BUSINESS DEPARTMENT E-NEWS ALERT — AUGUST 7, 2003
The Securities and Exchange Commission recently approved new rules proposed by the New York
Stock Exchange (“NYSE”) and National Association of Securities Dealers (“NASD”) that require shareholder approval (subject to certain exceptions) of all equity compensation plans and material revisions to such plans. These rules generally apply to equity compensation plans adopted after June
30, 2003 or pre-existing plans that subsequently become materially amended. While many of the NYSE and NASD provisions are similar, the rules are still different and may be administered differently.
Companies should review their equity compensation plans and other arrangements and the new applicable rules in order to plan for the new shareholder approval requirements. The following is a summary of some of the important aspects of the new requirements.
NYSE EQUITY COMPENSATION PLANS
The NYSE defines an equity compensation plan as a plan or other arrangement that provides for the delivery of equity securities (either newly issued or treasury shares) of the listed company to any employee, director, or other service provider as compensation for services. A compensatory grant of options or other equity securities that is not made under a plan is considered an equity compensation plan for these purposes.
There are certain exceptions to the broad definition of equity compensation plans. The following are specifically excluded from the definition of “equity compensation plans”:
• plans that are made available to shareholders generally, such as a typical dividend reinvestment plan; and
• plans that merely allow employees, directors or other service providers to elect to buy shares on the open market or from the listed company for their current fair market value regardless of whether (a) the shares are delivered immediately or on a deferred basis or (b) the payments for the shares are made directly or by giving up compensation that is otherwise due (for example, though payroll deductions).
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In addition, phantom stock type plans, where employees receive cash payments rather than actual shares, even though the amount of the payment is based upon the price of the shares, would not be
“equity compensation plans”.
NASD STOCK OPTIONS PLANS & OTHER EQUITY COMPENSATION ARRANGEMENTS
The NASD rules do not use the term “equity compensation plan”, but require shareholder approval to establish or materially amend all stock option purchase plans pursuant to which options or stock may be acquired by officers, directors, employees, or consultants, except for the following:
• warrants or rights issued generally to all security holders of the company or stock purchase plans available on equal terms to all security holders of the company;
• tax qualified, non-discriminatory employee benefit plans (for example, plans that meet the requirements of Section 401(a) or 423 of the Internal Revenue Code) or parallel nonqualified plans, provided such plans are approved by the issuer's compensation committee or a majority of the issuer's independent directors; or plans that merely provide a convenient way to purchase shares on the open market or from the issuer at fair market value;
• plans or arrangements relating to an acquisition or merger (as further discussed below); and
• issuances to a person not previously an employee or director of the company, or following a bona fide period of non-employment, as an inducement material to the individual's entering into employment with the company, provided such issuances are approved by either the issuer's compensation committee comprised of a majority of independent directors or a majority of the issuer's independent directors.
The NASD rules also would exclude cash-settled phantom stock type plans as described above.
The new rules will eliminate existing exceptions to stockholder approval requirements, including exceptions for broad based plans (under which executive officers and directors may receive grants, provided that such persons do not receive a majority of the grants), the Nasdaq de minimis exception
(for the grant of awards totaling the lesser of 1% of the number of shares of the issuer’s stock, 1% of the outstanding voting power, or 25,000 shares), and exceptions for grants of treasury shares, all of which will now be subject to shareholder approval.
The NASD has also proposed changes that will require issuers to notify Nasdaq no later than fifteen
(15) calendar days prior to establishing or materially amending a stock option plan, purchase plan or
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other equity compensation arrangement pursuant to which stock may be acquired by officers, directors, employees, or consultants without shareholder approval.
EXCEPTIONS TO THE SHAREHOLDER APPROVAL REQUIREMENT
In addition to the NYSE and NASD exceptions from obtaining shareholder approval, certain grants are exempt from the shareholder approval requirement under both the NYSE and NASD rules. These grants include (1) employment inducement awards, (2) certain grants made in connection with mergers and acquisitions, and (3) plans intended to meet the requirements of Sections 401(a) or 423 of the
Internal Revenue Code and parallel excess plans. These three exemptions are explained in further detail below.
