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Report to Congressional Requesters:
April 2004:
SECURITIES MARKETS:
Opportunities Exist to Enhance Investor Confidence and Improve Listing
Program Oversight:
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-04-75]:
GAO Highlights:
Highlights of GAO-04-75, a report to congressional requesters
Why GAO Did This Study:
The equity listing standards of the three largest U.S. securities
markets—the American Stock Exchange (Amex), the Nasdaq Stock Market,
Inc. (NASDAQ), and the New York Stock Exchange (NYSE)—have received
heightened attention as part of efforts to restore investor confidence
following the 2001 terrorist attacks and the unexpected corporate
failures beginning that year. GAO was asked to discuss (1) the status
of the Securities and Exchange Commission’s (SEC) recommendations to
the three largest markets for improving their equity listing programs,
(2) SEC’s oversight of NASDAQ’s moratorium on the enforcement of
certain of its listing standards and the status of affected listed
companies (issuers), and (3) actions the three largest markets have
taken to strengthen corporate governance.
What GAO Found:
The only significant open recommendation from SEC’s inspections of the
three largest U.S. markets’ equity listing programs was a
recommendation that these markets append a modifier to the stock symbol
of issuers that do not meet their continued listing standards to
provide the public early and ongoing notification of issuers’
noncompliance with these standards. NYSE has taken steps to implement
this recommendation for its quantitative standards by transmitting an
indicator of an issuer’s noncompliance with stock data to information
vendors, but concerns remain about the further distribution of this
information from the vendors to investors. NASDAQ has provided some
ongoing notification of noncompliance with certain listing standards
since before 1980. More recently, NASDAQ and Amex have proposed using
indicators to address SEC’s recommendation, but the indicators
generally would not be transmitted early in the deficiency process. In
the absence of voluntary action by the markets, further SEC action is
warranted to ensure that the public receives early and ongoing
notification of issuers’ noncompliance with listing standards.
Following the market instability after September 11, 2001, SEC allowed
a NASDAQ rule to remain in effect that imposed a 3-month moratorium on
enforcing NASDAQ’s bid-price related listing standards. While its full
effect could not be determined, the moratorium met its objective of
allowing noncompliant issuers more time to trade without facing the
threat of delisting. According to NASDAQ, the moratorium provided
relief to at least 509 issuers—about 11 percent of all its issuers. SEC
subsequently approved another NASDAQ rule that allows some issuers to
trade up to 2 years while noncompliant with the bid-price standard—a
long time absent a means of providing the public with both early and
ongoing notification of an issuer’s listing status.
In response to a 2002 SEC request and rules implementing the Sarbanes-
Oxley Act of 2002, the three largest U.S. markets have adopted changes
to their corporate governance listing standards that when implemented
should promote stronger board oversight and greater accountability.
Increasing the role and authority of independent directors is central
to these governance reforms. Consistent with the position of some
market participants, GAO encourages SEC, in conjunction with the
markets, to seriously consider using listing standards to further
strengthen board independence by requiring a supermajority of
independent directors and separating the positions of chief executive
officer and board chairman. Also, to better ensure that they hold
themselves accountable to standards consistent with those imposed on
issuers, SEC asked the three largest markets to evaluate their own
governance. SEC’s timely review of both the markets’ oversight of
issuers’ compliance with the new corporate governance standards and the
markets’ changes to their governance will be important to ensuring the
effectiveness of issuers and markets’ actions.
What GAO Recommends:
This report includes 12 recommendations to SEC designed to enhance
investor confidence in the markets, further strengthen the listing
standards of the self-regulatory organizations (SRO) that oversee the
markets, and improve SEC and SRO oversight of the markets’ listing
programs. SEC generally agreed with the recommendations; the SROs
expressed concerns about those related to notifying the public of
noncompliance with listing standards and enhancing board independence.
www.gao.gov/cgi-bin/getrpt?GAO-04-75.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Rick Hillman at (202)
512-8678 or hillmanr@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
The SROs Have Addressed All OCIE Recommendations, Except One to Use
Stock Symbol Modifiers:
OCIE Does Not Routinely Use SRO Internal Review Reports in Planning and
Conducting Inspections:
The NASDAQ Moratorium and Subsequent Rule Changes Allowed Issuers to
Remain Listed Longer:
Listing Standards Have Been Used as a Vehicle for Improving Corporate
Governance:
Conclusions:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendixes:
Appendix I: Scope and Methodology:
Appendix II: Quantitative Listing Standards for Domestic Issuers of the
Three Largest Markets:
Appendix III: Deficiency and Hearing Processes for Domestic Issuers
Listed on the Three Largest Markets:
The Amex Deficiency and Hearing Processes for Domestic Issuers:
The NASDAQ Deficiency and Hearing Processes for Domestic Issuers:
The NYSE Deficiency and Hearing Processes for Domestic Issuers:
Appendix IV: Market Participants Contacted During This Review:
Appendix V: Comments from the Securities and Exchange Commission:
Appendix VI: Comments from the American Stock Exchange:
Appendix VII: Comments from the Nasdaq Stock Market, Inc.:
Appendix VIII: Comments from the New York Stock Exchange:
Appendix IX: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Staff Acknowledgments:
Tables:
Table 1: Lowest and Highest Numbers of Issuers Trading Noncompliant with
Quantitative Continued Listing Standards in Calendar Year 2003, by
SRO:
Table 2: Total Number of Issuers Trading Noncompliant with Quantitative
Continued Listing Standards in Calendar Year 2003 and Their Listing
Status on December 31, 2003, by SRO:
Table 3: The American Stock Exchange's Quantitative Standards for
Initial Listing of Domestic Issuers:
Table 4: The American Stock Exchange's Quantitative Standards for
Continued Listing of Domestic Issuers:
Table 5: The NASDAQ National Market's Quantitative Standards for Initial
Listing of Domestic Issuers:
Table 6: The NASDAQ National Market's Quantitative Standards for
Continued Listing of Domestic Issuers:
Table 7: The NASDAQ SmallCap Market's Quantitative Standards for Initial
Listing of Domestic Issuers:
Table 8: The NASDAQ SmallCap Market's Quantitative Standards for
Continued Listing of Domestic Issuers:
Table 9: The New York Stock Exchange's Quantitative Standards for
Initial Listing of Domestic Issuers:
Table 10: The New York Stock Exchange's Quantitative Standards for
Continued Listing of Domestic Issuers:
Figures:
Figure 1: Maximum Number of Calendar Days in NASDAQ Bid-Price Compliance
Periods from August 1991 (Premoratorium) through December 2003 (Latest
Rule Change):
Figure 2: Key Points in Amex's Deficiency Process for Domestic Issuers:
Figure 3: Key Points in Amex's Hearing Process for Domestic Issuers:
Figure 4: Key Points in NASDAQ's Equity, Total Assets and Total Revenue,
Publicly Held Shares, and/or Round-Lot Shareholders Deficiency Process
for Domestic Issuers:
Figure 5: Key Points in NASDAQ's Market Value of Listed Securities and
Market Makers Deficiency Process for Domestic Issuers:
Figure 6: Key Points in NASDAQ's Market Value of Publicly Held Shares
Deficiency Process for Domestic Issuers:
Figure 7: Key Points in NASDAQ's SCM and NNM Bid-Price Deficiency
Process for Domestic Issuers:
Figure 8: Key Points in NASDAQ's Hearing Process for Domestic Issuers:
Figure 9: Key Points in NYSE's Price Deficiency Process for Domestic
Issuers:
Figure 10: Key Points in NYSE's Nonprice Deficiency Process for Domestic
Issuers:
Figure 11: Key Points in NYSE's Hearing Process for Domestic Issuers:
Abbreviations:
AFEP-AGREF: Association of French Private Sector Companies and
Association of Major French Corporations:
AFL-CIO: American Federation of Labor and Congress of Industrial
Organizations:
Amex: American Stock Exchange:
CEO: Chief Executive Officer:
CFTC: Commodity Futures Trading Commission:
EDGAR: Electronic Data Gathering, Analysis, and Retrieval:
IG: Inspector General:
NASD: National Association of Securities Dealers, Inc.
NASDAQ: Nasdaq Stock Market, Inc.:
NNM: NASDAQ National Market:
NYSE: New York Stock Exchange:
OCIE: Office of Compliance Inspections and Examinations:
SEC: Securities and Exchange Commission:
SCM: SmallCap Market:
SRO: self-regulatory organization:
Letter April 8, 2004:
The Honorable John D. Dingell:
Ranking Minority Member:
Committee on Energy and Commerce:
House of Representatives:
The Honorable Barney Frank:
Ranking Minority Member:
Committee on Financial Services:
House of Representatives:
The Honorable Paul E. Kanjorski:
Ranking Minority Member:
Subcommittee on Capital Markets, Insurance, and Government Sponsored
Enterprises:
Committee on Financial Services:
House of Representatives:
The equity listing standards of the three largest U.S. securities
markets--the American Stock Exchange (Amex), Nasdaq Stock Market, Inc.
(NASDAQ), and New York Stock Exchange (NYSE)--have received heightened
attention as part of public and private efforts to restore investor
confidence in the markets.[Footnote 1] Listing standards have been the
focus of attention because they govern which companies can be listed
for trading on a particular market and are intended in part to maintain
public confidence in the markets. In its role as a self-regulatory
organization (SRO), each market establishes and enforces the standards
that companies must meet to be listed for trading.[Footnote 2] To
oversee the effectiveness of the SROs' listing programs, the Securities
and Exchange Commission (SEC), through its Office of Compliance
Inspections and Examinations (OCIE), periodically inspects these
programs and makes recommendations intended to improve them.
Your ongoing interest in learning how the three largest SROs have
addressed OCIE's recommendations for improving their listing programs,
particularly those related to protecting investors, has broadened as
listing standards have increasingly become the focus of solutions to
challenges facing the markets.[Footnote 3] First, in response to the
market turmoil resulting from the September 2001 terrorist attacks on
the United States, NASDAQ, subject to SEC's oversight, implemented a
rule that imposed a moratorium on enforcing its listing standards for
bid price[Footnote 4] and market value of publicly held shares[Footnote
5] and subsequently implemented two additional rules that further
relaxed its bid-price standard. These actions raised questions about
how NASDAQ and SEC, in their regulatory roles, balanced the goal of
market stability against that of investor protection. Second, the
unexpected failures of several major corporations beginning in 2001
focused congressional and regulatory attention on improving issuers and
SROs' corporate governance--that is, the way boards oversee management
to ensure that organizations are well-run and shareholders are treated
fairly.[Footnote 6]
As agreed with your offices, we discuss the following in this report:
(1) the status of OCIE's recommendations to the three largest SROs for
improving their markets' equity listing programs, focusing on a
recommendation intended to ensure early and ongoing public notification
of issuers' noncompliance with continued listing standards; (2) the
extent to which OCIE uses SROs' internal review reports in its
inspection process;[Footnote 7] (3) SEC's oversight of NASDAQ's
moratorium and subsequent bid-price rule changes and the listing status
of the issuers directly affected by these changes; and (4) actions the
three largest SROs have taken to strengthen corporate governance for
issuers and themselves.
To report on the status of OCIE's recommendations to the three largest
SROs for improving their markets' equity listing programs, we reviewed
OCIE's inspection reports and related workpapers and obtained available
information from OCIE, Amex, NASDAQ, and NYSE officials on OCIE's
recommendations and the SROs' efforts to address them. In addition to
these steps, in reviewing actions to address OCIE's recommendation
intended to ensure early and ongoing public notification of issuers'
noncompliance with continued listing standards, we contacted 11
information vendors, visited their Web sites, or both, to determine
whether they were distributing the information on issuers'
noncompliance with NYSE's quantitative continued listing
standards.[Footnote 8] To report on the extent to which OCIE uses SROs'
internal review reports in its inspection process, we obtained and
reviewed information from OCIE and other regulatory agencies on their
policies for using these reports in planning and conducting inspections
and examinations and reviewed authoritative standards and selected SRO
internal review reports. To report on SEC's oversight of NASDAQ's
moratorium and subsequent bid-price rule changes and the listing status
of issuers directly affected by these changes, we reviewed relevant
NASDAQ proposed and final rules and discussed their purposes with
NASDAQ officials, obtained information from SEC officials on their
review of the proposals, and analyzed data provided by NASDAQ. Finally,
to report on the actions the three largest SROs have taken to
strengthen corporate governance for issuers and themselves, we reviewed
SROs' proposed and final (new) corporate governance rules for issuers
and self-evaluations of their own governance. We obtained information
from regulatory officials on the purpose of the new rules and their
plans for ensuring compliance with them. We also obtained selected
market participants' views of the adequacy of the SROs' new
rules.[Footnote 9] We performed our work from April 2002 through March
2004 in accordance with generally accepted government auditing
standards. Appendix I provides a detailed discussion of our scope and
methodology.
Results in Brief:
OCIE has concluded that the three largest SROs have addressed the
recommendations that were unique to their markets from its inspections
of their listing programs. The only significant, open recommendation
applies to all three SROs--that they append a modifier to the stock
symbols of issuers that do not meet their continued listing standards
to provide the public early and ongoing notification of issuers'
noncompliance with these standards. OCIE's recommendation addressed its
concern that the SROs were allowing noncompliant issuers to remain
listed for significant periods of time without providing adequate
notification to investors. To avoid investor confusion caused by
temporary changes to stock symbols, NYSE has implemented procedures for
transmitting an indicator with the issuer's stock quotation data over
the consolidated tape[Footnote 10] to information vendors,[Footnote 11]
beginning 5 business days after NYSE notifies the issuer of its
noncompliance with the market's quantitative continued listing
standards. OCIE officials said that NYSE's response could meet the
intent of OCIE's recommendation as it relates to quantitative listing
standards, if concerns about distributing the information transmitted
by the indicator from vendors to investors were resolved. A NASDAQ
official told us that NASDAQ has used a symbol modifier since before
1980 to provide the public ongoing notification of some issuers'
noncompliance with quantitative listing standards. In April 2003,
NASDAQ tentatively proposed replacing the modifier with an indicator
that would be used in a manner similar to NYSE's. However, as in the
case of its symbol modifier, the indicator would not be transmitted
early in the deficiency process. Amex has also proposed using an
indicator that would not be transmitted early in the deficiency
process. Complementing OCIE's efforts, SEC's Division of Corporation
Finance (Corporation Finance) has proposed a rule that would require,
among other things, that an issuer report on SEC's Form 8-K[Footnote
12] the receipt of a notice of noncompliance with quantitative or
qualitative continued listing standards,[Footnote 13] along with an
explanation of the facts surrounding the issuer's noncompliance, within
2 business days of receiving the notice.[Footnote 14] If finalized, the
revised filing requirement would provide investors the early
notification that OCIE seeks as well as information that would allow
them to better understand the issuer's noncompliant status. OCIE
officials told us that further use could be made of modifiers or
indicators to identify issuers that do not meet the markets'
qualitative listings standards, which include corporate governance
standards. For example, a NASDAQ official said that since before 1984,
NASDAQ has appended a modifier to the stock symbols of issuers that do
not comply with its qualitative listing standard that requires timely
filing of SEC quarterly and annual financial reports and in doing so
has provided investors early and ongoing notification that significant
corporate information has not been made available. OCIE plans to report
to the Commission on the SROs' progress in implementing its
recommendation, and the Commission has authority under the Securities
Exchange Act of 1934 (the Exchange Act) to resolve implementation
issues or to take alternative actions to ensure that the public
receives early and ongoing notification of issuers' noncompliant
status.
OCIE officials told us that they do not routinely use SROs' internal
review reports in planning and conducting inspections designed to
assess the quality of SROs' oversight. These officials said that OCIE
does not have a written policy that specifically addresses the use of
internal review reports in inspections and that OCIE relies on the
guidance provided in a policy memorandum addressing their use in
examinations of broker-dealers, investment advisers, and investment
companies. Under the policy, internal review reports would be used in
inspections when OCIE believed specific problems existed at an SRO that
warranted further investigation. According to OCIE officials, routine
use of the reports would have a "chilling effect" on the flow of
information between SRO internal review staff and other SRO employees,
thereby reducing the effectiveness of the internal review function.
Nonetheless, professional standards recommend the use of the reports
for planning and conducting inspections, and officials of the
Inspectors General (IG) offices for the Commodity Futures Trading
Commission (CFTC) and the Department of the Treasury (Treasury) told us
that they routinely use the reports for these purposes. Also, our work
showed that some of the SROs' reports addressed topics that OCIE has
addressed in its listing program inspections, such as internal reviews
of SROs' initial and continued listing programs, and that the reports
could have been useful to OCIE in planning and conducting its
inspections. However, according to OCIE officials, to the best of their
knowledge, they have never requested an SRO internal review report as
part of a listing program inspection.
In September 2001, SEC allowed a NASDAQ rule to remain in effect that
imposed a 3-month moratorium on enforcing continued listing standards
for bid price and market value of publicly held shares.[Footnote 15]
NASDAQ had concluded that the moratorium was necessary because of the
increasing number of issuers that were falling below the applicable
standards after September 11. NASDAQ officials expressed concern that
delisting these issuers would, among other things, disadvantage
investors who would be limited to trading the related securities in
markets that were not subject to the same level of regulation and
transparency as NASDAQ.[Footnote 16] According to NASDAQ data, the
moratorium provided relief from pending or potential delisting to at
least 509 issuers, or about 11 percent of all NASDAQ issuers.[Footnote
17] After the moratorium expired, SEC allowed another NASDAQ rule to
remain in effect establishing a pilot program that (1) extended from 90
days[Footnote 18] to almost 1 year the period that SmallCap Market
(SCM) issuers that were noncompliant with the market's bid-price
continued listing standard could remain listed and (2) established
procedures that allowed NASDAQ National Market (NNM) issuers that
remained noncompliant with the bid-price standard to transfer to the
SCM.[Footnote 19] As of February 28, 2003, 246 of the 509 issuers
receiving relief through the moratorium (48 percent) continued to trade
on NASDAQ.[Footnote 20] Of these, 132 took advantage of the extended
compliance period. The remaining 263 of the 509 issuers (52 percent)
were delisted because they did not comply with one or more continued
listing standards or for other reasons, such as a merger with or
acquisition by another company. On December 23, 2003, SEC approved,
also as a pilot program, a NASDAQ rule that, subject to requirements
intended to protect investors, further extended the SCM and NNM bid-
price compliance periods for up to 2 years and almost 1 year,
respectively.
The collapse of several major U.S. corporations beginning in 2001
motivated efforts to strengthen the oversight of boards of directors
through revisions to the markets' corporate governance listing
standards. In response to a 2002 SEC request as well as rules
implementing the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley), the three
largest SROs adopted rules intended to significantly strengthen these
standards. Among other things, the new standards increase the role and
authority of independent directors and corporate governance
disclosures. However, unlike NASDAQ and NYSE's standards, Amex's
standards do not currently require issuers to disclose the names of the
directors they have designated as independent, hampering regulators and
investors' ability to assess the independence of boards. Market
participants told us that they support the SROs' new standards,
although they held differing views on the need for further
enhancements. Consistent with the position of some market participants,
we have expressed the view in prior work that SEC, in conjunction with
the SROs, should consider using listing standards to further strengthen
board independence by requiring a supermajority of independent
directors and separating the positions of chief executive officer (CEO)
and board chairman.[Footnote 21] SRO officials told us that they are
taking steps to enhance their ability to assess compliance with their
new corporate governance standards, and OCIE officials told us that
they will work with the SROs to ensure effective processes are in place
to more thoroughly assess compliance with these standards.
Complementing the SROs' enhancements to listing standards, SEC has
proposed rule changes that address longstanding investor interest in
gaining greater access to the director nomination process and approved
rules increasing disclosures of that process. Also, Corporation Finance
officials told us that in response to a market participant's request,
they plan to review SEC requirements governing disclosures of potential
director and director nominees' conflicts of interest. Further, to
better ensure that the SROs hold themselves to standards of governance
that are consistent with those imposed on issuers, SEC has asked the
SROs to evaluate their own governance, including board structures,
policies, and practices. Although SEC's Division of Market Regulation
(Market Regulation) has not completed its review of the SROs' self-
evaluations, as a result of this process, both NASDAQ and NYSE have
separated the positions of CEO and chairman, and NYSE has made other
significant changes to its governance structure.
This report makes 12 recommendations to the SEC Chairman that should
help restore investor confidence in the markets, further strengthen the
listing standards of the SROs, and improve SEC listing program
oversight. We recommend, among other things, that the Chairman take
actions, working with the SROs as necessary, to ensure that the public
receives early and ongoing notification of issuers' noncompliance with
the markets' continued listing standards; SRO internal review reports
are used in planning and conducting OCIE inspections of SROs; Amex
issuers are required to disclose the names of their independent
directors; serious consideration is given to requiring issuers to
establish a supermajority of independent directors and separate the
positions of CEO and chairman through revisions to listing standards;
OCIE conducts timely inspections to assess SRO oversight of issuers'
compliance with new corporate governance listing standards; and Market
Regulation places a high priority on completing reviews of the SROs'
self-evaluations of their governance practices.
We received comments on a draft of this report from SEC, Amex, NASDAQ,
and NYSE, which are included in appendixes V-VIII. SEC generally agreed
with our findings and recommendations and is taking or plans to take
actions to address them. The SROs expressed concerns about the
recommendations related to notifying the public of noncompliance with
listing standards, giving serious consideration to requiring a
supermajority of independent directors, and separating the positions of
CEO and chairman. Recognizing their concerns, we nonetheless continue
to believe that further SEC and SRO actions are needed to address our
recommendations. The comments are discussed in greater detail at the
end of this letter.
Background:
The Exchange Act established the regulatory structure of the U.S.
securities markets. These markets are regulated under a combination of
self-regulation (subject to SEC oversight) and direct SEC regulation.
This regulatory structure was intended to give SROs responsibility for
administering their own operations, including most of the daily
oversight of the securities markets and their participants. One of the
SROs--the National Association of Securities Dealers, Inc. (NASD)--is a
national securities association that regulates registered securities
firms, professionals, and NASDAQ.[Footnote 22] Other SROs include
national securities exchanges that operate the markets where securities
are traded.[Footnote 23] These SROs are primarily responsible for
establishing the standards under which their members conduct business;
monitoring the way that business is conducted; and bringing
disciplinary actions against their members for violating applicable
federal statutes, SEC's rules, and their own rules. SEC oversees the
SROs by inspecting their operations and reviewing their rule proposals
and appeals of final disciplinary proceedings.
Each SRO proposes the rules that establish its listing standards. To be
eligible for listing, issuers must comply with initial quantitative and
qualitative listing standards. Quantitative listing standards are
minimum financial requirements addressing such areas as the issuer's
total revenues, distribution, and market capitalization.[Footnote 24]
Qualitative listing standards, which include corporate governance
standards, are nonfinancial requirements addressing such matters as the
definition of director independence, the number of independent
directors on the board of directors and audit committee, and provisions
for annual stockholder meetings and shareholder approval of certain
corporate actions. In addition, to remain listed, issuers must maintain
compliance with the market's continued listing requirements. For
quantitative listing standards, these are generally lower than initial
listing standards, while for qualitative standards they are the same.
In general, a company applies to have its securities listed for trading
on a specific market, subject to that market's rules. This process
includes submitting an application for review, together with supporting
information such as financial statements, a prospectus, and relevant
share distribution information. The market's equity listing department
reviews these submissions for compliance with its initial listing
standards and conducts background checks of company officers and other
insiders. This department or a committee of the exchange makes the
listing decision. The equity listing department also monitors listed
companies for compliance with the market's continued listing standards
and, in accordance with the market's rules, is expected to take action
when these standards are not met.
Amex, NASDAQ, and NYSE are the three largest U.S. securities markets
for equities trading based on the number of listed U.S. companies.
According to Amex, as of the end of the third quarter 2003, it listed
735 issuers with a total market capitalization of approximately $282
billion.[Footnote 25] For this same period, NASDAQ said it listed 3,367
issuers with a total market capitalization of approximately $2.99
trillion for the SCM and the NNM combined. Finally, for this period,
NYSE told us that it listed approximately 2,800 issuers with a total
market capitalization of approximately $14.8 trillion.[Footnote 26]
The Exchange Act created SEC as an independent agency to oversee the
securities markets and their participants. SEC has a five-member
Commission headed by a chairman who is appointed by the President of
the United States for a 5-year term. In overseeing the SROs'
implementation and enforcement of rules, SEC may use its statutory
authority to, among other things, review and approve SRO-proposed rule
changes and abrogate (annul) SRO rules. Section 19(b) of the Exchange
Act governs the process by which SROs can change their rules. Section
19(b)(1) requires an SRO to file a proposed rule or amendment to an
existing rule with SEC for publication and solicitation of comments.
Under section 19(b)(2), SEC may approve the rule change by order or
conduct proceedings to determine whether it must be disapproved. SEC
must approve a proposal if it finds that it is consistent with Exchange
Act requirements; otherwise, it must institute disapproval proceedings.
However, if the rule change proposed by the SRO does not comply with
the filing requirements promulgated under section 19(b) of the Exchange
Act, SEC may deem the submission as not properly filed and reject it.
In addition, section 19(c) gives SEC power by rule to abrogate, add to,
or delete from the rules of an SRO, subject to specified procedures.
SEC officials said that SEC rarely uses this authority to amend SRO
rules, because, among other things, a number of procedural steps must
be satisfied, potentially making a section 19(c) ruling time-consuming.
SEC officials said that, in view of the procedural steps that would
need to be followed under section 19(c) to amend rules related to
listing standards and the need to consider any such proceeding in light
of Business Roundtable v. SEC, in which the D.C. Court of Appeals
vacated a listing standard that SEC had adopted using section 19(c)
authority, SEC prefers to rely on its powers of persuasion to convince
the SROs to enhance their corporate governance listing
standards.[Footnote 27]
SEC's Market Regulation division is responsible for the administration
and execution of SEC's programs under the Exchange Act relating to the
structure and operation of the securities markets, which includes
oversight of the SROs and review of their proposed rule changes. SEC
has delegated authority to Market Regulation with respect to other
aspects of SRO rulemaking as well, including the authority to publish
notices of proposed rule changes and to approve such proposed rule
changes.
In addition to granting authority to approve SRO-proposed rules, the
Exchange Act authorizes SEC to conduct reasonable, periodic, special,
or other examinations of all records that the SROs are required to
maintain.[Footnote 28] Under the Exchange Act, the national securities
exchanges, national securities associations, members of these exchanges
and associations, brokers, and dealers are required by SEC to preserve
certain books and records and keep them available for
inspection.[Footnote 29] The Exchange Act, in conjunction with relevant
rules, gives SEC the authority to request and review such records as
part of its inspections and examinations. These examinations may be
conducted at any time, or from time to time, as SEC deems necessary or
appropriate in the public interest, for the protection of investors or
otherwise in furtherance of the purposes of the Exchange Act.
OCIE, the SEC office responsible for conducting inspections and
examinations, is divided into three primary units--the Office of
Broker-Dealer and SRO Examinations, the Office of Market Oversight, and
the Office of Investment Advisor/Investment Company
Examinations.[Footnote 30] The Office of Broker-Dealer and SRO
Examinations and the Office of Market Oversight are responsible for
conducting examinations of broker-dealers and inspections of SROs
pursuant to the Exchange Act. According to OCIE officials, the
inspections conducted by the Office of Broker-Dealer and SRO
Examinations generally focus on a program area such as the listing
program, with the objective of evaluating whether the SROs' programs
and procedures are adequate and whether these programs and procedures
as well as recommendations from previous inspections are effectively
implemented. OCIE officials also told us that Office of Market
Oversight inspections primarily focus on issues related to trading
securities and that the Office of Investment Advisor/Investment Company
Examinations is responsible for examinations conducted pursuant to the
Investment Company and Investment Advisers Acts of 1940.
Under the Securities Act of 1933 and the Exchange Act, publicly traded
companies are required to file disclosures with SEC concerning their
business and financial affairs, both when securities are initially
offered and sold and on a periodic basis thereafter. Corporation
Finance reviews these disclosures, which include annual reports to
shareholders and proxy statements.[Footnote 31] Corporation Finance
also provides companies with assistance in interpreting SEC rules and
recommends to the Commission new rules for its approval.
The SROs Have Addressed All OCIE Recommendations, Except One to Use
Stock Symbol Modifiers:
OCIE has concluded that the three largest SROs have addressed the
recommendations that were unique to their markets from its inspections
of their listing programs. OCIE officials said that the only
significant, open recommendation was for the three SROs to use stock
symbol modifiers to provide the public early and ongoing notification
of issuers that do not meet their continued listing standards.
The SROs Have Addressed OCIE Recommendations That Were Unique to Their
Markets:
According to OCIE officials, Amex, NASDAQ, and NYSE have addressed the
recommendations that were unique to these markets' listing programs
from OCIE's recent inspection reports and have improved the structure
and operations of their programs in doing so. OCIE officials told us
that Amex's recent listing standards revisions met the intent of OCIE's
2001 inspection report recommendations.[Footnote 32] For example, in
response to these recommendations, Amex converted its discretionary
listing guidelines into mandatory listing standards to provide more
certainty to investors about the eligibility of issuers to trade on
Amex. In addition, Amex set firm time limits within which issuers that
are not compliant with its continued listing standards must regain
compliance.
According to OCIE's June 2002 inspection report on NASDAQ's listing
program, the SRO had addressed the recommendations from prior reports,
issued in 1997 and 1999, and the listing program was operating
according to NASDAQ's policies and procedures. OCIE found that the SRO
was generally thorough in its financial and regulatory reviews of
companies and complied with its obligation to compile periodic
management reports containing statistical data on issuers. While the
2002 report identified some new areas where the SRO could enhance
listing program operations, according to OCIE officials, NASDAQ
addressed the related recommendations.
