Location: FINRA Manual > Notices > 1985 > 85-20 Request for Comment on Proposed Corporate Governance Requirements for NASDAQ National Market System Companies
TO:	All NASD Members
LAST DATE FOR COMMENT: APRIL 28, 1985
The National Association of Securities Dealers, Inc., is requesting comment on proposed rule amendments which would require that companies with securities included in the NASDAQ National Market System (NASDAQ/NMS) adhere to certain standards of corporate governance. This notice contains a discussion of the background of these rules and a section-by-section analysis. The text of the proposed rules is attached.
The publication of the proposed rules is a result of an effort of several months by the NASD Corporate Advisory Board. The Corporate Advisory Board is a body consisting principally of the chief executive officers of NASDAQ companies, chaired by Wilson C. Wearn, Chairman and Chief Executive Officer of Multimedia, Inc., which reports to the NASD Board of Governors. The Advisory Board has played an important role in the evolution of NASDAQ as the fastest-growing and second-largest securities market in the United States, and in the development of NASDAQ/NMS.
Since its inception in 1982, NASDAQ/NMS has grown steadily in size and stature. In November 1984, the Securities and Exchange Commission approved a change to NASDAQ/NMS inclusion criteria which has resulted in a further enhancement in the quality of NASDAQ/NMS companies. As of the end of 1984, the average NASDAQ/NMS company had assets of over $570 million and equity in excess of $84 million. Their revenues averaged $181 million with net income of over $8 million. The average price per share for NASDAQ/NMS issues was in excess of $15 and the average issue had almost 8 million shares outstanding with a public float of 5.8 million shares and a market value in excess of $120 million. NASDAQ/NMS issues had an average of 11.5 market makers in the system.
As NASDAQ/NMS has matured, the Corporate Advisory Board has come to believe that it is appropriate to consider the quality of corporate governance of NASDAQ/NMS companies. This concern has been heightened by numerous state securities administrators who have noted the differences in approach to corporate governance by NASDAQ/NMS and certain of the exchanges. The Corporate Advisory Board believes that the likelihood of achieving a "blue-sky" exemption for NASDAQ/NMS companies in all 50 states will be greatly improved by the implementation of corporate governance criteria.
A special subcommittee of the Corporate Advisory Board chaired by B. Lee Karns, President and Chief Executive Officer of Comprehensive Care Corporation, devoted considerable time during the fall of 1984 to an analysis of corporate governance principles and the propriety of adopting corporate governance standards for NASDAQ/NMS. In January, the subcommittee reported its conclusions to the Corporate Advisory Board and recommended that numerous corporate governance rules be proposed for NASDAQ/NMS and that a survey be conducted of NASDAQ companies concerning additional aspects of corporate governance.
After careful consideration, the Corporate Advisory Board accepted the subcommittee's recommendations and in turn recommended to the NASD Board of Governors that the following corporate governance rules be proposed and that a survey on other possible rules be conducted. The NASD Board of Governors concurred in these recommendations.
SUMMARY OF PROPOSED RULES
The proposed rules, as drafted, would be added to Schedule D to the NASD By-Laws and would become additional criteria for eligibility in NASDAQ/NMS. The rules contain requirements generally similar to those of the New York Stock Exchange and the American Stock Exchange. The proposed rules are summarized below. The text of the rules appears as Exhibit A.
Applicability — The rules would apply to any issuer with a security traded in the NASDAQ/NMS market.
Eligibility — The Corporate Advisory Board contemplates that compliance with the corporate governance rules would be a requirement for a company to be eligible for continued inclusion in NASDAQ/NMS. 1/
Distribution of Annual and Interim Reports — The rules would require issuers to distribute both annual and interim reports to shareholders. Annual reports will be required to be distributed within "a reasonable period of time prior to the company's annual meeting," whereas interim reports would be distributed "within a reasonable time" following filing of required interim financial reports with the SEC or other regulatory authority. For companies required to file Form 10-Q with the SEC, quarterly reports to shareholders (on Form 10-Q or otherwise) would be required. Other companies would be required to provide shareholders with reports reflecting information contained in interim financial reports filed with the appropriate regulatory body.