Employment Inducement Awards
Shareholder approval is not required for employee inducement awards, which include grants of options or other equity-based compensation that serve as a material inducement to a person being hired or rehired following a bona fide period of interruption in employment. Inducement awards may include grants to new employees in connection with a merger or acquisition.
Mergers and Acquisitions
There are two exemptions that apply to mergers and acquisitions:
• Shareholder approval is not required to convert, replace, or adjust outstanding options or other equity compensation awards of another company in connection with a merger or acquisition of that other company.
• Shareholder approval is not required to make post transaction grants of options or other awards under plans acquired in mergers and acquisitions, provided that (i) the plan was previously approved by the target company’s shareholders, (ii) the number of shares available for grants is appropriately adjusted to reflect the transaction, (iii) the time during which those shares are available under the plan is not extended, and (iv) the options and other awards are not granted to individuals who were employed by the acquiring company immediately before the transaction
(the NASD narrows this proviso further by requiring that options are granted to employees of the target company).
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The merger/ acquisition related exceptions do not apply to plans adopted by target companies in contemplation of such a transaction.
Qualified Plans, Parallel Excess Plans, and Section 423 Plans
Shareholder approval is not required for plans that are intended to meet the requirements of Section 401(a) of the Internal Revenue Code (for example employee stock ownership plans – ESOPs – as defined in Section 4975(e)(7) of the Internal
Revenue Code), plans intended to meet the requirements of Section 423 of the
Internal Revenue Code, and parallel excess plans under the Employee Retirement
Income Security Act of 1974, as amended (“ERISA”). These plans are of course subject to a number of requirements under the Internal Revenue Code and ERISA including, for employee stock purchase plans under Internal Revenue Code Section
423, a requirement that the plan be approved by the shareholders within a year of its adoption. Changes to the group of employees eligible to participate in the plan or to the number of shares available for issuance are also subject to shareholder approval under Section 423 of the Internal Revenue Code. The NYSE and NASD exceptions do not change these shareholder approval requirements.
Although these exempt grants do not require shareholder approval, exempt grants do require the approval of the company’s independent compensation committee or the approval of a majority of the company’s independent directors. Companies must also notify the NYSE in writing when they rely on one of these exemptions. Companies should also keep in mind that even if a plan does not require shareholder approval under either the NYSE or NASD rules, the plans will be required to be disclosed in the company’s equity compensation table in its annual report as an equity compensation plan “not previously approved by security holders.”
MATERIAL REVISIONS
Both the NYSE and NASD rules set forth non-exclusive lists of certain “material revisions” to plans that will require shareholder approval. Under the new rules, material revisions or amendments include, but are not limited to, the following:
• A material increase in the number of shares available under the plan (other than solely to reflect a reorganization, stock split, merger, spin-off, or similar transaction). If the increase occurs under a formula plan (an “evergreen formula” which provides for automatic increases in the number of shares reserved for issuance), each such increase or grant will be considered a revision requiring shareholder approval, unless the plan has a term of not more than ten (10) years. If the increase occurs under a discretionary plan (no limit on the number of shares available and no formula providing for automatic increases in the number of shares available),
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the each grant under the plan will require separate shareholder approval regardless of whether the plan has a term or not more than ten (10) years.
• An expansion of the types of awards available under the plan.
• A material expansion of the class of employees, directors, or other service providers eligible to participate in the plan.
• A material extension of the term of the plan.
• A material change to the method of determining the strike price of options under the plan. A change in the method of determining “fair market value” from the closing price on the date of grant to the average of the high and low price on the date of grant is an example of a change the NYSE would not view as material.
• The deletion or limitation of any provision prohibiting repricing of options.