OCIE's March 2003 inspection report on NYSE's listing program concluded
that the SRO had substantially improved its listing program since
OCIE's initial report, issued in 1998, and was generally adhering to
SRO listing rules and procedures. For example, OCIE found that NYSE had
enhanced its systems for detecting issuers that were out of compliance
with its continued listing standards and prepared quarterly management
reports to assist in monitoring the status of listed companies. The
2003 report made some new recommendations that OCIE officials said NYSE
addressed.
The Intent of the Recommendation to Has Not Been Fully Addressed:
OCIE recommended that the SROs append a modifier to the stock symbols
of issuers that do not meet their continued listing standards to
provide the public early and ongoing notification of issuers'
noncompliance with these standards--a recommendation that Market
Regulation also made. NYSE has begun transmitting an indicator over the
consolidated tape to information vendors, which OCIE officials said
could address the intent of OCIE's recommendation as it relates to
NYSE's quantitative listing standards, if concerns about vendor
distribution of the information transmitted by the indicator are
addressed. NASDAQ and Amex have reservations about modifiers and their
proposals for implementing them would not provide early public
notification. Complementing OCIE's efforts, Corporation Finance
proposed changes to SEC's Form 8-K, which, if finalized, would provide
investors with early notification of an issuer's noncompliance with
qualitative and quantitative listing standards and additional
information on the issuer's noncompliant status. OCIE officials told us
that further use could be made of modifiers or indicators to identify
issuers that do not meet the markets' qualitative listings standards.
OCIE plans to report to the Commission on the SROs' progress in
implementing its recommendation, and the Commission has authority to
resolve implementation issues or to take alternative actions to ensure
that the public receives early and ongoing notification of issuers'
noncompliance with the SROs' continued listing standards.
OCIE and Market Regulation Recommended the Use of Symbol Modifiers to
Provide Early and Ongoing Notification of Issuers' Noncompliance:
In its most recent reports on Amex, NASDAQ, and NYSE's listing
programs, OCIE recommended that the three largest SROs use stock symbol
modifiers to provide the public early and ongoing notification of
issuers' noncompliance with their continued listing
standards.[Footnote 33] OCIE's recommendation would have extended
NASDAQ's practice of modifying the stock symbols of certain
noncompliant SCM issuers. Market Regulation concurred with the
recommendation and also requested that the three largest SROs append
the modifier.[Footnote 34] The recommendation addressed OCIE's concern,
which surfaced during its listing program inspections, that the SROs
were allowing deficient issuers to remain listed for significant
periods of time without adequately notifying investors. For example, an
OCIE report on the listing program of one SRO identified several
instances in which the SRO granted issuers excessive delisting
deferrals or did not commence delisting proceedings in a timely manner.
The report cited one instance of an issuer being allowed to remain
listed for approximately 2 years while out of compliance with the
market's continued listing standards. An OCIE report on another SRO
found that two issuers had been listed for at least 3 years without
meeting the SRO's continued listing standards.[Footnote 35]
According to OCIE and Market Regulation officials, modifiers would make
the listing status of an issuer more transparent to investors and
reduce the misleading perception that because an issuer is listed it
meets a market's continued listing standards. Investors currently
receive information on an issuer's noncompliance with these standards
through issuer press releases that are required by Amex, NASDAQ, and
NYSE rules. However, these rules do not provide for early public
investor notification of an issuer's noncompliance. For example, while
Amex's rules require it to send an issuer a deficiency notice within 10
business days of identifying the issuer's noncompliance with continued
listing standards, by applying the various rules in Amex's deficiency
process, the issuer would not have to issue a press release for up to
80 days after receiving the notice.[Footnote 36] NASDAQ's rules require
it to send a similar deficiency notice within 5 days, but an issuer is
not required to issue a press release for approximately 35-97 days (up
to 730 days in the case of bid-price deficiencies) after receiving the
notice, depending on the listing standard. Under NYSE's rules, the SRO
also sends its deficiency notice within 10 business days after
detecting the noncompliance, but issuers are not required to issue a
press release until 45 days after receiving a deficiency notice.
Further, OCIE and Market Regulation officials said that symbol
modifiers provide continuous disclosure that an issuer is not meeting
continued listing standards, unlike a press release, which is a one-
time event. Also, according to OCIE and Market Regulation officials,
information vendors may not distribute the press releases of smaller
companies, and vendors may not be consistent in the amount of time that
they make the press releases available to the public--factors that
could affect the usefulness of the releases for making investment
decisions.
The effect of implementing OCIE and Market Regulation's recommendation
on issuers that were noncompliant with quantitative listing standards
in 2003 is illustrated by table 1.[Footnote 37] The table shows that a
low of 1 percent of issuers (NASDAQ and NYSE) were trading noncompliant
with the market's quantitative continued listing standards during
calendar year 2003, meaning that as few as 1 percent of the issuers on
these markets would have been identified with a symbol modifier or
comparable identifier had OCIE's recommendation been implemented.
Similarly, a high of 10 percent of issuers (NASDAQ) traded noncompliant
with their market's quantitative continued listing standards, meaning
that at most 10 percent of the issuers on any of the markets would have
been identified with a modifier or comparable identifier during that
year.
Table 1: Lowest and Highest Numbers of Issuers Trading Noncompliant
with Quantitative Continued Listing Standards in Calendar Year 2003, by
SRO:
SRO: Amex;
Lowest number of noncompliant issuers trading (percent): 32 (4%)[A];
Highest number of noncompliant issuers trading (percent): 51 (7%)[A].
SRO: NASDAQ;
Lowest number of noncompliant issuers trading (percent): 45 (1%)[B];
Highest number of noncompliant issuers trading (percent): 351(10%)[B].
SRO: NYSE;
Lowest number of noncompliant issuers trading (percent): 15 (1%)[C];
Highest number of noncompliant issuers trading (percent): 48 (2%)[C].
Sources: Amex, NASDAQ, and NYSE.
Notes:
[A] For Amex, the percentages for the lowest and highest number of
noncompliant issuers are based on the month-end numbers and the 738
listed issuers trading on both December 31, 2003, and June 30, 2003.
[B] For NASDAQ, the percentages for the lowest and highest number of
noncompliant issuers are based on the month-end numbers and the 3,333
listed issuers trading on December 31, 2003, and the 3,620 listed
issuers trading on January 31, 2003, respectively.
[C] For NYSE, the percentages for the lowest and highest number of
noncompliant issuers are based on the month-end numbers and the 2,938
listed issuers trading on December 31, 2003, and the 2,959 listed
issuers trading on December 31, 2002, respectivly.
[End of table]
The total numbers of issuers identified with a symbol modifier or its
equivalent would have been greater for each market than the numbers
shown in the table, because not all issuers were noncompliant with the
quantitative listing standards at the same time. As shown in table 2,
the total number of issuers that traded while noncompliant with their
markets' quantitative standards at any time during calendar year 2003
ranged from 68 (NYSE) to 617 (NASDAQ). Of these issuers, some regained
compliance with continued listing standards by December 31, 2003, while
others continued to trade noncompliant or were delisted as of that
date.
Table 2: Total Number of Issuers Trading Noncompliant with Quantitative
Continued Listing Standards in Calendar Year 2003 and Their Listing
Status on December 31, 2003, by SRO:
SRO: Amex;
Total number of noncompliant issuers in 2003
(percent): 94 (100%);
Their Listing status on December 31, 2003: Number compliant
(percent): 22 (23%);
Their Listing status on December 31, 2003: Number noncompliant
(percent): 32 (34%);
Their Listing status on December 31, 2003: Number delisted
(percent): 40 (43%).
SRO: NASDAQ;
Total number of noncompliant issuers in 2003
(percent): 617[A] (100%);
Their Listing status on December 31, 2003: Number compliant
(percent): 381 (62%);
Their Listing status on December 31, 2003: Number noncompliant
(percent): 45 (7%);
Their Listing status on December 31, 2003: Number delisted
(percent): 191 (31%).
SRO: NYSE;
Total number of noncompliant issuers in 2003
(percent): 68 (100%);
Their Listing status on December 31, 2003: Number compliant
(percent): 13 (19%);
Their Listing status on December 31, 2003: Number noncompliant
(percent): 15 (22%);
Their Listing status on December 31, 2003: Number delisted
(percent): 40 (59%).
Sources: Amex, NASDAQ, and NYSE.
Note:
[A] According to NASDAQ, 486 of the 617 noncompliant issuers (79
percent) were noncompliant with standards related to bid price.
[End of table]
NYSE's Transmittal of Indicators Could Address the Intent of OCIE's
Recommendation If Vendor Distribution Concerns Are Addressed:
To avoid investor confusion caused by temporary changes to stock
symbols, on July 1, 2003, NYSE began transmitting an indicator that
reflects an issuer's noncompliance with its quantitative continued
listing standards.[Footnote 38] Under its procedures, NYSE transmits
the indicator over the consolidated tape with the issuer's quotation
data beginning 5 business days after it notifies an issuer of its
noncompliant status and continuing until the issuer regains compliance
with the listing standard or is delisted. According to NYSE officials,
the 5-business-day period provides the issuer an opportunity to bring
to NYSE's attention any inaccuracy in NYSE's noncompliance
determination, as well as an opportunity to release a statement to the
public. Further distribution of the information transmitted by NYSE's
indicator from the consolidated tape to investors is at the discretion
of information vendors. NYSE officials told us that NYSE has notified
all vendors by e-mail of the availability of the indicator and followed
up with some of the major vendors to further discuss its distribution,
but NYSE has not formally notified the public of the indicator's
availability. However, NYSE displays the indicator and a list of
companies that do not meet its continued listing standards on its Web
site. According to NYSE officials, the list included 15 issuers on
December 31, 2003.
The Associated Press, which according to a company representative,
provides quotation information to all major U.S. daily newspapers
except The Wall Street Journal, began distributing the information
transmitted by the NYSE indicator in September 2003.[Footnote 39] It
does so by appending an "h" to an issuer's stock symbol to identify
NYSE-listed securities that do not meet the market's continued listing
standards. A representative of Dow Jones & Company told us that the
organization plans to distribute the information transmitted by NYSE's
indicator to investors through print media such as The Wall Street
Journal and over the Internet through [Hyperlink, http://www.WSJ.com],
and that it would begin doing so when technical difficulties are
resolved.[Footnote 40] A representative of Ameritrade Holding Company
told us that the broker-dealer is considering publicizing the
information transmitted by NYSE's symbol indicator during calendar year
2004.[Footnote 41]
Of the five other information vendors we contacted that provide
quotation information to investors over the Internet, none planned to
distribute the information transmitted by NYSE's symbol indicator.
These vendors, including two broker-dealers, provide market data on
their own Web sites or to third-party vendors, including many financial
Web sites such as [Hyperlink, http://www.cbs.marketwatch.com],
[Hyperlink, http://www.cnnfn.com],
[Hyperlink, http://www.finance.yahoo.com],
[Hyperlink, http://www.moneycentral.msn.com], and
[Hyperlink, http://www.smartmoney.com]. [Footnote 42] In addition, none
of three additional broker-dealers whose Web sites we visited were
distributing the information transmitted by the indicator. Among the
reasons vendors gave for not distributing this information were a lack
of client demand and reluctance to divert resources from more important
initiatives.
OCIE and Market Regulation officials said that NYSE can and should do
more to actively encourage information vendors to implement and
distribute the information transmitted by its indicator. For example,
OCIE officials said that NYSE could consider adding provisions to its
contracts with information vendors requiring them to distribute and
display the indicator. NYSE officials said that this option is not
practical, in part because information vendors are NYSE customers. NYSE
officials said that SEC has the authority to implement rules requiring
information vendors to distribute and display indicators, and it would
be appropriate for them to do so. Officials of all three SROs stressed
the desirability of having a marketwide solution to the information
distribution issue.
OCIE officials also said that although NYSE displays the indicator with
the stock symbol of issuers and a list of companies that do not meet
its continued listing standards on its Web site, NYSE could do more to
make this information readily accessible to investors. To determine
whether a Web site visitor could locate the indicator and the list of
noncompliant NYSE issuers, we visited the NYSE Web site and inputted
the stock symbol of a noncompliant issuer in the "Quick Quote" search
box located on the top right corner of NYSE's home page. In response,
we received quotation information that included the indicator with a
footnote explaining that the issuer did not meet NYSE's continued
listing standards. However, the indicator was not readily identifiable
because it did not visually stand out from all of the other information
presented on the page. Also, the information explaining the meaning of
the indicator was located at the very bottom of the page, separate from
the indicator itself and mingled with press releases and information
vendor logos. In addition, NYSE did not provide a link to its list of
noncompliant issuers on its home page, limiting its accessibility to
investors who do not already know of its existence. OCIE officials told
us that NYSE's approach to implementing symbol modifiers could meet the
intent of its recommendation to provide early and ongoing notification
to investors as it relates to quantitative listing standards, provided
that issues related to the distribution of the indicator from vendors
to investors were resolved.
NASDAQ and Amex Have Reservations about Symbol Modifiers, and Their
Proposals Would Not Provide Early Public Notification:
NASDAQ and Amex have both expressed reservations to OCIE and Market
Regulation about the effectiveness and fairness of using symbol
modifiers to communicate information about issuers' noncompliance with
continued listing standards to the public. In commenting on the value
of modifiers, they both stated that investors would view a modifier as
a warning not to invest in a company, which could have other negative
consequences for the issuer, including impeding its ability to raise
capital and regain compliance with the market's continued listing
standards.
A NASDAQ official told us that since before 1980 NASDAQ has appended a
modifier--the character "C"--to the stock symbol of an SCM issuer if
the NASDAQ Hearing Panel determined that the issuer was noncompliant
with quantitative continued listing standards and granted the issuer a
conditional listing, termed an "exception." According to NASDAQ, 32
noncompliant SCM issuers received a NASDAQ Hearing Panel exception in
2003 and had the modifier appended to their stock symbol. NASDAQ has
not appended the modifier to the stock symbols of NNM issuers because,
according to market officials, doing so would have put the NNM at a
competitive disadvantage to NYSE, which until 2003 did not identify
noncompliant issuers with either a symbol modifier or indicator. NASDAQ
said that its use of modifiers to identify SCM issuers that are listed
under an exception to its listing standards has raised concerns among
these issuers. NASDAQ officials told us that issuers have complained
that the modifier has a depressive effect on their stock price,
frustrating their efforts to regain compliance with listing standards
related to bid price. In addition, they said that issuers have
indicated that a modifier may make it more difficult to attract
investors for a private placement or complete other transactions that
may address a deficiency with a listing standard, such as the
shareholder equity requirement. In contrast, NYSE officials told us
that while the few affected companies have not been pleased by the
presence of the indicator, these companies have generally not found it
to have an adverse affect on their ability to raise capital. However,
NYSE's experience with the indicator has been limited, due to the small
number of companies that have been out of compliance with its
quantitative listing standards since the implementation of the
indicator. Amex said it does not believe that anyone has attempted to
evaluate the collateral consequences of symbol modifiers, especially
for small and middle market companies--the types of companies that are
generally listed on Amex.
NASDAQ and Amex also said that symbol modifiers oversimplify each
issuer's unique situation by lumping together dissimilar deficiencies
under one type of notification, regardless of the seriousness of the
deficiency and the likelihood that it will be corrected. They also said
that other issues that might affect the continued listing status of an
issuer would not be disclosed to the public with a symbol modifier--for
example, a going concern opinion from an issuer's auditors, major
litigation, the initiation of a regulatory investigation, or notice
that security holders should no longer rely on previously issued
financial statements or a related audit report. Nonetheless, the use of
a modifier or indicator to alert the public to an issuer's
noncompliance with continued listing standards would not preclude using
different modifiers or indicators to identify different types of
deficiencies or significant events that are unrelated to listing
standards. For example, while NASDAQ uses the symbol modifier "C" for
SCM issuers that receive an exception to the certain continued
quantitative listing standards of that market, it uses the symbol
modifiers "Q" and "E" for both SCM and NNM issuers that have filed for
bankruptcy or have not filed required SEC reports,
respectively.[Footnote 43] Also, these required reports would generally
contain the information affecting the continued listing status of
issuers that is cited in NASDAQ and Amex's example above.
Additionally, Amex and NASDAQ stated that a significant number of
issuers are able to regain compliance with continued listing standards
within the time frames allowed under SRO rules. According to Amex
officials, during calendar year 2003, 26 (25 percent) of 104 issuers
deficient with both quantitative and qualitative listing standards
regained compliance with the standards before the expiration of the
compliance period, 31 (30 percent) were still trading within their
compliance period, and 47 (45 percent) had been delisted or were in the
delisting process by the end of the year.[Footnote 44] According to
NASDAQ officials, during calendar year 2003, 150 (75 percent) of 200
issuers deficient in those quantitative NASDAQ listing standards that
specify compliance periods regained compliance before the compliance
periods expired.[Footnote 45] The remaining 50 (25 percent) were either
delisted, achieved compliance after the compliance period expired, or
were in the hearings process as of December 31, 2003.
Further, the two SROs said that investors have access to timely and
comprehensive notice of an issuer's listing status through press
releases, thus obviating the need for symbol modifiers. Also, they both
stated that the information on listed companies available to investors
through the Electronic Data Gathering, Analysis, and Retrieval (EDGAR)
system--a searchable database on SEC's Web site--and media such as the
Internet are sufficient for investors to make informed investment
decisions. However, as previously discussed, issuers are not required
to issue press releases early in the deficiency process, and press
releases do not provide ongoing public notification of an issuer's
listing status.
OCIE did not formally respond to the markets' individual concerns.
However, according to OCIE and Market Regulation officials, using the
symbol modifier to provide investors early and ongoing notification of
noncompliance with continued listing standards would strike an
appropriate balance between investor and issuer needs. These officials
said that modifiers would provide investors with adequate, timely, and
continuous notice of the listing status of affected issuers and also
allow these issuers to remain listed on the markets as they address
deficiencies.
OCIE officials told us that NASDAQ's proposal for addressing OCIE's
recommendation does not provide for early notification of issuer's
noncompliance. In an April 22, 2003, letter to OCIE, NASDAQ tentatively
proposed replacing all its symbol modifiers with indicators, which
would be used in a manner similar to the NYSE indicator. NASDAQ said
that one advantage of using an indicator is that it would minimize the
potential for investor confusion that may result from symbol
modifications.[Footnote 46] As part of its proposal, NASDAQ would
discontinue use of the "C" modifier on the SCM and instead transmit an
indicator to the consolidated tape whenever the NASDAQ Hearing Panel
determined that an SCM or NNM issuer was noncompliant with NASDAQ's
quantitative continued listing standards and received an exception,
just as it does now with the "C" modifier. Under NASDAQ's tentative
proposal, an issuer that is deficient with applicable listing standards
could be listed on NASDAQ for up to 145 days before the indicator would
be transmitted. However, NASDAQ would not initially transmit an
indicator with the symbols of issuers that were deficient with
standards for which its rules specify a time period to regain
compliance, such as its bid-price standard. Instead, NASDAQ said it
would transmit an indicator for these issuers, if, after the expiration
of the compliance period, the issuer requested a hearing and the NASDAQ
Hearing Panel allowed the issuer to remain listed pursuant to an
exception. NASDAQ officials said that they do not consider it
appropriate to transmit the indicator earlier in the deficiency
process, because doing so would deny deficient issuers their due
process. OCIE officials said that NASDAQ should transmit the indicator
early in the deficiency process so that investors are fully informed
that an issuer is not in compliance with listing standards. Further,
they said NASDAQ should more fully address instances of noncompliance
with listing standards.
OCIE officials also told us that Amex has not addressed the intent of
OCIE's recommendation and that its proposals would not meet the goal of
providing early notification of issuers' noncompliance with continued
listing standards. In a May 21, 2003, letter to OCIE, Amex proposed
transmitting an indicator over the consolidated tape in a manner
similar to that used by NYSE. However, unlike at NYSE, under this Amex
proposal, an indicator would not be transmitted until the issuer
received notice that Amex was initiating delisting proceedings. As a
result, a noncompliant issuer could be listed for up to 18 months
before the indicator was transmitted.[Footnote 47] Amex officials told
us that they expected the SRO to begin using indicators during the
third quarter of 2004. They also said that they plan to discuss a
second proposal with the Amex Board of Governors at its April 2004
meeting. Under this proposal, an indicator would be transmitted when a
noncompliant issuer was granted an extension pursuant to an accepted
compliance plan, which would reduce the time that a noncompliant issuer
could be listed without an indicator from 18 months to up to 75
days.[Footnote 48] According to OCIE officials, Amex should transmit
its indicator when it first notifies an issuer that it is deficient
with one or more of its standards.
Proposed Changes to SEC's Form 8-K Would Provide Early Notification of
Noncompliance:
In June 2002, Corporation Finance proposed a rule that would require,
among other things, that issuers report on SEC's Form 8-K the receipt
of either a notice of noncompliance with quantitative and qualitative
continued listing standards or a notice of delisting within 2 business
days of receiving either notice.[Footnote 49] The proposed changes
would also require the issuer to discuss its planned response to either
notice and give an explanation of the facts surrounding the issuer's
noncompliance. OCIE officials said that the Form 8-K revisions, if
finalized, would complement the symbol modifier or its equivalent; that
is, the symbol modifier or indicator could be a trigger for investors
to do further research on an issuer, for example, by retrieving an
issuer's Form 8-K from the EDGAR system to learn more about the nature
of an issuer's noncompliance with listing standards and the issuer's
plans to take corrective action.
According to OCIE officials, public disclosure through the Form 8-K is
preferable to existing disclosures provided through press releases
because issuers will be required to file the form earlier in the
deficiency process. In addition, unlike press releases, Form 8-K
filings would be available to investors through the EDGAR system.
However, agency officials said that the filings would not provide the
ongoing notification OCIE seeks through the modifier because they
reflect the company's status at the time the Form 8-K is filed and, as
a result, would not provide information about the ongoing listing
status of issuers. OCIE officials also said that investors would have
to know that they could search for an issuer's Form 8-K. Corporation
Finance officials said they expect the Commission to consider whether
to approve the final Form 8-K revisions in March 2004.
OCIE Said that Modifiers or Indicators Could Be Used to Further
Identify Noncompliance with Qualitative Listing Standards:
OCIE officials told us that their discussions with the SROs have
focused on using modifiers or indicators when issuers do not meet their
market's quantitative listings standards but that they could also be
useful in further alerting the public to issuers' noncompliance with
qualitative listing standards, which include corporate governance
standards. The three largest SROs have already taken a step in this
direction. For example, Amex and NASDAQ have qualitative standards
addressing the timely filing of required SEC reports. According to a
NASDAQ official, since before 1984, NASDAQ has appended a modifier to
the stock symbols of all issuers within 2 business days of detecting
that they have not met time frames for filing required SEC quarterly
and annual financial reports and in doing so has provided investors
early and ongoing notification that significant corporate information
has not been made available. The required reports contain financial
statements and other information that NASDAQ officials described as
being critical for investors' decision making and for regulators'
assessment of issuers' compliance with listing standards. According to
Amex officials, the SRO expects to begin transmitting an indicator
identifying listed companies that have not filed required reports
during the third quarter of 2004, although it has not yet determined if
it will use the indicator for nonfiling of annual reports alone or for
both quarterly and annual reports. NYSE officials told us that the SRO
will also begin transmitting indicators for issuers that have not filed
required annual reports at the end of the first quarter of
2004.[Footnote 50]
OCIE officials said that they are exploring the feasibility of
requiring the SROs to implement symbol modifiers to disclose issuers'
noncompliance with other qualitative standards, such as corporate
governance standards. For example, all three SROs require a majority of
directors on issuer boards to meet their respective definition of
director independence. A modifier could potentially be used to indicate
when an issuer does not have the requisite number of independent
directors.
OCIE Plans to Report SRO Progress to the Commission, Which Has
Authority to Ensure Early and Ongoing Notification of Noncompliant
Issuers:
OCIE officials told us that they are in the process of drafting a
report to the Commission that details the progress the SROs have made
in addressing its symbol modifier recommendation. According to OCIE
officials, the report will discuss the implementation issues that OCIE
has encountered--including early public notification and information
distribution. The report will also recommend how these problems could
be resolved. OCIE officials told us that their goal was for the public
to get the same type of information from each of the SROs on issuers'
noncompliance with continued listing standards, even if small
differences existed in how each SRO provides the information. The
Commission has authority under the Exchange Act to address obstacles to
implementing symbol modifiers or indicators, or to take alternative
actions to meet the goal of early and ongoing public notification. For
example, the Commission could approve Corporation Finance's proposed
revisions to the Form 8-K to address early notification issues. Also,
according to an OCIE official, SEC could require the SROs to implement
symbol modifiers or indicators and prohibit the SROs through rulemaking
from entering into a contract with an information vendor that refuses
to display a modifier or indicator.[Footnote 51]
OCIE Does Not Routinely Use SRO Internal Review Reports in Planning and
Conducting Inspections:
OCIE officials told us that they do not routinely use SROs' internal
review reports in planning and conducting inspections designed to
assess the quality of SROs' oversight, nor does the guidance on which
they rely specifically address the use of these reports in SRO
inspections. Nonetheless, professional standards recommend that
internal review staff use the reports prepared by or on behalf of the
organizations they are reviewing for these purposes, and other
organizations that have an oversight role similar to OCIE's told us
that they do so. Our work showed that many of the topics and findings
in the SROs' internal review reports were similar to those covered in
OCIE's listing program inspections, and the reports could be useful to
OCIE in planning and conducting inspections.
OCIE Does Not Routinely Use SRO Internal Review Reports, Nor Does the
Guidance Upon Which It Relies Specifically Address Their Use:
OCIE officials said that they do not routinely use SROs' internal
review reports in planning and conducting inspections designed to
assess the quality of SRO oversight. Although OCIE does not have a
written policy that specifically addresses the routine use of internal
review reports in SRO inspections, OCIE officials said that they rely
on guidance provided in a policy memorandum that addresses the use of
these reports in examinations of broker-dealers, investment advisers,
and investment companies. The policy directs OCIE staff to request
internal review reports when they believe specific problems exist at an
SRO.[Footnote 52] OCIE officials said that, using their discretion,
they might review a sample of internal review reports to determine
whether a broker-dealer, investment adviser, investment company, or SRO
had identified problems being reviewed by OCIE and, if so, how the
problems were addressed. For example, OCIE officials told us that they
requested copies of NYSE's internal review reports when investigating
alleged violations by floor brokers at NYSE that resulted in a 1999
report, which concluded that NYSE failed to dedicate sufficient
resources to allow regulatory staff to perform required random and for-
cause examinations of floor-broker activity.[Footnote 53] OCIE
officials said that, to the best of their knowledge, they have never
requested an SRO internal review report as part of a listing program
inspection.
OCIE officials told us that routine use of SRO internal review reports
would have a "chilling effect" on the flow of information between SRO
internal review staff and other SRO employees. They said that routine
use would make employees less forthcoming in disclosing information to
SRO internal review staff for fear that the information would be
provided to government regulators and through them be made public. They
concluded that the consequences might outweigh the benefit of reviewing
the reports. Officials at one SRO said that they believe OCIE would
attempt to keep the SRO's internal review reports confidential, but
that there was no assurance that OCIE could do so. Officials at each of
the three largest SROs told us that they have provided and would
continue to provide OCIE with copies of their internal review reports
if OCIE requested them.
Professional Standards Recommend Using Internal Review Reports and
Other Organizations with an Oversight Function Said That They Do So:
The Government Auditing Standards, also called the Yellow Book,
recommend the use of internal review reports in conducting performance
and other types of reviews.[Footnote 54] The Yellow Book defines
performance reviews to include reviews that assess the extent to which
legislative, regulatory, or organizational goals and objectives are
being achieved. OCIE's SRO inspections share many of the attributes of
performance reviews, including their objectives. Although OCIE is not
required to follow the Yellow Book standards in inspecting SROs, OCIE
inspections may benefit from adopting some of the standards applicable
to performance reviews.[Footnote 55] The Yellow Book standards
recognize that previous reports can be a useful source of information
for planning and conducting reviews and can impact the areas on which
subsequent reviewers focus. The Yellow Book states that those
conducting reviews should determine if internal review staff have
previously done, or are doing, reviews of the program or the entity
being examined. It suggests that these staff review previous internal
review reports or other studies to consider how areas identified as
warranting further study might affect the selection of their review
objectives and that internal review staff follow up to assess the
actions taken to address significant report findings and
recommendations related to the objectives of the current review.
CFTC and Treasury IG officials told us that, consistent with Yellow
Book requirements, they routinely request internal review reports in
doing their work. According to CFTC IG officials, the agency's policy
is to request copies of all relevant audits, management reviews,
consultant reports, and other related materials so that they can
familiarize themselves with the program they are reviewing. They said
that this information provides them with useful background on the
program under review and helps them to determine the objectives and
scope of the current review.[Footnote 56] They also said that they use
internal review reports to follow up on the agency's implementation of
prior IG recommendations. Finally, Treasury IG guidance requires the
review of prior IG reports, GAO reports, management reviews, studies,
and consulting reports on the function or activity that is being
reviewed as a means of understanding the agency and its operations.
Treasury IG officials also told us that they refer to these reports in
establishing the objectives and scope of reviews and in following up on
actions to address previous recommendations.
