On November 26, 2013, the NASDAQ Stock Market LLC (Nasdaq) filed with the Securities and Exchange Commission (SEC) proposed amendments to its listing rules on compensation committee composition to, among other things, replace the current bright-line prohibition on the receipt of compensatory fees by compensation committee members with a requirement that a board of directors instead consider the receipt of such fees when determining eligibility for compensation committee membership. Absent action by the SEC to suspend or disapprove them, the amendments became effectively immediately upon filing.
The existing Nasdaq requirement, adopted in early 2013, prohibits the receipt of compensatory fees (other than director fees) by compensation committee members. Nasdaq is amending Nasdaq Listing Rule 5605(d)(2)(A) to eliminate this strict prohibition and replace it with a requirement that in affirmatively determining the independence of any director who will serve on the compensation committee, a company's board must consider the source of compensation of the director, including any consulting, advisory or other compensatory fee paid by the company to the director.1 Nasdaq is proposing the change in response to feedback from listed companies and others that the strict prohibition on compensatory fees was creating a burden on issuers and causing difficulty in recruiting eligible directors to serve on their boards. This change would harmonize Nasdaq's compensation committee composition requirements with the more flexible rules of the NYSE.
Nothwithstanding this change, compensation committee members must continue to be Independent Directors as defined under Nasdaq Listing Rule 5605(a)(2). That Rule prohibits a director from being considered independent, if among other things, the director
- accepted any compensation from the company (excluding director fees and benefits under a tax-qualified retirement plan, or non-discretionary compensation) in excess of $120,000 during any period of twelve consecutive months within the prior three years; or
- is a partner in, or a controlling shareholder or an executive officer of, any organization to which the company made, or from which the company received, payments for property or services in the current or any of the past three fiscal years that exceed 5% of the recipient's consolidated gross revenues for that year, or $200,000, whichever is greater.
However, solely for purposes of assessing a director's eligibility to serve on the compensation committee, the proposed amendments would require the board of directors to consider all compensation received by the director, including amounts which fall below the above caps and including all director fees and benefits under a tax-qualified retirement plan, or non-discretionary compensation.
Nasdaq is also amending Listing Rule 5605(d)(2) and the related commentary in IM-5605-6 in several other respects:
- The Rule will be further amended to specifically state that in "affirmatively determining the independence of any director who will serve on the compensation committee, the board of directors must consider all factors specifically relevant to determining whether a director has a relationship to the company which is material to that director's ability to be independent from management in connection with the duties of a compensation committee member," including but not limited to the source of director compensation and director affiliations with the company, its subsidiaries and an affiliate of a subsidiary. Nasdaq considers this change non-substantive and simply a clarification of the existing independence requirements.
- IM-5605-6 is being amended to state that:
when considering the sources of a director's compensation in determining independence for purposes of compensation committee service, the board should consider whether the director receives compensation from any "person or entity" that would impair the director's ability to make independent judgments about the company's executive compensation; and
when considering any affiliate relationship a director has with the company, a subsidiary of the company, or an affiliate of a subsidiary of the company, in determining independence for purposes of compensation committee service, the board should consider whether the affiliate relationship places the director under the direct or indirect control of the company or its senior management, or creates a direct relationship between the director and members of senior management, in each case of a nature that would impair the director's ability to make independent judgments about the company's executive compensation.2
Effective Date and Comment Period. Comments on the revised rule may be provided during a 21 day comment period from the date of publication in the Federal Register. Barring any action by the SEC to suspend or disapprove the proposals, the amendments were made effective immediately to enable listed companies to meet the deadline for complying with Nasdaq listing rules on compensation committee director independence, which remain the earlier of a company's first annual meeting after January 15, 2014, or October 31, 2014. Accordingly, Nasdaq believed it important to implement the proposed changes immediately, before companies propose changes to board and committee composition in connection with their 2014 annual meetings.
Implications for Canadian Issuers
While Nasdaq-listed Canadian foreign private issuers are not required to comply with Nasdaq Listing Rule 5605(d) and instead may follow their home company practice, subject to disclosing in their annual report filed with the SEC (or if not required to file a Form 20-F with the SEC, disclosing on their web site) the ways in which their practices differ from the applicable exchange's requirements, a number of Canadian foreign private issuers amended (or were in the process of amending) their compensation committee charters to comply with Nasdaq's compensation committee composition rules. If the Nasdaq rule changes are not disapproved or suspended by the SEC, those Canadian foreign private issuers will want to consider amending their charters again to take advantage of the increased flexibility afforded under the amended rules.
1 Consistent with this change, the amendments remove the exception in the current rule that states that compensatory fees do not include: (i) fees received as a member of the compensation committee, the board of directors or any other board committee; or (ii) the receipt of fixed amounts of compensation under a retirement plan (including deferred compensation) for prior service with the company (provided that such compensation is not contingent in any way on continued service). As a result, boards of directors would be required to consider such fees, in aggregate with all other sources of compensation of the director, to determine whether such compensation would impair the director's judgment as a member of the compensation committee.
2 As proposed, Nasdaq would retain existing language in IM-5605-6 stating that Nasdaq does not believe that ownership of a company's stock by itself, or possession of a controlling interest through ownership of a company's stock, precludes a board finding that it is appropriate for a director to serve on the compensation committee.
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