[Federal Register Volume 65, Number 236 (Thursday, December 7, 2000)]
[Notices]
[Pages 76690-76693]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-31140]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43641; File No. SR-PCX-00-40]


Self-Regulatory Organizations; Notice of Filing of a Proposed 
Rule Change and Amendment No. 1 Thereto by the Pacific Exchange, Inc. 
Relating to Audit Committee Requirements for Listed Companies

November 29, 2000.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on October 23, 2000, the Pacific Exchange, Inc. (``PCX'' or 
``Exchange''), through its wholly-owned subsidiary, PCX Equities, Inc. 
(``PCXE''), filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II 
and III below, which Items have been prepared by the PCXE. The Exchange 
filed Amendment No. 1 to the proposed rule change on November 22, 
2000.\3\ The Commission is publishing this notice to solicit comments 
on the proposed rule change, as amended, from interested persons.
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    \1\ 15 U.S.C. 7s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Letter dated November 20, 2000 from Cindy L. Sink, Senior 
Attorney, PCX, to Nancy Sanow, Assistant Director, Division of 
Market Regulation, Commission (``Amendment No. 1''). Amendment No. 1 
specifies an implementation plan for the proposed rule change.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The PCXE proposes to amend its rules pertaining to composition of 
audit committees of listed companies as recommended by the Blue Ribbon 
Committee on Improving Effectiveness of Corporate Audit Committees. The 
text of the proposed rule change is set forth below. New text is in 
italics. Deletions are in brackets.

Corporate Governance

Rule 5.3(a) Conflicts of interest--No change.

Rule 5.3(b) Independent Directors/Audit Committee

    The Corporation shall require that each listed domestic issuer 
have at least two independent directors on its board of directors. 
Such issuer must maintain an audit committee. [a majority of which] 
All audit committee members must be independent directors that 
satisfy the audit committee requirement set forth below.
    (1) Audit Committee Charter. The board of directors must adopt 
and approve a formal written charter for the audit committee. The 
audit committee must review and reassess the adequacy of the formal 
written charter on an annual basis. The charter must specify the 
following:
    (i) The scope of the audit committee's responsibilities and how 
it carries out those responsibilities, including structure, 
processes, and membership requirements;
    (ii) That the outside auditor is ultimately accountable to the 
board of directors and the audit committee of the company, that the 
audit committee and board of directors have the ultimate authority 
and responsibility to select, evaluate, and, where appropriate, 
replace the outside auditor (or to nominate the outside auditor to 
be proposed for shareholder approval in any proxy statement); and
    (iii) That the audit committee is responsible for ensuring that 
the outside auditor submits on a periodic basis to the audit 
committee a formal written statement delineating all relationships 
between the auditor and the company and that the audit committee is 
responsible for actively engaging in a dialogue with the outside 
auditor with respect to any disclosed relationships or services that 
may impact the objectively and independence of the outside auditor 
and for recommending that the board of directors take appropriate 
action in response to the outside auditors' report to satisfy itself 
of the outside auditors' independence.
    (2) Composition/Expertise Requirement of Audit Committee 
Members.
    (i) Each audit committee will consist of at least three 
independent directors, all of whom have no relationship to the 
company that may interfere with the exercise of their independence 
from management and the company (``Independent'');
    (i) Each member of the audit committee must be financially 
literate, as such qualification is interpreted by the company's 
board of directors in its business judgment, or must become 
financially literate within a reasonable period of time after his or 
her appointment to the audit committee; and
    (iii) At least one member of the audit committee must have 
accounting or related financial management expertise, as the Board 
of Directors interprets such qualification in its business judgment.
    (3) Independence Requirement of Audit Committee Members. In 
addition to the definition of Independent provided in 5.36(2)(i), 
the following restrictions shall apply to every audit committee 
member:
    (i) Employees: A director who is an employee (including non-
employee executive officers) of the company or any of its affiliates 
may not serve on the audit committee until three years following the 
termination of his or her employment. In the event the employment 
relationship is with a former parent or predecessor of the company, 
the director could serve on the audit committee after three years 
following the termination of the relationship between the company 
and the former parent or predecessor. ``Affiliate'' includes a 
subsidiary, sibling company, predecessor, parent company, or former 
parent company.
    (ii) Business Relationship. A director (a) who is a partner, 
controlling shareholder, or executive officer of an organization 
that has a business relationship with the company, or (b) who has a 
direct business relationship with the company (e.g., a consultant) 
may serve on the audit committee only if the company's board of 
directors determines in its business judgment that the relationship 
does not interfere with the director's exercise of independent 
judgment. In making a determination regarding the independence of a 
direct pursuant to this paragraph, the board of directors should 
consider, among other things, the materiality of the relationship to 
the company, to the director, and, if applicable, to the 
organization with which the director is affiliated. ``Business 
relationships'' can include commercial, industrial, banking 
consulting, legal, accounting and other relationships. A director 
can have this relationship directly with the company, or the 
director can be a partner, officer or employee of an organization 
that has such a relationship. The director may serve on the audit