Topics and Findings in SRO Internal Reviews and OCIE Listing Program
Inspections Were Similar, and the Reports Could be Useful to OCIE in
Planning and Conducting Inspections:
Our review of selected internal review reports of two SROs and
conversations with one other about its reports revealed that the SROs'
internal review functions have examined or were in the process of
examining aspects of their listing programs that OCIE covered in its
most recent inspections.[Footnote 57] Consistent with OCIE's inspection
objective related to evaluating the effectiveness of the SROs in
implementing rules and procedures applicable to listing issuers, all
three SROs conducted internal reviews of their initial and continued
listing programs and hearings and appeals processes for issuers that
received delisting notices. Also, one SRO addressed policies,
procedures, and systems for reviewing issuer information as part of the
initial listing process. Consistent with OCIE's inspection objective
related to determining whether the SROs have implemented
recommendations from previous OCIE inspections, officials of one SRO
told us that as part of their internal reviews, they follow up on
OCIE's recommendations to ensure that the corrective actions taken were
consistent with the intent of OCIE's recommendations. Finally, all
three SROs told us that they follow up on all recommendations made as a
part of their own internal reviews.
Moreover, SEC has recognized that a strong internal review function is
important to the effectiveness of the SROs in fulfilling their
regulatory responsibilities by recommending on at least two occasions
that the SROs strengthen this function to improve their oversight.
First, an investigation SEC began in 1994 into the operations and
activities of NASD and the market making activities of NASDAQ found
that NASD failed over a period of time to conduct an appropriate
inquiry into anticompetitive actions among NASDAQ market
makers.[Footnote 58] In responding to SEC's resulting recommendations,
NASD agreed to, among other things, ensure the existence of a
"substantial," independent internal review staff reporting directly to
NASDAQ's Board of Governors.[Footnote 59] Second, as discussed, SEC
reported in 1999 that its investigation of the activity of NYSE floor
brokers found that NYSE failed to dedicate sufficient resources to
allow regulatory staff to perform certain required examinations of
floor-broker activity. To address SEC's resulting recommendation, NYSE
agreed to maintain its Regulatory Quality Review Department as a
"substantial," independent internal review staff with adequate
resources to regularly review all aspects of NYSE.
The NASDAQ Moratorium and Subsequent Rule Changes Allowed Issuers to
Remain Listed Longer:
Following September 11, 2001, SEC allowed a NASDAQ rule to remain in
effect that implemented a moratorium on enforcing its continued listing
standards for bid price and market value of publicly held shares. After
the moratorium ended, SEC allowed a separate NASDAQ rule to remain in
effect that established a pilot program extending the bid-price
compliance period for SCM issuers from 90 days to almost 1 year and
allowing NNM issuers that were noncompliant with the bid-price standard
to transfer to the SCM at the end of the compliance period, rather than
enter the delisting process. On December 23, 2003, SEC approved another
NASDAQ rule proposal that further extended the time noncompliant
issuers could remain listed, also under a pilot program.
SEC Allowed NASDAQ's Rule Implementing a Moratorium on Enforcing Bid-
Price and Market Value of Publicly Held Shares Continued Listing
Standards to Remain in Effect:
In response to market conditions after September 11, SEC allowed a
NASDAQ rule to remain in effect that implemented a 3-month moratorium
on enforcing its continued listing standards for bid price and market
value of publicly held shares. According to NASDAQ officials, NASDAQ's
Listing and Hearing Review Council began to study the possible effects
of modifications to the bid-price standard about 1 year before the
moratorium. These officials said that as the market was already
experiencing a downturn in the months before September 11, 2001, many
NASDAQ-listed companies saw their stock price fall below the minimum
bid-price standard. According to NASDAQ officials, after this date,
market conditions worsened considerably and the bid price of more
issuers fell below the standard. NASDAQ expressed concern that, in the
absence of the moratorium, a large number of otherwise financially
sound companies would have to be delisted. According to NASDAQ
officials, delisting these issuers would, among other things,
disadvantage investors who would be limited to trading the related
securities in markets that were not subject to the same level of
regulation and transparency as NASDAQ. To give the markets time to
stabilize and to provide issuers that were noncompliant with only these
standards time to return to compliance, NASDAQ proposed the rule that
implemented the moratorium. The rule became operative on September 27,
2001, and the moratorium expired on January 2, 2002.[Footnote 60]
NASDAQ filed its proposal with SEC in accordance with a procedure set
forth in the Exchange Act and SEC regulations that allows a rule
proposed by an SRO to take effect upon filing without any action being
taken by SEC. A proposed rule change can become immediately effective
without SEC action if it is properly designated by the SRO as effecting
a change that (1) does not significantly affect the protection of
investors or the public interest; (2) does not impose any significant
burden on competition; and (3) by its terms does not become operative
for 30 days after the date of the filing, or such shorter time as SEC
may designate if consistent with the protection of investors and the
public interest.[Footnote 61] SEC, within 60 days of the date of
filing, may summarily abrogate the rule change if it appears to SEC
that such action is necessary or appropriate in the public interest,
for the protection of investors, or otherwise in furtherance of the
purposes of the Exchange Act.[Footnote 62]
SEC did not abrogate NASDAQ's proposed rule change implementing the
moratorium. Moreover, to provide issuers immediate relief, SEC waived
the 30-day waiting period and allowed the rule to become operative
immediately.[Footnote 63] In the notice of this proposal, SEC stated
that the rule's potential benefits could have been lost without
accelerating the operative date, because NASDAQ might otherwise have
been required to begin delisting proceedings against issuers that did
not meet the bid-price and market value of publicly held shares
standards.
The moratorium provided relief to at least 509[Footnote 64] issuers
that were noncompliant or approaching noncompliance with the bid-price
or market value of publicly held shares continued listing
standards.[Footnote 65] During the moratorium, NASDAQ stopped enforcing
these standards, which meant that noncompliant issuers were no longer
subject to NASDAQ's deficiency process, thereby relieving those that
were in the process from potential delisting. NASDAQ also stopped
tracking individual issuers' compliance with these standards so that
issuers approaching noncompliance that might otherwise have entered the
deficiency process did not do so. Because NASDAQ stopped tracking
individual issuers' compliance with the bid-price and market value of
publicly held shares standards during the moratorium, it could not
determine the total number of issuers that might have become
noncompliant in the absence of the moratorium and, therefore, benefited
from it. Neither could NASDAQ determine the number of noncompliant
issuers that would have returned to compliance in the absence of the
moratorium.
At the end of the moratorium, 447 of the 509 issuers that could be
identified as having received temporary relief remained listed. The
remaining 62 were no longer listed at the time the moratorium expired
on January 2, 2002. Of these, 47 were delisted for deficiencies in
listing standards not related to bid price and 15 were delisted for
other reasons, such as merger with or acquisition by another company.
SEC Subsequently Allowed a NASDAQ Rule to Remain in Effect That Allowed
Noncompliant SCM Issuers Almost 1 Year to Comply with the Bid-Price
Standard and NNM Issuers to Transfer to the SCM:
In February 2002, shortly after the moratorium ended, SEC allowed a
NASDAQ rule to remain in effect that extended the bid-price compliance
period from 90 days to almost 1 year for SCM issuers and allowed
noncompliant NNM issuers to transfer to the SCM at the end of the NNM
bid-price compliance period, rather than enter the delisting
process.[Footnote 66] The rule implemented these changes on a 2-year
pilot basis, and NASDAQ agreed to evaluate the rule's impact on the
market at the end of the 2-year period. First, the new rule extended
the initial SCM bid-price compliance period from 90 days to 180 days.
Second, at the expiration of the 180 days, SCM issuers that had not
regained compliance with the bid-price standard were allowed an
additional 180 days to regain compliance if they met one of three
initial SCM listing standards.[Footnote 67] The net result was that
noncompliant SCM issuers that met these higher initial listing
standards had almost 1 year to regain compliance before entering the
delisting process. The rule also established procedures for
noncompliant NNM issuers to transfer to the SCM at the end of the 90-
day NNM bid-price compliance period. Under these procedures, NNM
issuers that did not comply with the bid-price standard at the end of
the 90-day NNM compliance period could, in lieu of entering the
delisting process, elect to transfer to the SCM, if they (1) met all
but the SCM's bid-price continued listing standards, (2) filed an
application, and (3) paid the applicable listing fee. Under rules
applicable to SCM issuers, noncompliant NNM issuers that transferred to
the SCM could trade for as much as an additional 270 days (the
remaining 90 days of the first 180-day SCM compliance period and the
entire second 180-day compliance period).
According to NASDAQ, the rule was proposed in order to provide
noncompliant NNM issuers more time to develop and implement strategies
for regaining compliance with the bid-price standard. Until the rule
change, the bid-price continued listing standards for the SCM and NNM
were the same. As a result, NNM issuers failing to meet the bid-price
standard after the expiration of the compliance period were not
eligible to trade on the SCM and, if delisted by NASDAQ, would be
forced to trade in another over-the-counter market. NASDAQ filed this
rule change under the same procedure as the rule change implementing
the moratorium. As with the moratorium rule, SEC took no action to
abrogate the proposed rule and also waived the 30-day waiting period,
allowing NASDAQ to enforce it immediately. In waiving the 30-day
waiting period, SEC stated that no purpose would be served by having 30
days pass before the rule became operative because, during the
intervening period, issuers and investors could become confused about
which compliance period applied.[Footnote 68]
The February 2002 rule change affected the listing status of issuers
that were provided relief from pending or potential delisting by the
moratorium (moratorium issuers) and other issuers that were not
identified as receiving such relief (nonmoratorium issuers). As
previously discussed, 447 (88 percent) of the 509 moratorium issuers
continued to trade when the moratorium expired on January 2, 2002. By
February 28, 2003, approximately 1 year after NASDAQ implemented its
February 2002 rule change, the number of issuers trading had dropped to
246 (48 percent of the 509 moratorium issuers).[Footnote 69] This drop
reflects 201 additional delistings, increasing the total number of
moratorium issuers delisted from 62 to 263 (52 percent of the 509
moratorium issuers).[Footnote 70]
Of the 246 issuers that continued to trade as of February 28, 2003, 132
issuers were listed on the SCM and were trading under the extended
compliance period or had traded in an extended compliance period and
regained compliance with the bid-price standard, including 87 that had
transferred from the NNM. Under the premoratorium bid-price rule, all
of the 132 issuers would have entered the delisting process. Also, as
of February 28, 2003, 150 nonmoratorium issuers had traded or were
trading on the SCM under the extended bid-price compliance period,
including 89 issuers that transferred from the NNM. These 150 issuers
also would have entered the delisting process under the premoratorium
bid-price rule.
SEC Approved a Rule That Further Extended the Bid-Price Compliance
Periods:
In January 2003, the NASDAQ and NASD boards of directors approved
NASDAQ's plans to propose to SEC a rule change that would further
extend the SCM and NNM bid-price compliance periods up to 2 years and
almost 1 year, respectively, under a pilot program. Market Regulation
subsequently asked NASDAQ to modify its request to submit the proposal
under provisions that would allow the rule to be applied immediately
upon filing. Market Regulation officials said that they wanted to
assess whether the public perceived any negative consequences for
investors in allowing SCM issuers to trade while noncompliant for up to
2 years. After ongoing discussions with Market Regulation officials,
NASDAQ divided its proposal into two rule filings--one that would
partially implement the extended compliance periods and become
immediately effective upon filing, and the other that would subject the
remainder of the proposal to public notice and comment before final SEC
action.
Accordingly, in March 2003, NASDAQ submitted to SEC a proposal to
extend the bid-price compliance periods on both the SCM and NNM by 90
days.[Footnote 71] SEC took no action to abrogate the rule and waived
the 30-day waiting period, allowing NASDAQ to enforce the rule
immediately. The rule allowed noncompliant SCM issuers that met one of
three initial SCM listing standards another 90-day compliance period
extension, increasing the SCM compliance period to a potential total of
450 days.[Footnote 72] The rule also extended the NNM's initial bid-
price compliance period from 90 days to 180 days. At the end of the
180-day compliance period an NNM issuer could apply to transfer to the
SCM, provided it (1) met all but the SCM bid-price continued listing
standards, (2) filed an application, and (3) paid the applicable
listing fee. In addition, the rule extended the pilot program
established under the February 2002 rule change until December 31,
2004, by which time NASDAQ is expected to evaluate the rule's impact on
the market.
NASDAQ proposed the remainder of its plan to extend the SCM bid-price
compliance period up to 2 years and the NNM bid-price compliance period
to almost 1 year, using a different procedure that requires affirmative
SEC approval of the proposed rule change. This procedure allows SEC to
review comments submitted by the public before the rule becomes
effective. However, no public comments were submitted. SEC approved the
rule on December 23, 2003.[Footnote 73] The new rule amended the March
2003 rule to extend the SCM bid-price compliance period up to 2 years
and the NNM bid-price compliance period to almost 1 year under the
pilot program. The new rule allows NASDAQ to continue to grant a
noncompliant SCM issuer a second 180-day compliance period extension;
however, NASDAQ now requires the issuer to meet all SCM initial listing
standards, except for bid price, rather than only one of three initial
listing standards as specified in the February 2002 and March 2003 rule
changes.[Footnote 74] NASDAQ officials told us that this new
requirement was intended to protect investors by preventing financially
weak companies from taking advantage of the compliance period
extensions.
An SCM issuer that is still noncompliant with the bid-price standard at
the end of the 180-day extension but that meets all other SCM initial
listing standards can receive a further compliance period extension, up
to the time of its next scheduled shareholders' meeting, if the issuer
agrees to seek shareholder approval for a reverse stock split at that
meeting and implement it promptly afterward.[Footnote 75] The new rule
allows NASDAQ to grant this compliance period only if the next
shareholders' meeting is scheduled to occur within 2 years of the date
on which NASDAQ initially notified the issuer of its noncompliance,
thus limiting the time a noncompliant issuer can remain trading to 2
years. Under the new rule, NASDAQ must immediately begin delisting
proceedings if the issuer does not propose, obtain approval for, or
promptly execute the reverse stock split.
The new rule also permits NASDAQ to grant a noncompliant NNM issuer a
second 180-day compliance period extension, if the issuer meets all NNM
initial listing standards except bid price. An issuer may elect to
transfer to the SCM at the end of either the first or second compliance
period, provided it (1) meets all of the SCM continued listing
standards except bid price, (2) files an application, and (3) pays the
applicable listing fee. Thus, under the new rule, noncompliant NNM
issuers can remain listed for almost 1 year on the NNM and for up to 2
years if they transfer to the SCM instead of entering the delisting
process. Figure 1 shows how NASDAQ has lengthened the SCM and NNM bid-
price compliance periods from the premoratorium standards through the
December 2003 rule.
Figure 1: Maximum Number of Calendar Days in NASDAQ Bid-Price
Compliance Periods from August 1991 (Premoratorium) through December
2003 (Latest Rule Change):
[See PDF for image]
[End of figure]
In its approval order, SEC said that the length of the extended
compliance periods under the new rule raises investor protection
concerns. According to SEC, if a listing standard is suspended for too
long, the standard is not transparent and the investor protection
principles underlying the premise of listing standards could be
compromised. SEC said that the heightened requirements that NASDAQ
issuers must meet under the rule to be eligible for the extended
compliance periods should offer reassurance to investors that the
issuer remains a viable business despite its low bid price. SEC further
noted that if NASDAQ seeks permanent approval for the new rule, the
results of NASDAQ's study on the effects of the rule under the pilot
program would be essential in analyzing whether the length of the
extended compliance periods undermines investor protection.
Listing Standards Have Been Used as a Vehicle for Improving Corporate
Governance:
Responding to the unexpected collapse of several major corporations,
SEC requested in 2002 that the SROs strengthen their corporate
governance standards. In addition, Congress passed Sarbanes-Oxley,
which mandated that the SROs adopt rules governing audit committees of
listed issuers. The three largest SROs responded by adopting rules that
amended their corporate governance standards for listed companies, by
among other things, increasing the role and authority of independent
directors. Additionally, in response to an SEC request in 2003, the
three largest SROs began evaluating their own governance against the
standards proposed for their issuers. Finally, we reviewed the actions
taken by public and private institutions in four other countries
related to the role and authority of independent directors of issuers
in those markets.
Corporate Collapses Led to SEC and Congressional Efforts to Strengthen
Corporate Governance through Listing Standards:
The collapse of major U.S. corporations, such as the Enron Corporation,
Inc., and WorldCom, Inc., beginning in 2001 raised congressional, SEC,
and market participant concerns about the quality of corporate
governance at publicly traded companies. One area of concern focused on
the ability of directors to provide active and independent oversight of
management. For example, various congressional committees, including
the Senate Permanent Subcommittee on Investigations, held hearings as
part of their examination of the collapse of Enron.[Footnote 76] The
subcommittee's final report on the role of the board of directors in
Enron's collapse raised concerns about the failure of the Enron board
to safeguard the interests of shareholders by allegedly allowing
management to engage in, among other things, inappropriate conflict-of-
interest transactions.[Footnote 77] The report alleged that financial
ties existed between the company and certain board members that likely
compromised their independence. Also, at companies such as Enron and
WorldCom, allegedly conflicted boards approved excessive compensation
for their chief executives. Similarly, hearings by Congress as well as
an investigation mandated by a U.S. district court into the 2002
collapse of WorldCom questioned the effectiveness of the board's
oversight of the CEO. According to the court-mandated report, the CEO
appeared to have dominated the course of the company's growth, as well
as the agenda, discussions, and decisions of the board.[Footnote 78]
Consistent with the court's decision in Business Roundtable v. SEC, SEC
did not mandate changes to the SROs' listing standards to address these
lapses in corporate governance. Instead, the former SEC Chairman asked
NASDAQ and NYSE in a February 2002 letter to review ways in which they
could strengthen corporate governance through their listing
standards.[Footnote 79] He suggested several issues for the SROs to
consider, including whether public companies should be required to
adopt codes of conduct for their officers and directors, take steps to
ensure directors are qualified for board service, and further
strengthen audit committee requirements. SEC staff sent Amex a similar
letter in June 2002.[Footnote 80]
Also, responding to the corporate collapses, Congress mandated, with
the passage of Sarbanes-Oxley in July 2002, that listing standards be
used as a vehicle for improving corporate governance. Section 301 of
Sarbanes-Oxley sought to improve the effectiveness of issuer audit
committees by imposing requirements designed to enhance their
independence, authority, and responsibility. Sarbanes-Oxley required
SEC to direct the SROs through rulemaking to prohibit the listing of
issuers that do not meet these requirements. SEC issued its final rules
in April 2003.[Footnote 81]
The SROs Adopted Rules That, Among Other Things, Increase the Role and
Authority of Independent Directors:
Addressing the SEC request and Sarbanes-Oxley mandates, the three
largest SROs adopted rules that, according to SEC, should foster
greater board accountability to shareholders.[Footnote 82] Market
participants supported the rules but held differing views on the need
for further enhancements to board independence. OCIE officials said
that they will work with the SROs to ensure processes are developed to
more thoroughly assess compliance with the new standards. SEC has also
taken steps to further strengthen director accountability to
shareholders, including addressing longstanding investor interest in
gaining increased access to the director nomination process and
planning a review of SEC requirements governing disclosures of
qualitative corporate information.
SEC Stated That the SROs' Rules Should Foster Board Accountability:
The SROs submitted rules that SEC stated should foster greater
accountability, transparency, and objectivity in board
oversight.[Footnote 83] Among other things, these rules increase the
role of independent directors, extend corporate governance disclosures,
and expand shareholder oversight of equity compensation plans.[Footnote
84] SEC completed its review and approval of these rules for Amex,
NASDAQ, and NYSE between June 2002 and December 2003.[Footnote 85]
According to Corporation Finance and Market Regulation officials,
although they worked with the markets to harmonize their listing
standards in some key areas, they did not push the SROs to have
identical standards because some differences were warranted, such as
those related to the size of issuers.
New Rules Increased the Role of Independent Directors:
Amex, NASDAQ, and NYSE's new rules increase the role of independent
directors by (1) requiring that in most circumstances issuers have a
majority of independent directors on their boards and that they meet
regularly in executive sessions,[Footnote 86] (2) tightening the
definition of independence that applies to directors, (3) strengthening
independent directors' oversight of financial reporting, and (4)
increasing independent directors' authority over CEO compensation and
director nominations.[Footnote 87] First, according to Amex and NYSE,
requiring that a majority of directors be independent, with limited
exceptions, and free from relationships with the issuer or its
management that might compromise their independence, will promote board
decision making that is aligned with shareholders' interests and
thereby enhance board accountability. NASDAQ similarly stated that such
a requirement empowers independent directors to more effectively carry
out their oversight responsibilities. Further, according to Amex and
NASDAQ, requiring that independent directors regularly meet without
management present, as specified in these SROs' rules, is designed to
encourage open discussion among independent directors. NYSE's rules
include a similar requirement for independent directors and other
directors who are not company officers. NYSE's rules further require
issuers to disclose either the name of the director chosen to preside
at the executive sessions or the procedure by which a presiding
director is selected for each executive session. The issuers must also
disclose a method interested parties can use to communicate any
concerns directly to the presiding director or nonmanagement directors
as a group.
Second, the three SROs' new rules tighten the definition of director
independence by specifying additional bright-line criteria that boards
must apply when making independence determinations. The three SROs
specify, among other things, additional financial and employment
relationships for directors and immediate family members that would
preclude an independence determination. For example, Amex and NASDAQ's
new rules maintain a test of financial independence that prohibits
independent directors from receiving compensation from the issuer in
excess of $60,000, subject to limited exceptions such as compensation
for board service, but expand the specific types of compensation
prohibited to include other types of payments and apply this financial
test to the directors' immediate family. For example, NASDAQ's new
rules would prohibit payments such as political contributions. NYSE's
new definition of director independence also includes a test of
financial independence similar to that of Amex and NASDAQ with a
compensation ceiling of $100,000, unless this compensation is related
to board service.
In addition to providing bright-line criteria to aid boards in making
these independence determinations, NYSE's rules also recommend that
boards broadly consider other material relationships that might impair
a director's independence.[Footnote 88] Boards must disclose any
additional standards they adopt and explain to investors any
determination of independence for a director who does not meet these
standards.
Of the three SROs, NASDAQ and NYSE currently require issuers to
disclose which directors they have designated as independent. Some
market participants expressed concern that without this information
they would have difficulty assessing the independence of issuers'
boards. Likewise, regulators might face the same difficulty. Amex
officials said that they would consider providing this added
disclosure.
Third, the three SROs' new rules strengthen the role of independent
directors on audit committees and audit committee oversight of the
financial reporting process.[Footnote 89] Implementing SEC's final
rules related to Sarbanes-Oxley section 301 requirements, the SROs
further tightened the definition of independence that will apply to
audit committee members by prohibiting them from accepting any
consulting, advisory, or other compensatory fees, unless this
compensation is related to board service. Also, responding to SEC's
final rules, the SROs new rules mandate that audit committee charters
require the committees to have direct responsibility for the retention,
oversight, and compensation of the independent auditor, have access to
and funding for any other independent advisers they need to complete
their work, and establish procedures for treating accounting-related
complaints and the anonymous submission of these complaints by
employees.[Footnote 90] In addition to addressing the Sarbanes-Oxley
requirements, Amex, NASDAQ, and NYSE adopted other listing standards
for audit committees. For example, NASDAQ's rules require audit
committees to approve all related-party transactions.[Footnote 91]
Amex's rules require that the audit committee exercise appropriate
review and oversight of these transactions. NYSE's rules include a
requirement that the audit committee meet separately with management,
internal auditors, and outside auditors.
Finally, the three SROs' new rules increase independent directors'
authority over CEO compensation and the selection of new director
nominees. Amex and NASDAQ's rules allow boards to establish independent
compensation and nominating committees or require that a majority of
their independent directors fulfill these responsibilities.[Footnote
92] In contrast, NYSE's rules require boards to establish independent
compensation and nominating committees.[Footnote 93] According to Amex
and NYSE, requiring independent directors to set CEO compensation will
promote an objective evaluation of CEO performance and the design of a
compensation package that fairly reflects that performance and includes
appropriate incentives. NASDAQ stated that such a requirement helps to
ensure that appropriate incentives are in place, consistent with the
board's responsibility to maximize shareholder value. Similarly, the
three SROs stated that giving independent directors responsibility for
nominating new directors will help ensure the quality and independence
of nominees.
Amex issuers must comply with the new rules increasing the role of
independent directors by their first annual shareholders' meeting after
March 15, 2004, or by October 31, 2004, whichever is earlier.[Footnote
94] NASDAQ and NYSE issuers have until their first annual shareholders'
meeting after January 15, 2004, or October 31, 2004, whichever is
earlier.[Footnote 95] However, NASDAQ issuers had until January 15,
2004, to comply with NASDAQ's new rule related to audit committee
approval of related-party transactions.
New Rules Extended Corporate Governance Disclosures:
Amex, NASDAQ, and NYSE's new rules require issuers to adopt a code of
conduct and ethics that is applicable to all directors, officers, and
employees.[Footnote 96] Amex and NASDAQ require that these codes
address conflicts of interest, compliance with laws and regulations,
and enforcement of the codes. NYSE's rules recommend that the codes
address these and other topics. All three SROs require issuers to
disclose their codes and any waivers granted to officers and
directors.[Footnote 97] NYSE's rules further require boards to adopt
and disclose corporate governance guidelines addressing such topics as
director qualifications and responsibilities, management succession,
and annual performance evaluations. According to NYSE, increased
corporate governance disclosures should enhance investors'
understanding of issuers' corporate governance policies and procedures
and promote adherence to them by directors and management. In addition,
NYSE's rules require audit committees to disclose their charters and
nominating and compensation committees to adopt and disclose charters
that address their purpose and responsibilities, among other things.
The three SROs also adopted rules implementing disclosure requirements
for foreign private issuers (foreign issuers) listed on their
markets.[Footnote 98] Amex and NYSE's rules require that foreign
issuers disclose significant differences between their corporate
governance practices and those required by the SROs.[Footnote 99]
NASDAQ requires foreign issuers to disclose any exemptions granted by
NASDAQ to its corporate governance rules and describe any alternative
measures taken by the issuer.[Footnote 100]
Amex issuers have until June 1, 2004, to adopt and disclose a code of
conduct and ethics, and NASDAQ issuers have until May 4, 2004, to do
so. Foreign issuers listed on Amex or NASDAQ must begin disclosing any
differences between their corporate governance practices and those
required by the SRO beginning on or after January 1, 2004,
respectively. NYSE issuers must comply with the new disclosure
requirements by their first annual meeting after January 15, 2004, or
by October 31, 2004, whichever is earlier.
New Rules Expand Shareholder Oversight of Equity Compensation Plans:
Finally, the three SROs have implemented rules expanding requirements
that issuers obtain shareholder approval of certain equity compensation
plans.[Footnote 101] In addition to maintaining previous requirements
that shareholders approve equity compensation plans involving directors
and officers, the new rules include requirements that shareholders
approve plans offered to employees and material modifications to all
plans subject to shareholder approval.[Footnote 102] According to
NASDAQ, while the use of equity compensation plans can align director,
officer, and employee interests with those of shareholders and assist
in recruiting and retaining employees, they can also dilute the value
of existing shares. For example, many equity compensation plans award
an employee (or director or officer) stock options, or the rights to
purchase a certain number of shares of the issuer's stock at a
predetermined price for a fixed period. If the market value of the
stock rises above the predetermined price, the option holders can
profit by exercising their options to buy the stock at the
predetermined price and then selling the stock at the higher market
price.[Footnote 103] As option holders exercise their options, the
issuers would deliver to them newly issued stock or previously issued
treasury stock, thus increasing the supply of outstanding
shares.[Footnote 104] Any company earnings would then be spread among
the existing and the new shareholders, thereby reducing the earnings of
existing shareholders. According to NYSE, broadening the approval
requirements for equity compensation plans provides shareholders a
means of protecting their economic interests. NASDAQ stated that the
new rules provide shareholders a greater voice in the use of equity
compensation.
Amex and NYSE's new rules also preclude their broker-dealer members
from voting on behalf of shareholders when the issuers seek shareholder
approval of equity compensation plans, unless the shareholders have
first given the broker-dealer voting instructions. Amex required
issuers to seek shareholder approval in accordance with these rules
after October 9, 2003, and NASDAQ and NYSE began doing so after June
30, 2003.
Market Participants Supported the SROs' Efforts but Had Differing Views
on Whether Board Independence Should Be Further Enhanced:
Market participants expressed support for Amex, NASDAQ, and NYSE's
efforts to improve corporate governance through listing standards.
However, some said that more could be done to further enhance corporate
governance, particularly board independence. Of these market
participants, several told us that boards should be required through
listing standards to adhere to higher standards of independence; others
said that boards should be encouraged to voluntarily adopt stricter
standards. According to one market participant, more time was needed to
fully implement and assess the impact of the SROs' many new corporate
governance standards before determining whether further changes were
warranted.
First, several market participants said that stricter standards of
independence should be applied to independent directors than are
included in Amex, NASDAQ, and NYSE's new rules. For example, these
rules leave in place standards that preclude an independence finding
when a board interlock involves the compensation committee.[Footnote
105] Some market participants would go further and preclude an
independence finding when any interlocking board relationship exists,
reasoning that any relationship directors have with the CEO on another
board could impair their independence. Others said that the definitions
adopted by the three SROs do not sufficiently address financial
conflicts of interest for independent directors who are not audit
committee members. They said that, similar to the Sarbanes-Oxley
requirements for audit committee members, boards should not be able to
designate directors as independent if they receive any compensation
from the issuer that is not related to board service. One market
participant told us that the definition of director independence should
also prohibit financial relationships between the director and any
executive officer.[Footnote 106] However, others noted limitations to
defining director independence through bright-line criteria. Three
market participants said that bright-line criteria may impede
independently minded individuals from serving on boards. For example,
one market participant said that an independently minded person who has
a financial relationship valued at $61,000--$1,000 over the
compensation limit NASDAQ has established--would not be able to serve
as an independent director. Another market participant told us that no
independence definition could be structured to control all possible
conflict-of-interest scenarios, particularly indirect relationships.