Independent Directors — The rules would require issuers to maintain a minimum of two independent directors on each company's board. "Independent director" is defined so as to exclude officers or employees of the company or its subsidiaries or any other individual having a relationship which, in the opinion of the Board of Directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. The determination of independence of any particular director would therefore be left to the judgment of each company's board.
Audit Committees — The rules require an issuer to establish and maintain an audit committee, a majority of the members of which shall be independent directors.
Shareholder Meetings — Companies will be required to hold an annual meeting of shareholders.
Quorum — The rules would require companies to establish a quorum requirement of at least 50% of the outstanding shares for any meeting of the holders of common stock.
Solicitation of Proxies — Issuers would be required to solicit proxies and distribute proxy statements for all meetings of shareholders and file copies of proxy solicitations with the NASD.
Conflicts of Interest — The rules would address situations in which companies may have a conflict of interest in transactions with persons related to the company. The rules would require that companies conduct "an appropriate review" of all related party transactions on an ongoing basis and that the audit committee be utilized for the review of potential conflicts where appropriate.
Listing Agreement — As drafted, the rules would require each NASDAQ/NMS issuer to execute a listing agreement as prescribed by the NASD. A listing agreement would establish a contractual relationship between each issuer and the NASD.
Effective Date — The rules provide a 12-month "grandfather" period for any NASDAQ/NMS issuer in the system at the time the rules are approved. They would immediately apply to all companies entering the system after they became effective. In addition, the effectiveness of the rules could be delayed for securities entering the system until some reasonable period following approval of the rules.
In view of the fact that some companies may be required to change their corporate charters, comments are specifically requested with respect to the issues of grandfathering and an appropriate phase-in period for the rules.
SANCTIONS FOR NON-COMPLIANCE
The Corporate Advisory Board believes that the appropriate sanction for a NASDAQ/NMS company which fails to meet corporate governance criteria should be deleted from NASDAQ/NMS. Under such an approach, companies deleted from NASDAQ/NMS would remain in NASDAQ. Under present SEC rules, however, any NASDAQ security meeting Tier 1 criteria is mandated to be included in NASDAQ/NMS and cannot be deleted from NASDAQ/NMS while remaining in NASDAQ. The NASD is submitting Section 2 of the proposed rules for comment with the expectation that these rules will be amended.
SURVEY ON VOTING RIGHTS AND CHANGE OF CORPORATE CONTROL
As noted above, the NASD Board of Governors has also approved a survey of NASDAQ companies on two other aspects of corporate governance. That survey will be sent to all NASDAQ companies in the near future.
The first topic addressed by the survey concerns voting rights. The NASD is not proposing at this time to restrict the voting rights assigned to various classes of stock issued by NASDAQ/NMS companies. As the question of voting rights has assumed greater importance in recent years, the New York Stock Exchange has undertaken a review of its policies in this area. The California Corporations Department is also conducting a review of that state's policies on voting rights. In this environment, it was concluded that the Association should survey NASDAQ companies to determine their views on this important issue.
The second matter included in the survey concerns possible restrictions on a corporation's issuance of stock in connection with a change of control. Certain exchanges restrict the percentage of new shares which a company may issue without shareholder approval. In view of the multiplicity of issues related to such restrictions and the continuing evolution of practices concerning mergers and acquisitions, it was concluded that the Association should obtain more information with respect to NASDAQ companies' views prior to developing specific rule proposals on this question.
NASDAQ companies are urged to review the survey carefully when it is received and return it to the Association with a complete expression of their views.
REQUEST FOR COMMENTS
The Association is requesting comments on the proposed rules prior to final Board consideration. All comments received during this comment period will be reviewed by the Corporate Advisory Board and changes will be recommended as deemed appropriate. The Board of Governors will then reconsider the proposal. If the Board approves the rules or an amended version, they must be filed with, and approved by, the Securities and Exchange Commission before becoming effective.