• Any actual repricing of options. “Repricing” means any of the following or any other action that has the same effect: (i) lowering the strike price of an option after it is granted, (ii) any action that is treated as a repricing under GAAP, (iii) canceling an option when its strike price exceeds the fair market value of the underlying stock in exchange for another option or other equity security (unless the cancellation and exchange occurs in connection with a merger, acquisition, or similar transaction).
The list of material revisions set forth above is not an exhaustive list and other amendments may be considered material. An amendment will not be considered a material revision if it curtails rather than expands the scope of the plan in question.
The NASD rules, in a departure from the NYSE rules, provide that while general authority to amend a plan would not obviate the need for shareholder approval, if a plan permits a specific action without further shareholder approval, then no such approval would generally be required. The provision would be subject to the NASD’s shareholder voting requirements for formula and discretionary plans as described below.
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PRE-EXISTING PLANS UNDER THE NYSE RULES
With regard to pre-existing plans (those plans adopted before June 30, 2003), the NYSE rules generally do not require shareholder approval of pre-existing plans unless and until they are materially revised.
Plans adopted on or after June 30, 2003 are subject to the new rules regarding shareholder approval.
Exceptions to the general rule that shareholder approval is not required for pre-existing plans include the following:
• Pre-existing discretionary plans, whether or not previously approved by the shareholders, must be approved by the shareholders during the Transition Period (defined below). Absent shareholder approval during the Transition Period, additional grants may not be made under discretionary plans after expiration of the Transition Period. However, if a plan can be separated into discretionary and non-discretionary portions (for example, a plan that permits grants from a designated number of shares and additional grants without regard to a specific share limit), the non-discretionary portion can continue to be used separately after the
Transition Period without shareholder approval.
• Pre-existing formula plans that either (1) have not been previously approved by the shareholders or (2) do not have a term of ten (10) years or less must be approved by the shareholders during the Transition Period. A shareholder approved formula plan may continue to be used after the Transition Period if it is amended to provide for a term of ten (10) years or less from the date of its original adoption or, if later, the date its most recent shareholder approval. Such an amendment would not be considered a “material revision” requiring shareholder approval. In-lieu of such an amendment, a formula plan may continue to be used without shareholder approval if the grants after June 30, 2003 are made only from the shares available under the plan as of that date.
The Transition Period during which shareholder approval of a pre-existing plan, if necessary, must be obtained, will end upon the first to occur of: (a) the listed company’s next annual meeting at which directors are elected that occurs on or after December 27, 2003; (b) June 30, 2004; and (c) the expiration of the plan.
PRE-EXISTING PLANS UNDER THE NASD RULES
The NASD approach to pre-existing plans, while fundamentally the same as the NYSE approach, is addressed in less detail and contains certain important differences from the NYSE approach. Similar to the NYSE approach, the NASD’s general rule regarding pre-existing plans is that any material revision to pre-existing plans or plans adopted after June 30, 2003 will require shareholder approval.
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The NASD did not establish a Transition Period for obtaining shareholder approval of formula and discretionary plans (as did the NYSE) but instead provided that shareholder approval is required every ten (10) years for formula plans with a term in excess of 10 years, and that shareholder approval is required for each grant under a discretionary plan.
NYSE PROXY VOTING ON EQUITY COMPENSATION PLANS
In addition to the NYSE changes dictating when and if shareholder approval is required, the NYSE has also made a change regarding the logistics of obtaining shareholder approval. As of September 28,
2003, the NYSE will preclude its member organizations from voting on equity compensation plans unless the beneficial owner of the shares has provided voting instructions. A similar change was not included in the amendments to the NASD rules as the NASD rules currently prohibit discretionary voting by broker-dealers without explicit instructions from the beneficial owner.
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For more information on this E-News Alert, please contact Stephan Coonrod ( stephanc@prestongates.com
) or any other attorney in the Securities Group at Preston Gates & Ellis LLP.
The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
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