This market participant said that indirect relationships, which include
social relationships, can compromise a director's independence as much
as direct financial relationships with issuers. Amex, NASDAQ, and NYSE
officials told us that it was difficult to establish bright-line
criteria that might signal conflicts of interest for all directors.
NYSE officials said that for this reason, they decided to require
issuers to disclose more information on their independence
determinations and thus allow investors to make their own assessments
of a board's independence.
Second, some market participants stated that boards should comprise a
supermajority (two-thirds or three-fourths) of independent directors,
rather than the simple majority that the three SROs' new rules require.
According to one market participant, having a supermajority of
independent directors would reassure investors that the board was
independent and represented their interests. Several market
participants said, however, that smaller issuers are having a harder
time recruiting enough qualified independent directors to meet the
majority independent director requirement because of the costs involved
in searching for and retaining them. Amex officials said that for this
reason, their SRO did not propose requiring a supermajority of
independent directors. Two market participants told us that many boards
continued to look for independent directors among CEOs. According to
them, many qualified, willing, and less costly candidates are available
for independent director positions among the ranks of professionals
just below CEO, such as chief financial officers and chief operating
officers. Officials from the American Institute of Certified Public
Accountants told us that they have compiled a database with contact
information on financial and other business professionals who are
interested in serving as independent directors. NASDAQ officials said
that they have not seen any evidence that supports requiring a
supermajority of independent directors through a listing standard and
that their goal of independent board decision making is achieved
through their standard requiring a majority of independent directors.
NYSE officials told us that they debated a supermajority of independent
directors requirement, but said that a consensus did not exist in its
favor. According to these officials, time is needed to first implement
and evaluate the effect of the majority independent director
requirement before assessing whether a supermajority of independent
directors is needed.
Finally, several market participants recommended separating the
positions of CEO and chairman. In the United States, many companies are
under the leadership of a combined CEO/chairman, in contrast to
companies in other countries where these roles tend to be separated,
such as in the United Kingdom.[Footnote 107] However, market
participants expressed concern that this combined role can provide the
potential for conflict, because CEOs are part of the management team
that the board oversees. According to a January 2003 report by The
Commission on Public Trust and Private Enterprise, a 12-member body
sponsored by The Conference Board and comprising leaders from business,
finance, and academia, in many of the corporate scandals of the recent
past strong CEOs appeared to have exerted a dominant influence over
their boards, often stifling the efforts of directors to perform the
oversight needed to ensure a healthy system of corporate governance.
The report further stated that boards have often lacked the structure
and information needed to perform their roles properly or have
abdicated their responsibility to provide the oversight required of
them, and that, in such circumstances, boards cannot properly oversee
the CEO's performance. Several market participants agreed with the
Commission's recommendation for strengthening board independence and
leadership by separating the role of CEO and chairman and providing
that the chairman be independent or, as an alternative, providing for
leadership of the independent directors by establishing an independent
lead or presiding director.[Footnote 108] According to one market
participant, it is important that an independent director, whether an
independent chairman, lead director, or presiding director, lead board
meetings and have control over meeting agendas, meetings schedules, and
the flow of information from management to the other independent
directors. Two market participants said that NYSE's new rule requiring
boards to disclose the name of or process for selecting a director to
preside over executive sessions was a step toward encouraging this
independent leadership, although the new rule did not assign this
individual specific responsibilities.
Other market participants opposed separating the positions of CEO and
chairman of the board. One market participant said that the SROs' rules
requiring that independent directors meet regularly in executive
session is adequate to ensure board independence. According to this
market participant, CEOs are very responsive to directors because they
view the board as their boss. Others said CEOs may lose authority if
the position is too weakened. Amex, NASDAQ, and NYSE officials told us
that they had considered requiring the separation of CEO and chairman
in developing their corporate governance rule proposals, but that they
determined it was not appropriate to require all issuers to have this
particular leadership structure at all times. According to NASDAQ and
NYSE officials, an issuer may benefit from having a combined CEO and
chairman under some circumstances, such as when the company is
undergoing a merger. These officials said that in the case of a merger,
the combined CEO and chairman position could provide the company the
strong, unified leadership needed to guide the company through a
difficult transition period.
In prior work, we expressed the view that SEC, in conjunction with the
SROs, should consider using listing standards to further strengthen
board independence by requiring a supermajority of independent
directors and separating the positions of CEO and chairman. Although
such practices do not guarantee that boards will be well managed,
greater board independence could promote board decision making that is
aligned with shareholders' interests, thereby enhancing board
accountability. While board independence does not require eliminating
all nonindependent directors, we have taken the position in previous
work that it should call for a supermajority of independent
directors.[Footnote 109] Our prior work also recognized that
independent leadership of the board is preferable to ensure some degree
of control over the flow of information from management to the board,
scheduling of meetings, setting of board agendas, and holding top
management accountable. The board has a clear responsibility to hold
the CEO accountable for results. However, this system of checks and
balances can be undermined when the positions of CEO and chairman are
combined. A chairman who is also the CEO can have a significant impact
on the direction of the company as well as on the role and composition
of the board. For example, such individuals can have undue influence
over who is asked to join or leave the board. For these reasons, we
have supported the separation of the positions of CEO and chairman.
OCIE Plans to Work with the SROs to Ensure That Processes Are Developed
to More Thoroughly Assess Compliance with the New Standards:
SRO officials told us that they are revising the processes they use for
assessing issuers' compliance with corporate governance listing
standards, including issuers' self-certifications and reviews of public
information. According to SRO officials, self-certifications are a
means of holding issuers accountable for complying with their corporate
governance standards, recognizing that the SRO cannot independently
verify compliance with each individual standard. For example, these
officials said that it would be difficult to independently determine
compliance with some standards, such as those requiring independent
directors to meet in executive sessions, nominate other independent
directors, and determine CEO compensation, unless they were actually in
the boardroom.
SRO officials said that as part of their efforts to ensure compliance
with corporate governance listing standards, they have extended their
historical use of issuer self-certifications of compliance with audit
committee requirements to many of the new standards.[Footnote 110]
NASDAQ, for example, has updated its self-certification form and now
requires issuers to certify compliance with its new audit committee
composition, audit committee charter, executive sessions, and code of
conduct standards. According to NASDAQ officials, issuers are not
required to certify compliance with standards for which NASDAQ can
independently determine compliance, such as the standard requiring a
majority of independent directors. Amex and NYSE's new self-
certification forms address their new rules relating to the composition
and responsibilities of the board and audit, nominating, and
compensation committees and their new disclosure requirements. As part
of its new rules, NYSE further requires that CEOs annually certify that
they are not aware of any violations of NYSE's corporate governance
standards and that issuers disclose these CEO certifications in their
annual reports. According to NYSE, requiring CEO certifications will
focus the CEO and senior management's attention on the issuer's
compliance with corporate governance listing standards. Amex and NASDAQ
officials said that they did not consider requiring CEO certifications
necessary to ensuring compliance with corporate governance listing
standards.
In addition to requiring self-certifications of compliance with
corporate governance standards, the three SROs require their issuers to
notify them upon becoming noncompliant with corporate governance
standards. Amex, NASDAQ, and NYSE have each used their corporate
governance listing standards to implement SEC's new rule directing the
SROs to require their issuers to promptly notify them when an executive
officer becomes aware of any material noncompliance with the Sarbanes-
Oxley-mandated audit committee requirements. All three SROs apply the
notification requirement to all of their corporate governance listing
standards, not just the Sarbanes-Oxley-related listing standards. NYSE
designated the CEO responsible for this notification.
Officials from the three SROs said that they have expanded their
current process of reviewing periodic SEC filings, such as proxy
statements, to include information that might indicate an issuer is
noncompliant with the new corporate governance standards. For example,
NASDAQ officials said that they review the financial disclosures in
proxy statements to determine whether directors designated as
independent have prohibited relationships with the issuer. Also, NYSE
officials said that they review proxy statements to determine whether
members of the management team are listed as members of the audit
committee, which would be a violation of NYSE's listing standards.
Officials of all three SROs said that they conduct manual reviews of
required SEC filings, including proxy statements. They also said that
they have automated systems that flag potential corporate governance
issues for review and that they are enhancing these systems to allow
them to better assess compliance with their new corporate governance
requirements. Additionally, they said that they will continue to
monitor other public disclosures, such as press releases, and the
financial press for information that could indicate noncompliance with
corporate governance standards. For example, NASDAQ officials said that
news that an audit committee member had retired would lead to an
inquiry about whether the issuer had filled the position, if the
retirement would cause the audit committee to become noncompliant with
NASDAQ's rules, and whether the person filling the position met the
SRO's independence standards.
OCIE officials said that they will work with the SROs to ensure that
effective processes are in place to more thoroughly assess compliance
with the new standards. These officials told us that while the SROs can
use information available in public disclosures to assess whether
issuers comply with some of the new standards, such as whether
directors satisfy the definition of independence, these disclosures do
not contain information that would help assess compliance with other
standards. For example, the new rules require that audit committee
charters address the audit committees' responsibility to hire,
compensate, and oversee outside auditors. OCIE officials said that
while the SROs are able to determine whether the audit committee
members satisfied the new audit committee independence standards by
reviewing public disclosures, they would not be able to determine
whether audit committees were actually providing independent oversight
of the outside auditors using the same information. They said that a
similar challenge exists with respect to rules requiring that
independent directors determine executive compensation and nominate new
directors. According to OCIE officials, sources of information are
available that the SROs could use in helping to assess compliance with
their new standards. For example, they said that the SROs could
consider reviewing board and committee meeting agendas and minutes to
assess whether independent directors may have discussed matters
pertaining to the outside auditor without management present. They said
that while it would not be practical for SROs to conduct such detailed
compliance reviews for all issuers, conducting them on a sample basis
could further promote compliance with the listing standards.
In addition to issues related to assessing compliance with corporate
governance standards, the SROs have considered what sanctions should be
imposed on issuers that do not comply with these standards. Concerned
about the range of options available, in December 2003 and November
2003, respectively, Amex and NYSE each adopted a rule under which they
reserve the right to issue public reprimand letters to issuers that do
not comply with their corporate governance standards.[Footnote 111]
Amex and NYSE officials said that the only sanction otherwise available
is delisting the issuer, a step that they said could, in certain
circumstances, be perceived as more harmful to investors than the
issuer's noncompliance. NYSE officials said that their experience to
date has been that companies genuinely wish to comply with corporate
governance standards; however, some of the standards have subjective
elements, and a company may dispute a view by NYSE that it failed to
comply with the standards and extend negotiations longer than
acceptable. According to these officials, potential public announcement
of noncompliance might be a useful tool in such circumstances.
According to Amex and NYSE officials, the SROs would, if necessary,
delist an issuer that did not, after receiving the public reprimand
letter, return to compliance with the market's listing standards. In
contrast, NASDAQ officials opposed the lesser sanction, stating that
they did not want issuers to knowingly violate corporate governance
rules with the expectation that the only consequence would be a letter
of reprimand. They said that part of ensuring a fair and transparent
marketplace is to consistently apply and enforce listing standards and
that if a requirement is significant enough to be a listing standard,
then issuers that do not comply with the standard should be subject to
delisting. According to these officials, the penalty of delisting is a
more effective means of achieving issuer compliance, and thereby
protecting investors, than a lesser sanction.
SEC Has Taken Steps to Further Increase Director Accountability:
SEC has taken steps to revise regulations that have allowed issuers to
exclude disclosures regarding shareholder director nominees in the
issuer's proxy statement. For at least 60 years, shareholders have
sought greater access to the issuer's proxy as a means of replacing
ineffective or unresponsive directors and improving board
accountability to shareholders.[Footnote 112] In April 2003, the
Commission directed Corporation Finance to formulate possible changes
in the rules and regulations governing director elections, including
SEC's Rule 14a-8, which addresses shareholder access to the proxy
statement.[Footnote 113] Responding to Corporation Finance's
recommendations,[Footnote 114] SEC proposed a rule in October 2003 that
creates a mechanism for including, in issuer proxy material,
disclosures of director nominees made by long-term shareholders, or
groups of long-term shareholders, with significant holdings.[Footnote
115] Specifically, the proposed rule includes triggers that, when
activated, require disclosure in an issuer's proxy materials of
shareholder director nominees. For example, under one proposed trigger,
this disclosure would be required when more than 35 percent of the
shareholders who cast votes at the annual shareholders' meeting oppose
at least one of the issuer's director nominees. The issuer is then
required to include disclosure regarding shareholder director nominees
in the proxy materials within the next two annual shareholders'
meetings provided, among other things, that the nominees meet all
applicable independence and eligibility requirements. Also, in response
to the staff report, SEC adopted rules that strengthen disclosure
requirements related to an issuer's nomination of directors and to
shareholders' communication with directors.[Footnote 116] According to
SEC, the enhanced disclosures are intended in part to provide
shareholders with additional information for use in evaluating the
board of directors and nominating committees of the companies in which
they invest.
SEC officials told us that they plan to review disclosure requirements
regarding potential director and director nominees' conflicts of
interest. Items 401 and 404 of SEC's Regulation S-K describe certain
background information that an issuer must disclose in its proxy
statement about its executive officers, directors, and director
nominees, as well as certain relationships and transactions between the
issuers and these individuals. These disclosure requirements focus on
employment, family, and business relationships between the director or
director nominees and the issuer or executive officers. In December
2001, the American Federation of Labor and Congress of Industrial
Organizations (AFL-CIO) filed a petition with SEC requesting that it
consider a rulemaking to amend Regulation S-K to require additional
conflict-of-interest disclosures. In its rule-making petition, the AFL-
CIO stated that it discovered after Enron's collapse that several
directors considered independent by the Enron board, including two who
served on the audit committee, had relationships with Enron or its
senior executives that could have interfered with their ability to
exercise independent judgment. One, for example, was president of a
not-for-profit organization that received contributions from Enron.
Regulation S-K does not currently require disclosure of this
relationship. The AFL-CIO and other market participants who shared its
views said that increased disclosure of conflicts of interest would
allow investors to better assess the independence of a board. Other
market participants, however, told us that the current disclosure
requirements in Regulation S-K were adequate for investors and that
further requirements would only make the proxy statement bulkier and
harder to read. Corporation Finance officials told us that they plan to
review Regulation S-K disclosure requirements under items 401 and 404.
At SEC's Request, the Three Largest SROs Began Evaluating Their Own
Corporate Governance:
In a March 2003 letter, the SEC Chairman asked Amex, NASDAQ, and NYSE
to review their governance, including board structures, policies, and
practices, to ensure that it serves the public well. In these letters,
the Chairman asked the SROs to discuss how their governance practices
compare with the standards for issuers they proposed in the rules
submitted to SEC. According to the Chairman, the SROs should serve as
models of good governance. As such, he said they should adhere to the
same high standards of governance they were requiring of the issuers
listed on their markets. The three SROs provided reports to SEC in May
2003 that include varying amounts of information.
Amex reported that its board's governance structure and practices were
consistent with the listing standards in effect before its new
standards were implemented. The report did not discuss the extent to
which Amex's governance conformed with its new listing standards, such
as those requiring a majority of independent directors, or whether Amex
would consider imposing higher standards on itself than it had on
issuers, for example, by separating the positions of CEO and chairman
as NASDAQ and NYSE have done (discussed below). The report stated that
as Amex's corporate governance listing standards for issuers evolve,
Amex would assess whether changes to its governance structure and
practices were warranted. Amex officials told us that because NASD and
Amex have recently agreed that Amex would become an independent entity,
Amex planned to delay assessing and making changes to its governance
structure until its separation from NASD was complete.
NASDAQ's May 2003 report stated that its board met NASDAQ's new
corporate governance listing standards to the fullest extent
permissible under NASDAQ's by laws.[Footnote 117] Although NASDAQ's new
listing standards require issuers to establish either a nominating
committee composed entirely of independent directors to nominate new
directors or provide that a majority of the independent directors carry
out this function, NASDAQ's by laws prevent it from complying with this
listing standard. That is, NASDAQ's by laws require its nominating
committee to include individuals who are not NASDAQ directors. As a
result, NASDAQ's nominating committee currently consists entirely of
individuals who are not serving on the board, although they meet
NASDAQ's definition of director independence. NASDAQ reported that it
could revise its by laws so that a new committee of the board
consisting of independent directors nominates directors and that it
will discuss this change with SEC. Under NASDAQ's by laws, the board
can choose whether to combine or separate the positions of CEO and
chairman. NASDAQ reported that it was in the process of separating
these positions--a separation that was completed later that month.
NASDAQ officials said that this action complimented larger structural
changes to NASDAQ's governance that took place in April 2000, when NASD
members voted to sell a substantial part of NASD's ownership in NASDAQ.
One of the goals of this restructuring was to minimize the potential
for conflicts of interest associated with NASD's responsibility for
both the business operations and regulation of NASDAQ.
Concurrent with the submission of its May 2003 report to SEC describing
its governance structure, NYSE announced that its board had appointed a
committee, called the Special Committee on Governance, to review and
develop recommendations for improving NYSE's governance. On June 5,
2003, the NYSE board adopted the initial recommendations of the
committee, including those allowing only nonindustry directors to serve
as audit committee and compensation committee members and requiring, to
the extent feasible, that the NYSE audit committee comply with
applicable standards prescribed by NYSE for issuer audit
committees.[Footnote 118] NYSE also implemented a recommendation
prohibiting all its employees from serving on the boards of business
corporations. According to NYSE, following the adoption of the
recommendation, the NYSE chairman and other senior executives agreed to
resign from directorships on issuers' boards, effective at the
respective companies' next annual shareholder meeting, unless the
companies could find directors to replace them sooner.
The NYSE board also adopted recommendations that would result in
disclosures consistent with those included in NYSE's new corporate
governance listing standards, including disclosures of compensation for
the chairman, directors, and executive officers. In August 2003, the
NYSE board disclosed that the compensation package of the CEO, also
chairman of the board, was worth $139.5 million, including accrued
savings and incentives. In a September letter to the chairman of NYSE's
governance and compensation committees, the SEC Chairman stated that
approval of the CEO compensation package raised serious questions
regarding the effectiveness of NYSE's governance structure and called
for further information about the procedures and considerations that
governed the award of the pay package. The controversy prompted the
September 2003 resignation of the CEO/chairman. According to NYSE,
shortly thereafter, two directors who served on the committee that
approved the compensation package resigned.
In December 2003, SEC approved a NYSE rule proposal that is intended to
enhance NYSE's governance structure.[Footnote 119] The new rule amends
NYSE's constitution, creating an independent board of directors and a
board of executives as an advisory body. The new board of directors
consists of individuals who are independent from NYSE management,
members, member organizations, and listed companies (with the exception
of the CEO); and the board has responsibility for corporate governance,
executive compensation, internal controls, and regulatory
supervision.[Footnote 120] Although the board of directors can choose
whether to combine or separate the positions of CEO and chairman, NYSE
decided to separate them after consultations with SEC.[Footnote 121]
The board of executives includes representatives of broker-dealers,
institutional investors, large public funds, and listed companies.
Although SEC has approved NYSE's proposal, public debate has continued
as to the adequacy of its governance reforms.
The SEC Chairman and Market Regulation also sent letters to other SROs
requesting that they review their governance, and, according to Market
Regulation officials, they have received written responses from each
SRO.[Footnote 122] Market Regulation officials said that the Chairman's
letters to the SROs and their written responses were the first steps of
a comprehensive review by SEC of SRO governance. These officials said
that the recently approved changes to NYSE's governance structure could
be instructive as they continue their review of Amex, NASDAQ, and the
other SROs' governance. Further, these officials said that the new
governance standards in place at Amex, NASDAQ, and NYSE for listed
issuers could serve as a benchmark for SRO governance.
Other Countries Also Have Taken Steps to Enhance Board Independence:
Private or public institutions in the United Kingdom, France, Germany,
and Japan reviewed the corporate governance practices of issuers in
2002 and 2003. Although differences exist between the roles,
responsibilities, and characteristics of managers, directors, and
shareholders and the regulation of corporate governance in these
countries, their issuers were encouraged to increase the role and
authority of independent directors on their boards of directors. The
United Kingdom, Germany, and France have promoted sound corporate
governance by encouraging issuers to disclose in their annual reports
the extent of their compliance with codes of corporate governance,
explaining to investors the reasons for any areas of noncompliance.
These codes include provisions encouraging greater board independence.
Recent changes to Japan's corporate law allows issuers to choose a
governance structure similar to that found in the United States by
placing independent directors in key roles on boards.
The United Kingdom:
UK issuers are required by the listing rules of the Financial Services
Authority to describe in a narrative statement in their annual reports
how they apply the principles set out in the Combined Code on Corporate
Governance (Combined Code) and explain any deviations from them.
According to the Secretary of State for Trade and Industry, the merit
of the "comply or explain" approach is that it recognizes that
circumstances exist in which it is not sensible or appropriate for a
company, especially a smaller one, to meet every Combined Code
principle, but it requires issuers to explain the reason for any
noncompliance to shareholders.
In 2002, the Secretary of State for Trade and Industry and the
Chancellor of the Exchequer commissioned a review of the role and
effectiveness of nonexecutive directors,[Footnote 123] and the
Coordinating Group on Accounting and Audit commissioned a simliar
review of audit committees.[Footnote 124] As a result of these reviews,
the Combined Code was revised to include provisions recommending, among
other things, that half of the issuer's board--including the chairman,
all of the members of the audit and compensation committees, and a
majority of the members of the nominating committee--meet a tightened
definition of independence. In addition, the Combined Code's new
provisions address the qualifications of audit committee members and
the committee's authority over the outside auditor. Before these
revisions, the code generally called for fewer independent directors on
these committees and the board.
Germany:
In September 2001, the German Federal Minister of Justice appointed the
Government Commission on the German Corporate Governance Code to
develop an official corporate governance code for Germany, which it
completed in February 2002. The German code includes corporate
governance-related statutes that were already in effect at the time the
code was published and with which issuers must comply as well as
corporate governance practices that are recommended but not required. A
requirement that issuers annually disclose their reasons for deviating
from the code's recommendations was enacted in July 2002.
According to the commission, unlike boards in the United Kingdom and
United States, German issuers have a two-tier board structure,
consisting of a management board that is responsible for managing the
issuer and a supervisory board that appoints, supervises, and advises
the members of the management board. The new German code recommends,
among other things, that the supervisory board establish an audit
committee and that the committee chairman not be a former member of the
management board. Further, the code recommends charging the audit
committee with hiring and compensating the outside auditor as well as
ensuring the auditor's independence.
France:
In 2002, the Association of French Private Sector Companies and
Association of Major French Corporations (in French, AFEP-AGREF) and
the French Business Confederation,[Footnote 125] convened a private
working group to produce a code of corporate governance known as the
Bouton report.[Footnote 126] French issuers are not required by law to
disclose compliance with the corporate governance principles outlined
in this report; however, the report recommends that issuers include a
discussion of the extent to which they have complied with the report's
recommendations in their annual reports. Among other things, the Bouton
report recommends that at least half of the issuer's board consist of
independent directors, an increase from the one-third recommended by a
similar report previously published by AFEP-AGREF and the French
Business Confederation. Further, the Bouton report recommends that two-
thirds of the audit committee consist of independent directors, also an
increase from the one-third previously recommended.
Japan:
According to the Japanese Association of Corporate Directors, in Japan,
corporate governance structures more closely resembling those of the
United States were introduced in May 2002 under laws that made sweeping
revisions to the country's Commercial Code. Before these revisions,
boards of directors managed issuers through a member vested with the
authority to carry out the board's directives, and shareholders were
required to elect outside auditors to monitor the boards' management.
Revisions to the Commercial Code in 2001 strengthened the statutory
auditor system by, among other things, requiring outside auditors to be
independent.
According to the Japanese association, under the 2002 revisions to the
Commercial Code, large Japanese issuers can choose from among three
corporate governance structures--the traditional structure described
above and two other structures under which independent directors are
involved in overseeing management. Under one of the two new options,
boards would appoint a CEO who, similar to CEOs in the United States,
would be responsible for managing the company's business operations,
and a separate board of directors that would oversee the CEO and hold
the CEO accountable to shareholders. Issuers that choose this structure
must establish audit, nominating, and compensation committees
consisting of a majority of independent directors. Under the other new
option, an asset committee would be established within the board. This
committee would have the authority to make decisions related to the
transfer and disposal of major company assets and to make other
management decisions. The board would oversee the asset committee and
would have at least one independent director.
Conclusions:
Investors need timely and ongoing information on the listing status of
issuers for use in making investment decisions. In the absence of such
information, they might logically but incorrectly assume that all
issuers comply with the listing standards of their markets. Although
NYSE has taken steps to address OCIE's recommendation to provide early
and ongoing public notification of issuers' noncompliance with
quantitative continued listing standards by introducing symbol
indicators, investors may be unaware of the availability of the
information transmitted by the indicators. Existing plans for
distributing the information to the print media have not been fully
implemented and distribution to investors through the Internet is
limited. Further, although the indicator is displayed on NYSE's Web
site with the stock symbol, the indicator is not sufficiently visible
to investors. As a result, investors that do not independently learn of
the indicator's availability may not become aware of its existence when
they visit the Web site.
Although NASDAQ and Amex have discussed transmitting an indicator in a
manner similar to NYSE for noncompliance with their quantitative
continued listing standards, we are concerned about the hesitancy of
both SROs to voluntarily provide the public early notification of an
issuer's noncompliant status. We are also concerned that the
distribution issues affecting the NYSE indicator would be applicable to
the NASDAQ and Amex indicators. Corporation Finance's proposed
revisions to SEC's Form 8-K would, if approved, ensure that investors
receive early notification of issuers' noncompliance with quantitative
and qualitative continued listing standards. Also, finalizing the
revised filing requirement would complement OCIE and Market
Regulation's efforts by providing investors a source of information on
the facts surrounding an issuer's noncompliant status. Further
extension of OCIE's recommendation to qualitative listing standards,
including corporate governance standards, could be valuable to
investors and is an objective worthy of further OCIE and Market
Regulation exploration with the SROs. In the absence of voluntary
action by the SROs, further SEC action is warranted to ensure that the
public receives early and ongoing notice of an issuer's noncompliance
with its market's listing standards.
OCIE's reluctance to routinely use SROs' internal review reports in
planning and conducting inspections is inconsistent with the standards
of organizations with functions similar to OCIE's. The development of a
comprehensive policy regarding the use of SROs' internal review reports
as part of SRO inspections would be valuable because these reports
could aid OCIE in determining the objectives and scope of inspections
designed to assess the SROs' effectiveness in fulfilling their
oversight responsibilities. SEC recognized the importance of the
internal review function to the quality of SRO oversight when it
recommended that NASDAQ and NYSE strengthen this function to address
weaknesses SEC identified. Reviewing, among other things, internal
review objectives, scope, findings, recommendations, and resulting
corrective actions would provide SEC insights into the quality of the
function and at least one indicator of the effectiveness of the SROs.
SEC acted within its authority and followed its applicable regulations
in allowing rules to remain in effect that implemented a 3-month
enforcement moratorium on NASDAQ's continued listing standards for bid-
price and market value of publicly held shares as well as subsequent
changes to NASDAQ's bid-price standard. While data are not available
from which to determine the full effect of the moratorium and
subsequent rule changes on the listing status of NASDAQ issuers, the
rules met their objective of allowing noncompliant issuers more time to
trade. SEC also acted within its authority and followed applicable
regulations in approving another NASDAQ rule that allowed SCM issuers
to continue trading up to 2 years while noncompliant with the bid-price
standard as part of a pilot program. NASDAQ's study on the effects of
the pilot program will provide essential information to the Commission
for use in evaluating whether the rule should be allowed to become
permanent. However, 2 years is a long time to allow a noncompliant
issuer to continue trading in the absence of a means of providing the
public early and ongoing notification of the issuer's listing status.
Amex, NASDAQ, and NYSE have adopted changes to their corporate
governance standards that when implemented should promote stronger
board oversight and greater accountability. Independent directors play
a key role in these governance reforms; however, of the three largest
SROs only Amex does not require that issuers disclose the names of all
their independent directors, hampering the ability of investors and
regulators to assess the independence of these directors. While the
SROs have strengthened their corporate governance listing standards,
opportunities exist to further strengthen board independence by
revising listing standards to require a supermajority of independent
directors and the separation of the positions of CEO and chairman. We
recognize that issuers would require a reasonable amount of time to
implement any such reforms; for example, a 2-year implementation period
would not be unrealistic.
OCIE's plans to work with the SROs to ensure that they have effective
processes in place for evaluating issuers' compliance with their new
corporate governance standards could be central to ensuring compliance
with the standards and merit prompt action. Also, through its
inspection process, OCIE could assess the SROs' oversight of issuers'
compliance with the new standards and ensure that the standards are
meeting their intended purpose. Corporation Finance's proposed changes
to rules governing shareholders' access to the director nomination
process and its plans to review issuers' disclosures of conflicts of
interest in the proxy statement complement the SROs' efforts to improve
their corporate governance standards and could result in further
enhancements to board accountability to shareholders. As a result, they
deserve timely attention.