All written comments should be addressed to:
James M. Cangiano, Secretary
National Association of Securities Dealers, Inc.
All comments must be received by April 28, 1985. Any questions regarding this notice should be directed to either Dennis C. Hensley or T. Grant Callery at (202) 728-8294.
DRAFT CORPORATE GOVERNANCE PROVISIONS AS APPROVED BY THE CORPORATE ADVISORY BOARD
Add new Part II D to Schedule D to the NASD By-Laws as follows; existing sections D and E to be redesignated as E and F respectively.
D. Rules for Issuers of NASDAQ National Market System Securities
1.	Applicability
a.	This Part II D shall apply to any NASD/NMS issuer.
b.	For purposes of this Part II D, "NASDAQ/NMS issuer" shall mean the issuer of a security included in the NASDAQ System which has been designated as a national market system security pursuant to Rule HAa2-l under the Securites Exchange Act of 1934.
2.	Eligibility
No security shall be eligible for inclusion in the NASDAQ National Market System unless the issuer of said security is in compliance with this Part II D.
3.	Distribution of Annual and Interim Reports
a.	Each NASDAQ/NMS issuer shall distribute to shareholders copies of an annual report containing audited financial statements of the company and its subsidiaries. The report shall be distributed to shareholders a reasonable period of time prior to the company's annual meeting of shareholders and shall be filed with the Corpora tion at the time it is distributed to shareholders.
(i)	Each NASDAQ/NMS issuer which is subject to SEC Rule 13a-13 shall distribute copies of quarterly reports including statements of operating results and financial position to shareholders within a reasonable time following the company's filing of Form 10-Q with the Securities and Exchange Commission. If the form of such quarterly report differs from Form 10-Q, copies of the report shall also be provided to the Corporation. The financial statements contained in quarterly reports shall be prepared in a manner consistent with generally accepted accounting principles but are not required to be audited.
(ii)	Each NASDAQ/NMS issuer which is not subject to SEC Rule 13a-13 and which is required to file on a periodic basis with the Securities and Exchange Commission, or another federal or state regulatory authority reports relating primarily to operations and financial position shall distribute to shareholders reports which reflect the information contained in such interim reports. Such reports shall be distributed to shareholders within a reasonable period of time following filing with the appropriate regulatory authority. If the form of the interim report provided to shareholders differs from that filed with the regulatory authority, copies of such report shall also be provided to the Corporation.
4.	Independent Directors
Each NASDAQ/NMS issuer shall maintain a minimum of two independent directors on its board of directors. For purposes of this section, "independent director" shall mean a person other than an officer or employee of the company or its subsidiaries or any other individual having a relationship which, in the opinion of the board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.
5.	Audit Committee
Each NASDAQ/NMS issuer shall establish and maintain an Audit Committee, a majority of the members of which shall be independent directors.
6.	Shareholders Meetings
Each NASDAQ/NMS issuer shall hold an annual meeting of shareholders and shall provide notice of such meeting to the Corporation.
7.	Quorum
Each NASDAQ/NMS issuer shall provide in its by-laws for a quorum for any meeting of the holders of common stock of at least 50% of the outstanding shares of the company's common voting stock.
8.	Solicitation of Proxies
Each NASDAQ/NMS issuer shall solicit proxies and provide proxy statements for all meetings of shareholders and shall provide copies of such proxy solicitation to the Corporation.
9.	Conflicts of Interest
Each NASDAQ/NMS issuer shall conduct an appropriate review of all related party transactions on an ongoing basis and shall utilize the company's Audit Committee as a forum for the review of potential conflict of interest situations where appropriate.
10.	Listing Agreement
Each NASDAQ/NMS issuer shall execute a Listing Agreement in the form designated by the Corporation.
11.	Effective Date
This Part II D shall apply to any issuer which first has a security desig nated as a national market system security after_______, and shall become effective as to any other NASDAQ/NMS issuer on [twelve months after approval].
1/ This approach is discussed further on in connection with sanctions.