U.S. Stock Exchanges to Determine Exemptions for Canadian and Other Foreign Private Issuers
The U.S. Securities and Exchange Commission has proposed new requirements for compensation committees of issuers listed on a U.S. stock exchange. The rules are mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).
The proposed new rules relate to the independence of compensation committee members, their responsibilities when retaining advisers, and disclosure about conflicts of interest of advisers who provide executive compensation consulting services.
The proposals are part of a broader movement in Canada and the United States toward heightened regulation of executive compensation and compensation committees. The market has already started to reflect the need of compensation committees for independent and objective advice, with many compensation advisers separating executive compensation consulting from the provision of other compensation-related services to issuers, such as pension and benefits advice. The latest regulatory developments in the United States and Canada will promote further changes in the compensation advisory industry, similar to changes already experienced by the accounting industry involving the separation of audit and non-audit services.
Exemptions and Implementation
Under the proposals, foreign private issuers, including MJDS (Multijurisdictional Disclosure System) issuers, would be exempt from the conflict-of-interest disclosure requirements. Depending on how the U.S. stock exchanges exercise their discretion to implement the SEC's rules, foreign private issuers may or may not be exempt from the other requirements. On the other hand, the SEC is proposing that controlled companies (those in which a shareholder or group of shareholders holds more than 50% of the voting power for the election of directors) not be subject to any of the requirements except those regarding conflict-of-interest disclosure. Taking the proposed exemptions together, controlled companies that are foreign private issuers would not be subject to any of the new rules.
Comments on the SEC proposals are due by April 29, 2011. The U.S. stock exchanges will be proposing listing standards to implement the SEC rules later this year, with the final listing standards in place in 2012.
Independence of Compensation Committee Members
Issuers, other than controlled companies, whose equity securities are listed on a U.S. stock exchange will be required to have entirely independent compensation committees. The U.S. stock exchanges will be required to define "independent" for this purpose. The definition may or may not be the same as the definition for audit committee members but, in formulating it, U.S. stock exchanges must take into account relevant factors, including
- the compensation paid to a director by the issuer, including any consulting, advisory or other fees; and
- whether the director is affiliated with the issuer.
Foreign private issuers will be exempt if they disclose why they do not have an entirely independent compensation committee.
Notably, the U.S. stock exchanges already require compensation committees to comprise independent directors, but the existing definition of independence permits those committee members (i) to receive a certain amount of compensation from the issuer for non-board services; and (ii) to be affiliated with the issuer, for example, as a representative of a major shareholder. Similar standards apply in Canada under National Policy 58-201, Corporate Governance Guidelines. The U.S. stock exchanges are now required to revisit their independence criteria for compensation committees.
Although Canadian securities regulators have recently proposed new disclosure requirements for compensation committees, they are not expected to propose changes to the independence criteria (to conform them to the audit committee criteria or otherwise). For details on the Canadian proposals in respect of compensation committees, please see our bulletin Changes to Executive Compensation Disclosure in Canada.
Compensation Committee Advisers
The SEC is proposing the following rules in respect of advisers retained by compensation committees of U.S.-listed issuers, other than controlled companies:
- Compensation committees must have full authority to retain compensation consultants, legal counsel and other advisers.
- Compensation committees must be directly responsible for the appointment, compensation and oversight of their advisers, and issuers must provide the necessary funding.
- Although the rules do not require advisers to be independent, compensation committees may retain advisers only after considering their independence. Factors affecting an adviser's independence will include the amount of fees the adviser receives from the issuer in relation to the adviser's total revenue, whether the adviser provides other services to the issuer, and the existence of business or personal relationships between employees of the adviser and members of the issuer's compensation committee.
It will be up to the U.S. stock exchanges to determine whether or not foreign private issuers will be exempt from some or all of these requirements.
Disclosure About Conflicts of Interest
The SEC is proposing to require U.S. issuers to disclose whether the compensation committee received advice from a compensation adviser, whether the adviser's work raised any conflicts of interest and how such conflicts are addressed. This disclosure would have to appear in an issuer's proxy statement for a shareholder meeting at which directors are to be elected. Since foreign private issuers are generally exempt from the SEC's proxy rules, they would also be exempt from these new disclosure requirements. However, Canadian securities regulators have proposed their own disclosure requirements to deal with conflicts of interest. Specifically, the Canadian proposals would require disclosure of any non-executive compensation services an adviser provided, whether the board or compensation committee had to preapprove those services, and the amount of fees billed by the adviser for compensation-related and all other services provided to the issuer.
Related Regulatory Developments
The SEC proposals discussed above are the latest in a series of regulatory developments in the United States and Canada relating to executive compensation and compensation committees. These developments include the following:
- Say-on-pay is now mandatory for U.S. issuers, and the OSC is considering whether it should be mandatory in Canada.
- Regulators in the United States have proposed rules governing incentive-based compensation arrangements of certain U.S.-regulated financial institutions with assets of US$1 billion or more.
- Under the Dodd-Frank Act, U.S.-listed issuers will be required to develop policies on clawing back executive officers' compensation if the issuer's financial results are restated within three years as a result of material non-compliance with financial reporting requirements. The amount of the clawback would be the compensation paid in excess of what would have been paid had the financial results not been misstated
- Canadian securities regulators are proposing to require disclosure about the link between compensation practices and risk management, including disclosure of whether directors and officers are permitted to hedge the value of their holdings of the issuer's equity securities. Similar disclosures are required under SEC rules and the Dodd-Frank Act.
The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.