Finally, given the SROs' role as standard setters for corporate
issuers, the public has the right to expect the SROs to serve as models
of strong governance. Market Regulation continues to assess the self-
evaluations of corporate governance that the three largest SROs
prepared, as well as the practices of 16 other SROs, including 8
securities exchanges and 8 clearinghouses. These reviews have resulted
in actions by NASDAQ and NYSE to improve board independence and
transparency of decision making and could result in additional changes
when Market Regulation completes its assessment. Although SEC will need
to consider the applicability of the changes made at NASDAQ and NYSE to
the other SROs, action by NASDAQ and NYSE to split the position of CEO
and chairman is one that could, where appropriate, enhance the
governance of other SROs. Further, once any changes are in effect,
OCIE, through its inspection process, could also ensure that the SROs
have implemented proposed changes to their own corporate governance,
determine that these changes are having their intended effect, and
identify other appropriate changes.
Recommendations for Executive Action:
To restore investor confidence in the markets, further strengthen the
listing standards of the SROs, and improve SEC listing program
oversight, we recommend that the Chairman, SEC, take the following 12
actions:
* work with NYSE to ensure the distribution of NYSE's indicator through
the print media and the Internet and improve the visibility of the
indicator on the NYSE Web site;
* work with NASDAQ and Amex to ensure that the public receives early
and ongoing notification of issuers' noncompliance with their markets'
quantitative continued listing standards--using issuer's receipt of the
initial deficiency notice as the reference point for determining when
public notification should begin or, if approved in a manner consistent
with our following recommendation, the filing of the revised Form 8-K;
* ensure that the Commission expeditiously finalizes the rule requiring
that issuers file the Form 8-K after receiving notice of being
deficient with their market's listing standards and include a time
frame for doing so that, consistent with its initial proposal, ensures
early public notification of issuers' noncompliant status;
* work with Amex, NASDAQ, and NYSE to assess the feasibility of
providing early and ongoing public notification of issuers'
noncompliance with qualitative listing standards;
* ensure the development and implementation of a policy requiring OCIE
staff to routinely use SRO internal review reports in planning and
conducting SRO inspections;
* work with Amex to ensure that issuers disclose the names of those
directors that they have designated as independent;
* work with the SROs to further enhance board independence by giving
serious consideration to requiring issuers, through listing standards,
to establish a supermajority of independent directors and to separate
the positions of CEO and chairman, recognizing that a reasonable period
of time would be needed to make such changes effective;
* work with the SROs to ensure that they have established effective
processes for ensuring issuers' compliance with corporate governance
listing standards;
* ensure that OCIE conducts timely inspections of the three largest
SROs to assess their oversight of issuers' compliance with corporate
governance standards;
* ensure that Corporation Finance places a high priority on
establishing and meeting time frames for completing its rulemaking
related to shareholder access to the director nomination process and
reviewing issuers' qualitative disclosure requirements related to
potential director and director nominee conflicts of interest;
* ensure that Market Regulation places a high priority on establishing
and meeting time frames for completing its reviews of the SROs' self-
evaluations of their governance, and works with Amex and, as
appropriate, the other 16 SROs under review, to further enhance their
own board independence by giving serious consideration to separating
the positions of CEO and chairman; and:
* ensure that OCIE conducts timely inspections of the three largest
SROs to ensure that steps are taken to address any weaknesses
identified in their self-evaluations and that new requirements
governing SRO boards are effectively implemented.
Agency Comments and Our Evaluation:
We received written comments on a draft of this report from SEC, Amex,
NASDAQ, and NYSE that are reprinted in appendixes V-VIII, respectively.
As discussed below, SEC generally agreed with our recommendations and
is taking or plans to take actions to address them. Also as discussed
below, Amex and NYSE expressed concerns about our recommendations
related to providing the public early and ongoing notification of
issuers' noncompliance with their markets' listing standards, and Amex
and NASDAQ discussed their concerns about our recommendation related to
enhancing board independence by giving serious consideration to
requiring issuers, through listing standards, to establish a
supermajority of independent directors and to separate the positions of
CEO and chairman. SEC and the three SROs also provided technical
comments that have been incorporated into the report where appropriate.
SEC commented that it will continue working with the SROs to ensure
that the goal of providing investors early and ongoing notice of
issuers' noncompliance with their markets' listing standards is met.
NYSE responded that it has fully addressed OCIE's related
recommendation as is pertains to quantitative listing standards and
that SEC would need to impose any additional requirements related to
the dissemination of indicators on information vendors. Our view,
consistent with OCIE's, continues to be that until the dissemination
issue is resolved, NYSE's use of indicators does not meet the intent of
OCIE's recommendation. For this reason and because the satisfactory
resolution of the distribution issue is pivotal to the acceptability of
using indicators to address OCIE's recommendation, SEC and NYSE have a
mutual interest in working together and with information vendors to
resolve the issue. Also, a joint SEC and NYSE effort could enhance the
likelihood of voluntary action by information vendors. Finally, if Amex
and NASDAQ should provide OCIE with proposals for using indicators that
are otherwise acceptable, SEC may wish to involve them in resolving the
information distribution issue.
NASDAQ expressed a willingness to change its procedures for notifying
the public of issuers' noncompliance with the market's listing
standards and to work with OCIE to implement its recommendation. Amex
affirmed that transparency with respect to an issuer's compliance with
listing standards is important but reiterated reservations expressed in
the report that neither the indicator nor the symbol modifier is an
appropriate or necessary method for providing such transparency. Amex
also said that, notwithstanding its views, issues related to the use of
indicators will be re-examined by the Amex Board of Governors at its
April 2004 meeting. Consistent with SEC's view, we continue to believe
that achieving early and ongoing public notification of issuers'
noncompliance with listing standards is important to investors'
decision making. Accordingly, we support SEC's commitment to working
with the SROs to achieve this goal, whether through implementation of
modifiers, indicators, or another alternative.
Although SEC, NASDAQ, and Amex did not specifically comment on how
early notification of noncompliance with issuers' listing standards
would be achieved in conjunction with symbol modifiers or indicators,
SEC said that Corporation Finance's proposed revisions to the Form 8-K
were to ensure early public notice of an issuer's noncompliant status.
Consistent with our recommendation, the Commission has approved
Corporation Finance's proposed revisions, as modified based on public
comment. The final rule, approved on March 11, 2004, requires issuers
to file the Form 8-K within 4 business days of being notified by the
SRO of their noncompliance with either a quantitative or qualitative
listing standard. Because the approved rule addresses our
recommendation that the Form 8-K filing provide for early public
notification, we believe that using the filing as the trigger for
transmitting the indicator is warranted. Doing so would provide
consistency across the markets and enhance the complementary
relationship between the indicator as a mechanism for providing ongoing
public notification and the Form 8-K as a source of more detailed
information on the nature of the issuer's deficient status.
SEC also commented that the SROs should provide investors timely
notification not only when issuers are noncompliant with financial
listing standards, but also when they are noncompliant with corporate
governance standards. Accordingly, SEC said that it would discuss with
the SROs the feasibility of appending a modifier to or transmitting an
indicator with the symbol of an issuer that is noncompliant with
corporate governance standards. NYSE expressed concern about extending
the use of indicators to qualitative listing standards, such as
corporate governance standards, elaborating that the indicator is not
an appropriate or effective method of conveying more complex, "less
binary" information. NYSE explained that a large number of qualitative
standards exist, with some situations of noncompliance being more
serious than others and some matters being potentially easier to
correct than others. NYSE said that using an indicator for all the
standards would "homogenize" the information, which could lead the
public to ignore the indicator as a conveyor of useful information.
NYSE also noted that the present dissemination mechanism is limited as
to the number of different indicators that can be used, so that the
cost of employing additional indicators would likely be significant.
Amex also expressed concern about the feasibility of addressing all
"significant factors" with an indicator, stating that many are
inherently subjective and not susceptible to an objective determination
of whether the "triggering event" has occurred. Amex also said that
using many different types of indicators would be confusing to
investors and the marketplace. Nonetheless, the use of indicators for
noncompliance with qualitative standards is among the topics that Amex
expects to address at its April 2004 Board of Governors meeting. We
agree that use of modifiers or indicators may not be appropriate for
noncompliance with all qualitative listings standards. However, as
NASDAQ has demonstrated through its use of a symbol modifier for
issuers that have not filed required SEC reports and as we have
recommended, early and ongoing public notification of noncompliance
with additional qualitative standards may be appropriate and should be
explored further.
SEC commented that it recognizes that SRO internal audit reports may be
a useful tool in the inspection process. In response to our
recommendation, SEC said that it will implement a formal written policy
concerning the selection and review of SRO internal audit reports
during inspections.
Regarding our recommendation that Amex ensure that issuers disclose the
names of those directors that they have designated as independent, SEC
noted that Amex responded on February 23, 2004, by filing a rule change
that requires this disclosure and that the rule change became effective
on filing. Amex also cited the rule change in its comments.
Amex said that while our recommendation related to requiring issuers,
through listing standards, to establish a supermajority of independent
directors and separate the positions of CEO and chairman, warrants
further consideration, issuers, the markets, and SEC need more time to
adjust to the various new requirements that have already been imposed
on the markets and assess their impact. NASDAQ similarly commented that
time is needed for the numerous new governance changes to take effect
and their results assessed. NASDAQ said that mandating a supermajority
of independent directors might prove unduly burdensome, particularly
for smaller issuers, and that insufficient information is available to
determine if it would provide greater benefits than a simple majority.
NASDAQ also said that separating the positions of CEO and chairman
might enhance the governance of some companies but that concerns exist
that mandating the separation could make boards more inefficient and
lead to unnecessary conflict. NASDAQ also said that insufficient
information is available to justify taking the step at this time and
that other steps it has taken, such as requiring a majority of
independent directors, will significantly reduce the concerns
associated with a combined CEO/chairman. NYSE commented that it is not
opposed to companies adopting requirements for a separate CEO and
chairman or a supermajority of independent directors, if they choose to
do so.
Recognizing that a reasonable amount of time would need to be allowed
for issuers to establish a supermajority of independent directors and
separate the positions of CEO and chairman, we continue to believe that
in the absence of voluntary action by issuers, SEC should, working with
the SROs, seriously consider mandating such requirements through
listing standards. SEC's January 2004 proposals that would require
boards of mutual funds to comprise 75 percent (a supermajority)
independent directors and have an independent board chairman are
consistent with our recommendation. Although the conflicts of interest
between the boards of directors and management of mutual funds may be
more apparent than such conflicts at other publicly traded companies,
we believe that the rationale behind SEC's proposals is equally
applicable to publicly traded companies, regardless of whether they
manage financial or physical assets. As SEC has noted, and we agree,
with a supermajority of independent directors and an independent board
chairman, independent directors will set the board agenda as well as
have the power to control the outcome of board votes. Although SEC and
we recognize that such actions do not guarantee effective management,
we both agree that greater board independence could promote board
decision making that is aligned with shareholders' interests, thereby
enhancing board accountability. As SEC has stated, these proposals,
along with others in its January 2004 rule-making package, would
bolster the effectiveness of independent directors and enhance the role
of the board as the primary advocate for shareholders. We acknowledge,
however, that some issuers would not be in a position to immediately
implement these best practices and that any improvements, therefore,
would likely be best accomplished on an incremental basis. In this
regard, we encourage SEC and the SROs, as industry leaders, to reach
out to issuers and use their leverage to assist in the process of
transitioning issuers' governance structures into models of corporate
responsibility.
Regarding our recommendation related to ensuring that OCIE conducts
timely inspections of the three SROs to assess their oversight of
issuers' compliance with corporate governance standards, SEC said that
it expects to continue to conduct timely inspections of the SROs'
programs and procedures for ensuring that issuers comply with corporate
governance requirements and to enhance its review to include the new
corporate governance standards. We believe that OCIE's efforts will be
important to ensuring the successful implementation of the new
standards and enhancing SRO oversight of the markets, particularly if
OCIE shares any best practices that it identifies with the SROs.
Regarding our recommendations related to reviewing the SROs' self-
evaluations of their own corporate governance and following up with
inspections of the SROs, SEC commented that it is currently conducting
a comprehensive review of SRO governance that will take into
consideration the new corporate governance standards. SEC also said
that when appropriate and after any changes or new requirements are
implemented at the SROs, it will inspect the SROs to determine whether
they have effectively implemented their own enhanced governance
standards. SEC's ongoing and proposed actions are consistent with our
recommendations and should enhance the quality of SRO governance,
particularly if, as noted above, the best practices identified are
shared with all the SROs.
In response to our recommendation that Market Regulation work with Amex
to further enhance its board independence by giving serious
consideration to separating the position of CEO and chairman, Amex
commented that draft changes to the Amex constitution are being
considered in connection with NASD's proposed sale of its interest in
Amex to the Amex Membership Corporation. Amex said that the proposed
changes provide that if Amex's CEO is also the chairman of the Amex
Board of Governors, a "lead governor"--designated by the Board of
Governors from among the independent governors--would preside over
executive sessions. Amex noted that the proposed changes are subject to
various approvals, including by SEC and Amex members. Amex's proposals
are consistent with NASDAQ's by laws and NYSE's constitution, which
also retain the option of having the same person serve as CEO and
chairman. However, we believe that the unique role of the SROs as
standard setters suggests that absent compelling reasons to the
contrary, SEC should ensure that Amex opts for separating these
positions as NASDAQ and NYSE have done.
:
As agreed with your offices, unless you publicly announce the contents
of this report earlier, we plan no further distribution until 30 days
from the report date. At that time, we will send copies of this report
to the Chairmen and Ranking Minority Members of the Senate Committee on
Banking, Housing, and Urban Affairs and its Subcommittee on Securities
and Investment; the Chairman, House Committee on Energy and Commerce;
the Chairmen of the House Committee on Financial Services and its
Subcommittee on Capital Markets, Insurance, and Government Sponsored
Enterprises; and other interested congressional committees. We will
send copies to the Chairmen of SEC, Amex, NASDAQ, and NYSE and to other
interested parties. We also will make copies available to others upon
request. In addition, the report will be available at no charge on the
GAO Web site [Hyperlink, http://www.gao.gov].
If you have any further questions, please contact me at (202) 512-8678,
[Hyperlink, hillmanr@gao.gov], or Cecile Trop at (312) 220-7600,
[Hyperlink, tropc@gao.gov]. Additional GAO contacts and staff
acknowledgments are listed in appendix IX.
Signed by:
Richard J. Hillman,
Director, Financial Markets and Community Investment:
[End of section]
Appendixes:
Appendix I: Scope and Methodology:
To report on the status of the Securities and Exchange Commission's
(SEC) Office of Compliance Inspections and Examinations' (OCIE)
recommendations to the three largest self-regulatory organizations
(SRO) for improving their markets' equity listing programs, we reviewed
OCIE's inspection reports on the American Stock Exchange (Amex), Nasdaq
Stock Market, Inc. (NASDAQ), and the New York Stock Exchange (NYSE)
listing programs and related workpapers and correspondence. We also
obtained information from OCIE, Amex, NASDAQ, and NYSE on OCIE's
listing program inspection report findings and recommendations, and the
SROs' efforts to address the recommendations. Further, we obtained
data, in documentary form, from the three SROs on the number of
noncompliant issuers trading during 2003 and their trading status as of
December 31, 2003. In addition to these steps, in reviewing the
effectiveness of NYSE's actions to address OCIE's recommendation
intended to ensure early and ongoing notification of issuers'
noncompliance with continued listing standards, we contacted a
nonprobability (nonrandom) sample of 11 vendors. This sample included
broker-dealers, vendors that supply information to the print media, and
vendors that supply information through the Internet, either on their
own Web sites or through third-party vendors, to determine whether they
were distributing the information on issuers' noncompliance with NYSE's
quantitative continued listing standards that NYSE transmits by its
indicator. Our selection of the 11 vendors was based on a list from
NYSE of the largest vendors of quotation data, a list from NYSE of
recommended contacts, and our own research on vendors that supply
quotation information over the Internet. Ultimately, we interviewed
eight information vendors between August and November 2003 to determine
whether they were publicizing the information and were successful in
contacting six of these vendors in February and March 2004 for followup
interviews. We also attempted to contact three additional vendors by
telephone, but were unsuccessful. As a result, we visited their Web
sites in September 2003 and again in February 2004 to determine whether
they were publicizing the information transmitted by NYSE's indicator.
Because we did not conduct a random sample of all vendors that receive
quotation data from NYSE, our findings regarding the use of NYSE's
indicator cannot be generalized to the entire population of vendors. To
determine whether a Web site visitor could locate the indicator and the
list of noncompliant NYSE issuers, we visited the NYSE Web site and
independently searched for this information.
To report on the extent to which OCIE uses SROs' internal review
reports in its inspection process, we obtained information from OCIE on
its policy for reviewing internal review reports as part of its
inspections and examinations, and information from Amex, NASDAQ, the
National Association of Securities Dealers, Inc., and NYSE on the
purpose and scope of their respective internal review functions. We
reviewed the Government Auditing Standards, also called the Yellow
Book, to identify best practices for using internal review reports in
oversight inspections such as those conducted by OCIE. We also reviewed
the examination policies of the Federal Deposit Insurance Corporation,
the Federal Reserve Board, the Office of the Comptroller of the
Currency, and the Office of Thrift Supervision to determine the extent
to which bank and thrift examiners are required to use internal review
reports as part of their examinations. In addition, we obtained
information from officials representing the Inspectors General of the
Commodity Futures Trading Commission and the Department of the Treasury
on the extent to which they use internal review reports as part of
their inspections and examinations. Further, we reviewed selected SRO
internal review reports on their listing programs and discussed the
contents of other reports with SRO officials. We did not review OCIE's
entire inspection process because SEC was doing a review of the
agency's operations during the time we did our work.
To report on SEC's oversight of NASDAQ's moratorium and subsequent bid-
price rule changes and the listing status of the issuers directly
affected by these changes, we reviewed relevant NASDAQ proposed and
final rules and discussed their purposes with NASDAQ officials. We also
obtained information from SEC officials on their review of these
proposals. In addition to these steps, in reporting on the listing
status of firms directly affected by the NASDAQ moratorium and
subsequent rule changes, we analyzed data generated between September
26, 2001, and February 28, 2003, from NASDAQ's Web Issuer Support
Services System, NASDAQ's primary source of data for monitoring
compliance with NASDAQ's listing standards. Our data begin with
September 26, 2001, rather than September 27, 2001, the date the
moratorium was imposed, because NASDAQ stopped tracking compliance with
the bid-price and market value of publicly held shares listing
standards on the date the moratorium was imposed and, therefore, no
data were available on September 27, 2001. Based on our analysis, we
determined the listing status of the issuers NASDAQ identified as
having received direct relief through the moratorium (moratorium
issuers) as of January 2, 2002, the day the moratorium was lifted. We
could not determine the number of issuers that might have received
indirect relief, because, as previously discussed, NASDAQ stopped
tracking individual issuers' compliance with the bid-price and market
value of publicly held shares continued listing standards during the
moratorium. As a result, we could not determine the total number of
issuers that might have become noncompliant with these standards in the
absence of the moratorium, the number of noncompliant issuers that
would have returned to compliance in the absence of the moratorium, or
the number of issuers approaching noncompliance that actually became
noncompliant. We determined the listing status of the moratorium
issuers as of February 28, 2003, approximately 1 year after NASDAQ
implemented its postmoratorium rule change, because by this date
issuers that were affected by the moratorium would have had an
opportunity to go through NASDAQ's deficiency process. Examining this
period also allowed us to determine the listing status of issuers
affected by the first postmoratorium bid-price rule change. We
discussed the results of our data analysis with NASDAQ officials.
Although we did not independently verify the accuracy of the NASDAQ
data, we performed internal checks to assess the data's reliability and
concluded that they were reliable for the purposes of this report.
To report on the actions the three largest SROs have taken to
strengthen corporate governance for issuers and themselves, we reviewed
relevant legislation, GAO and other testimony to Congress, testimony to
SROs, corporate governance studies, investigative reports on the
collapse of major U.S. corporations, SEC's proposed and final
rulemakings related to shareholder access to the director nomination
process, and SEC's qualitative corporate disclosure requirements for
issuers. We also reviewed the three SROs' proposed and final (new)
corporate governance rules for issuers as well as the rules they have
replaced. Additionally, we obtained information from SRO officials on
the purpose of the new rules and the SROs' plans for ensuring
compliance with them. We also obtained information from SEC on its
review of these rules and its plans to review qualitative corporate
disclosure requirements. Further, we obtained an assessment from a
nonprobability sample of 14 market participants representing the
investor, legal, business, and financial communities on the adequacy of
the SROs' new rules and SEC's qualitative corporate disclosure
requirements. Because we did not conduct a random sample of all market
participants, the views expressed in this report on the corporate
governance rules of the three SROs cannot be generalized to the entire
population of market participants. In addition, we attended a forum
that GAO sponsored on corporate governance and accountability issues
and attended corporate governance conferences given by organizations in
the public and private sectors. We also reviewed the three largest
SROs' self-evaluations of their own corporate governance, including
board structures, policies, and practices. Finally, we reviewed
publicly available information to identify actions that private and
public institutions took in the United Kingdom, Germany, France, and
Japan between January 2002 and June 2003 to strengthen corporate
governance. This included a review of the new or revised corporate
governance codes used in the United Kingdom, Germany, and France, and
descriptions by Japanese corporate associations of recent revisions to
Japanese corporate law. Due to limitations on the scope of our inquiry,
we may not have identified all of the actions taken over this period.
Also due to these limitations, we did not discuss in the report the
corporate or regulatory structure of the countries or the respective
roles, responsibilities, and characteristics of shareholders,
corporate managers, and boards.
We did our work in accordance with generally accepted government
auditing standards between April 2002 and March 2004. We performed our
work in Chicago, Ill.; New York City, N.Y.; and Washington, D.C.
[End of section]
Appendix II: Quantitative Listing Standards for Domestic Issuers of the
Three Largest Markets:
Table 3: The American Stock Exchange's Quantitative Standards for
Initial Listing of Domestic Issuers:
Standard: Stockholders' equity[B];
Minimum requirements[A]: Option 1: $4 million;
Minimum requirements[A]: Option 2: $4 million;
Minimum requirements[A]: Option 3: $4 million;
Minimum requirements[A]: Option 4: N.A.[C].
Standard: Market capitalization[D];
Minimum requirements[A]: Option 1: N.A;
Minimum requirements[A]: Option 2: N.A;
Minimum requirements[A]: Option 3: $50 million;
Minimum requirements[A]: Option 4: $75 million[E].
Standard: Pretax income[F];
Minimum requirements[A]: Option 1: $750,000;
Minimum requirements[A]: Option 2: N.A;
Minimum requirements[A]: Option 3: N.A;
Minimum requirements[A]: Option 4: N.A..
Standard: Operating history;
Minimum requirements[A]: Option 1: N.A;
Minimum requirements[A]: Option 2: 2 years;
Minimum requirements[A]: Option 3: N.A;
Minimum requirements[A]: Option 4: N.A..
Standard: Distribution;
Minimum requirements[A]: Option 1: One of the following:
1. 800 public shareholders and 500,000 publicly held shares,
2. 400 public shareholders and 1 million publicly held shares, or;
3. 400 public shareholders, 500,000 publicly held shares, and average
daily trading volume of 2,000 shares in the previous 6 months;
Minimum requirements[A]: Option 2: One of the following:
1. 800 public shareholders and 500,000 publicly held shares,
2. 400 public shareholders and 1 million publicly held shares, or;
3. 400 public shareholders, 500,000 publicly held shares, and average
daily trading volume of 2,000 shares in the previous 6 months;
Minimum requirements[A]: Option 3: One of the following:
1. 800 public shareholders and 500,000 publicly held shares,
2. 400 public shareholders and 1 million publicly held shares, or;
3. 400 public shareholders, 500,000 publicly held shares, and average
daily trading volume of 2,000 shares in the previous 6 months;
Minimum requirements[A]: Option 4: One of the following:
1. 800 public shareholders and 500,000 publicly held shares,
2. 400 public shareholders and 1 million publicly held shares, or;
3. 400 public shareholders, 500,000 publicly held shares, and average
daily trading volume of 2,000 shares in the previous 6 months..
Standard: Price[G];
Minimum requirements[A]: Option 1: $3;
Minimum requirements[A]: Option 2: $3;
Minimum requirements[A]: Option 3: N.A;
Minimum requirements[A]: Option 4: $3.
Standard: Market value of publicly held shares[H];
Minimum requirements[A]: Option 1: $3 million;
Minimum requirements[A]: Option 2: $15 million;
Minimum requirements[A]: Option 3: $15 million;
Minimum requirements[A]: Option 4: $20 million.
Source: The American Stock Exchange.
Notes:
While data provided in the table reflect information from the American
Stock Exchange, the definitions provided in the following notes are
from David L. Scott, Wall Street Words (1997).
[A] A company must meet all of the minimum requirements under option 1,
2, 3, or 4.
[B] Stockholders' equity is the stockholders' interest in the assets of
a business. It includes the amount invested by the stockholders in the
enterprise plus the profits (or minus the losses).
[C] Not applicable.
[D] Market capitalization is the total value of all of a firm's
outstanding shares, calculated by multiplying the price of a stock by
the total number of shares outstanding.
[E] A company may also meet the total market capitalization standard
with $75 million each in total assets and total revenue in the most
recent fiscal year or in 2 of the last 3 fiscal years.
[F] Companies can meet the pretax income requirement either in the last
fiscal year or in 2 of the last 3 fiscal years.
[G] Price is the dollar amount at which a share of common stock trades.
Amex's standards specify that a company must satisfy the share price
requirement for a reasonable period of time but do not define
"reasonable.":
[H] According to the American Stock Exchange, market value of publicly
held shares is the price of a stock multiplied by the number of
outstanding shares held by investors that are not officers, directors,
and 10 percent or greater shareholders.
[End of table]
Table 4: The American Stock Exchange's Quantitative Standards for
Continued Listing of Domestic Issuers:
Standard: Stockholders' equity;
Minimum requirements: $2 million, $4 million, or $6 million[A].
Standard: One of the following:
1. publicly held shares,
2. number of public shareholders, or;
3. market value of publicly held shares;
Minimum requirements:
1. 200,000,
2. 300, or;
3. $1 million[B].
Source: The American Stock Exchange.
Notes:
[A] The stockholders' equity requirement is $2 million if the issuer
has sustained losses from continuing operations or net losses in 2 of
its 3 most recent fiscal years, $4 million if the issuer has sustained
losses from continuing operations or net losses in 3 of its 4 most
recent fiscal years, and $6 million if the issuer has sustained losses
from continuing operations or net losses in 4 of its 5 most recent
fiscal years.
[B] Delisting will be considered if the issuer does not meet the $1
million minimum requirement for market value of publicly held shares
for more than 90 consecutive calendar days.
[End of table]
Table 5: The NASDAQ National Market's Quantitative Standards for
Initial Listing of Domestic Issuers:
Standard: Stockholders' equity;
Minimum requirements[A]: Option 1: $15 million;
Minimum requirements[A]: Option 2: $30 million;
Minimum requirements[A]: Option 3: N.A.
Standard: One of the following:
1. market value of listed securities[B] or;
2. total assets and total revenue;
Minimum requirements[A]: Option 1: N.A;
Minimum requirements[A]: Option 2: N.A;
Minimum requirements[A]: Option 3:
1. $75 million or;
2. $75 million and $75 million.
Standard: Income from continuing operations before income taxes[C];
Minimum requirements[A]: Option 1: $1 million;
Minimum requirements[A]: Option 2: N.A;
Minimum requirements[A]: Option 3: N.A.
Standard: Publicly held shares[D];
Minimum requirements[A]: Option 1: 1.1 million;
Minimum requirements[A]: Option 2: 1.1 million;
Minimum requirements[A]: Option 3: 1.1 million.
Standard: Market value of publicly held shares;
Minimum requirements[A]: Option 1: $8 million;
Minimum requirements[A]: Option 2: $18 million;
Minimum requirements[A]: Option 3: $20 million.
Standard: Bid price[E];
Minimum requirements[A]: Option 1: $5;
Minimum requirements[A]: Option 2: $5;
Minimum requirements[A]: Option 3: $5.
Standard: Round-lot shareholders[F];
Minimum requirements[A]: Option 1: 400;
Minimum requirements[A]: Option 2: 400;
Minimum requirements[A]: Option 3: 400.
Standard: Market makers[G];
Minimum requirements[A]: Option 1: 3;
Minimum requirements[A]: Option 2: 3;
Minimum requirements[A]: Option 3: 4.
Standard: Operating history;
Minimum requirements[A]: Option 1: N.A;
Minimum requirements[A]: Option 2: 2 years;
Minimum requirements[A]: Option 3: N.A.
Source: Nasdaq Stock Market, Inc.
Notes:
While data provided in the table reflect information from the Nasdaq
Stock Market, Inc., the definitions provided in the following notes are
from David L. Scott, Wall Street Words (1997), unless otherwise
indicated.
[A] A company must meet all of the requirements under option 1, 2, or
3.
[B] According to the Nasdaq Stock Market, Inc., market value of listed
securities is the price per share multiplied by the total number of
shares outstanding held by the public, officers, directors, and
beneficial owners.
[C] A company can meet the income from continuing operations
requirement in either the latest fiscal year or in 2 of the last 3
fiscal years.
[D] According to the Nasdaq Stock Market, Inc., publicly held shares,
also referred to as public float, are the total shares outstanding less
any shares held by officers, directors, or beneficial owners of 10
percent or more.
[E] According to the Nasdaq Stock Market, Inc., bid price is the price
a buyer is willing to pay for a security.
[F] Round-lot shareholders hold 100 shares or a multiple thereof.