[[Page 76691]]

committee without the above-referenced board of directors' 
determination after three years following the termination of, as 
applicable, either (a) the relationship between the organization 
with which the director is affiliated and the company, (b) the 
relationship between the director and his or her partnership status, 
shareholder interest or executive officer position, or (c) the 
direct business relationship between the director and the company.
    (iii) Cross Compensation Committee Link. A director who is 
employed as an executive of another corporation where any of the 
company's executives serves on that corporation's compensation 
committee may not serve on the audit committee.
    (iv) Immediate Family. A director who is an Immediate Family 
member of an individual who is an executive officer of the company 
or any of its affiliates cannot serve on the audit committee until 
three years following the termination of such employment 
relationship. ``Immediate Family'' includes a person's spouse, 
parents, children, siblings, mothers-in-law and fathers-in-law, sons 
and daughters-in-law, and anyone (other than employees) who shares 
such person's home.
    (v) Notwithstanding the requirements of subparagraphs (3)(i) and 
(3)(iv), one director who is no longer an employee or who is an 
Immediate Family member of a former executive officer of the company 
or its affiliates, but is not considered independent pursuant to 
these provisions due to the three-year restriction period, may be 
appointed, under exceptional and limited circumstances, to the audit 
committee if the company's board of directors determines in its 
business judgment that membership on the committee by the individual 
is required by the best interests of the corporation and its 
shareholders, and the company discloses, in the next annual proxy 
statement subsequent to such determination, the nature of the 
relationship and the reasons for that determination.
    (4) Written Affirmation. As part of the initial listing process, 
and with respect to any subsequent changes to the composition of the 
audit committee, and otherwise approximately once each year, each 
company should provide the Exchange written confirmation regarding:
    (i) any determination that the company's board of directors has 
made regarding the independence of directors pursuant to any of the 
subparagraphs above;
    (ii) the financial literacy of the audit committee member;
    (iii) the determination that at least one of the audit committee 
members has accounting or related financial management expertise; 
and
    (iv) the annual review and reassessment of the adequacy of the 
audit committee charter.
    (5) ``Officer'' has the meaning specified in Rule 16a-1(f) under 
the Securities Exchange Act of 1934, or any successor rule.
    (6) Initial Public Offering. Companies listing in conjunction 
with their initial public offering (including spin-offs and carve 
outs) will be required to have two qualified audit committee members 
in place within three months of listing and a third qualifier member 
in place within twelve months of listing.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the PCXE included statements 
concerning the purpose of, and basis for, the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange has prepared summaries, set forth in 
Sections A, B, and C below, of the most significant aspects of such 
statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The proposed rule change modifies PCXE Rule 5.3(b), on audit 
committee requirements of listed domestic issuers, to conform to 
recommendations made by the Blue Ribbon Committee on Improving 
Effectiveness of Corporate Audit Committees and rule changes adopted by 
other SROs.\4\ The proposed rule change specifies four requirements for 
a qualified audit committee, defines certain terms for purposes of the 
proposed audit committee requirements, and sets forth requirements for 
