The New York Stock Exchange ("NYSE") and the NASDAQ Stock Market ("NASDAQ," together with the NYSE, the "Exchanges") have proposed changes to their respective listing standards to implement the final rules issued by the Securities and Exchange Commission (the "SEC") on June 20, 2012 regarding compensation committee and compensation committee adviser requirements pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Final Rules").1 The Final Rules directed the Exchanges to adopt listing standards that, generally, (i) require members of an issuer's compensation committee to be comprised of "independent" directors, to be defined by the respective Exchanges after consideration of certain specified factors; and (ii) authorize, but do not require, an issuer's compensation committee to retain independent consultants, legal counsel, and other advisers after consideration of at least six specified "competitively neutral" independent factors.
Each Exchange's proposed rules address the requirements of the Final Rules and implement amendments to its listing standards. The NYSE's proposed rules generally do not extend beyond implementation of the Final Rules, whereas NASDAQ has added certain requirements beyond those required by the Final Rules. The proposed rules of both the NYSE and NASDAQ are summarized below, including those regarding the compensation committee independence standards, the compensation committee's utilization of compensation advisers, exceptions for smaller reporting companies and controlled companies, and effective dates.
Compensation Committee Independence Standards
The Final Rules require the Exchanges to develop their own definition of "independence" to apply in determining whether members of the compensation committee are independent. In determining their formulations of "independence" for compensation committee members, the Exchanges must consider relevant factors, including the source of any compensation received by the director and any affiliations the director may have with the issuer and other related entities.
- The NYSE's proposed rules supplement the NYSE's
existing director independence tests and require an issuer's
board of directors to consider, when determining the independence
of a director who will serve on the issuer's compensation
committee (in addition to the existing independence tests), all
relevant factors that may be material to that director's
ability to be independent from management when performing his or
her duties as a compensation committee member.
- Such factors are to include the source of any compensation received by the director (including any consulting, advisory, or other compensatory fee paid by the issuer to such board member) and whether the director is affiliated with the issuer, a subsidiary of the issuer, or an affiliate of a subsidiary of the issuer.
- Specifically, the board should consider, with respect to sources of compensation, whether the director receives compensation from any source that would impair his or her ability to make independent judgments about compensation and, with respect to affiliations, whether his or her ability to make independent judgments would be impaired as a result of the affiliate relationship because the director may be considered to be under the direct or indirect control of the issuer or its senior management or to have a direct relationship with members of senior management.
The new guidelines regarding compensation committee members do not add any additional bright-line tests regarding independence and do not change the NYSE's existing commentary to the general director independence standards, which provide that ownership of even a significant amount of stock, alone, will not prevent the board from determining that a director is independent.
- While not required by the Final Rules, NASDAQ has taken the
opportunity to adopt a rule that requires issuers (including
smaller reporting companies), subject to certain exceptions, to
have an independent compensation committee consisting of at least
two members of the board of directors who will be responsible for
determining, or recommending to the full board for determination,
the compensation of the chief executive officer and all other
executive officers of the issuer. Under the proposed NASDAQ rules,
subject to certain exceptions, issuers will also be required to
certify that they have adopted a formal written compensation
committee charter and that the compensation committee will review
and reassess the adequacy of the charter on an annual basis. This
rule more closely aligns NASDAQ listing standards with those of the
NYSE with respect to compensation committees. However, under the
proposed NASDAQ rule, the compensation committee charter must
include the prohibition contained in NASDAQ's existing rules
that the CEO not be present during the deliberations or voting on
his or her compensation.
In addition, as mandated by the Final Rules, the board of directors must consider any compensation received by and any affiliations of a compensation committee member in determining his or her independence. However, unlike the NYSE's proposed rules, NASDAQ's proposed rules prohibit a compensation committee member from accepting directly or indirectly any consulting, advisory, or other compensatory fee from the issuer or any of its subsidiaries (not including, for this purpose, (1) fees received as a member of any board committee or (2) the receipt of fixed amounts of compensation under a retirement plan for prior service with the issuer). This proposed rule applies the same standard regarding receipt of compensation by compensation committee members that currently applies to audit committee members under the NASDAQ independence rules.
With respect to director affiliate relationships, while NASDAQ's proposed rules require an issuer's board of directors to specifically consider whether the director is affiliated with the issuer, a subsidiary of the issuer, or an affiliate of a subsidiary of the issuer to determine whether such affiliation would impair the director's judgment as a member of the compensation committee, affiliated persons are not prohibited from serving as members of the compensation committee (as is the case for the audit committee). The proposed rules' commentary states that there may be circumstances where it is appropriate to have certain "affiliated" directors serve on the compensation committee, for instance representatives of significant stockholders, because their interests are aligned with the interests of other stockholders.