[G] According to the Nadsaq Stock Market, Inc., market makers are firms
or individuals that maintain a firm bid and offer price in a given
security by standing ready to buy or sell at publicly quoted prices.
[End of table]
Table 6: The NASDAQ National Market's Quantitative Standards for
Continued Listing of Domestic Issuers:
Standard: Stockholders' equity;
Minimum requirements[A]: Option 1: $10 million;
Minimum requirements[A]: Option 2: N.A.
Standard: One of the following:
1. market value of listed securities or;
2. total assets[B] and total revenue.c;
Minimum requirements[A]: Option 1: N/A;
Minimum requirements[A]: Option 2:
1. $50 million or;
2. $50 million and $50 million.
Standard: Publicly held shares;
Minimum requirements[A]: Option 1: 750,000;
Minimum requirements[A]: Option 2: 1.1 million.
Standard: Market value of publicly held shares;
Minimum requirements[A]: Option 1: $5 million;
Minimum requirements[A]: Option 2: $15 million.
Standard: Bid price;
Minimum requirements[A]: Option 1: $1;
Minimum requirements[A]: Option 2: $1.
Standard: Round-lot shareholders;
Minimum requirements[A]: Option 1: 400;
Minimum requirements[A]: Option 2: 400.
Standard: Market makers;
Minimum requirements[A]: Option 1: 2;
Minimum requirements[A]: Option 2: 4.
Source: Nasdaq Stock Market, Inc.
Notes:
While data provided in the table reflect information from the Nasdaq
Stock Market, Inc., the definitions provided in the following notes are
from David L. Scott, Wall Street Words (1997).
[A] An issuer must meet the requirements under option 1 or 2.
[B] Total assets include all property and items of value owned by the
company.
[C] Total revenue is the inflow of assets that results from the sales
of goods and services and earnings from dividends, interest, and rent.
[End of table]
Table 7: The NASDAQ SmallCap Market's Quantitative Standards for
Initial Listing of Domestic Issuers:
Standard: One of the following:
1. stockholders' equity,
2. market value of listed securities, or;
3. net income from continuing operations;
Minimum requirements:
1. $5 million,
2. $50 million, or;
3. $750,000.
Standard: Publicly held shares;
Minimum requirements: 1 million.
Standard: Market value of publicly held shares;
Minimum requirements: $5 million.
Standard: Bid price;
Minimum requirements: $4.
Standard: Round-lot shareholders;
Minimum requirements: 300.
Standard: Market makers;
Minimum requirements: 3.
Standard: One of the following:
1. operating history or;
2. market value of listed securities;
Minimum requirements:
1. 1 year or;
2. $50 million.
Source: Nasdaq Stock Market, Inc.
[End of table]
Table 8: The NASDAQ SmallCap Market's Quantitative Standards for
Continued Listing of Domestic Issuers:
Standard: One of the following:
1. stockholders' equity,
2. market value of listed securities, or;
3. net income from continuing operations;
Minimum requirements:
1. $2.5 million,
2. $35 million, or;
3. $500,000.
Standard: Publicly held shares;
Minimum requirements: 500,000.
Standard: Market value of publicly held shares;
Minimum requirements: $1 million.
Standard: Bid price;
Minimum requirements: $1.
Standard: Round-lot shareholders;
Minimum requirements: 300.
Standard: Market makers;
Minimum requirements: 2.
Source: Nasdaq Stock Market, Inc.
[End of table]
Table 9: The New York Stock Exchange's Quantitative Standards for
Initial Listing of Domestic Issuers:
Standard: One of the following:
1. round-lot shareholders,
2. total stockholders and average monthly trading volume,[A, B];
3. total stockholders and average monthly trading volume,[C] or;
4. publicly held shares;
Minimum requirements:
2,000;
2,200 and 100,000 shares, respectively;
500 and 1 million shares, respectively;
or;
1.1 million.
Standard: Market value of publicly held shares;
Minimum requirements: $60 million or $100 million[D].
Standard: One of the following:
1. aggregate pretax earnings,
2. aggregate operating cash flow[G] and global market capitalization
and revenue, or;
3. global market capitalization[I] and revenue;
Minimum requirements:
1. $10 million,[E,F];
2. $25 million,[H] $500 million, and $100 million, respectively;
or;
3. $750 million[F] and $75 million,f respectively.
Source: The New York Stock Exchange.
Notes:
The New York Stock Exchange introduced a pilot program, effective
January 29, 2004, through July 29, 2004, that amends certain of its
minimum quantitative standards for initial listing. While data provided
in the table reflect information from the New York Stock Exchange, the
definitions provided in the following notes are from David L. Scott,
Wall Street Words (1997), unless otherwise indicated.
[A] For this alternative standard and related requirements, the average
monthly trading volume is calculated over the most recent 6 months.
[B] According to the New York Stock Exchange, volume is the number of
shares or contracts traded in a security or an entire market during a
given period and is normally considered on a daily basis, with a daily
average being computed for longer periods.
[C] For this alternative standard and related requirement, the average
monthly trading volume is calculated over the most recent 12 months.
[D] The $60 million minimum requirement applies to companies that
listed through initial public offerings, as a result of spin-offs, or
under the affiliated companies requirement. The minimum requirement is
$100 million for other companies.
[E] A company must achieve the $10 million aggregate pretax earnings
requirement for the last 3 fiscal years, with at least $2 million in
each of the most recent 2 fiscal years, and being profitable in all 3
years.
[F] The New York Stock Exchange has revised this standard under the
pilot program.
[G] Aggregate operating cash flow is the cash generated from the
operations of a company. Generally, it is defined as net income
adjusted for noncash charges and income.
[H] A company's 3-year total for aggregate operating cash flow must
equal $25 million and the company must report a positive amount each
year.
[I] According to NYSE, global market capitalization includes all
domestic and foreign companies and all domestic and foreign shares.
[End of table]
Table 10: The New York Stock Exchange's Quantitative Standards for
Continued Listing of Domestic Issuers:
Standard: Price[A];
Minimum requirements: $1.
Standard: Both of the following:
1. total stockholders and;
2. total stockholders and trading volume.[B];
Minimum requirements:
1. 400 and;
2. 1,200 and 100,000, respectively.
Standard: Publicly held shares;
Minimum requirements: 600,000.
Standard: For those companies that listed pursuant to the aggregate
pretax earnings standard:
1. global market capitalization[C] and total stockholders' equity or;
2. global market capitalization;
Minimum requirements:
1. $75 million[D] and $75 million,d respectively, or;
2. $25 million.[D].
Standard: For those companies that listed pursuant to the aggregate
operating cash flow, and global market capitalization and revenue
standards:
1. global market capitalization and total revenues or;
2. global market capitalization;
Minimum requirements:
1. $250 million[E] and $20 million, respectively, or;
2. $75 million.[E].
Standard: For those companies that listed pursuant to the global market
capitalization and revenue standard:
1. global market capitalization and total revenues or;
2. global market capitalization;
Minimum requirements:
1. $375 million[D] and $15 million,d respectively, or;
2. $100 million.[D].
Source: The New York Stock Exchange.
Notes:
The New York Stock Exchange introduced a pilot program, effective
January 29, 2004, through July 29, 2004, that amends certain of its
minimum quantitative standards for continued listing. While data
provided in the table reflect information from the New York Stock
Exchange, the definitions provided in the following notes are from
David L. Scott, Wall Street Words (1997), unless otherwise indicated.
[A] An issuer is out of compliance with the price standard if the
average price is below the minimum standard over a 30-consecutive-day
trading period.
[B] An issuer is out of compliance with the trading volume standard if
the average monthly trading volume is below the minimum requirement in
the most recent 12-month period and total stockholders are less than
1,200.
[C] According to NYSE, global market capitalization includes all
domestic and foreign companies and all domestic and foreign shares. An
issuer is out of compliance with the global market capitalization
standard if average global market capitalization is below the minimum
standard for a 30-consecutive-trading-day period.
[D] The New York Stock Exchange has revised this standard under the
pilot program.
[E] The New York Stock Exchange has added this standard under the pilot
program.
[End of table]
[End of section]
Appendix III: Deficiency and Hearing Processes for Domestic Issuers
Listed on the Three Largest Markets:
After a domestic company is listed on the American Stock Exchange
(Amex), Nasdaq Stock Market, Inc. (NASDAQ), or the New York Stock
Exchange (NYSE), it must comply with the market's quantitative
continued listing standards (see app. II). If a domestic issuer does
not maintain compliance with one or more of these standards, the SRO's
rules generally require that its deficiency, or delisting, process
begins. If an SRO decides to delist a noncompliant issuer, the issuer
may request a review of the delisting decision through the SRO's
hearings process. The deficiency and hearings processes for domestic
issuers listed on Amex, NASDAQ, and NYSE are described below.
The Amex Deficiency and Hearing Processes for Domestic Issuers:
Amex's procedures require the SRO to send an issuer a deficiency letter
within 10 business days of determining that the issuer is deficient
with one or more continued listing standards. The letter offers the
issuer an opportunity to submit a compliance plan detailing definitive
actions the issuer has taken or will take to return to compliance with
Amex's continued listing standards. If Amex accepts the issuer's plan,
the issuer will be granted a compliance period for up to 18 months,
during which time it will have the opportunity to regain compliance
with the continued listing standards (see fig. 2). The issuer must
issue a press release within 5 business days disclosing that it does
not meet Amex's continued listing standards and that its listing is
being continued pursuant to an extension.
Figure 2: Key Points in Amex's Deficiency Process for Domestic Issuers:
[See PDF for image]
Notes:
All days are calendar days, unless otherwise indicated.
[A] Amex has 45 days to review an issuer's proposed compliance plan. If
Amex rejects the plan, or if the issuer does not submit a plan within
30 days, Amex is to send the issuer a delisting letter.
[B] The issuer must issue a press release within 5 business days
disclosing that it does not meet Amex's continued listing standards and
that its listing is being continued pursuant to an extension; we have
converted the 5 business days to 7 calendar days for purposes of this
figure.
[C] The compliance period begins on the day that Amex sends an issuer a
deficiency letter. Under its rules, Amex can grant issuers a compliance
period of up to 18 months.
[D] See figure 3.
[End of figure]
Under Amex procedures, the SRO is to send an issuer a delisting letter
if it does not regain compliance within the compliance period granted,
Amex rejects its proposed compliance plan, or it does not submit a plan
within 30 calendar days. The delisting letter explains the basis for
Amex's decision to begin delisting proceedings against an issuer and
informs the issuer of its right to a hearing (see fig. 3). The issuer
must issue a press release announcing the initiation of delisting
proceedings and the basis for the delisting decision within 7 calendar
days of receiving the delisting letter. The Amex hearing panel may
decide to uphold the delisting decision or allow the issuer to remain
listed if it determines that the delisting decision was erroneous.
Normally, trading in an issuer's securities will continue pending a
decision by the Amex hearing panel. If the hearing panel upholds the
delisting decision, trading in the issuer's securities will be
suspended. The issuer may request a review by the Committee on
Securities, appointed by the Amex Board of Directors, which can uphold
the delisting decision or reinstate the issuer's securities for
trading.
Figure 3: Key Points in Amex's Hearing Process for Domestic Issuers:
[See PDF for image]
Notes:
All days are calendar days, unless otherwise indicated.
[A] The Amex hearing panel must hold a hearing within 45 days of
receiving an issuer's request to review the delisting decision.
According to an Amex official, the Amex hearing panel issues a decision
within 5 calendar days of holding the hearing.
[End of figure]
The NASDAQ Deficiency and Hearing Processes for Domestic Issuers:
NASDAQ's procedures require the SRO to send a deficiency letter when an
issuer becomes deficient in one or more of its continued listing
standards. The deficiency process differs depending on the listing
standard. An issuer with a deficiency in the equity, total assets and
total revenue, publicly held shares, and/or round-lot shareholders
standards has 10 business days from the date of the letter to comply
with the applicable standard or submit a compliance plan (see fig. 4).
Figure 4: Key Points in NASDAQ's Equity, Total Assets and Total
Revenue, Publicly Held Shares, and/or Round-Lot Shareholders Deficiency
Process for Domestic Issuers:
[See PDF for image]
Notes:
All days are calendar days, unless otherwise indicated.
[A] An issuer with a deficiency in the equity, total assets and total
revenue, publicly held shares, and/or round-lot shareholders standards
has 10 business days from the date of the letter to comply with the
applicable standards or submit a compliance plan; we have converted the
10 business days to 14 calendar days for purposes of this figure.
[B] NASDAQ takes up to 63 calendar days to review an issuer's
compliance plan. If NASDAQ rejects the plan, the issuer does not submit
a plan within 10 business days, or the issuer does not regain
compliance within the compliance period, NASDAQ is to send the issuer a
delisting letter.
[C] NASDAQ procedures allow the SRO to accept an issuer's compliance
plan and grant a short extension period during which the issuer must
meet certain milestones to regain compliance. Upon receipt of a
delisting letter, an issuer may request a hearing to remain listed
under a short-term exception to the listing standards.
[D] See figure 8.
[End of figure]
Issuers that fail to meet the market value of listed securities and
market maker standards for 10 consecutive business days are granted an
automatic compliance period during which they have the opportunity to
regain compliance with the applicable standard (see fig. 5).
Figure 5: Key Points in NASDAQ's Market Value of Listed Securities and
Market Makers Deficiency Process for Domestic Issuers:
[See PDF for image]
Notes:
All days are calendar days, unless otherwise indicated.
[A] See figure 8.
[End of figure]
Issuers that do not meet the market value of publicly held shares and
bid-price standards for 30 consecutive business days are granted
automatic compliance periods during which they have the opportunity to
regain compliance with the applicable standard. Figure 6 describes the
key points in the deficiency process for issuers deficient in the
market value of publicly held shares standard, and figure 7 describes
the key points in the deficiency process for issuers deficient in the
NASDAQ National Market (NNM) and SmallCap (SCM) bid-price standards.
Figure 6: Key Points in NASDAQ's Market Value of Publicly Held Shares
Deficiency Process for Domestic Issuers:
[See PDF for image]
Notes:
All days are calendar days, unless otherwise indicated.
[A] See figure 8.
[End of figure]
Figure 7: Key Points in NASDAQ's SCM and NNM Bid-Price Deficiency
Process for Domestic Issuers:
[See PDF for image]
Notes:
All days are calendar days, unless otherwise indicated.
[A] An SCM or NNM issuer must meet all of its market's initial listing
standards, except for bid price, to take advantage of the second 180-
day bid-price compliance period; if the issuer does not meet these
standards, NASDAQ is to send the issuer a delisting letter.
[B] If an NNM issuer has not regained compliance with the bid-price
standard 45 days before the expiration of the second NNM 180-day
compliance period, NASDAQ is to send a letter notifying the issuer of
its noncompliance, the pending expiration of the compliance period, and
its right to request a hearing.
[C] NNM issuers that do not regain compliance at the end of the second
180-day compliance period may elect to transfer to the SCM provided
that they meet all of the SCM continued listing standards, except for
bid price, and other requirements; if the issuer does not meet all the
SCM continued standards and requirements or elects not to transfer to
the SCM, NASDAQ is to send the issuer a delisting letter.
[D] An issuer must meet all initial SCM listing standards, except for
bid price, to take advantage of the additional compliance period; if
the issuer does not meet these standards, NASDAQ is to send the issuer
a delisting letter.
[E] If the issuer meets all initial SCM listing standards, except for
bid price, it will be provided with an additional compliance period up
to its next shareholder meeting scheduled to occur within the next 370
days, provided the issuer commits to seeking shareholder approval of a
reverse stock split to address the bid-price deficiency at that
meeting. If the issuer does not meet all the initial standards or fails
to timely propose, obtain approval of, or promptly execute the reverse
stock split, NASDAQ is to send the issuer a delisting letter.
[F] See figure 8.
[End of figure]
If NASDAQ rejects an issuer's compliance plan, if the issuer does not
submit a plan, or if an issuer does not regain compliance within the
applicable compliance period, NASDAQ is to send the issuer a delisting
letter. Upon receipt of a delisting letter, the issuer has 7 calendar
days to issue a press release announcing receipt of the delisting
letter and the basis for the delisting decision. It may also within
this time frame request a hearing to remain listed under an exception
to the listing standards (see fig. 8).[Footnote 127] Before the
hearing, issuers are asked to submit a compliance plan for the NASDAQ
Hearing Panel's review. If the NASDAQ Hearing Panel determines that the
issuer will be able to implement in the short term a plan of compliance
that will likely enable the issuer to achieve and sustain long-term
compliance, the NASDAQ Hearing Panel may allow the issuer to remain
listed under a temporary exception to the listing standards. Normally,
trading in an issuer's securities will continue pending a decision by
the NASDAQ Hearing Panel. If the NASDAQ Hearing Panel determines that
it is unlikely that the issuer will be able to achieve and sustain
long-term compliance, the issuer's securities will be delisted. An
issuer may appeal the NASDAQ Hearing Panel decision to the NASDAQ
Listing and Hearing Review Council, which can uphold the delisting
decision or reinstate the issuer's securities for trading.
Figure 8: Key Points in NASDAQ's Hearing Process for Domestic Issuers:
[See PDF for image]
Notes:
All days are calendar days, unless otherwise indicated.
[A] The delisting letter at the end of the compliance period triggers
the requirement for the press release.
[B] An issuer may appeal a delisting decision to the NASDAQ Listing and
Hearing Review Council.
[End of figure]
The NYSE Deficiency and Hearing Processes for Domestic Issuers:
NYSE has different deficiency procedures for price and nonprice
deficiencies. If an issuer's average closing price over a 30-day
trading period is less than $1, NYSE must send a deficiency letter to
the issuer within 10 business days, stating that the issuer has the
later of 6 months or its next annual meeting of shareholders (should
the company determine that its action to cure the price deficiency
requires shareholder approval) to bring the share price and average
share price back above $1 (see fig. 9). NYSE transmits an indicator on
the consolidated tape 5 business days following notification to the
issuer that it is below the $1 share-price requirement. In addition,
the issuer is required to issue a press release within 45 calendar days
of notification from NYSE that it is below the $1 share-price
requirement. NYSE may initiate delisting proceedings before the
expiration of the compliance period, by shortening the period, if it
appears likely that the issuer will be unable to regain compliance due
to an abnormally low price.
Figure 9: Key Points in NYSE's Price Deficiency Process for Domestic
Issuers:
[See PDF for image]
Notes:
All days are calendar days, unless otherwise indicated.
[A] NYSE issues a press release disclosing the issuer's listing status
and the basis for its delisting decision.
[B] According to NYSE officials, continued listing during a hearing is
rare in cases of a price deficiency. See figure 11.
[End of figure]
NYSE must send an issuer a deficiency letter within 10 business days of
determining that the issuer is deficient with one or more nonprice
continued listing standards. The letter provides the issuer an
opportunity to submit a compliance plan to NYSE detailing definitive
actions the issuer has taken or is taking to return to compliance with
the continued listing standards. NYSE transmits an indicator on the
consolidated tape 5 business days following notification to the issuer
that it is not in compliance with NYSE nonprice continued listing
standards. In addition, the issuer is required to issue a press release
within 45 calendar days of notification from NYSE that it is not in
compliance with NYSE nonprice continued listing standards (see fig.
10). If NYSE accepts the issuer's plan, the issuer will be granted a
compliance period, during which time it will have an opportunity to
regain compliance with the standards. This compliance period is subject
to quarterly monitoring of the goals outlined in the issuer's plan, and
NYSE may, subject to approval, initiate delisting proceedings before
the expiration of the compliance period if the issuer fails to meet a
goal or if it appears likely that the issuer will be unable to regain
compliance.
Figure 10: Key Points in NYSE's Nonprice Deficiency Process for
Domestic Issuers:
[See PDF for image]
Notes:
All days are calendar days, unless otherwise indicated.
[A] NYSE has 45 days to review an issuer's proposed compliance plan. If
NYSE rejects the plan, or if the issuer does not submit a plan within
the 45-day time frame, NYSE is to send the issuer a delisting letter.
[B] NYSE issues a press release disclosing the issuer's listing status
and the basis for its delisting decision.
[C] See figure 11.
[End of figure]
Under NYSE procedures, the SRO is to issue a press release and send an
issuer a delisting letter if the issuer does not regain compliance
within the 6-month compliance period for price deficiencies or the 18-
month compliance period for nonprice deficiencies, NYSE rejects the
issuer's proposed compliance plan, the issuer does not submit a plan
within the 45-calendar-day time frame, or the issuer fails to meet a
quarterly milestone. The press release and the delisting letter explain
the basis for NYSE's decision to begin delisting proceedings against an
issuer and inform the issuer of its right to a hearing by a committee
of the board of directors (see fig. 11). Generally, trading in an
issuer's securities will continue pending a decision by the committee.
The committee may decide to uphold the delisting decision or allow the
issuer to remain listed.
Figure 11: Key Points in NYSE's Hearing Process for Domestic Issuers:
[See PDF for image]
Notes:
All days are calendar days, unless otherwise indicated.
[A] The issuer must request a review of the delisting decision within
10 business days; we have converted the 10 business days to 14 calendar
days for purposes of this figure.
[B] According to a NYSE official, a committee of the board of directors
holds a hearing within 70 days of the issuer's request and issues a
decision within 1 day of holding a hearing.
[End of figure]
[End of section]
Appendix IV: Market Participants Contacted During This Review:
As part of our review of the actions the three largest SROs have taken
to strengthen corporate governance for issuers and themselves, we
interviewed market participants representing the following 14 investor,
legal, business, and professional organizations:
American Federation of Labor and Congress of Industrial Organizations:
American Institute of Certified Public Accountants:
Association for Investment Management and Research:
The Business Roundtable:
California Public Employees' Retirement System:
The Corporate Library:
Council of Institutional Investors:
Institute of Internal Auditors:
Institutional Shareholder Services:
Investment Company Institute:
National Association of Corporate Directors:
Securities Industry Association:
Teachers Insurance and Annuity Association-College Retirement Equities
Fund:
Weil, Gotshal, & Manges LLP:
[End of section]
Appendix V: Comments from the Securities and Exchange Commission:
UNITED STATES:
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549:
February 26, 2004:
Richard J. Hillman,
Director, Financial Markets And Community Investment,
United States General Accounting Office,
Washington, DC 20548:
Dear Mr. Hillman:
Thank you for the opportunity to comment on the General Accounting
Office's draft report entitled Securities Markets: SEC Has
Opportunities to Enhance Investor Confidence and Drove Listing Program
Oversight. In the draft report, GAO discusses issues related to the
equity listing standards of the self-regulatory organizations. We agree
that there are fundamental investor protection issues related to SRO
listing standards and programs. As you recognize in your report, the
Commission has significantly enhanced these areas during the period of
your review. Your report details many of these enhancements.
In your report, you discuss methods for ensuring that investors receive
early and ongoing notice if an issuer listed on a particular market is
not compliant with all of that market's listing standards. As outlined
in your report, we believe that disclosing this information to
investors in a timely, clear and ongoing manner is important so that
investors understand that an issuer could be delisted. We will continue
to work with the SROs to ensure that this goal is fully and adequately
achieved. We also believe, as you do, that the SROs should timely
notify investors not only when issuers are noncompliant with financial
listing standards, but also when they are noncompliant with corporate
governance standards. We will discuss with the SROs the feasibility of
appending a modifier to or transmitting an indicator with the symbol of
an issuer that is not in compliance with corporate governance
standards.
In your report, you further recommend that the Commission expeditiously
adopt a proposed rule requiring an issuer to file a Form 8-K within a
specified timeframe after receiving notice from an SRO that the issuer
is not in compliance with a continued listing standard. The rule was
proposed to ensure early public notice of an issuer's noncompliant
status. The Division of Corporation Finance expects the Commission to
consider whether to approve this rule change in March 2004.
You also recommend that we routinely use internal review reports in
planning and conducting SRO inspections. You note that internal audit
reports can be helpful in assessing whether an
SRO addressed prior inspection findings and recommendations and to
learn background information regarding particular SRO program areas. We
agree that internal audit reports are one source of information with
respect to an SRO's performance and compliance. Their value depends on
the thoroughness of the review and the content of the report. As you
are aware, our SRO oversight inspections are generally more
comprehensive than a review conducted by an SRO internal audit
department. In addition, during our inspections, we consistently review
whether an SRO has effectively implemented our recommendations from
prior inspections. We also thoroughly review SRO policies and
procedures to familiarize ourselves with a particular program area or
department. As we have discussed with you, we recognize that SRO
internal audit reports may be a useful tool in the inspection process.
We currently selectively request and review SRO internal audit reports
during inspections when we believe it is appropriate to follow-up on
particular problems or issues at an SRO. In response to your
recommendation, we will implement a formal written policy concerning
the selection and review of SRO internal audit reports during
inspections.
With regard to your recommendation that the Amex listing standards
require companies to disclose the names of its directors that were
designated as independent, we note that on February 23, 2004, Amex
filed such a rule change. Amex's rule filing requires companies to
disclose the names of directors that the company's board of directors
has determined to be independent. This rule change became effective
upon filing.
Additionally, in your report, you recommend that we conduct timely
inspections of the SROs to assess their oversight of issuers'
compliance with corporate governance standards. Reviewing corporate
governance requirements is currently included in our listing inspection
process. We expect to continue to conduct timely inspections of the
SROs' programs and procedures for ensuring that issuers comply with
corporate governance requirements and to enhance our review to include
the new corporate governance requirements.
Also, you recommend that we place a high priority on completing our
review of the governance self-evaluations of the three listed markets
that are the focus of your report. SEC staff, through its Division of
Market Regulation, currently is conducting a comprehensive review of
SRO governance. This assessment will take into consideration the new
corporate governance standards for listed issuers that are now in place
at Amex, NYSE and Nasdaq. In many respects, these standards could serve
as a benchmark for SRO governance. There are, however, additional
factors to be considered when assessing SRO governance, including the
Exchange Act's "fair representation" requirements. Moreover, the
Commission in December approved significant revisions to the NYSE's
governance structure, which also could be instructive as the Commission
assesses SRO governance generally. We assure you that SRO governance
remains a high priority for us as we continue to work on this important
project. In addition, when appropriate and after any changes or new
requirements are implemented at the SROs, we will inspect whether the
SROs have effectively implemented their own enhanced governance
standards.
Thank you again for the opportunity to comment on the final draft
report. We also thank you and your staff for the courtesy extended
during this review.
Sincerely,
Signed by:
Annette L. Nazareth,
Director,
Division of Market Regulation;
Signed by:
Lori A. Richards,
Director,
Office of Compliance Inspections and Examinations;
Signed by:
Martin P. Dunn,
Deputy Director,
Division of Corporation Finance:
[End of section]
Appendix VI: Comments from the American Stock Exchange:
AMERICAN STOCK EXCHANGE"
February 26, 2004:
Michael J. Ryan, Jr.
Executive Vice President & General Counsel:
American Stock Exchange
86 Trinity Place:
New York, NY 10006-1872
T 212 3061200:
F 212 3061152
michael.ryan@amex.com:
Mr. Richard J. Hillman,
Director:
Financial Markets and Community Investment
U.S. General Accounting Office:
Washington, DC 20548:
Dear Mr. Hillman:
The American Stock Exchange ("Amex" or "Exchange") appreciates the
opportunity to provide comments on the draft report of the United
States General Accounting Office ("GAO") entitled Securities Markets:
SEC Has Opportunities to Enhance Investor Confidence and Improve
Listing Program Oversight ("Draft Report"). The Draft Report provides a
comprehensive analysis of several important issues related to the
equity listing programs of the three largest U.S. securities markets -
Amex, the New York Stock Exchange ("NYSE") and the Nasdaq Stock Market
("Nasdaq"). Our comments are addressed to certain of your specific
conclusions and recommendations.
Symbol Modifiers:
You note in the Draft Report that investors need timely and ongoing
information about the listing status of issuers for use in making
investment decisions. Although we agree that transparency with respect
to an issuer's compliance with continued listing standards is
important, we do not believe that an indicator or symbol modifier is an
appropriate or necessary method of providing such transparency. As we
have previously discussed with both the SEC and GAO staff, our views in
this regard are based on several concerns.
First, use of an indicator or symbol modifier to identify a
noncompliant company lumps all noncompliant issuers together, whether
the noncompliance concerns a transient and correctable issue or a
potentially unresolvable deficiency. By contrast, the press release
currently required of noncompliant issuers (or a Form 8-K if required
by pending SEC rule revisions) provides more meaningful and accurate
information to the investing public.
Second, an issuer which has received notice that it is below continued
listing standards is not necessarily in immediate jeopardy of being
delisted in that issuers often regain compliance. All three markets
provide a window of opportunity for a company that falls below
continued listing standards to return to compliance. These processes
are in place in recognition of the fact that many listed companies are
able to return to compliance and that precipitous delisting action
would harm the impacted issuer as well as its shareholders, employees
and other stakeholders and could have a destabilizing effect on the
capital markets in times of an economic downturn.
Third, the use of a symbol modifier could jeopardize an issuer's
ability to resolve a continued listing deficiency, by attaching the
equivalent of a "scarlet letter" to the company, thus reducing its
ability to negotiate effectively with investors and lenders. Indeed, as
noted in the Draft Report, some companies listed on Nasdaq's SmallCap
market have confirmed these concerns.