companies listing on the Exchange in conjunction with an initial public 
offering.
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    \4\ See Securities Exchange Act Release Nos. 42231 (Dec. 14, 
1999), 64 FR 71523 (Dec. 21, 1999) (approving SR-NASD-99-48); 42232 
(Dec. 14, 1999), 64 FR 71518 (Dec. 21, 1999) (approving SR-AMEX-99-
38); and 42233 (Dec. 14, 1999), 64 FR 71529 (Dec. 21, 1999) 
(approving SR-NYSE-99-39). The proposed rule changes were, in large 
part, adapted from NYSE Listed Company Manual Sections 303.00, 
303.01, and 303.02.
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    First, proposed Rule 5.3(b)(1) requires the board of directors of 
companies listed on the Exchange to adopt and approve a formal written 
charter for the audit committee. The audit committee must review and 
reassess the adequacy of the formal written charter on an annual basis. 
The charter must specify: (i) The scope of the audit committee's 
responsibilities and how it carries out those responsibilities, 
including structure, processes, and membership requirements; (ii) that 
the outside auditor is ultimately accountable to the board of directors 
and the audit committee of the company, that the audit committee and 
board of directors have the ultimate authority and responsibility to 
select, evaluate, and, where appropriate, replace the outside auditor 
(or to nominate the outside auditor to be proposed for shareholder 
approval in any proxy statement); and (iii) that the audit committee is 
responsible for ensuring that the outside auditor submits on a periodic 
basis to the audit committee a formal written statement delineating all 
relationships between the auditor and the company; that the audit 
committee is responsible for actively engaging in a dialogue with the 
outside auditor with respect to any disclosed relationships or services 
that may impact the objectivity and independence of the outside 
auditor; and for recommending that the board of directors take 
appropriate action in response to the outside auditor's report to 
satisfy itself of the outside auditor's independence.
    Second, proposed Rule 5.3(b)(2) sets forth the composition and 
expertise requirements of audit committee members. The proposal 
requires: (i) Each audit committee to consist of at least three 
independent directors, all of whom have no relationship to the company 
that may interfere with the exercise of their independence from 
management and the company (``Independent''); (ii) each member of the 
audit committee to be financial literate, as such qualification is 
interpreted by the company's board of directors in its business 
judgment, or to become financially literate within a reasonable period 
of time after his or her appointment to the audit committee; and (iii) 
at least one member of the audit committee to have accounting or 
related financial management expertise, as the Board of Directors 
interprets such qualification in its business judgment.
    Third, proposed Rule 5.3(b)(3) provides the independence 
requirements of audit committee members. In addition to the definition 
of Independent provided in Rule 5.3(b)(2)(i), the following 
restrictions apply to every audit committee member.
    (i) Employees. A director who is an employee (including non-
employee executive officers) of the company or any of its affiliates 
may not serve on the audit committee until three years following the 
termination of his or her employment. In the event the employment 
relationship is with a former parent or predecessor of the company, the 
director could serve on the audit committee after three years following 
the termination of the relationship between the company and the former 
parent or predecessor. ``Affiliate'' includes a subsidiary, sibling 
company, predecessor, parent company, or former parent company.
    (ii) Business Relationship. A director (a) who is a partner, 
controlling

[[Page 76692]]

shareholders, or executive officer of an organization that has a 
business relationship with the company, or (b) who has a direct 
business relationship with the company (e.g., a consultant) may serve 
on the audit committee only if the company's board of directors 
determines in its business judgment that the relationship does not 
interfere with the director's exercise of independent judgment. In 
making a determination regarding the independence of a director 
pursuant to this paragraph, the board of directors should consider, 
among other things, the materiality of the relationship to the company, 
to the director, and, if applicable, to the organization with which the 
director is affiliated. ``Business relationships'' can include 
commercial, industrial, banking, consulting, legal, accounting and 
other relationships. A director can have this relationship directly 
with the company, or the director can be a partner, officer or employee 
of an organization that has such a relationship. The director may serve 
on the audit committee without the above-reference board of director's 
determination after three years following the termination of, as 
applicable, either (a) The relationship between the organization with 
which the director is affiliated and the company, (b) the relationship 
between the director and his or her partnership status, shareholder 
interest or executive officer position, or (c) the direct business 
relationship between the director and the company.
    (iii) Cross Compensation Committee Link. A director who is employed 
as an executive of another corporation where any of the company's 
executives serves on that corporation's compensation committee may not 
serve on the audit committee.
    (iv) Immediate Family. A director who is an Immediate Family member 
of an individual who is an executive officer of the company or any of 
its affiliates cannot serve on the audit committee until three years 
following the termination of such employment relationship. ``Immediate 
Family'' includes a person's spouse, parents, children, siblings, 
mothers-in-law and fathers-in-law, sons and daughters-in-law, and 
anyone (other than employees) who shares such person's home.
    (v) Notwithstanding the requirements of subparagraphs (3)(i) and 
(3)(iv) of Rule 5.3(b), one director who is no longer an employee or 
who is an Immediate Family member of a former executive officer of the 
company or its affiliates, but is not considered independent pursuant 
to these provisions due to the three-year restriction period, may be 
appointed, under exceptional and limited circumstances, to the audit 
committee if the company's board of directors determines in its 
business judgment that membership on the committee by the individual is 
required by the best interests of the corporation and its shareholders, 
and the company discloses, in the next annual proxy statement 
subsequent to such determination, the nature of the relationship and 
the reasons for that determination.
    Fourth, proposed Rule 5.3(b)(4) sets forth on ongoing written 
affirmation requirement. The proposal provides that as part of the 
initial listing process, and with respect to any subsequent changes to 
the composition of the audit committee, and otherwise approximately 
once each year, each company should provided the Exchange written 
confirmation regarding: (i) any determination that the company's board 
of directors has made regarding the independence of directors pursuant 
to any of the subparagraphs above; (ii) the financial literacy of the 
audit committee number; (iii) the determination that at least one of 
the audit committee members has accounting or related financial 
management expertise; and (iv) the annual review and reassessment of 
the adequacy of the audit committee charter.
    Proposed Rule 5.3(b)(5) defines ``Officer'' to have the meaning 
specified in Rule 16a-1(f) under the Act, or any successor rule. 
Moreover, proposed Rule 5.3(b)(6) provides that companies listing in 
conjunction with their initial public offering (including spin-offs and 
carve outs) will be required to have two qualified audit committee 
members in place within three months of listing and a third qualified 
member in place within twelve months of listing.
    Finally, the Exchange proposes to implement a transition period in 
order to provide its issuers with sufficient time to come into 
compliance with the proposed rule change.\5\ Specifically, the Exchange 
proposes (i) to ``grandfather'' all public company audit committee 
members qualified under current PCX rules until they are re-elected or 
replaced and (ii) give companies eighteen months from the date of SEC 
approval of this rule filing to recruit the requisite members for their 
audit committees. Issuers listed on the Exchange as of the effective 
date of the proposed rule change will have six months to adopt a formal 
written audit committee charter.
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    \5\ See Amendment No. 1, supra note 3.
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2. Statutory Basis
    The PCXE believes that the proposed rule change is consistent with 
Section 6(b)(5) of the Act,\6\ which requires, among other things, the 
Exchange's rules to be designed to prevent fraudulent and manipulative 
acts and practices and, in general, to protect investors and the public 
interest.
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    \6\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The PCXE does not believe that the proposed rule change will impose 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    The PCXE did not solicit or receive written comments on the 
proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the Exchange consents, the Commission will:
    (A) by order approve such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in

[[Page 76693]]

the Commission's Public Reference Room. Copies of such filing will also 
be available for inspection and copying at the principal office of the 
Exchange. All submissions should refer to the File No. SR-PCX-00-40 and 
should be submitted by December 28, 2000.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\7\
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    \7\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-31140 Filed 12-6-00; 8:45 am]
BILLING CODE 8010-01-M