Last week the SEC adopted final rules directing national securities exchanges to establish listing standards relating to Compensation Committees. (You may recall that Section 952 of Dodd-Frank Wall Street Reform and Consumer Protection Act required the SEC to adopt such rules by July 1, 2011, which slipped a bit.)
Below is a short summary of what these new rules require:
1. Each member of a listed issuer’s Compensation Committee must be a member of the board of directors and meet heightened “independence” standards. The rules do not set out a uniform “independence” standard for Compensation Committee membership, and exchanges have the flexibility to develop independence requirements appropriate for the issuers listed on their exchange and consistent with the standards of the Dodd-Frank Act. In developing their definitions of “independence” applicable to Compensation Committee members, the exchanges must consider “relevant factors,” including but not limited to:
- a director’s source of compensation, including any consulting, advisory or compensatory fee paid by the issuer; and
- whether a director is affiliated with the issuer, a subsidiary of the issuer, or an affiliate of a subsidiary of the issuer.
These factors cover the same matters as the heightened independence standards for Audit Committees, so it seems likely that the exchanges will consider whether Audit Committee membership prohibitions should also apply to Compensation Committee members. Current public companies and companies planning for an IPO may wish to consider whether their current directors (or anticipated nominees) are likely to provide an adequate base of potential committee members meeting the heightened standards.
2. The Compensation Committee may, in its sole discretion, retain or obtain the advice of compensation consultants, legal counsel and other advisers (“compensation advisers”). The Compensation Committee must be:
- directly responsible for the appointment, compensation and oversight of the work of any compensation adviser retained by the Compensation Committee (as opposed to compensation consultants or legal counsel retained by management); and
- provided with appropriate funding from the issuer for payment of reasonable compensation, as determined by the Compensation Committee, to any compensation adviser retained by the Compensation Committee (whether or not such advisers are independent)
3. Before engaging a compensation adviser, the Compensation Committee must “take into account” the “independence” factors enumerated in Section 10C(b)(2) of the Dodd-Frank Act (other services, amount of fees, conflict of interest policies and procedures, business or personal relationships with CC members, and stock ownership), as well as any business or personal relationships between the executive officers of the issuer and the compensation adviser or the person employing the adviser. Note this just requires consideration of these factors, not that the compensation adviser actually be independent; Compensation Committees may engage non-independent compensation advisers if they have considered these factors.
Many companies have already been funding their Compensation Committee’s use of advisers. It remains to be seen whether Compensation Committees will be more active in using advisers as a result of the SEC’s rules, including whether the listing rules adopted by exchanges will create incentives (or disincentives) for Compensation Committees on this topic.
Exchanges will have 90 days to propose amendments to address these new SEC requirements and up to one year to amend their rules to meet these requirements. Exemptions from the Compensation Committee heightened “independence” standards will be available to limited partnerships, companies in bankruptcy proceedings, registered open-end management investment companies and certain foreign private issuers, and broader relief will be available to controlled companies and smaller reporting companies.
In addition, the SEC amended Item 407 of Regulation S-K to provide that companies must disclose whether any work performed by a compensation consultant “has raised any conflict of interest,” including the nature of the conflict and how it is being addressed. This new disclosure requirement applies to proxy or information statements with respect to shareholder meetings at which directors will be elected occurring on or after January 1, 2013.