On June 20, 2012, the Securities and Exchange Commission (SEC)
issued final rules under Section 10C of the Securities Exchange Act
of 1934 (Section 10C), as added by Section 952 of the Dodd-Frank
Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank
Act). The final rules direct national securities exchanges (e.g.,
the NYSE and NASDAQ) to incorporate independence standards for
compensation committees and compensation advisors into their
listing standards. In addition, the SEC adopted amendments to the
proxy disclosure rules regarding the use of compensation
consultants and any related conflicts of interest.
National securities exchanges will have 90 days from when the final
rules are published in the Federal Register to propose listing
standards and one year from the date of publication to finalize the
standards. The revised proxy disclosure rules, which are not
subject to the immediately preceding rulemaking process, generally
are effective for proxy statements filed on or after January 1,
2013.
The following client alert summarizes key provisions of the final
rules regarding the listing standards for the independence of
compensation committees and compensation committee advisors and the
final proxy disclosure rules for compensation consultants.
Compensation Committee Independence
The listing standards must provide that each compensation
committee member be a member of the board of directors and
"independent." The rules define a "compensation
committee" as:
any committee designated by the board as the compensation
committee;
- in the absence of a designated committee, a board committee who performs the functions typically performed by a compensation committee; or
- if neither of the above apply, the members of the board tasked with the oversight of executive compensation.
The SEC interprets Section 952 of the Dodd-Frank Act as providing the exchanges with considerable discretion to determine their own independence standards for compensation committee members. Accordingly, the listing standards need only consider certain relevant independence factors, including, but not limited to:
- the source of a director's compensation, including consulting, advisory or other compensatory fees paid to the director by the listed issuer; and
- whether a director is affiliated with the company, a subsidiary of the listed issuer or an affiliate of the listed issuer.
The final rules do not prescribe any factors that expressly
prohibit the finding of independence; however, exchanges are
expected to consider whether the express prohibitions relating to
audit committee independence should apply.
Compensation Committee Advisors
The SEC provides that a compensation committee may, in its sole
discretion, retain or obtain the advice of any compensation advisor
(e.g., compensation consultants, outside counsel, etc.) only after
considering certain
independence factors. The compensation committee will be directly
responsible for the appointment, compensation and oversight of the
compensation advisor, and listed issuers must appropriately fund
the retention of the advisor. To be
clear, the final rules do not require a compensation committee
obtain advice solely from independent compensation advisors. A
compensation committee is expressly permitted to
receive advice from non-independent compensation advisors such as
in-house counsel, outside counsel, or a non-independent
compensation consultant or other advisor, including those advisors
retained by management. However, except with regard to in-house
counsel, the compensation committee still needs to consider the
independence factors described immediately below.
Before seeking the advice of a compensation advisor, the
compensation committee must at least consider the following six
independence factors, as well as any other factor identified by the
exchange:
- whether the company employing the compensation advisor provides other services to the listed issuer;
- the amount of fees the company employing the compensation advisor has received from the listed issuer, as a percentage of the employing company's total revenue;
- the policies and procedures of the company employing the compensation advisor that are designed to prevent conflicts of interest;
- whether the compensation advisor has any personal or business relationship with any member of the compensation committee;
- whether the compensation advisor (or any member of the advisor's immediate family) owns any stock of the listed issuer; and
- whether the compensation advisor or the company employing the compensation advisor has any personal or business relationship with an executive officer of the listed issuer.
The independence factors should be considered in their totality
and no single factor should be determinative of independence. No
materiality, numerical or other clearly defined thresholds apply. A
compensation committeeis
not required to describe the committee's process
for selecting a compensation advisor pursuant to the new listing
standards. The SEC acknowledged that requiring such a description
would dramatically "increase the length of proxy statement
disclosures on executive compensation without necessarily providing
additional material information to investors."
Compensation Consultant Disclosure
Section 10C(c)(2) requires an issuer to disclose whether (A) the
compensation committee has retained or obtained the advice of a
compensation consultant and (B) the work of the compensation
consultant has raised any conflicts of interest and, if so, the
nature of the conflict and how such conflict is being addressed. In
March 2011, the SEC proposed amendments to Item 407 of Regulation
S-K requiring certain compensation consultant disclosures,
including the disclosure of any conflicts of interest.
Under the final rules, the SEC decided to keep the proposed
disclosure requirements under Item 407(e)(3)(iii) that requires
disclosure of "any role of compensation consultants in
determining or recommending the amount or form of executive and
director compensation." Specifically, issuers are required
to:
- disclose the consultant;
- state whether the consultant was engaged by the compensation committee directly or any other person;
- describe the nature and scope of the consultant's assignment, including the material elements of any instructions given to the consultant; and
- in certain circumstances, the aggregate fees.
To address the disclosure of any compensation consultant
conflicts of interest under Section 10C(c)(2), the final rules
adopt new disclosure requirements under Item 407(e)(3)(iv) rather
than incorporating the conflicts
of interest disclosure into Item 407(e)(3)(iii) as initially
proposed. Item 407(e)(3)(iv) requires the disclosure of any
conflicts of interest, including how the conflict is being
resolved, for any compensation consultant for whom disclosure is
required under Item 407(e)(3)(iii). Disclosure is required
regardless of whether the compensation consultant provides advice
on executive or director compensation or is retained by management,
the compensation committee or the board. There is no explicit
definition of what constitutes a conflict of interest. However, the
final rules add an instruction to Item 407(e)(3) stating that an
issuer should at a minimum consider the six independence factors
described above for compensation committee advisors in determining
whether a conflict of interest exists.
No disclosure is required for any compensation consultant who only
consults on broad-based, non-discriminatory plans or provides
non-customized survey data, nor is disclosure required for any
potential or perceived conflicts of interest. Additionally,
disclosure is not required
for any advisor other than a compensation consultant.
Although not mandated by Section 10C(c)(2), all issuers subject to the proxy disclosure
rules are required to disclose whether there are any
compensation consultant conflicts of interest and how the conflicts
are being resolved. This includes controlled companies, non-listed
issuers and smaller reporting companies.
Exemptions
Controlled companies and smaller reporting companies are exempt from the listing standards described above, but not from the compensation consultant disclosure requirements. Similarly, the following categories of listed issuers are exempt from the listing standards for compensation committee independence (but not from the listing standards for compensation committee advisors or the compensation consultant disclosure requirements, as otherwise applicable):
- limited partnerships;
- companies in bankruptcy proceedings;
- open-end management investment companies registered under the Investment Company Act of 1940; and
- any foreign issuer who discloses it does not have a compensation committee in its annual report.
Additionally, exchanges are permitted to consider whether a
listing standards exemption is appropriate for any other category
of issuer such as emerging growth companies under the Jumpstart Our
Business Startups Act (the JOBS Act) or other newly listed
issuers.
Next Steps
The final rules will not be a radical change for listed issuers. However, issuers must be prepared to comply with the new listing standards. Policies, procedures and committee charters should be reviewed and revised accordingly once the final listing standards are adopted. Similarly, issuers subject to the proxy disclosure rules should assess (or re-assess) any potential conflicts of interest with regard to compensation consultants in light of the new disclosure requirements.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.