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87-46 SEC Approval of NASD Corporate Governance Standards for NASDAQ/NMS Issuers and Amendments to Schedule D to the NASD By-Laws Concerning Designation of NASDAQ National Market System (NASDAQ/NMS) Securities
TO: All NASD Members and Other Interested Persons
The Securities and Exchange Commission has approved amendments to its rules, to Schedule D to the NASD By-Laws, and to the NASD's Transaction Reporting Plan, which will have the effect of: (1) requiring NASDAQ/NMS companies to comply with certain standards of corporate governance; (2) moving NASDAQ/NMS designation criteria from an SEC rule to Schedule D to the NASD By-Laws; (3) eliminating the concept of mandatory NASDAQ/NMS designation; and (4) designating all securities subject to an effective transaction reporting plan as "national market system securities."
The new corporate governance standards will become effective for issuers that have securities designated as NASDAQ/NMS securities after August 4, 1987. For issuers having securities that are currently designated or will become designated on or before August 4, the standards will become effective 18 months thereafter.
The text of the amendments to Schedule D to the NASD By-Laws is attached.
At a meeting on June 11, 1987, the SEC approved amendments to Schedule D to the NASD By-Laws and to the NASD's Transaction Reporting Plan. The primary effect of these amendments is to give SEC approval to corporate governance rules for NASDAQ/NMS securities that were adopted by the NASD Board of Governors in July 1985. The rules were developed by the NASD Corporate Advisory Board and the NASD Board of Governors during late 1984 and early 1985. Comments on the proposed rules were solicited from NASD members and NASDAQ issuers in March 1985. The SEC also solicited public comment on the proposed rules as its normal routine in its consideration of them.
SUMMARY OF AMENDMENTS
In addition to corporate governance standards, the amendments to Schedule D to the NASD By-Laws incorporate the Tier 2 NASDAQ/NMS criteria currently in SEC Rule 11Aa2-l.
The SEC is amending Rule 11Aa2-l to replace the existing NASDAQ/NMS designation criteria with a standard that will designate as "national market system securities" all over-the-counter and exchange-listed securities for which transactions are reported pursuant to an effective transaction reporting plan approved by the SEC.
The SEC is also amending Rule 11Aa3-l, its transaction reporting rule, to require the NASD to designate those NASDAQ securities that are subject to transaction reporting.
The amendments are contained in a new Part III of Schedule D to the NASD By-Laws. The following summarizes the provisions of the corporate governance standards as well as other changes approved by the SEC.
• Corporate Governance Provisions
The NASD's new corporate governance standards for NASDAQ/NMS issuers are included in Section 5 of new Part III of Schedule D. The rules will become effective for issuers having securities designated as NASDAQ/NMS securities after August 4, 1987. For issuers having securities that are currently designated or will become designated as NASDAQ/NMS securities on or before August 4, the standards will become effective 18 months thereafter (February 1989).
Substantive provisions of the corporate governance rules are:
Applicability of Rules to Foreign Issuers—The NASD has the authority to exempt a foreign issuer from application of the rules in cases where compliance would be in contravention of law or business practice in the issuer's country of domicile.
Distribution of Annual and Interim Reports—Issuers are required to distribute annual, quarterly, and other interim reports to shareholders. Annual reports must be distributed a reasonable period of time prior to the company's annual meeting. Interim reports must be distributed either before or as soon as practicable following filing of reports with the issuer's regulatory authority. Issuers filing Form 10-Q with the SEC must distribute statements of operations. Other issuers must distribute information as contained in their required interim reports.
Independent Directors—Issuers are required to maintain a minimum of two independent directors on their boards. An "independent director" is defined to exclude officers or employees of the company or its subsidiaries or other individuals having a relationship with the issuer that, in the opinion of the board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.
Audit Committees—Issuers are required to establish and maintain an audit committee, a majority of the members of which must be independent directors.
Shareholder Meetings—Issuers are required to hold an annual shareholder meeting.
Quorum—Issuers must establish a quorum requirement of at least 33 1/3 percent of the outstanding shares, or at such greater level as specified in the corporate by-laws, for any meeting of the holders of common stock.
Solicitation of Proxies—Issuers are required to solicit proxies for all shareholder meetings and to file copies of proxy solicitations with the NASD.
Conflicts of Interest—Issuers are required to conduct an appropriate review of all related-party transactions. The rules provide that either the audit committee or a comparable body must be used for reviewing potential conflicts.
Listing Agreement—Each NASDAQ/NMS issuer must execute a listing agreement as prescribed by the NASD.
