Article by Susan P. Serota, Peter J. Hunt, Cindy V. Schlaefer and Henry Hernandez
The Securities and Exchange Commission has approved changes to the NYSE and Nasdaq rules requiring shareholder approval of all stock option and other equity compensation arrangements, and material revisions to the terms of those arrangements, with limited exceptions. These rules, originally proposed in October, 2002 (and described in our earlier Client Alert dated November 13, 2002, also available on our website), are effective June 30, 2003, subject to limited transitional relief. Broad-based option plans, grants to rank and file employees and the use of treasury shares are no longer exempt from shareholder approval requirements.
Only compensatory plans issuing equity securities are subject to shareholder approval
All equity compensation plans or arrangements of listed companies providing for the delivery of equity securities (either newly issued or treasury shares) to any employee, director or other service provider are now potentially subject to shareholder approval.
- Non-compensatory plans that are made available to shareholders generally (such as dividend reinvestment plans) or that merely facilitate the purchase of shares for their current fair market value (even if the shares are delivered on a deferred basis or the payments are made through payroll deduction), are not subject to shareholder approval.
- Plans that do not provide for delivery of equity securities (e.g. phantom stock awards that are settled in cash) are not considered equity compensation plans.
Material revisions requiring shareholder approval
Shareholder approval is required not only to adopt a plan or arrangement, but for all material revisions, including the following:
- A material increase in the number of shares available.
- Formula Plans - Shareholder approval is not required for each automatic increase in shares available under an evergreen formula, or for automatic grants pursuant to a formula in the plan, provided the plan has a term of not more than ten years.
- Discretionary Plans - Plans that do not have a limit on the number of shares available, and that are not formula plans, require shareholder approval for each grant – whether or not the term of the plan exceeds ten years. NOTE: NYSE rules will require listed companies which previously funded their equity compensation plans with an unlimited number of treasury shares to obtain shareholder approval as such plans will be treated as discretionary plans under the new rules.1
- A deletion or limitation of any provision prohibiting repricing of options.
- NYSE rules provide that a plan that does not specifically permit repricing of options is considered to prohibit repricing. Any actual repricing –however effected – by a NYSE company with such a plan will therefore be considered a material revision and require shareholder approval. (However, if the repricing commenced before June 30, 2003, the new rule will not apply.)
- Nasdaq companies are merely encouraged to explicitly and clearly state whether repricing is permitted under their plans.
- An expansion of the types of awards available under a plan.
- A material expansion of the class of persons eligible to participate in the plan.
- A material extension of the term of the plan.
- A material change to the method of determining the exercise price of options.
Limited exemptions are available
The following equity compensation awards are exempt from the shareholder approval requirements, but generally must be approved by the company’s independent compensation committee or a majority of the independent directors. The company must also provide the NYSE or Nasdaq with written notice when it relies on one of these exemptions.
- New Hires . Shareholder approval is not required if the equity compensation is awarded as a material inducement to the hiring of a person who was not previously an employee (or, under the Nasdaq rules, a director), or who is being rehired after a bona fide period of interruption of employment. This includes new employees hired in connection with a merger or acquisition.
- NYSE rules require that the company issue an explanatory press release promptly following an inducement grant in reliance on this exemption. Nasdaq is considering a similar disclosure requirement.
- Mergers and Acquisitions . Options and other equity compensation awards may be converted, replaced or adjusted to reflect a merger or acquisition without shareholder approval. An acquiring company may also use shares available under a target company’s pre-existing, shareholder-approved equity plan to make grants with respect to the acquiring company’s shares after the transaction without further shareholder approval, provided that the awards are not made to existing employees of the acquiring company or its subsidiaries.2
- The Nasdaq rules do not appear to require independent director approval for this exemption to apply.
Grandfathered plans and NYSE transition relief
Plans adopted before June 30, 2003, are not subject to the new rules unless and until they are materially revised.
However, under the NYSE rules, if the existing plan is a discretionary plan (whether or not approved by shareholders) that does not contain a limit on the number of shares that may be issued, additional grants may be made under that plan without further shareholder approval only for a limited transition period, and only in a manner consistent with past practice.
In addition, under the NYSE rules, if the existing plan is a formula plan that does not have a term limit of ten years or less (and is not amended to include one) or was not previously approved by shareholders, grants can continue to be made only during the limited transition period.
- For example, under the NYSE rules, a broad-based plan with an evergreen formula that was not approved by shareholders will need shareholder approval for grants after the expiration of the transition period – even if the plan has a term of ten years or less. (However, grants could continue to be made from shares available before June 30, 2003, based on formulaic increases prior to that date.)
- A plan with an evergreen formula that has been previously approved by shareholders can continue to provide formulaic increases in the number of shares available under the plan after end of the NYSE limited transition period, provided the plan is amended to impose a term of ten years or less from the date of its original adoption or, if later, the date of its most recent shareholder approval. This amendment would not be viewed as a "material revision" requiring shareholder approval under the NYSE rules.
The NYSE transition period ends on the earliest of (i) the next annual meeting at which directors are elected that occurs on or after December 28, 2003, (ii) June 30, 2004, or (iii) the expiration of the plan.
NYSE broker voting rules
Effective for shareholder meetings on or after September 28, 2003, the NYSE will not allow brokers to vote on equity compensation plans presented to shareholders unless the beneficial owner of the shares has given voting instructions. The NYSE will be establishing a working group to facilitate implementation of this rule.
Next Steps
Companies should identify all of their equity compensation arrangements that could potentially be subject to the new NYSE and Nasdaq rules—these can include arrangements not typically considered "plans," such as discretionary grants of options or other equity securities to a service provider outside of a shareholder approved plan.
Companies should focus in particular on whether they have any "formula" or "discretionary" plans, as these plans may be available in their current form only for a limited transition period without requiring shareholder approval. Remember that formula plans can include not only plans with evergreen formulas but also plans (such as nonqualified deferred compensation plans) that provide for company "matching" contributions in the form of company stock.
Where a company provides a nonqualified excess benefits plan that includes participant-directed investments in company stock, the company should consider plan amendments that may qualify the plan as a "parallel excess plan" exempt from the shareholder approval rules. In this regard, it is important to remember that many such plans also intend to qualify as "top hat" plans exempt from many of the requirements of ERISA—the company needs to consider the impact of any plan amendments on the plan’s "top hat" status.
Any NYSE or Nasdaq company considering an amendment to an equity compensation plan needs to consider carefully whether the amendment would be a "material revision" requiring shareholder approval. And, when relying on an exemption from shareholder approval for the adoption or amendment of an equity compensation plan or award, the company must determine whether it is necessary to obtain approval of the company’s independent compensation committee (or a majority of the independent directors), and what notice and disclosure requirements apply.
1. The Nasdaq rules never permitted this exception.
2. Note that the shares of the listed company reserved for issuance in connection with assumed options or plans of the target must be counted in determining whether the transaction would involve the issuance of 20% or more of the listed company’s outstanding common stock and thus require approval of the listed company’s shareholders.
The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances
