The Securities and Exchange Commission in June 2012 adopted Rule 10C-1 of the Securities Exchange Act of 1934 pursuant to Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Rule 10C-1 in part requires national securities exchanges to adopt listing standards for public companies addressing the independence of compensation committee members and the use by compensation committees of compensation advisers. Our prior article discussing Rule 10C-1 in detail can be found here.

The NYSE and NASDAQ have now proposed amendments to their respective listing standards relating to compensation committees of listed companies pursuant to Rule 10C-1. The full text of the proposed rule changes can be found for the NYSE here, and for NASDAQ here.

Timing

The SEC will accept comments for a 21-day period, after which the SEC will decide whether to approve the listing standards as proposed or require the exchanges to make changes. There are differences between the two proposals, so the SEC also may ask the exchanges to sync up their approaches in some respects. Rule 10C-1 requires the SEC to declare the listing standards effective by July 27, 2013. NYSE companies would have to comply with the new standards by the earlier of the first annual shareholder meeting after January 15, 2014 and October 31, 2014. NASDAQ companies would have to comply by the earlier of the second annual shareholder meeting after the final rules are issued and December 31, 2014, except that standards relating to the compensation committee's authority to retain independent advisers and responsibility to consider adviser independence would be effective upon final rule approval.

Heightened Compensation Committee Independence Standards

Rule 10C-1 requires boards to consider both the sources of compensation of a compensation committee member and the member's affiliations with the company.

While the Rule permits the exchanges to specify additional factors, neither the NYSE or NASDAQ did so. As required by Rule 10C-1, both exchanges' proposed listing standards contain cure periods that allow companies to correct deficiencies under specified limited circumstances.

NYSE

In addition to general director independence standards, the proposed NYSE listing standards would require the board to affirmatively determine the independence of each compensation committee member considering all factors relevant to determining whether he or she has a relationship with the company that is material to his or her ability to be independent from management in connection with his or her duties as a committee member. The board's consideration must include, but need not be limited to:

  • Sources of compensation, including any consulting, advisory or other compensatory fees paid by the company to the director. In commentary, the NYSE states that the board should consider whether the committee member receives compensation from any person or entity that would impair his or her ability to make independent judgments about the company's executive compensation.
  • Affiliations with the company, a subsidiary of the company or an affiliate of a subsidiary of the company. As explained by the NYSE in commentary, the board should consider whether an affiliate relationship places the committee member under the direct or indirect control of the company or its senior management, or creates a direct relationship between the director and senior management members, in each case of a nature that would impair his or her ability to make independent judgments about the company's executive compensation.

The NYSE retained commentary to director independence standards noting that ownership of even a significant amount of company stock would not, by itself, preclude finding that a director is independent.

While the board must consider these factors, this is not a bright-line test, and the board may find a director independent even though he or she receives a compensatory fee from or has an affiliation with the company, so long as his or her ability to make independent judgments about the company's executive compensation is not impaired.

NASDAQ

The NASDAQ proposal would require compensation committee members to meet general independence standards and prohibit them from accepting, directly or indirectly, any consulting, advisory or other compensatory fees from the company or any of its subsidiaries, other than board and committee fees and fixed amounts under retirement plans for prior service. Unlike the NYSE, NASDAQ proposes a bright-line test, such that the receipt of any consulting, advisory or other compensatory fees by a director would preclude serving on the compensation committee, the same standard NASDAQ applies to audit committee members.

Though not a bright-line test, NASDAQ company boards would also have to consider whether compensation committee members are affiliated with the company, a subsidiary of the company or an affiliate of a subsidiary of the company and whether any affiliation would impair his or her judgment as a member of the compensation committee. In commentary, NASDAQ states that it does not view ownership of company stock in and of itself as a bar to compensation committee service, even if that ownership constitutes control.

The board is not required to apply a "look back" in making these determinations, so the prohibition on fees and affiliations that must be considered are limited to those fees received or affiliations that existed during a director's committee service.

Compensation Committee Authority and Responsibility

The NYSE listing standards currently require compensation committees to have charters, but the charters will need to be amended to reflect the authority and responsibilities of committees as required under these new compensation committee and adviser independence rules, including that the committee has the sole discretion to retain compensation advisers and direct responsibility for the appointment, compensation and oversight of compensation advisers.

As now required for NYSE companies, the proposed NASDAQ listing standards would require NASDAQ companies to have an independent compensation committee with at least two members. NASDAQ also proposes to require compensation committees to have a charter that addresses the committee's structure, authority and responsibilities and includes the currently applicable prohibition on the chief executive officer being present during voting or deliberations on his or her compensation. The committee would have to review and assess the adequacy of the charter annually.

Compensation Committee Adviser Independence

The NYSE and NASDAQ proposed standards would require compensation committee charters to state that the committee must consider conflicts of interest before selecting consultants, counsel or other advisers (other than in-house legal counsel). While compensation committees must consider these factors prior to selecting an adviser, it is important to note that the rules would not limit the committee to selecting only independent advisers.

The exchanges propose requiring that compensation committees may select an adviser only after considering the six independence standards specified by the SEC in Rule 10C-1 and, in the case of NYSE companies, any other factors relevant to the adviser's independence. The standards specified in Rule 10C-1 include:

  • whether the company employing the compensation adviser is providing any other services to the listed company;
  • the amount of fees the company employing the compensation adviser has received from the listed company, as a percentage of the consulting company's total revenue;
  • what policies and procedures have been adopted by the company employing the compensation adviser to prevent conflicts of interest;
  • whether the compensation adviser has any business or personal relationship with a member of the compensation committee;
  • whether the compensation adviser owns any stock of the company (which the SEC interprets to include stock owned by the adviser and his or her immediate family members); and
  • whether the compensation adviser or the company employing the adviser has any business or personal relationship with an executive officer of the listed company.

Neither exchange has proposed additional standards or elaborated on the Rule 10C-1 standards, and no doubt questions will arise. For example — What constitutes "providing advice" to the committee? What types of information constitute "advice" that triggers the requirement?

Since compensation committees are not prohibited from selecting non-independent advisers, a committee could continue to be advised by the company's outside legal counsel. As proposed, the NYSE standards would require a compensation committee to consider the six independence standards with respect to any outside legal counsel, but the NASDAQ standards would only require the committee to do so if it wanted to retain its own independent counsel.

Exemptions

As proposed, smaller reporting companies listed on NYSE or NASDAQ would not need to comply with the heightened compensation committee independence standards or the requirement to consider adviser independence; however, listed smaller reporting companies would have to have an independent compensation committee with a written charter. None of the new listing standards would apply to controlled companies, limited partnerships, companies in bankruptcy proceedings, open-end management investment companies registered under the Investment Company Act of 1940, and foreign private issuers that disclose in their annual report the reasons that they do not have an independent compensation committee.

What Listed Companies Should Do Now

Although the listing standards are subject to revision and will not be final for some time, there are several things that a listed company can do to prepare for the new requirements.

  • Review the applicable proposed standards and update the board and compensation committee regarding the new requirements and when they are expected to apply to the company.
  • Consider the independence of current compensation committee members under the proposed standards.
  • Determine how to assess compensation adviser independence, begin collecting conflicts information from advisers, and consider adviser independence under the proposed standards.
  • Consider updates to D&O questionnaire, compensation committee charter and policies, and proxy statement disclosure that will be necessary under new standards.
  • If you are a NASDAQ company without a separate independent compensation committee, prepare to comply with the requirement to have one.

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.