- Neither the NYSE's nor NASDAQ's proposed rules have a "look-back" period; this means that only compensation earned or affiliations that occur during the director's service on the compensation committee would be considered.
- Both the NYSE's and NASDAQ's proposed rules contain provisions that would allow issuers to cure any defects in their compensation committee composition under certain circumstances (where an issuer's compensation committee member ceases to be independent due to reasons outside of the compensation committee member's reasonable control and, under the proposed NASDAQ rule, due to a vacancy on the compensation committee). The proposed rules specify the time frames within which the defect may be cured.
In accordance with the Final Rules, the Exchanges have proposed rules that authorize, but do not require, an issuer's compensation committee to retain or obtain advice from compensation advisers and require compensation committees to select any such compensation advisers only after the consideration of six specified "competitively neutral" independence factors (and any other additional factors determined by the relevant Exchange). As set forth in the Final Rules, the "competitively neutral" independence factors are: (1) the provision of other services to the issuer by the person that employs the compensation adviser; (2) the amount of fees received from the issuer by the person that employs the compensation adviser as a percentage of the total revenue of the person that employs the compensation adviser; (3) the policies and procedures of the person that employs the compensation adviser that are designed to prevent conflicts of interest; (4) any business or personal relationship of the compensation adviser with a member of the compensation committee; (5) any stock of the issuer owned by the compensation adviser; and (6) any business or personal relationships between the executive officers of the issuer and the compensation adviser or the person employing the compensation adviser.
- Neither of the Exchanges added any additional specific factors to be considered, but the NYSE's proposed rules do state that any other factors that would be relevant to the compensation adviser's independence from management should also be considered.
- The proposed rules of each Exchange do not prohibit an issuer from hiring and utilizing the services of a compensation adviser that is not considered to be independent under the standards set forth above; however, under the SEC disclosure rules, if a compensation adviser has a conflict of interest (as determined based on the analysis described above), the nature of the conflict must be disclosed in the issuer's proxy statement (or information statement for an annual meeting or any shareholder meeting at which directors are to be elected) as well as information on how the conflict is being addressed. Pursuant to the Final Rules, both Exchanges exempted in-house legal counsel from review under the compensation adviser independence standards.
Exceptions for Smaller Reporting Companies and Controlled Companies
Under the NYSE's proposed rules, smaller reporting companies continue to be required to have standing compensation committees consisting of independent directors but are not required to comply with the additional independence standards relating to compensation committee members in the proposed rules, and are also not required to consider the "competitively neutral" independence factors in the selection of compensation advisers. Under NASDAQ's proposed rules, smaller reporting companies must have a compensation committee consisting of at least two independent directors, but are otherwise exempt from the proposed rules regarding compensation committee and compensation adviser independence.
Controlled companies are generally exempt from the Exchanges' current rules relating to director independence. These exemptions generally remain unchanged and would now exempt controlled companies from the new compensation committee independence standards as well. Additionally, controlled companies are not required to consider the competitively neutral independence factors when selecting compensation consultants. However, under the Final Rules, controlled companies are subject to SEC disclosure requirements relating to the existence of any compensation consultant conflicts of interests.
The Final Rules provide that the Exchanges' proposed rule changes must be approved by the SEC no later than June 27, 2013. Subject to approval by the SEC:
- The NYSE's proposed rules provide that issuers will have until the earlier of their first annual meeting after January 15, 2014 or October 31, 2014 to comply with new listing standards.
- NASDAQ's proposed rules provide, solely with respect to the provision providing that the compensation committee shall have specific authority and responsibilities relating to compensation advisers, that such provision shall be effective immediately (which, in the absence of an existing compensation committee, would apply to the independent directors who determine or recommend compensation of the executive officers). With respect to the remaining provisions under NASDAQ's proposed rules, issuers will generally have until the earlier of their second annual meeting held after the date of the SEC's approval of NASDAQ's proposed rule changes or December 31, 2014 to comply. Special exemptions and/or phase-in rules apply to foreign private issuers and smaller reporting companies.
1 The Final Rules are described in our previous Client Memorandum, SEC Final Rules: Compensation Committee Independence and the Role and Disclosure of Compensation Consultants and Other Advisers (June 26, 2012).
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