United States: Independence Of Compensation Consultants – Looking Forward And Backward

Last Updated: February 21 2013
Article by Robert K. Morris

Most Read Contributor in United States, October 2017

On January 11 2013, the Securities and Exchange Commission approved rule changes proposed by the New York Stock Exchange ("NYSE") and the NASDAQ Stock Market ("Nasdaq")1, adding new requirements for consultants retained by compensation committees of NYSE and Nasdaq companies. The new rules, effective July 1 2013, require that compensation committees, prior to selecting or receiving advice of a compensation consultant, legal counsel or other adviser, must consider all factors relevant to the independence of the consultant, counsel or other adviser from management, and in particular, must consider six enumerated factors. These factors are: the provision of other services to the company by the person that employs the compensation consultant, legal counsel or other adviser; the amount of fees received from the company by the person that employs the compensation consultant, legal counsel or other adviser, as a percentage of the total revenue of the person that employs the compensation consultant, legal counsel or other adviser; the policies and procedures of the person that employs the compensation consultant, legal counsel or other adviser that are designed to prevent conflicts of interest; any business or personal relationship of the compensation consultant, legal counsel or other adviser with a member of the compensation committee; any stock of the company owned by the compensation consultant, legal counsel or other adviser; and any business or personal relationship of the compensation consultant, legal counsel, other adviser or the person employing the adviser with an executive officer of the company.2

The rules only require an independence assessment, and do not by their terms impose a requirement that such a consultant be independent.3

The committee is not required to conduct the independence assessment with respect to in house legal counsel for the company, or for any compensation consultant, legal counsel or other adviser whose role is limited to activities for which no disclosure would be required under Item 407(e)(3)(iii) of Regulation S-K (see discussion below). These activities are: consulting on any broad-based plan that does not discriminate in scope, terms or operation in favor of executive officers or directors of the company, and that is available generally to all salaried employees; or providing information that either is not customized for a particular company or that is customized based on parameters that are not developed by the compensation consultant, and about which the compensation consultant does not provide advice.4

In the past, even though NYSE and Nasdaq rules did not mandate an independence assessment of compensation consultants, most compensation committees have been attentive to independence considerations in obtaining the advice of consultants. Committees have ordinarily considered it an inherent part of their duties to assess, if a consultant's advice as to management compensation is sought, whether the consultant's professional judgment might be colored by any relationship it might have with the company or its management. However, such assessment may have been conducted in a variety of ways, with consideration of a variety of factors bearing on independence, not necessarily tracking precisely the factors now included in the new NYSE and Nasdaq rules.

In particular, disclosure requirements which have applied to prior year's proxy statements have impacted a compensation committee's assessment of a consultant's independence. Disclosure has previously been required of any role of compensation consultants in determining or recommending the amount or form of executive and director compensation in the prior fiscal year (other than a role limited to consulting on any broad-based plan that does not discriminate in scope, terms or operation in favor of executive officers or directors of the company, and that is available generally to all salaried employees; or providing information that either is not customized for a particular company or that is customized based on parameters that are not developed by the compensation consultant, and about which the compensation consultant does not provide advice).5 In addition, if the consultant also provided additional services to the company for which it was paid more than $120,000 during the last year, disclosure has been required as to the fees paid to the consultant for determining or recommending the amount or form of executive and director compensation and the aggregate fees for such additional services.6 In the past, a committee would likely be mindful of the need for such disclosure before retaining a consultant in these circumstances.

For proxy statements filed after January 1 2013, i.e. proxy statements for the 2013 season of spring annual meetings, an additional disclosure requirement applies. This year, with regard to any compensation consultant identified pursuant to the disclosure requirements described above, if the consultant's work "has raised any conflict of interest," disclosure is required of the nature of the conflict and how the conflict is being addressed.7 The consultant's work here would be work performed during 2012. For purposes of this requirement, companies are instructed that the same six enumerated factors now contained in the new NYSE and Nasdaq rules be considered in determining whether a conflict of interest exists.8

Here lies a process issue. This disclosure requirement is triggered where the 2012 work of the consultant "has raised any conflict of interest," based on a consideration of the specific enumerated factors. This leaves open the question as to who should determine whether any conflict of interest has been raised based on these factors. Very likely, the compensation committee reached some conclusion about whether the consultant's work raised a conflict of interest. However, since the explicit enumerated factors were not required to be considered by the committee at that time, very likely the committee's consideration was done in a more generalized manner, without the consideration of the factors. Regardless, in connection with the development of disclosure in the 2013 proxy statement, these factors are now required to be considered.

In most cases, there will be a reluctance to have the compensation committee now revisit the issue of the consultant's independence with respect to its 2012 work, and consider the six enumerated factors in that connection. The persons responsible for the proxy statement disclosure will likely need to make this determination in the first instance, subject to overall approval of the proxy statement by the board of directors.

In this regard, information will need to be developed to permit assessment of the enumerated factors. Some of this information will be readily available, such as determining whether the consultant has rendered other services to the company, and how much it received for such services. Other items may require a more searching inquiry of the consultant, such as ascertaining the percentage of its total revenues represented by its revenues from other services (if any) provided to the company, its policies and procedures designed to prevent conflicts of interest, any business or personal relationship it may have with a member of the compensation committee (alternatively, this information could be derived from a query to committee members), any stock of the company owned by the consultant, or any relationship of the consultant with an executive officer of the company (alternatively this information could be derived from a query to executive officers).

After developing this information, the persons responsible for preparing proxy statement disclosure may be able to make an appropriate determination that the compensation consultant's work did not "raise" any conflict of interest, so that no additional proxy statement disclosure is required. In this event, it may well be prudent to share the conclusion expressly with the compensation committee, explaining the consideration given to the six factors in connection with preparing the proxy statement. This would not require any specific approval of the committee, but would have the benefit of providing the committee with an advance look at the considerations the committee will have to examine in evaluating the independence of consultants after July 1 2013.

In future years, where under NYSE and Nasdaq rules the compensation committee will be required to assess a consultant's independence when it has been engaged or its advice received, the issue of whether the consultant's work has raised a conflict of interest will have been resolved prior to preparation of proxy statement disclosure, and likely will require no additional consideration at that time.


1 Release No. 34-68639 (NYSE approval); Release No. 34-68640 (Nasdaq approval).

2 NYSE Rule 303A.05(c)(iv); Nasdaq Rule 5605(d)(3)(D).

3 NYSE Commentary to Rule 303A.05(c); Nasdaq Rule 5605 (d)(3).

4 NYSE Commentary to Rule 303A.05(c); Nasdaq Rule 5605(d)(3).

5 Regulation S-K, Item 407(e)(3)(iii).

6 Regulation S-K, Item 407(e)(3)(iii)(A).

7 Regulation S-K, Item 407(e)(3)(iv).

8 Regulation S-K, Instruction to Item 407(e)(3)(iv).

This article is presented for informational purposes only and is not intended to constitute legal advice.

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