Finally, and perhaps most significantly, there are many factors other
than compliance with continued listing standards which are potentially
far more material to both current and prospective investors. These
factors include: a "going concern" opinion from the company's auditors,
major litigation, failure to obtain regulatory approval of a new
product, material write-offs or restructuring charges, material
impairment, termination of a business relationship with a significant
customer, and initiation of a regulatory investigation. While the Draft
Report suggests that other indicators could also be used, we are
concerned about the feasibility of addressing all significant factors
in this manner in that many are inherently subjective and not
susceptible to an objective determination of whether the triggering
event has occurred. Further, use of many different types of indicators
would also be confusing to investors and the marketplace.
However, notwithstanding our views in this regard, as noted in the
Draft Report, this issue will be re-examined by the Amex Board of
Governors at its April 2004 meeting.
Corporate Governance:
We agree with your conclusion that the significant changes to the Amex,
NYSE and Nasdaq corporate governance standards applicable to listed
issuers should promote stronger board oversight and greater
accountability. With respect to your recommendation that Amex adopt a
requirement that issuers disclose the names of those directors that
they have designated as independent, we note that Amex rules were
recently amended to incorporate this requirement.[NOTE 1]
The Draft Report also concludes that further opportunities exist - and
recommends that serious consideration be given - to strengthen board
independence by revising listing standards to require a supermajority
of independent directors and the separation of the positions of chief
executive officer and chairman. In this regard, it is important to
recognize that the new enhanced corporate governance requirements at
all three marketplaces have only recently been adopted and are still in
the process of implementation. While your recommendations warrant
further consideration, we believe issuers, the markets and the SEC need
more time to adjust to the new requirements and to assess the impact of
these requirements on public companies and the capital raising process.
However, the Amex monitors the need for revisions to its listing
requirements generally on an ongoing basis and is committed to working
closely with the SEC staff to ensure that the Amex corporate governance
requirements promote the highest level of integrity and accountability
by listed issuers.
With the implementation of the new enhanced corporate governance
requirements, we have devoted considerable resources to assessing and
enhancing our processes for
evaluating listed issuer compliance. As noted in the Draft Report,
these enhancements include expanded manual reviews of issuer SEC
filings, improved automated monitoring systems and additional staffing.
We look forward to the input from and the opportunity to work with the
SEC's Office of Compliance Inspections and Examinations with respect to
these processes.
We wholeheartedly agree with your conclusion that, given our role as
standard setters, the public has the right to expect the marketplaces
to serve as models of strong governance. As you note in the Draft
Report, the Amex's corporate governance structure has been under review
in the context of the separation of the Amex from the NASD. Draft
changes to the Amex Constitution are now being considered in connection
with the proposed sale by the NASD of its interest in the Amex to the
Amex Membership Corporation. The proposed changes would provide, among
other things, for a Board of Governors that consists of 15 governors,
nine of whom would be "independent." The definition of "independent"
excludes not only members of the Amex and employees or other affiliates
of members and broker-dealers, but also directors, officers or
employees of Amex-listed issuers. The proposed changes also provide
that if the chief executive officer of the Amex is also the chairman of
the Amex Board of Governors, the chainnan will not participate in
executive sessions of the Board. In that case, the "lead governor" -
designated by the Board from among the independent governors - would
preside over executive sessions. These changes are subject to various
approvals, including by Amex members in a vote scheduled for March 2004
and by the SEC, before becoming effective.
Thank you for the opportunity to provide comments on the Draft Report.
We have separately provided several technical comments to your staff,
and appreciate their hard work and thoughtful consideration of the
issues addressed. If you have any questions, please contact me
directly, Claudia Crowley, Vice President (212-306-2432,
claudia.crowley@amex.com) or Ivonne Natal, Associate General Counsel
(212-306-1397, ivonne.natal@amex.com).
Sincerely,
Signed by:
Michael J. Ryan, Jr.
NOTES:
[1] See SR-Amex-2004-06.
[End of section]
Appendix VII: Comments from the Nasdaq Stock Market, Inc.
NASDAQ:
Michael S. Emen
Senior Vice President
Listing Qualifications:
February 25, 2004:
Mr. Richard J. Hillman:
Director, Financial Markets and Community Investment
United States General Accounting Office:
441 G Street, N. W.
Washington, DC, 20548:
Dear Mr. Hillman:
This is in response to your February 11, 2004 letter to Robert
Greifeld, President and Chief Executive Officer of the NASDAQ Stock
Market, Inc. ("NASDAQ") enclosing the draft report, entitled Securities
Markets: SEC Has Opportunities to Enhance Investor Confidence and
Improve Listing Program Oversight (the "Draft Report"). We appreciate
the opportunity to comment on this draft, as well as the
professionalism shown by the staff of the General Accounting Office
("GAO") throughout their review. The Draft Report has three principal
areas of discussion: the manner in which the three major markets,
NASDAQ, the New York Stock Exchange, Inc. ("NYSE") and the American
Stock Exchange, Inc. ("Amex"), have enforced their equity listing
standards, as reflected by the oversight reports of the Office of
Compliance Inspections and Examinations ("OCIE") of the Securities and
Exchange Commission ("SEC"); the implementation and oversight of
NASDAQ's bid price moratorium and the subsequent adoption by NASDAQ of
a pilot program implementing modified bid price rules; and, the actions
taken by the major markets to strengthen corporate governance for
listed issuers and themselves. While the Draft Report is generally
thorough and accurate, we believe that the discussion concerning
ongoing notification of issuer noncompliance with equity listing
standards requires further clarification, particularly with respect to
NASDAQ's existing procedures to provide notice to investors, which are
significantly more comprehensive and transparent than the comparable
procedures in place today at the other markets, and NASDAQ's
willingness to work with OCIE to implement further notification
procedures consistent with our process.
1) OCIE Findings and Recommendations:
NASDAQ is profoundly committed to adopting and enforcing significant
listing standards. We have over 40 staff engaged in monitoring and
enforcing issuer compliance. The backbone of our process is a state-of-
the art electronic data storage and analysis system. As noted in the
Draft Report, our commitment to regulatory excellence was recognized by
OCIE, which found that NASDAQ is "generally thorough in its financial
and regulatory reviews of companies.":
As you know, following its last round of inspections, OCIE recommended
that the three major markets implement a practice of identifying
issuers which were not in compliance with their continued listing
requirements. In response, the NYSE indicated that it would, for the
first time, identify companies not in compliance with certain of its
listing requirements.[NOTE 1] It proposed to do this not through means
of a symbol modifier, but by imbedding a message in data transmitted to
vendors, with the expectation that these vendors would then find a
means to display this information. We advised OCIE that we would be
prepared to pursue a similar process for NASDAQ issuers, recognizing
that NASDAQ's process is different.[NOTE 2] While we have had
preliminary discussions with OCIE subsequent to this, we have yet to
resolve these issues. We have, however, made clear, both to OCIE and
GAO staff that we are open to changing our existing procedures and are
willing to work cooperatively with OCIE in the near term to implement
an appropriate solution.
NASDAQ agrees that it is important for investors to understand how our
rules operate and how they are being applied to specific issuers. Our
commitment to transparency is evident both in the expanding content of
our legal/compliance web site (see www.nasdaq.com/about/
LegalCompliance.stm) and in various aspects of our existing rules. For
instance, NASDAQ believes that nothing is more important to investors
than the financial information contained within an issuer's periodic
reports to the SEC. In the absence of such information, no market is
able to determine whether the issuer is in compliance with its listing
requirements and investors are unable to assess accurately the
underlying listed enterprise. We believe that rigorous enforcement of
SEC filing requirements should be consistent across all markets. NASDAQ
has, for more than 20 years, followed the practice of immediately
affixing an "E" modifier to the ticker symbol of an issuer which is
delinquent in meeting any of its periodic SEC filing requirements,
whether they be quarterly filings due on a Form 10-Q or annual filings.
An issuer is considered delinquent if the filing is late or is missing
certain information such as the certifications required by the Sarbanes
Oxley Act of 2002 ("SOX"). At
the same time, a letter is sent to the issuer advising that it will be
delisted unless it files an appeal. An issuer pursuing such an appeal
is required, no later than seven calendar days after receiving the
delisting notice, to issue a press release advising investors that it
is subject to being delisted. This notice is required to include the
basis for the delisting letter so that investors have specific notice
of why the issuer's listing is at risk. Our practice in this most
critical area provides early and ongoing notice to investors, operates
extremely quickly and is unmatched by any other market. In addition to
this, if an issuer listed on the NASDAQ SmallCap market pursues an
appeal of any delisting notification and is granted a temporary
exception by a Hearings Panel, NASDAQ affixes a "C" modifier to the
ticker symbol so that investors know that the company is non-compliant,
has received fair process, and continues to be listed as a result of
that process. [NOTE 3]
2) Bid Price Moratorium and Subsequent Rule Changes:
NASDAQ's bid price moratorium was implemented in response to the
extraordinary market conditions that followed the tragedy of September
11, 2001. Those events shocked financial markets and a national economy
already in the throes of a significant downturn. In January 2002, the
moratorium expired and was replaced by a pilot program to significantly
extend the compliance grace periods in which SmallCap Market issuers
could regain compliance with the bid price rules. [NOTE 4] While the
moratorium was applied to all issuers, eligibility for these new,
longer compliance grace periods was principally limited to viable
companies which, but for bid price, could still satisfy one of NASDAQ's
initial listing standards. Our expectation was that these extended
compliance grace periods would allow such companies to focus on
reinvigorating their businesses without having to worry that they were
about to be delisted, a prospect which could adversely affect their
business dealings and would deprive their shareholders of the ability
to participate in a transparent, liquid and well-regulated market
environment.
The GAO's review confirmed that the moratorium and related rule changes
worked as intended and benefited a considerable number of companies.
This means shareholders, employees and other constituents of these
companies benefited as well. The Draft Report also acknowledges that
the SEC acted within its authority and followed its applicable
regulations in approving the various rule changes.
Today, the total number of issuers trading below our minimum bid price
requirement is minimal. This is further confirmation that the
moratorium and pilot program have accomplished their objectives. As of
the end of January 2004, only 28 issuers (4 on the National Market and
24 on the SmallCap Market) were trading below $1, compared with 611
NASDAQ issuers trading below $1 as of September 30, 2001, shortly after
the moratorium was declared.
3) Corporate Governance Reforms:
The Draft Report acknowledges that the recent rule changes adopted by
the SRO's should promote stronger board oversight and greater
accountability. The implementation of these rules is a significant step
towards restoring investor confidence in the U.S. securities markets.
The SRO's new governance rules, like SOX, are predicated on the
important role that must be played by independent directors. Consistent
with that, NASDAQ alone among the markets requires that independent
directors approve of related party transactions.
While the rules of the SRO's are in many respects quite similar, in
certain areas NASDAQ has avoided a one-size fits all approach. We also
sought to avoid overly prescriptive rules. And, we believe it is
critically important that our rules not impose such significant burdens
on issuers that it would harm their ability to take risks and to
innovate. It is in this context that we'd like to respond to the Draft
Reports recommendation that the markets adopt additional rules
mandating the separation of the Chairman and CEO roles and requiring
that listed issuers have a supermajority of independent directors.
NASDAQ certainly considered whether to mandate the separation of the
roles of the Chairman and CEO. We agree that this may enhance the
governance of some companies. In fact, as the Draft Report notes,
NASDAQ recently took this step for its own Board of Directors. However,
many companies and others are concerned that mandating this separation
could make corporate boards more inefficient and lead to unnecessary
conflict. Moreover, we believe there is insufficient information
available to justify taking such a potentially far-reaching step at
this time. And, we also believe that other steps we have taken, such as
requiring a majority of independent directors and an independent
nominations and executive officer compensation process, will
significantly reduce the concerns associated with a combined Chairman/
CEO.
Similarly, we considered mandating that listed issuers have a
supermajority of independent directors. We remain concerned that such a
requirement would prove unduly burdensome, particularly for smaller
issuers and believe there is insufficient information available to
determine that a supermajority of independent directors would provide
governance benefits above and beyond what can be achieved through a
simple majority.
We also believe, in view of the numerous governance changes that listed
companies have been asked to digest as a consequence of SOX, related
SEC regulations and the new SRO rules, that it is important that we
allow time for these new rules to take effect and then assess their
results. We are committed to doing just that.
The Draft Report recommends that OCIE work with the SRO's to make sure
that they establish effective procedures to ensure that listed issuers
comply with the new corporate governance
listing standards. We look forward to this, and have had preliminary
discussions with OCIE in this regard. We believe strongly that the new
rules must be rigorously enforced if we are ultimately to succeed in
restoring investor confidence in our markets.
Finally, in terms of its internal governance, NASDAQ believes that it
substantially complies with all of its new listing standards. 5NASDAQ
has, throughout the process of proposing and then adopting new
corporate governance rules, sought to "eat our own cooking" by
complying with those rules as if we too were a listed issuer.
We appreciate this opportunity to provide comments on the Draft Report
and look forward to working constructively with OCIE to address the
issues discussed above.
Sincerely,
Signed by:
Michael S. Emen
NOTES:
[1] However, according to the Draft Report, the NYSE does not plan to
take any action to identify issuers delinquent in satisfying their SEC
interim (quarterly) filing obligations. In contrast, and as discussed
below, NASDAQ has long affixed an "E" modifier to the symbol of such
companies immediately upon the onset of the delinquency.
[2] As noted in the Draft Report, OCIE has not yet concluded at what
point in the NASDAQ process it would be appropriate to append a symbol
modifier or take equivalent action. This is because our process
incorporates the use of non-discretionary compliance periods for
certain deficiencies. Further, NASDAQ's delisting process, for those
deficiencies without compliance grace periods, is generally much
quicker than those of the exchanges. As noted in Figure 8 of Appendix
VII of the Draft Report, the outside time frame for a NASDAQ Panel to
hold a hearing and issue a decision is generally less than three
months. In contrast, the process at the Amex and NYSE, depicted in
Figures 2 and 10, can take at least 18 months. While the process
reflected in NASDAQ's pilot rules for bid price deficiencies may take
up to two years, it is important to distinguish these cases because
such companies are NOT subject to being delisted until the expiration
of the compliance grace period and, because the price itself is an
early, obvious, and continuing sign to the investing public. Also,
given the widespread availability of historical trading information on
the internet, it is extremely simple to determine how long a particular
issuer has been trading below $1. Further, NASDAQ believes that our
practice in this area is well known to the investing public.
[3] SmallCap issuers receiving exceptions are also required to issue a
press release providing further notice and transparency to the
application of the "C" modifier.
[4] NASDAQ subsequently proposed further changes to these rules, which
included lengthening the compliance grace periods applicable to
National Market issuers.
[5] As noted in the Draft Report, NASDAQ's by-laws require it to have a
nominations committee, which includes individuals who are not NASDAQ
directors.
[End of section]
Appendix VIII: Comments from the New York Stock Exchange:
New York Stock Exchange, Inc.
2o Broad Street:
New York, NY 10005:
Janice O'Neill
Vice President
Corporate Compliance
tel: 212.656.2407
fax: 212.656.5111
joneill@nyse.com:
NYSE:
February 27, 2004:
Mr. Richard J. Hillman:
Director, Financial Markets and Community Investment:
U.S. General Accounting Office:
Washington, D.C. 20548:
Re: GAO Report 04-75:
Securities Markets: SEC Has Opportunities to Enhance Investor
Confidence and Improve Listing Program Oversight:
Dear Mr. Hillman:
The New York Stock Exchange (the "Exchange" or "NYSE") appreciates this
opportunity to offer comments on certain matters discussed in the
above-referenced GAO Report (the "Report"). The Exchange also wishes to
compliment the professionalism and courtesy of the GAO staff that met
with Exchange officials in the course of preparing their Report.
We would first like to underscore our appreciation of the role played
by the staff of the SEC's Office of Compliance, Inspections and
Examinations (OCIE) in the NYSE's oversight of its listing program,
including the proper and diligent application by the Exchange of its
rules and policies applicable to listed companies. Self-regulation in
the securities industry is premised on active and knowledgeable
oversight by the SEC of the self-regulatory organizations, and we
firmly believe that our listing program has improved as a result of the
inspections performed by OCIE and the comments that have emerged
therefrom.
Accordingly, we support the GAO recommendations that would continue the
SEC's active role in working with Exchange staff to ensure that our own
oversight program is as effective as possible. We also support the
position that SRO rules and standards should be transparent and that
relevant information regarding a company should be readily available to
investors. We do have concerns, however, about the details of some of
the GAO's recommendations, and we would like to explain those concerns
in this letter.
Summary:
We will address four separate matters. They are:
* The use of market data "indicators" to convey information regarding
listed company status:
* The GAO recommendations regarding supermajority board requirements and
the separation of the role of chairman of the board and CEO:
* The GAO recommendation contemplating that OCIE staff would routinely
use SRO internal review reports in planning and conducting inspections
of the SROS * NYSE's preparations to oversee listed company compliance
with the new corporate governance standards.
A. The use of market data "indicators" to convey information regarding
listed company status.
The Report discusses in considerable detail NYSE's dissemination of an
"indicator" over the consolidated tape with each quote or reported
trade in the stock of an issuer that has been determined by the
Exchange to be below NYSE financial continued listing criteria. It is
worth noting as a general matter that the number of companies involved
is a very small percentage of the listed company population,
approximately one-half of one percent at year-end 2003. In addition, we
would like to make the following points regarding this matter of ticker
symbol "indicators":
* Contrary to the position noted in the Report, the NYSE believes that
it has fully addressed the OCIE recommendation in this area, in that
any vendor dissemination requirements would have to be imposed by the
SEC.
* We have agreed to use ticker symbol indicators as one means of
informing interested persons that a listed company is below compliance
with financial continued listing standards, or is delayed in filing its
annual report on Form 10-K. However, we continue to believe that a
ticker symbol indicator is not an effective method for the
dissemination of more complex information, and this should limit the
purpose for which the device is used. We believe it is ill suited, for
example, to convey information regarding a company's status vis-a-vis
qualitative listing standards, such as the Exchange's recently expanded
corporate governance standards.
We would like to briefly elaborate on each of these points:
1. The NYSE believes that it has fully addressed OCIE's recommendation
regarding use of a ticker indicator for companies below NYSE financial
continued listing standards.
The Report states that NYSE's transmittal of the ticker indicator over
the consolidated tape will address the intent of OCIE's recommendation
if distribution concerns are addressed. The Report goes on to explain
that while the Associated Press has made the
indicator available in the stock tables in supplies to newspapers, and
the Wall Street Journal has indicated an intent to do so, none of the
five electronic data vendors contacted by the GAO planned to distribute
the symbol indicator. The GAO Report states that among the reasons
vendors gave were a lack of client demand and reluctance to divert
resources from more important initiatives.
The GAO Report states OCIE's position that NYSE can and should do more
to actively encourage information vendors to implement and distribute
the indicator information, specifically, that NYSE could amend its
vendor contracts to require indicator display. NYSE respectfully
disagrees that this is a realistic alternative. Rules dictating what
market data must be displayed by vendors are properly the province of
the SEC, and to date those rules have extended only to real time quote
and trade information. Beyond that, market data is a service that
responds to the needs and demands of subscribers, and the marketplace
itself determines what ancillary information is made available over the
screens of data vendors. If that is to change, it would be the province
of the SEC to enact the additional requirements.
For this reason it is the position of the NYSE that it has responded in
full to OCIE's recommendation regarding the use of an indicator for
companies below financial continued listing standards.
2. An indicator associated with a ticker symbol is not an effective
method to convex complex information.
Under the subheading "The Commission Has Authority to Ensure Early and
Ongoing Notification of Noncompliant Issuers", the Report states that
OCIE officials told the GAO staff that to date they had not explored
with the SROs the possibility of using modifiers (or indicators) for
noncompliance with qualitative listing standards, but that doing so
"could be an important step in providing the public the information
they need about issuers' noncompliance with these standards." One of
the Report's recommendations then is that the SEC "work with [the SROs]
to assess the feasibility of providing early and ongoing public
notification of issuers' noncompliance with qualitative listing
standards.":
The NYSE has been responsive to suggestions that indicators be used as
one mechanism to signal an issuer's noncompliance with financial
continued listing status, or that the issuer is late in filing its
annual report on Form 10-K. However, after much discussion and
assessment of the types of actual situations that could arise, we are
convinced that a ticker symbol indicator is not an appropriate or
effective method to convey more complex, less binary, information. This
would certainly be the case with respect to compliance with the various
corporate governance standards of the SROs. There are a large number of
such standards, and a variety of ways in which an issuer may be
noncompliant. Some matters may be much more easily corrected than
others; some situations may be considerably more serious than others.
An attempt to use an indicator to convey a company's status with
respect to these standards would homogenize the infornation, omitting
content and color and making it difficult to assess the meaning of
the indicator in any particular case. This, in turn, could lead people
to ignore the indicator as a conveyor of useful information.
Separately, we think it is worth noting that the present mechanism
through which the market data indicators are disseminated is
technically limited in the number of different indicators that can be
utilized, so that the cost to employ additional indicators would likely
be significant - which would affect the cost/benefit analysis.
Of course, as the Report notes, this is not a matter that has yet been
the subject of discussion between the SROs and the SEC. Nonetheless, in
view of its discussion in the Report, we considered it worth giving our
views.
B. The GAO recommendations regarding listed company supermajority board
requirements and the separation of the role of chairman of the board
and CEO:
The Report recommends that the SEC "work with the SROs to further
enhance board independence by giving serious consideration to requiring
issuers, through listing standards, to establish a supermajority of
independent directors and to separate the positions of CEO and
chairman.":
The Report devotes a number of pages to discussing the opinions of
various "market participants" regarding a number of corporate
governance reforms, including the two mentioned above, and notes the
divergent opinions that exist. The Report also accurately notes that we
informed the GAO staff that our Corporate Accountability and Listing
Standards Committee carefully considered both these issues and
determined that they should not be among the recommendations for new
standards. This does not mean that the NYSE considers these in any way
inappropriate for companies that desire to adopt them, and many NYSE
listed companies have boards with a supermajority of independent
directors, and an increasing number of companies are separating the
roles of chairnan and CEO. The NYSE itself, in its new governance
architecture, has a completely independent board but for the CEO, and
has itself separated the roles of chairman and CEO. However, after
careful consideration, and input from a variety of knowledgeable,
experienced constituents, we did not consider either of these to be
appropriate as a requirement for all listed companies at this time.
C. The GAO recommendation contemplating that OCIE staff would routinely
use SRO internal review reports in planning and conducting inspections
of the SROS.
The Report states that OCIE officials told the GAO staff that they do
not routinely use SROs' internal review reports in planning and
conducting inspections of the SROs, because OCIE is concerned that such
routine use might make SRO employees less forthcoming in disclosing
information to SRO internal review staff, and this chilling effect
might outweigh the benefit to OCIE of reviewing the reports.
The Report makes clear that this is not an access issue - that OCIE
requests and is furnished such SRO reports when it considers it
necessary. Nonetheless, the Report focuses on the fact that government
auditing standards recommend the use of internal review reports, and
accordingly the GAO has made the recommendation referred to above.
It is not a question of whether routinely reviewing the internal audit
reports would be useful. Undoubtedly it would be, at least to a certain
extent. The point, however, is its relative utility compared to the
adverse effect it may have. Accordingly, we firmly support the position
OCIE has taken on this issue.
D. NYSE's preparations to oversee listed company compliance with the
new corporate governance standards.
The Report notes that OCIE plans to work with the SROs to ensure they
have effective processes in place for evaluating issuers' compliance
with the new corporate governance standards.
NYSE well understands that to be a part of OCIE's mission and expects
to work closely with the SEC staff with respect to NYSE's oversight of
the listed companies. We have already spent significant time and
resources on our oversight plans, which are based on a combination of
issuer self-certification, required public disclosure, and direct
oversight. Our format will ask the issuers to specifically provide us
with essential information, including pointing to precisely where
required disclosures and discussion can be found in their proxy
statements, web sites, and other relevant disclosure media. Our intent
is to leverage the work we will require of our issuers to enable us to
efficiently oversee their compliance with our requirements. We have
already shared our program and plans with SEC officials, and we look
forward to working with them to assure effective oversight.
The new corporate governance standards are a significant addition to
the NYSE's requirements, and a significant addition to our oversight
responsibility. We have as a result more than doubled the personnel,
and made a significant investment in the technology, that we use to
directly oversee company compliance. Our program will certainly evolve,
but we have already spent considerable effort to expand our resources
and build upon existing processes to create a thorough, effective and
efficient program.
I would like to again express the NYSE's appreciation for the
opportunity to work with the GAO staff in their preparation of the
Report, and for the opportunity to add our views by providing this
letter. As always, if we can be of further assistance to GAO or to
Congress, we would be pleased to do so.
Very truly yours,
Signed by:
Janice O'Neill:
[End of section]
Appendix IX: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Richard Hillman, (202) 512-8678 Cecile Trop, (312) 220-7600:
Staff Acknowledgments:
In addition to those named above, Rachel DeMarcus, Stefanie Jonkman,
Marc Molino, Josephine Perez, Carl Ramirez, Barbara Roesmann, and Cory
Roman made key contributions to this report.
(250075):
FOOTNOTES
[1] Amex, NASDAQ, and NYSE are the three largest U.S. securities
markets for equities trading based on the number of listed U.S.
companies.
[2] The markets are regulated under a combination of self-regulation
(subject to oversight by the Securities and Exchange Commission) and
direct federal regulation. Except where the context otherwise requires,
we use the term "SRO" to include NASDAQ, although as of March 10, 2004,
NASDAQ's application for registration as a national securities exchange
was pending at the Securities and Exchange Commission. Until its
application is approved, NASDAQ is not an SRO. Instead, NASDAQ proposes
its rules through the responsible SRO, the National Association of
Securities Dealers, Inc.
[3] The term "three largest SROs" is used in this report to refer to
Amex, NASDAQ, and NYSE.
[4] NASDAQ defines bid price as the price a buyer is willing to pay for
a security.
[5] Market value of publicly held shares is the bid price multiplied by
the number of outstanding shares held by investors that are not
officers, directors, or 10 percent or greater shareholders.
[6] Issuers are organizations such as corporations that are selling or
have sold their securities to the public.
[7] The term "internal review reports," as used in this report,
includes internal audit reports, management review reports, and
internal reports prepared by outside consultants or auditors.
[8] Quantitative continued listing standards are the minimum financial
requirements that issuers must meet to remain listed for trading on a
market. See appendix II for Amex, NASDAQ, and NYSE's quantitative
listing standards.
[9] See appendix IV for a list of the market participants that we
contacted during this review.
[10] The consolidated tape is a high-speed electronic system that
continuously provides the last sales price and volume of securities
transactions in listed Amex and NYSE stocks to information vendors.
NASDAQ operates a similar, but separate, tape to transmit information
on its stocks to information vendors.
[11] Information vendors supply quotation and market data for
investors' use.
[12] Issuers use the Form 8-K to report significant specified corporate
events as well as any other event or change that the issuers deem to be
of importance to investors and that has not been previously reported.
(Proposed Rule: Additional Form 8-K Disclosure Requirements and
Acceleration of Filing Date, SEC Release No. 33-8106, June 17, 2002.)
[13] Qualitative continued listing standards are the market's minimum
nonfinancial requirements that issuers must meet to remain listed for
trading on a market.
[14] Corporation Finance officials told us that they are considering
alternatives to the proposed 2-business-day filing requirement based on
public comments.
[15] NASDAQ proposed the moratorium in a filing with SEC under
procedures contained in federal securities law and SEC regulations that
allowed the proposal to become effective upon filing, subject to a
waiting period that SEC waived.
[16] Transparency is, among other things, the degree to which trade and
quotation information is available to the public.
[17] NASDAQ stopped tracking individual issuers' compliance with the
bid-price and market value of publicly held shares standards during the
moratorium; therefore, the total number of issuers affected by the
moratorium could not be determined.
[18] Unless otherwise indicated, all days in this report are calendar
days.
[19] NASDAQ is a two-tier market, consisting of the SCM, which as of
December 31, 2003, listed 685 smaller companies, and the NNM, which as
of December 31, 2003, listed 2,648 larger companies. Quantitative
listing standards are generally lower for the SCM than the NNM.
[20] We determined the listing status of the 509 issuers as of February
28, 2003, approximately 1 year after NASDAQ implemented its
postmoratorium rule change--because by this date issuers that were
affected by the moratorium would have had an opportunity to go through
NASDAQ's deficiency process. Examining this period also allowed us to
determine the listing status of issuers affected by the first
postmoratorium bid-price rule change.
[21] U.S. General Accounting Office, Protecting the Public's Interest:
Considerations for Addressing Selected Regulatory Oversight, Auditing,
Corporate Governance, and Financial Reporting Issues, GAO-02-601T
(Washington, D.C.: Apr. 9, 2002); and Financial Statement Restatements:
Trends, Market Impacts, Regulatory Responses, and Remaining Challenges,
GAO-03-138 (Washington, D.C.: Oct. 4, 2002).
[22] NASD is registered as a national securities association under
section 15A, 15 U.S.C. § 78o-3 and is considered an SRO pursuant to
section 3(a)(26), 15 U.S.C. § 78c(a)(26). NASD develops rules and
regulations governing the business and sales practices of NASD members,
conducts regulatory reviews of members' business activities, and
disciplines those members that fail to comply with its rules and
regulations. NASDAQ and Amex are subsidiaries of NASD. NASD has
delegated to NASDAQ the responsibility for operating NASDAQ as well as
for developing, adopting, and administering rules governing listing
standards for NASDAQ issuers. In April 2000, NASD members voted to
restructure NASD and sell a substantial part of NASD's ownership in
NASDAQ in part to minimize the potential for conflicts of interest
associated with NASD's responsibility for both the business operations
and regulation of NASDAQ. Unlike NASDAQ, Amex is a registered SRO. On
November 3, 2003, NASD and Amex announced an agreement to make Amex an
independent entity and transfer control of Amex to the Amex Membership
Corporation. The agreement is subject to approval by Amex, Amex
Membership Corporation, Amex and NASD's Boards of Governors, Amex seat
holders, and SEC.
