevent treatment of a director as "independent" under the proposals. These include:

[a] In the case of the NYSE Proposal, employment as an interim chairman or CEO once such employment ceases. Commentary to NYSE Proposed Rule 303A[2][b][i].

[b] In the case of both NYSE and NASDAQ proposals, receipt of a pension. NYSE Proposed Rule 303A[2][b][ii]; NASDAQ Proposed Rule 4200[a][15][B][iv].

[c] In the case of both NYSE and NASDAQ proposals, ownership of stock, by itself. Commentary to NYSE Proposed Rule 303A[2][a]; Interpretative Material to NASDAQ Proposed Rule 4200[a][15].

In all events, a board of a listed company subject to the new NYSE and NASDAQ rules will need to weigh carefully the totality of relationships between the issuer and a director in making a determination [not already precluded by a specific rule] that a director is independent.7

D. Notification, Certification

Both the NYSE and NASDAQ would require their listed companies [the CEO in the case of the NYSE] to provide them with "prompt" notification after any executive officer becomes aware of any material non-compliance with the new corporate governance standards. NYSE Proposed Rule 303A[12][b] and NASDAQ Proposed Rule 4350[m]. In addition, the NYSE proposes that each listed company's CEO must certify to the NYSE each year that he or she is not aware of any violation by the company of NYSE corporate governance standards and such certification [along with Sarbanes-Oxley CEO and CFO certifications] must be disclosed in the company's annual report. NYSE Proposed Rule 303A[12][a]. Please see Table 2.


[1] All references to NYSE Listed Company Manual Proposed Rule 303A are to the proposed rules in the NYSE's Oct. 8, 2003 filing with the SEC [the NYSE Proposal] and all references to NASDAQ Proposed Rules 4200 and 4350 are to the proposed rules in the NASDAQ's Oct. 9, 2003 filing with the SEC [the "NASDAQ Proposal"]. The NYSE and NASDAQ are proposing that the required effective date for compliance with their new listing standard rules would generally be the earlier of a listed company's first annual meeting after
Jan. 15, 2004 or no later than Oct. 15, 2004.

Both the NYSE and NASDAQ propose delays in applicability of the new rules in specific situations which are not discussed in the column. Also, exceptions and exemptions from the rules are provided [e.g., in the case of the NYSE Proposal, "foreign private issuers" are provided certain exceptions and under both the NYSE and NASDAQ Proposals "controlled companies" [those in which more than 50 percent of the voting power is held by an individual, group or another company] are provided certain exceptions.] These exceptions are not discussed in the column.

The American Stock Exchange submitted to the SEC proposals to enhance the corporate governance requirements applicable to its listed companies. These proposals are not discussed in the column.

[2] See NYSE Proposed Rule 303A[1]; NASDAQ Proposed Rule 4350[c][1].

[3] The NYSE proposed rule would allow a committee "denominated" by some name other than the compensation committee to make the determinations described in the text, provided it is comprised solely of independent directors and has a published charter [presumably containing the provisions required as to a compensation committee].

[4] The commentary to the NYSE proposal also states "[n]othing in this provision should be construed as precluding discussion of CEO compensation with the board generally, as it is not the intent of this standard to impair communication among members of the board." Commentary to NYSE Proposed Rule 303A[5].

[5] Under the NASDAQ Proposal, if the compensation committee consists of at least three members, a nonindependent director [so long as he is not a current officer or employee and does not have a family member who is a current officer or employee of the company] may serve on the compensation committee for no more than two years if the board determines it is in the best interests of the company and shareholders. This arrangement and the reasons for it must be disclosed in the company's proxy statement for its next annual meeting subsequent to such determination. NASDAQ Proposed Rule 4350[c][3][C].

[6] To assist in making this determination, the board can adopt and disclose categorical standards and make a general disclosure if a director meets these standards. See Commentary to NYSE Proposed Rule 303A[2][a].

[7] The NYSE urges boards to "consider all relevant facts and circumstances" and to "consider the issue not merely from the standpoint of the director, but also from that of persons or organizations with which the director has an affiliation." Commentary to NYSE Proposed Rule 303A[2][a].

[8] The NYSE Proposal defines "immediate family member" to mean a person's spouse, parents, children, siblings, in-laws [parents, children and siblings], and anyone else [other than domestic employees] who shares such person's home. General Commentary to NYSE Proposed Rule 303A[2][b]. The NASDAQ Proposal defines family members to mean a person's spouse, parents, children and siblings, including in-laws, or anyone residing in such person's home. NASDAQ Proposed Rule 4200[a][14].

[9] Unlike the corresponding NYSE threshold test [which refers to more than $100,000 in "direct compensation"], the latest NASDAQ proposal deletes a reference to "compensation" and adopts instead the broader term of "payments." NASDAQ's Interpretative Material notes that the use of the broader term "payments" is intended to capture payment under arrangements such as consulting or personal service contracts and political contributions.

[10] According to the NYSE's commentary, even though charitable organizations are not "companies" for purposes of this test, proxy disclosure is required if the listed company makes contributions to any charity in which a director serves as an executive officer if, within the prior three years, contributions in any single fiscal year exceeded the greater of $1 million or 2 percent of such charity's consolidated gross revenues. And, the commentary goes on to observe, in affirmatively determining director "independence," boards are required to consider the materiality of a director's relationship with any such charity in determining whether that director has any material relationship with the listed company. Commentary to NYSE Proposed Rule 303A[2][b][v]. Under the NASDAQ Proposal payments to a charitable organization would be subject to the payment limit of Proposed Rule 4200[a][15][D]. See Interpretative Material to NASDAQ Proposed Rule 4200[a][15][D].