As we previously blogged, in June 2012 the SEC adopted final rules directing national securities exchanges to establish listing standards relating to compensation committees. The NYSE and Nasdaq have now done so.
SEC Approves Listing Rules Affecting Compensation Committees and Advisers
The SEC has approved new NYSE and Nasdaq listing rules that implement Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Previously, in June 2012, the SEC adopted Rule 10C-1 under the Securities Exchange Act of 1934, as amended, which directed the national securities exchanges to adopt listing rules to implement the independence requirements set forth in Section 952 for compensation committee members as well as for compensation consultants and other compensation advisers.
Under the new listing requirements, issued on January 11, 2013, members of the compensation committee must meet heightened independence tests akin to the heightened requirements for members of the audit committee. Additionally, the compensation committee must be vested with the authority to retain outside advisers and is required to evaluate the independence of such advisers prior to their engagement.
The new listing rules do not, however, require that compensation advisers meet any specific independence test or mandate that companies retain compensation advisers in developing their executive compensation programs.
Compensation committee authority
NYSE Rules. The NYSE rules previously required companies to have a compensation committee and that such committee adopt a formal written charter setting forth the scope of the committee’s responsibilities. The new NYSE listing rules now require that the charter include additional provisions with respect to compensation advisers.
The charter must specify that:
- the compensation committee, in its sole discretion, must have the authority to retain or obtain the advice of a compensation consultant, independent legal counsel or other adviser
- the compensation committee must be directly responsible for the appointment, compensation and oversight of the work of any compensation consultant, independent legal counsel or other adviser retained by the compensation committee and
- the company must provide appropriate funding for the payment of reasonable compensation to advisers retained by the compensation committee
Nasdaq Rules. Prior to the new rules, Nasdaq did not require a separate compensation committee or that such a committee have a formal written charter setting forth its responsibilities. Under the new listing rules, Nasdaq companies are required to have a compensation committee composed of at least two independent directors and the committee is required to have a formal written charter specifying the scope of the committee’s responsibilities.
The charter must:
- specify the committee’s responsibility for determining or recommending to the board for determination the compensation of the CEO and all other executive officers of the company
- provide that the CEO may not be present during voting or deliberations on his or her compensation
- set forth the committee’s responsibilities and authority with respect to retaining appointing, compensating, and overseeing its own advisers
- require the committee to consider certain independence factors before selecting advisers and
- ensure the committee receives appropriate funding from the company to engage its advisers
Compensation committee members: heightened independence requirements
In addition to independence standards that already apply to directors of companies listed on the NYSE and Nasdaq, compensation committee members must also meet heightened independence requirements.
NYSE Rules. The NYSE requires that companies have a compensation committee that is composed entirely of independent directors. Under the NYSE rules, no director is deemed to be independent unless the board of directors affirmatively determines that no material relationship exists between the director and the company. In determining the independence of directors who will serve on the compensation committee, the board of directors will also need to consider (i) the source of any compensation paid to the director, including any consulting, advisory or other compensatory fee paid by the company, and (ii) whether the director is affiliated with the company or a subsidiary, or an affiliate of a subsidiary.
Nasdaq Rules. Under the Nasdaq rules, directors will not be considered independent for purposes of membership on the compensation committee if the director has accepted, directly or indirectly, any consulting, advisory or compensatory fees paid by the issuer. The Nasdaq rules specify that compensatory fees do not include fees received as a member of the board of directors or any board committee or the receipt of fixed amounts of compensation under a retirement plan for prior service with the company. In addition, companies must also consider whether the director is affiliated with the company, a subsidiary of the company or an affiliate of a subsidiary of the company to determine whether such affiliation would impair the director’s judgment as a member of the compensation committee.
Both the NYSE and Nasdaq rules make clear that an individual’s status as an affiliate due to stock ownership does not automatically bar the board from determining that an individual is independent. The NYSE and Nasdaq rules also include cure periods for the failure of a director serving on the compensation committee to satisfy the heightened independence requirements. Additionally, the new compensation committee standards do not apply to controlled companies, limited partnerships, companies in bankruptcy and foreign private issuers following their home country practices that do not require compensation committees. Nasdaq has also retained the exception that will allow for one non-independent director to serve on the compensation committee under exceptional and limited circumstances, as long as the director is not an executive officer. This exception is only permitted if the committee is composed of at least three members and the company’s board determines it is in the best interest of the company and its stockholders.