[23] The national securities exchanges are Amex, the Boston Stock
Exchange, the Chicago Board Options Exchange, the Chicago Stock
Exchange, the International Securities Exchange, the National Stock
Exchange, NYSE, NQLX, OneChicago, the Pacific Exchange, and the
Philadelphia Stock Exchange.
[24] Market capitalization is the price of a stock multiplied by the
total number of shares outstanding and represents the market's total
valuation of a public company.
[25] According to Amex and NASDAQ, their total market capitalization
includes the value of shares and American Depository Receipts in the
United States. The receipts are issued by a U.S. depository bank and
represent shares of a foreign corporation held by the bank.
[26] According to NYSE, its total market capitalization includes the
global market value of all listed companies.
[27] Business Roundtable v. SEC, 905 F. 2d 406 (D.C. Cir. 1990).
[28] Section 17(b) of the Exchange Act; 15 U.S.C. § 78q(b).
[29] Section 17(a) of the Exchange Act; 15 U.S.C. § 78q(a).
[30] SEC generally refers to its reviews of SROs as "inspections" and
its reviews of broker-dealers, investment companies, and investment
advisers as "examinations."
[31] A proxy statement contains material information that SEC
regulations require issuers to provide their shareholders as a
prerequisite to soliciting votes, including biographical information on
directors and director nominees and information on their financial and
business relationships with the issuer and its executive officers.
[32] We also addressed the need for Amex to improve its listing
standards in a November 2001 report. See U.S. General Accounting
Office, Securities Regulation: Improvements Needed in the Amex Listing
Program, GAO-02-18 (Washington, D.C.: Nov. 27, 2001).
[33] In our November 2001 report on Amex's listing program, we also
addressed the need for ongoing notification of issuers' listing status
and recommended that the SEC Chairman direct Amex to implement
mandatory equity listing requirements or provide ongoing public
disclosure of the noncompliant status of companies.
[34] Market Regulation asked the three SROs in a May 1, 2002, letter to
consider whether it would be feasible and advisable to use symbol
modifiers to disclose issuers' noncompliance with continued listing
standards.
[35] In response to the OCIE report, the SRO said that under its
policy, these issuers were considered compliant with its continued
listing standards. OCIE responded that the SRO's application of such a
policy was improper and that such issuers should be considered to be
noncompliant.
[36] See appendix III for a description of the deficiency and hearing
processes of the three largest SROs.
[37] We did not provide data on the number of qualitative deficiencies
at each SRO because differences exist in how they address these
deficiencies. While officials from all three SROs told us they send
deficiency notices to issuers upon detecting noncompliance with
quantitative listing standards, they do not use similar notices in all
instances of noncompliance with qualitative listing standards.
Officials of two SROs told us that because some qualitative
deficiencies were more serious than others and because it was not
always possible to make an objective assessment of compliance with
these standards, they use their discretion in determining whether to
send an issuer a deficiency notice, which would trigger the deficiency
and delisting process, or whether to work informally with an issuer to
address the deficiency.
[38] In May 2000, Market Regulation approved an amendment to NYSE's
procedures for delisting securities, which, if implemented, would have
required that a modifier be attached to the stock symbol of an issuer
that no longer met the quantitative continued listing standards of the
exchange. Upon further analysis, NYSE determined that because attaching
the modifier would change the stock symbol of an issuer, investors
would be required to know the modified stock symbol, for example, to
retrieve information on a noncompliant issuer through the Internet. As
a result, NYSE filed a rule in December 2000 withdrawing its May 2000
rule. Unlike the modifier, NYSE's indicator does not change an issuer's
stock symbol.
[39] For example, The Associated Press provides quotation information
to such newspapers as The Boston Globe, The Chicago Tribune, The Los
Angeles Times, The New York Times, USA Today, and The Washington Post.
[40] Dow Jones & Company provides quotation information to the public
through The Wall Street Journal and Barron's--financial print media--
and through www.WSJ.com.
[41] Ameritrade Holding Corporation provides electronic brokerage
services to investors, primarily through the Internet.
[42] Third-party vendors, such as Yahoo, have a contract to receive
consolidated tape information from another information vendor, rather
than the Consolidated Tape Association.
[43] NYSE also uses an indicator to identify issuers that file for
bankruptcy.
[44] For purposes of this discussion, Amex provided us with data on the
number of issuers that were noncompliant with both qualitative and
quantitative standards in 2003. In contrast, the data in tables 1 and 2
reflect issuers with only quantitative deficiencies. Also, the 47
issuers that Amex identified as either in the delisting process or
already delisted by December 31, 2003, could include some of those Amex
issuers identified in table 2 as remaining noncompliant at the end of
the year, because that category comprises both issuers that were
trading within their compliance period and issuers that were in the
delisting process.
[45] The 200 deficient issuers include only those issuers that NASDAQ
identified in 2003 as noncompliant with quantitative listing standards
for which NASDAQ's rules specify a compliance period. These include
NASDAQ's bid price, market value of publicly held securities, market
capitalization, and market maker standards. In contrast, the data
NASDAQ provided in tables 1 and 2 reflect deficiencies with all of
NASDAQ's quantitative standards and include issuers that were
identified as noncompliant in 2002, but continued to trade noncompliant
into 2003, and issuers that were identified as noncompliant in 2003.
[46] NASDAQ said that when a symbol is changed by appending a symbol
modifier, an investor that is trying to get a quote using the original
symbol will sometimes receive a message that says "security not in
NASDAQ" or "security not found."
[47] Amex does not have a minimum bid-price listing standard, but
instead uses its discretion in delisting issuers with a low bid price
by evaluating bid price in the context of an issuer's trading,
financial, and operational circumstances. As a result, Amex officials
said that Amex would not use an indicator in association with a low bid
price. They also noted that low price is readily apparent to investors.
[48] A compliance plan describes the steps the issuer has committed to
taking in order to return to compliance with the market's listing
standards.
[49] As previously discussed, Corporation Finance officials said that
they are considering alternatives to the proposed 2-business-day filing
requirement based on public comments.
[50] Instead of requiring timely filing of SEC reports, NYSE's rules
require issuers to notify NYSE if they do not file the required reports
on time.
[51] In order to require the SROs to take actions to resolve
implementation issues associated with symbol modifiers, the Commission
would have to use its section 19(c) rule-making authority, subject to
specified procedures. As previously discussed, SEC rarely uses this
authority.
[52] The policy also directs OCIE staff to request internal review
reports as part of a review of internal controls or supervisory systems
of broker-dealers, investment advisers, and investment companies. OCIE
officials said that they have not conducted these types of reviews at
the SROs; therefore, the use of internal audit reports would not be
applicable in this context.
[53] Order Instituting Public Proceedings Pursuant to Section 19(h)(1)
of the Securities Exchange Act of 1934, Making Findings and Ordering
Compliance with Undertakings, SEC Release No. 34-41574 (June 29, 1999);
and Inspection of the New York Stock Exchange's Undertakings Regarding
the Surveillance, Examination, Investigatory, and Disciplinary
Programs for Independent Floor Brokers, (Aug. 23, 2001). The 2001
report followed up on actions NYSE took to improve its regulation of
independent floor brokers as a result of the 1999 findings.
[54] The Yellow Book refers to reviews as "audits."
[55] Generally accepted government auditing standards (also known as
"GAGAS" and outlined in the Yellow Book) apply to audits and
attestation engagements of government entities, programs, activities,
and functions.
[56] Bank examiners may request the internal review reports of the
banks they are reviewing. However, while Treasury and CFTC IG officials
use internal review reports in determining the objectives and scope of
their reviews, bank examiners use them in testing the bank's internal
audit or loan review function. An OCIE official told us that in reviews
of broker-dealers, investment companies, and investment advisors, OCIE
also uses the internal review reports of these entities in testing
internal controls.
[57] NASD is responsible for conducting oversight inspections of Amex.
[58] Report Pursuant to Section 21(a) of the Securities Exchange Act of
1934 Regarding the NASD and NASDAQ Market, SEC Release No. 34-37542
(Aug. 8, 1996).
[59] More recently, NASDAQ has taken steps to further bolster the
independence of its internal review function by providing that its
internal review department report directly to the audit committee,
which consists solely of independent directors, and mandating that its
internal review department have free and open access to information
deemed necessary by the department to perform its reviews.
[60] Self-Regulatory Organizations: Notice of Filing and Immediate
Effectiveness of Proposed Rule Change by the National Association of
Securities Dealers, Inc. to Provide Nasdaq Issuers Temporary Relief
from Listing Requirements Relating to the Bid Price for Continued
Inclusion and the Market Value of the Public Float, SEC Release No. 34-
44857 (Sept. 27, 2001). After the date of this release, NASDAQ changed
the name of the market value of public float listing standard to market
value of publicly held shares.
[61] These criteria are found in SEC Rule 19b-4(f)(6), 17 C.F.R.
240.19b-4(f)(6), which implements section 19(b)(3)(A) of the Exchange
Act, 15 U.S.C. § 78s(b)(3)(A). SEC Rule 19b-4(f)(6) also requires that,
for a rule change to take effect immediately upon filing with SEC, the
SRO must give SEC written notice of its intent to file the proposed
rule change, along with a brief description and text of the proposed
rule change, at least 5 business days before the date of filing of the
proposed rule change, or such shorter time as designated by SEC. This
5-day period allows SEC staff to offer its opinion to the SRO regarding
whether the proposal meets the criteria for filing under Rule 19b-
4(f)(6).
[62] Section 19(b)(3)(C) of the Exchange Act, 15 U.S.C. § 78s(b)(3)(C).
[63] Without SEC action, a rule filed under this procedure would become
"effective" immediately but not "operative" until 30 days later. The
net result would be a 30-day delay before the SRO could enforce the
proposed rule. However, if SEC waives the 30-day period, the proposed
rule can become "effective" and "operative" at the same time. According
to SEC staff, the 30-day "preoperative" waiting period gives affected
parties, such as issuers and investors, time to adjust to the new rule.
The period also serves to give SEC time during which it can evaluate
the rule and, if warranted, abrogate it without significantly
disrupting SRO operations. In waiving the 30-day waiting period, SEC is
to consider the proposed rule's impact on efficiency, competition, and
capital formation, as required by 15 U.S.C. § 78c(f).
[64] Of these 509 issuers--about 11 percent of the issuers listed on
NASDAQ--152 traded on the SCM and 357 traded on the NNM.
[65] Before the moratorium, if bid price or market value of publicly
held shares fell below the continued listing standards for 30
consecutive trading days, the issuer was classified as noncompliant and
had 90 days to return to compliance.
[66] Self-Regulatory Organizations; Notice of Filing and Immediate
Effectiveness of a Proposed Rule Change by the National Association of
Securities Dealers, Inc., Relating to the Bid Price Criteria of Nasdaq
Listing Standards, 67 Fed. Reg. 6306 (Feb. 11, 2002).
[67] The three SCM initial listing standards were a minimum of (1)
$5,000,000 in shareholders' equity, (2) $50,000,000 in market
capitalization, or (3) $750,000 in net income from continued operations
in the most recent fiscal year or in 2 of the last 3 most recent fiscal
years. Issuers are required to meet at least one of these three
standards to be eligible for initial listing. SCM initial listing
standards for shareholders' equity, market capitalization, and net
income are higher than for continued listing.
[68] According to a Market Regulation official, if SEC had not granted
NASDAQ's request to waive the 30-day waiting period, different SCM
issuers could have been subject to different compliance periods,
depending on which rule applied at the time they became deficient.
[69] The 246 moratorium issuers trading on February 28, 2003, included
issuers that were in full compliance with the continued listing
standards as well as issuers that were noncompliant with bid-price or
other continued listing standards.
[70] Of the 201 moratorium issuers that were delisted between January
2, 2002, the day the moratorium expired, and February 28, 2003, 70 were
delisted for noncompliance with the bid-price standard alone or
noncompliance with the bid-price and other listing standards; 95 were
delisted for noncompliance with listing standards not related to bid
price; and 36 were delisted for other reasons, such as merger with or
acquisition by another company.
[71] Self-Regulatory Organizations: Notice of Filing and Immediate
Effectiveness of Proposed Rule Change by the National Association of
Securities Dealers, Inc. Relating to the Bid Price Test in Nasdaq
Listing Standards, 68 Fed. Reg. 12729 (Mar. 17, 2003).
[72] The three SCM initial listing standards were a minimum of (1)
$5,000,000 in shareholders' equity, (2) $50,000,000 in market value of
listed securities, or (3) $750,000 in net income from continued
operations in the most recent fiscal year or in 2 of the last 3 most
recent fiscal years.
[73] Self-Regulatory Organizations; Order Granting Approval to Proposed
Rule Change and Amendment Nos. 1 and 2 Thereto and Notice of Filing and
Order Granting Accelerated Approval to Amendment No. 3 Thereto by the
National Association of Securities Dealers, Inc. to Modify an Existing
Pilot Program Relating to the Bid Price Test of the Nasdaq Maintenance
Listing Standards, 68 Fed. Reg. 75677 (Dec. 31, 2003). Also, see SEC's
correction to the text of the rule: Self-Regulatory Organizations;
Order Granting Approval to Proposed Rule Change and Amendment Nos. 1
and 2 Thereto and Notice of Filing and Order Granting Accelerated
Approval to Amendment No. 3 Thereto by the National Association of
Securities Dealers, Inc. to Modify an Existing Pilot Program Relating
to the Bid Price Test of the Nasdaq Maintenance Listing Standards, 69
Fed. Reg. 6707 (Feb. 11, 2004).
[74] See appendix III, figure 7, for NASDAQ's current bid-price
deficiency process.
[75] A reverse stock split is the reduction of the total number of
shares outstanding. The total number of shares will have the same
market value immediately after the reverse split as before it, but each
share will be worth more. For example, if a firm with 10 million
outstanding shares selling at $10 a share executes a reverse 1 for 10
split, the firm will end up with 1 million shares selling for $100
each.
[76] Other congressional committees holding hearings on the collapse of
Enron included the Senate Committee on Banking, Housing, and Urban
Affairs; the Senate Committee on Commerce, Science, and Transportation;
the House Committee on Energy and Commerce, Subcommittee on Oversight
and Investigations; and the House Committee on Financial Services and
its Subcommitee on Capital Markets, Insurance, and Government Sponsored
Enterprises.
[77] U.S. Senate Permanent Subcommittee on Investigations, The Role of
the Board of Directors in Enron's Collapse, 107th Cong., 2nd sess.,
2002, S. Rept. 107-70.
[78] Dick Thornburgh, First Interim Report of Dick Thornburgh,
Bankruptcy Court Examiner (November 2002).
[79] SEC's 2002 request was preceded by a 1998 request that resulted in
NASD and NYSE convening the Blue Ribbon Committee on Improving the
Effectiveness of Corporate Audit Committees (Blue Ribbon Committee) to
make recommendations for strengthening audit committee oversight. Amex,
NASDAQ, and NYSE adopted many of the resulting recommendations in 1999
as listing standards. Among other things, they required issuers to
establish audit committees comprising directors that meet specific
independence and financial literacy requirements and required audit
committees to adopt written charters detailing their responsibilities.
SEC also followed a Blue Ribbon Committee recommendation by requiring
issuers to disclose these charters as an appendix to the proxy
statement at least once every 3 years.
[80] SEC also sent letters to other securities exchanges requesting
that they review their corporate governance listing standards.
[81] Standards Relating to Listed Company Audit Committees, 68 Fed.
Reg. 18788 (Apr. 16, 2003). SEC's final rules require most issuers to
comply with the new audit committee requirements by their first annual
shareholders' meeting after January 15, 2004, or by October 31, 2004,
whichever is earlier.
[82] NASDAQ officials said that NASDAQ's Listing and Hearing Review
Council, a standing independent advisory committee on listing and
corporate governance issues, began an evaluation of potential actions
to strengthen corporate governance listing standards before NASDAQ
received the SEC Chairman's February 2002 letter.
[83] Amex submitted its initial rule proposals in separate filings to
SEC on May 6 and June 23, 2003. NASDAQ submitted its initial rule
proposals in separate filings on June 11 and October 9, 2002. NYSE
submitted its initial rule proposals on August 16, 2002.
[84] An equity compensation plan is a plan or other arrangement under
which the equity securities of the issuer are used to compensate such
persons as officers, directors, or employees for services rendered.
[85] The SROs submitted revised rule filings during this period in
response to ongoing discussions with SEC officials and SEC's April 2003
rules implementing Sarbanes-Oxley audit committee requirements.
[86] Amex, NASDAQ, and NYSE's new rules apply in full to all domestic
issuers listing common equity securities, with limited exceptions. For
example, all three SROs exempt from the "majority of independent
directors" standard those issuers for which an individual, a group, or
another company holds more than 50 percent of the voting power. In
addition, Amex exempts small business issuers from this standard,
requiring instead that their boards of directors consist of at least 50
percent independent directors. Small business issuers, based on SEC's
definition, are those issuers that, among other things, have less than
$25 million in revenues and market capitalization.
[87] Self Regulatory Organizations; New York Stock Exchange, Inc. and
National Association of Securities Dealers, Inc.; Order Approving
Proposed Rule Changes Relating to Corporate Governance, 68 Fed. Reg.
64154 (Nov. 12, 2003); Self-Regulatory Organizations; Order Granting
Approval of Proposed Rule Change by the American Stock Exchange LLC and
Notice of Filing and Order Granting Accelerated Approval of Amendment
No. 2 Relating to Enhanced Corporate Governance Requirements Applicable
to Listed Companies, 68 Fed. Reg. 68432 (Dec. 8, 2003).
[88] According to NYSE, material relationships can include commercial,
industrial, banking, consulting, legal, accounting, charitable, and
familial relationships.
[89] Amex, NASDAQ, and NYSE's new rules retain a previous requirement
that issuers have audit committees of at least three members and
consist solely of independent directors. The new rules also continue to
require that each audit committee member be "financially literate" and
that at least one have "financial expertise," although Amex uses the
term "financial sophistication." Amex and NASDAQ define financial
literacy as the ability to read and understand financial statements.
NASDAQ defines financial expertise as having past employment experience
in finance or accounting, requisite professional certification in
accounting, or other comparable experience. Amex defines financial
sophistication in a similar manner. NYSE delegates the responsibility
for defining financial literacy to issuers' boards. NYSE specifies that
the financial expert must have accounting or related financial
management expertise, although it delegates the responsibility to
boards to further define this expertise. Pursuant to Sarbanes-Oxley
section 407, issuers are required to disclose whether their audit
committees have at least one financial expert meeting the definition of
financial expert provided in SEC's rulemaking that implements section
407. Although none of the SROs' definitions of financial expert meet
SEC's stricter definition, Corporation Finance officials stated that
they expect most issuers will seek audit committee experts that meet
SEC's definition, rather than disclose to investors that they do not
have such an expert. Issuers other than small business issuers must
comply with this disclosure requirement in their annual reports for
fiscal years ending on or after July 15, 2003, and for small business
issuers, December 15, 2003.
[90] Amex, NASDAQ, and NYSE's new rules retain the requirement that
audit committees have charters that include descriptions of the
committee's scope of responsibilities and the way in which the
committee will carry them out.
[91] Related-party transactions refer to financial transactions between
the issuer and a director, director nominee, officer, significant
shareholders, or the immediate family members of any of these.
[92] Amex's rules require the independent compensation committee or a
majority of independent directors to determine, or recommend to the
board for determination, the compensation of the CEO. NASDAQ has a
similar requirement for determining the compensation of the CEO and all
other executives.
[93] NYSE's rules require the independent compensation committee to
determine and approve the CEO's compensation either alone or with the
rest of the independent directors.
[94] Certain types of Amex issuers have different implementation
schedules for the new listing standards. For example, Amex foreign
private issuers and small business issuers have until July 31, 2005, to
comply with the rules increasing the role of independent directors.
[95] As with Amex issuers, certain types of NASDAQ and NYSE issuers
also have different implementation schedules for the new listing
standards. For example, NASDAQ foreign private issuers and small
business issuers (issuers that, among other things, generate less than
$25,000,000 in revenues) have until July 31, 2005, to comply with the
rules increasing the role of independent directors. NYSE foreign
private issuers have until July 31, 2005, to comply with Sarbanes-
Oxley-related audit committee listing standards.
[96] NASDAQ uses the term "code of conduct" instead of "code of conduct
and ethics."
[97] SEC enacted a rule pursuant to Sarbanes-Oxley section 406 that
requires disclosure of (1) whether issuers have adopted a code of
ethics that applies to the company's principal executive, financial,
and accounting officers or other persons performing such functions and,
if not, the reasons why not; (2) any code that is adopted; and (3)
waivers from the code granted to any of the aforementioned officers.
Issuers must comply with the code of ethics disclosure requirements in
their annual reports for fiscal years ending on or after July 15, 2003.
[98] While Sarbanes-Oxley applies generally to both U.S. and foreign
issuers, SEC's section 301 rules are flexible and include various
exemptions. In particular, foreign issuers may, in specified
circumstances, be exempt from section 301's independence requirements
for, and specified duties of, audit committees.
[99] Amex's new rules state that foreign issuers seeking relief from
its corporate governance rules should provide written certification
from independent counsel of the issuer's home country stating that the
issuer's corporate governance practices are not prohibited by home
country law. NYSE requires a written certification stating that the
issuer's corporate governance practices comply with home country law
and the rules of the principal securities market for the issuer's
stock.
[100] NASDAQ's rules permit foreign issuers to request an exemption
from NASDAQ's corporate governance rules if the NASDAQ rule is contrary
to a law, rule, or regulation in their home country or is contrary to
generally accepted business practices in that country.
[101] SEC approved NASDAQ and NYSE's proposals related to shareholder
approval of equity-based compensation plans on June 30, 2003. (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 Nos.
1 and 2 and NASDAQ Amendments Nos. 2 and 3 Thereto Relating to Equity
Compensation Plans, 68 Fed. Reg. 39995 (July 3, 2003).) SEC approved
Amex's related proposals on October 9, 2003. (Self-Regulatory
Organizations; Notice of Filing and Order Granting Accelerated Approval
of a Proposed Rule Change Amendment Nos. 1, 2, and 3 Thereto by the
American Stock Exchange LLC Relating to Shareholder Approval of Stock
Option Plans and Other Equity Compensation Arrangements, 68 Fed. Reg.
59650, (Oct. 16, 2003).) SEC approved an amendment to Amex's new rules
on December 3, 2003. (Self-Regulatory Organizations; Notice of Filing
and Order Granting Accelerated Approval to a Proposed Rule Change and
Amendment No. 1. Thereto by the American Stock Exchange LLC Relating to
Broker Voting on Equity Compensation Plans, 68 Fed. Reg. 69092 (Dec.
11, 2003).)
[102] The three SROs do not require shareholder approval of inducement
awards to new employees; certain grants, plans, and amendments related
to mergers and acquisitions; and certain specific types of plans, such
as those that are already regulated under Internal Revenue Code and
Treasury regulations. All three SROs require that the independent
compensation committee or a majority of the independent directors
approve the use of an inducement exemption and promptly disclose it
thereafter. Amex and NASDAQ further exempt warrants or rights issued
generally to all shareholders or stock purchase plans available on
equal terms to all shareholders.
[103] If the market value of the stock falls below the predetermined
price specified in the equity compensation plan, the stock options
could expire worthless.
[104] Treasury stock is stock that has been bought back by the issuer
and is available for retirement or resale; the stock is issued but not
outstanding.
[105] Board interlocks occur when an issuer's director is employed as
an executive officer of another company and that second company's board
employs as a director any of the issuer's current executive officers.
For example, a compensation committee interlock occurs when an issuer's
director is employed as an executive officer of another company and
that company's compensation committee employs any of the issuer's
current executive officers.
[106] For example, under this approach, a director that provided legal
services to the CEO for personal matters would not be considered
independent.
[107] UK issuers listed on the London Stock Exchange are required to
disclose the extent to which they comply with the Combined Code on
Corporate Governance, the United Kingdom's official corporate
governance code, and the reasons for any noncompliance. The code
recommends separating the roles of CEO and chairman. According to a
2002 study commissioned by the UK Department of Trade and Industry,
over 90 percent of UK issuers disclosed compliance with this provision.
See Derek Higgs, Review of the Role and Effectiveness of Non-executive
Directors, January 2003.
[108] The report discussed three alternative structures from which
boards could choose to balance the powers of the CEO and independent
directors. Under the first alternative, the CEO and chairman positions
are separated, with the chairman position filled by an independent
director. Under the second alternative, the CEO and chairman positions
are separated, but if the chairman is not an independent director, the
position of lead independent director is established. Under the third
alternative, if the CEO and chairman positions are combined, a
presiding director is established. See The Conference Board Commission
on Public Trust and Private Enterprise, Findings and Recommendations
Part 2: Corporate Governance and Part 3: Audit and Accounting, January
2003.
[109] U.S. Comptroller General David M. Walker, Integrity: Restoring
Trust in American Business and the Accounting Profession, (document
based on author's speech to the American Institute of Certified Public
Accountants), November 2002. See also U.S. General Accounting Office,
Mutual Funds: Assessment of Regulatory Reforms to Improve the
Management and Sale of Mutual Funds, GAO-04-533T (Washington, D.C.:
Mar. 10, 2004).
[110] NYSE calls its self-certification form a "written affirmation."
[111] Amex calls its public reprimand letter a "public warning" letter.
[112] For example, SEC held hearings on shareholders' access to the
director nominating process in 1943. See Securities and Exchange
Commission Proxy Rules: Hearings on H.R. 1493, H.R. 1821, and H.R. 2019
Before the House Committee on Interstate and Foreign Commerce, 78th
Cong., 1st Sess., at 17-19 (1943); testimony of Chairman Ganson
Purcell.
[113] SEC's Rule 14a-8 governs shareholder access to the issuer's proxy
statement for the inclusion of shareholder proposals. Shareholders can
conduct their own proxy contest, sending out proxy materials to other
shareholders in accordance with applicable rules and regulations.
According to market participants, proxy contests are prohibitively
expensive for shareholders as they must prepare and pay for the
dissemination of proxy materials at a potential cost of hundreds of
thousands or even millions of dollars. Shareholders can nominate
directors at the annual shareholder meeting, but because most
shareholders vote through a proxy before the meeting, such nominees
have little chance of being elected. According to market participants,
other alternatives available to shareholders seeking to replace
directors, such as shareholder litigation, are also costly and
conflict-intensive.
[114] SEC Division of Corporation Finance, Staff Report: Review of the
Proxy Process Regarding the Nomination and Election of Directors (July
2003).
[115] Proposed Rule: Security Holder Director Nominations, SEC Release
Nos. 34-48626 and IC-26206, File No. S7-19-03 (Oct. 14, 2003).
[116] Final Rule: Disclosure Regarding Nominating Committee Functions
and Communications Between Security Holders and Boards of Directors,
SEC Release Nos. 33-8340 and IC-26262, File No. S7-14-03 (Nov. 24,
2003).
[117] By laws are the rules and practices governing the management of
an organization. Pursuant to section 19(b)(1) of the Exchange Act, SROs
must file a proposed rule change with SEC for any changes to their by
laws.
[118] Nonindustry directors, as defined in the NYSE constitution,
represented listed companies or the investing public. Industry
directors represented NYSE members.
[119] NYSE Rulemaking: Order Approving Proposed Rule Change Relating to
the Amendment and Restatement of the Constitution of the Exchange to
Reform the Governance and Management Architecture of the Exchange, 68
Fed. Reg. 74678 (Dec. 24, 2003).
[120] NYSE's revised constitution also created the position of chief
regulatory officer, who is responsible for the management and
administration of regulatory functions and reports directly to the
board's Regulatory and Oversight Committee.
[121] In December 2003, NYSE's board of directors announced the
appointment of a new CEO.
[122] The SEC Chairman sent letters to the other eight securities
exchanges in March 2003 asking them to review their governance. Market
Regulation officials told us that in May 2003 they sent a similar
letter to the following eight securities industry SROs that operate
clearinghouses: the Boston Stock Exchange Clearing Corporation,
Depository Trust Company, Emerging Market Clearing Corporation, Fixed
Income Clearing Corporation, National Securities Clearing Corporation,
Options Clearing Corporation, Pacific Clearing Corporation/Pacific
Stock Exchange, and the Stock Clearing Corporation/Philadelphia Stock
Exchange. A clearinghouse is an organization that handles the clearance
and settlement of transactions. Clearance and settlement in the
securities markets involves comparing the details of the transaction
between buyer and seller (or their brokers) and exchanging the
securities for cash payment.
[123] Derek Higgs, Review of the Role and Effectiveness of Non-
executive Directors, January 2003.
[124] Sir Robert Smith, Audit Commitees Combined Code Guidance, January
2003.
[125] AFEP-AGREF and the French Business Confederation are two leading
French business associations.
[126] Daniel Bouton, Promoting Better Corporate Governance in Listed
Companies, September 2002.
[127] For all deficiencies, if an issuer chooses not to request a
hearing following receipt of a delisting letter, the issuer is to be
delisted in 7 calendar days. In addition, rather than request a hearing
or delist, NNM issuers have the opportunity to transfer to the SCM,
provided they meet all SCM continued listing standards, except for bid
price. An issuer that wishes to transfer from NNM to SCM must submit an
application, a copy of the SCM Listing Agreement, and pay the
applicable entry fee.
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