• Related Amendments
Also approved by the SEC was a restructuring, without major substantive change, of the manner in which "national market system securities" are designated. These amendments eliminate from SEC Rule 11Aa2-l the NASDAQ/NMS financial designation criteria and place those criteria in Schedule D to the NASD By-Laws. Also, the mandatory designation criteria that were included in the SEC rule have been eliminated.*
In addition, the SEC approved amendments which transfer the NASDAQ/NMS designation procedures in the NASD's National Market System Designation Plan to Schedule D to the By-Laws. The overall effect of these changes is to place NASDAQ/NMS designation procedures in the same posture under SEC rules as the listing procedures of the exchanges.
* * * * *
Questions concerning this notice may be directed to either S. William Broka, Vice President, NASDAQ Operations-Companies, at (202) 728-8050, or T. Grant Callery, NASD Associate General Counsel, at (202) 728-8285.
Frank J. Wilson
Executive Vice President
and General Counsel
AMENDMENTS TO SCHEDULE D TO THE NASD BY-LAWS
NEW PART III
DESIGNATION OF NASDAQ NATIONAL MARKET SYSTEM SECURITIES
Pursuant to Securities and Exchange Commission Rule 11Aa2-l, those securities for which transaction reporting is required by an effective transaction reporting plan are designated as national market system securities. The Association has filed with the Securities and Exchange Commission a transaction reporting plan under which securities satisfying the requirements of this Part III are covered by the transaction reporting plan and transactions in such securities are subject to the transaction reporting provisions of Part XI of this schedule.
Applications for Designation
Quantitative Designation Criteria
In order to be designated, an issuer shall be required to substantially meet the criteria set forth in paragraph (a), (b), or (c) below.
Initial public offerings substantially meeting such criteria are eligible for immediate inclusion in NASDAQ/NMS upon prior application and with the written consent of the managing underwriter that immediate inclusion is desired. All other qualifying issues, excepting special situations, are included on the next inclusion date established by the Association.
Warrants to purchase designated securities may be designated if the warrants substantially meet the above criteria; provided, however, that they shall not be required to meet the criteria set forth in paragraph (a)(2) if immediately after the distribution, there are at least 450,000 warrants outstanding.
The computations required by paragraphs (a)(l) and (b)(l) shall be taken from the issuer's most recent financial information filed with the Association. The computations required in paragraphs (a)(2), (a)(3), (b)(2), and (b)(3) shall be as of the date of application of the issuer. Determinations of beneficial ownership for purposes of paragraphs (a)(2) and (b)(2) shall be made in accordance with SEC Rule 13d-3. In the case of American Depositary Receipts, the computations required by paragraphs (a)(l) and (b)(l) shall relate to the foreign issuer and not to any depositary or any other person deemed to be an issuer for purposes of Form S-12 under the Securities Act of 1933.
In addition to meeting the quantitative criteria for NASDAQ/NMS inclusion, the issue must also be:
Quantitative Maintenance Criteria
After designation as a NASDAQ National Market System security, a security must substantially meet the criteria set forth below to continue to be designated as a national market system security.
Common stock of issuer must continue to be designated.
At least two authorized NASDAQ market makers.
Should an issuer file under any of the sections of the Bankruptcy Act or announce that liquidation has been authorized by its board of directors and that it is committed to proceed, its securities shall not remain designated unless it is determined that the public interest and the protection of investors would be served by continued designation.
Non-Quantitative Designation Criteria
No provision of this Section 5 shall be construed to require any foreign issuer to do any act that is contrary to a law, rule, or regulation of any public authority exercising jurisdiction over such issuer or that is contrary to generally accepted business practices in the issuer's country of domicile. The Association shall have the ability to provide exemptions from the applicability of these provisions as may be necessary or appropriate to carry out this intent.
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 that, in the opinion of the board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.
Each NASDAQ/NMS issuer shall establish and maintain an audit committee, a majority of the members of which shall be independent directors.
Each NASDAQ/NMS issuer shall hold an annual meeting of shareholders and shall provide notice of such meeting to the Association.
Each NASDAQ/NMS issuer shall provide for a quorum as specified in its by-laws for any meeting of the holders of common stock; provided, however, that in no case shall such quorum be less than 33 1/3 percent of the outstanding shares of the company's common voting stock.
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 Association.
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 or a comparable body for the review of potential conflict-of-interest situations where appropriate.
Each NASDAQ/NMS issuer shall execute a Listing Agreement in the form designated by the Association.
This Part III, Section 5 shall apply to any issuer that first has a security designated as a national market system security after August 4, 1987, and shall become effective as to any other NASDAQ/NMS issuer on February 1, 1989.
Note: Current Parts III through XI are renumbered Parts IV through XII, respectively.
* The original purpose of establishing mandatory designation criteria was to enable the SEC and the securities industry to gain experience in transaction reporting for over-the-counter securities which had not previously been subject to last-sale trade reporting. While this was true in 1981 when the rule was adopted, both the NASD and the SEC have concluded that last-sale trade reporting in the over-the-counter market has been well established and, since most issuers enter NASDAQ/NMS by voluntary designation, the mandatory designation standards no longer serve a useful purpose.