The Nasdaq Stock Market, Inc. ("Nasdaq") has approved certain changes to its corporate governance standards and submitted those changes to the SEC for approval.

As described in greater detail below, these proposals will:

• implement certain rules required to be adopted by the Sarbanes-Oxley Act of 2002;
• narrow the definition of director independence and increase participation of independent directors in company decisions;
• require that a company's board have a majority of independent directors;
• mandate that a company adopt a code of conduct and that all of its directors receive continuing education;
• mandate shareholder approval of stock option plans in which officers and directors participate;
• require approval by the audit committee of related party transactions;
• clarify the existing prohibition against misrepresenting information; and
• require, through issuance of a press release, notification of going concern qualifications in audit opinions.

Sarbanes-Oxley Act Listing Requirements

Pursuant to the Sarbanes-Oxley Act the SEC was obligated to issue rules requiring national securities exchanges, such as Nasdaq, to adopt certain specified listing standards.

In response to this requirement, Nasdaq has proposed the following audit committee requirements. Under the proposed rules, the audit committee members must be able to read and understand financial statements at the time of their appointment (as opposed to the current standard of "within a reasonable time thereafter"). In addition, the audit committee must:

• be composed entirely of independent directors (minimum of 3), with "independence" defined to prohibit the director's receipt of any consulting, advisory or other compensatory fees from the company (other than board service fees) and to prohibit other affiliations with the company, in addition to the normal independence requirements discussed below;
• have at least one member of the committee who is considered a "financial expert" through education or experience as a public accountant, auditor, principal financial or accounting officer, comptroller or similar position;
• be directly responsible for the appointment, compensation, and oversight of the work of any registered public accounting firm engaged by the company (provision must be added to Audit Committee Charter);
• establish procedures to receive and respond to employees' and others' complaints and concerns regarding the company's accounting or auditing matters (must be added to Charter). The audit committee should set up a hotline to receive anonymous complaints or comments regarding the company's financial statements or accounting practices;
• be provided by the company with appropriate funding for engaging the company's outside auditors and any other counsel or advisors (must be added to Charter).

Please note that the independence standards for audit committee service are stricter than the general independence standards discussed below.

Independent Directors

An independent director is currently defined as a person other than an officer or employee or a person who, in the opinion of the board of directors, has a relationship that will interfere with the exercise of independent judgment in carrying out the responsibilities of a director. The current rules also specify that the following relationships preclude independence; compensation in excess of $60,000 paid to a director, familial relationships with officers, payments in excess of the greater of $200,000 or 5% of the recipient's gross revenues between the listed company and a for-profit company with which the director is associated, and relationships arising from interlocking service on another company's compensation committee.

The new proposal will extend the current prohibition on the receipt of $60,000 in "compensation" to include "any payments" (which would include political contributions) in excess of $60,000 (other than compensation for board service) and to extend this prohibition to the receipt of such payments by an immediate family member of a director. In addition, the proposal will delete the phrase "for-profit business" from the existing rule so that a director will not be considered independent if the company makes payments to any entity (even a charity) where the director is an executive officer and such payments exceed the greater of $200,000 or 5% of the recipient's gross revenues.

The new rules will also

• prohibit a director from being deemed independent if any family member of the director is employed as an executive officer, or has been within the past three years, of the issuer or any of its affiliates.
• prohibit former partners or employees of the outside auditors who worked on a company's audit engagement from being deemed independent for three years; and
• apply a three-year "cooling off" period to directors who are not independent due to : (i) interlocking compensation committees; (ii) the receipt by the director, or a family member of the director who is not an employee of the issuer, of any payments in excess of $60,000 other than for board service; or (iii) the receipt by an entity with which the director is associated, of any payments in excess of the greater of $200,000 or 5% of the recipient's gross revenues.

It should be noted that the definition of independent director for purposes of audit committee service is more stringent than the one for other board service. For purposes of serving on the audit committee only, in addition to satisfying the restrictions above, the director cannot receive any compensation or payments from the company.

Independent Director Meetings

Nasdaq's proposed rule will require that an issuer's board be made up of a majority of independent directors. The new rules will require that independent directors meet separately, without management, on a regular basis, but at least twice per year.

The new rules will also require that compensation of executive officers be approved by a compensation committee comprised solely of independent directors or by a majority vote of the independent directors. The CEO may be present (but may not vote) at all meetings discussing executive compensation, except where his own compensation will be discussed.

The proposed rules will also require that new directors be nominated by a nominating committee comprised of independent directors or by majority vote of the independent directors.

Nasdaq's proposals requiring a company to change the composition of its board or other committees will become effective as of the company's first annual meeting occurring after January 1, 2004.

Code of Conduct

Nasdaq proposes to require all companies to have a code of conduct applicable to all directors, officers and employees, addressing conflicts of interest and compliance with laws, rules and regulations, and providing for an enforcement mechanism. Waivers of the code of conduct for directors and executive officers may only be granted by the board or a board committee and must be promptly disclosed. The code of conduct must be publicly available. The corporate code of conduct proposed by Nasdaq will have a broader application than the code of ethics for senior financial officers mandated by the Sarbanes-Oxley Act, as it will apply to all officers, directors and employees of any issuer and not just the senior financial officers.

The enforcement mechanism must ensure prompt and consistent enforcement of the code, protection for persons reporting questionable behavior, clear and objective standards for compliance, and a fair process by which to determine violations.

Director Continuing Education

The proposed rules will mandate continuing education for all company directors pursuant to rules to be developed by Nasdaq.

Stock Option Plans

Nasdaq rules generally require shareholder approval for all stock option or purchase plans in which officers or directors participate. The current rules contain an exception for plans in which at least a majority of the participants are not officers or directors. The proposed rule changes will eliminate this exception and, accordingly, will require shareholder approval for all plans in which officers and directors participate.

The current rules also exempt inducement grants to new officers from the shareholder approval requirement. The new proposal will require that inducement grants be subject to approval by either (i) a compensation committee comprised solely of independent directors or (ii) a majority of the company's independent directors.

The exception for tax qualified, non-discriminatory plans such as Employee Stock Ownership Plans will be retained.

With respect to implementation of the proposed rule, Nasdaq has proposed that existing plans be grandfathered and that the rule become effective 60 days after SEC approval.

Related Party Transactions

Nasdaq's conflict of interest rule currently provides that an issuer must conduct an appropriate review of all related party transactions on an ongoing basis and utilize its audit committee or comparable body of the board of directors for the review of potential conflicts of interest. Nasdaq is proposing to expand this rule by requiring the audit committee or comparable body of the board of directors to actually approve, rather than merely review, related party transactions.

Explicit Prohibition on Misrepresenting Information to Nasdaq

Current Nasdaq rules do not explicitly state than an issuer that makes a material misrepresentation to Nasdaq, omits necessary material information in a communication with Nasdaq, or otherwise fails to provide requested material information, may be delisted. The new proposal will clarify that an issuer can be delisted for misrepresenting material information to Nasdaq.

Requirement to Disclose Audit Opinions with Going Concern Qualifications

Nasdaq proposes to require issuers to disclose in a press release the receipt of an audit opinion with a going concern qualification. Ordinarily, if an auditor concludes that substantial doubt exists about the entity's ability to continue as a going concern for a reasonable period of time, the auditor provides this conclusion through an explanatory paragraph in the auditor's opinion. While the audit opinion is available in the Form 10-K, the proposed rule change will require that the going concern qualification be brought to the attention of investors and potential investors through a press release issued within seven calendar days after the filing of the Form 10-K. Nasdaq's market surveillance will also have to be notified.

The proposed rule changes will become effective only upon SEC approval.

Please contact this firm with any questions about this memorandum or its application to specific circumstances.