Assessing compensation adviser independence
Under both the NYSE and the Nasdaq new listing rules, compensation committees are required to assess the independence of compensation advisers, which include not only compensation consultants, but also legal counsel and other advisers that provide advice to the compensation committee. The compensation committee may select, or receive advice from, a compensation consultant, legal counsel or other adviser only after taking into consideration the following factors:
- the provision of other services to the company by the employer of the compensation consultant, legal counsel or other adviser
- the amount of fees received from the company by the employer of 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 employer of 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
In addition, the NYSE requires consideration of all factors relevant to an adviser’s independence. Nasdaq does not have a similar catch-all requirement.
Both the NYSE and the Nasdaq new listing rules make clear that the compensation committee does not need to evaluate the independence of in-house counsel that provides advice and guidance to the compensation committee. Furthermore, the compensation committee does not need to evaluate the independence of compensation advisers that provide services related to any broad-based plan that does not discriminate in favor of executive officers or directors and that is available generally to all salaried employees or that provides information that either is not customized for a particular issuer or that is customized based on parameters that are not developed by the adviser.
The listing rules do not mandate that the compensation committee use the services of a compensation consultant, legal counsel or any other advisers in determining its executive compensation programs or that such advisers be independent. However, as noted above, if the compensation committee does retain an adviser, the company must provide appropriate funding, as determined by the compensation committee, for payment of reasonable compensation to such advisers retained by the compensation committee.
Compliance by smaller reporting companies
The NYSE and Nasdaq listing rules do not require smaller reporting companies (as defined in Rule 12b-2 of the Exchange Act) to comply with the heightened independence standards for members of the compensation committee or the requirements related to compensation adviser independence. Under the NYSE listing rules, smaller reporting companies will continue to be required to comply with the existing listing requirements concerning the compensation committee’s authority, responsibility and funding of compensation advisers. The Nasdaq listing rules require smaller reporting companies to have a compensation committee of at least two members, each of whom must be independent. Additionally, the Nasdaq listing rules permit a smaller reporting company to adopt a board resolution, as opposed to a formal written charter, that specifies the compensation committee’s responsibilities and authority. Smaller reporting companies are not required to review and reassess the adequacy of the compensation committee charter or board resolution on an annual basis.
Companies will need to comply by July 1, 2013 with the new NYSE and Nasdaq listing rules relating to (i) the authority of a compensation committee to retain compensation consultants, legal counsel, and other compensation advisers, (ii) the funding for such advisers and (iii) the responsibility of the committee to consider independence factors before selecting or receiving advice from such advisers.
The remaining provisions of the NYSE and Nasdaq listing rules, including compensation committee member independence and the adoption of a formal committee charter that complies with the new listing rules, will need to be in place by the earlier of the first annual meeting of stockholders that occurs after January 15, 2014 or October 31, 2014.
The new NYSE and Nasdaq listing rules both generally provide that the existing transition period for companies that list in connection with an initial public offering will continue to apply.
As noted in our previous client alert, new disclosures related to compensation consultant conflicts of interest are effective for the 2013 proxy season. Item 407(e)(3)(iv) of Regulation S-K requires companies to disclose any conflicts that exist with compensation consultants who are required to be identified in the proxy statement. In evaluating whether a conflict exists, companies should consider the independence factors listed above.
At the very least, listed companies will need to evaluate their existing compensation committee charters to ensure that the additional provisions contained in the new listing rules are addressed. Nasdaq-listed companies that have operated without a compensation committee, or do not have a charter for their compensation committee, will need to establish a committee with the requisite scope of responsibility and adopt a charter that complies with the new rules.
Companies must also evaluate the relationships that compensation committee members have with the company to determine if those relationships compromise such member’s independence.
Finally, to the extent that compensation committees engage advisers to assist them, the committee must evaluate the independence factors set forth above before engaging those advisers.
As a practical matter, companies that comply with the “outside director” standard for purposes of Section 162(m) of the Internal Revenue Code, which limits the deductibility of annual compensation that exceeds US$1 million paid to certain public company executives, may not see much impact from the heightened independence requirements, in that Section 162(m) prohibits any form of consulting or similar arrangement with a director. However, the new independence standard regarding affiliate status may raise issues for companies with compensation committee members who are employees or representatives of large shareholders, such as private equity firms. Companies should consult with counsel to evaluate the independence of their compensation committee members under these new listing standards and begin to prepare for potential changes in committee membership that may be appropriate in order to comply with those standards.