The Securities and Exchange Commission (SEC) on January 11, 2013, approved the amended proposals of the NYSE and NASDAQ to amend their respective listing standards relating to independence requirements for compensation committees and compensation advisers of listed companies to comply with Rule 10C-1 adopted by the SEC pursuant to the Securities Exchange Act of 1934, as amended (Exchange Act). The SEC's adoption of Rule 10C-1 had been mandated by Section 952 of the Dodd-Frank Wall Street Reform and Protection Act of 2010.
The full text of the approved amendments can be found for the NYSE at http://www.sec.gov/rules/sro/nyse/2013/34-68639-ex5.pdf and for NASDAQ at http://www.sec.gov/rules/sro/nasdaq/2013/34-68640-ex5.pdf.
Deadlines
The NYSE and NASDAQ amendments become operative on July 1, 2013. By that date, listed companies must comply with the new standards relating to (i) the compensation committee's authority to, in its sole discretion, retain compensation advisers, (ii) the committee's direct responsibility for the appointment, compensation and oversight of compensation advisers, (iii) the company's responsibility to provide appropriate funding to pay the reasonable fees of the compensation advisers, and (iv) the committee's responsibility to consider conflicts of interest before selecting or receiving advice from any compensation advisers. For NYSE listed companies, this includes amending their compensation committee charters to comply with the new standards. For NASDAQ listed companies that do not have a separate compensation committee on July 1, 2013, the new standards described above apply to the independent directors who oversee the compensation of the company's chief executive officer and other executive officers. NYSE listed companies have until the earlier of their first annual shareholders' meeting after January 15, 2014 or October 31, 2014, to comply with the heightened compensation committee member independence standards.
NASDAQ listed companies have until the earlier of their first annual shareholders' meeting after January 15, 2014 or October 31, 2014, to comply with the remaining new standards, including those relating to (i) establishing a compensation committee, if not already in place, (ii) the adoption of a compensation committee charter or amendments thereto that complies with the new standards, and (iii) heightened compensation committee member independence. Each NASDAQ listed company must certify to NASDAQ that it has complied with the new standards no later than 30 days after the final implementation deadline applicable to it. There is no equivalent requirement for NYSE listed companies.
Heightened Compensation Committee Independence Standards
NYSE
In addition to general director independence standards, the amendments to the NYSE listing standards 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 does 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 amendments to the NASDAQ listing standards 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 (provided that such compensation is not contingent on continued service). Unlike the NYSE, the NASDAQ standard is a bright-line test, such that the receipt of any consulting, advisory or other compensatory fees by a director precludes serving on the compensation committee. This is the same standard NASDAQ applies to audit committee members. NASDAQ company boards must also 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 impairs 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 prohibitions on fees and affiliations that must be considered are limited to those fees received or affiliations that existed during a director's committee service. As required by Rule 10C-1 of the Exchange Act, both exchanges' proposed listing standards contain cure periods that allow companies to correct deficiencies under specified limited circumstances by the earlier of its next annual shareholders' meeting or one year from the occurrence of the event that caused the deficiency.
Likewise, under exceptional and limited circumstances, NYSE and NASDAQ companies may appoint a non-independent director to the compensation committee if the company's board determines that such director's membership on the committee is in the best interests of the company and its shareholders, so long as the non-independent director is not currently an executive officer, employee, or a family member of an executive officer, and the committee is comprised of at least three members.
Compensation Committee Authority and Responsibility
NYSE
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 standards, including that (i) the committee has the sole discretion to retain compensation advisers, (ii) the committee has direct responsibility for the appointment, compensation and oversight of compensation advisers, (iii) the company must provide appropriate funding, as determined by the committee, for payment of reasonable compensation to the compensation advisers, and (iv) the committee must consider the independence standards discussed below when selecting or receiving advice from a compensation adviser.
NASDAQ
As has been required for NYSE companies, the amendments to the NASDAQ listing standards require NASDAQ companies to have a separate compensation committee with at least two independent members. The new standards also require compensation committees to have a charter that addresses (i) the committee's responsibilities and how it carries out those responsibilities, including structure, processes and membership requirements, (ii) the committee's responsibility for determining, or recommending to the board for determination, the compensation of the chief executive officer and all other executive officers of the company, (iii) the currently applicable prohibition on the chief executive officer being present during voting or deliberations on his or her compensation, (iv) that the committee has the sole discretion to retain compensation advisers, (v) that the committee has direct responsibility for the appointment, compensation and oversight of compensation advisers, (vi) that the company must provide appropriate funding, as determined by the committee, for payment of reasonable compensation to the compensation advisers, and (vii) that the committee must consider the independence standards discussed below when selecting or receiving advice from a compensation adviser. The committee must review and assess the adequacy of the charter annually.
Compensation Committee Adviser Independence
The amendments to the NYSE and NASDAQ standards require compensation committee charters to state that the committee must consider conflicts of interest before selecting consultants, counsel or other advisers (other than (i) in-house legal counsel, and (ii) any adviser whose role is limited to consulting on any broad-based plan or providing information that is either not customized for the company or that is customized based on parameters that are not developed by the adviser and about which the adviser does not provide advice). While compensation committees must consider these factors prior to selecting an adviser, it is important to note that the new standards do not limit the committee to selecting only independent advisers.
The amendments require that compensation committees may select an adviser only after considering the six independence standards specified by the SEC in Rule 10C-1 of the Exchange Act 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 compensation adviser'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.
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.
Exemptions
Smaller reporting companies listed on NYSE or NASDAQ do not need to comply with the heightened compensation committee independence standards or the requirement to consider adviser independence; however, listed smaller reporting companies are required to have an independent compensation committee with a written charter. None of the new listing standards 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
There are several things that a listed company should do to prepare for the new requirements in advance of the applicable deadlines.
Before July 1, 2013, listed companies should:
- Review the applicable new standards and update the board and compensation committee regarding the new requirements and when they apply to the company.
- Update compensation committee charters or, alternatively for NASDAQ listed companies, adopt board resolutions approving (i) the compensation committee's authority to, in its sole discretion, retain compensation advisers, (ii) the committee's direct responsibility for the appointment, compensation and oversight of compensation advisers, (iii) the company's responsibility to provide appropriate funding to pay the reasonable fees of the compensation advisers, and (iv) the compensation committee's responsibility to consider conflicts of interests before selecting or receiving advice from any compensation advisers. For NASDAQ listed companies that do not have a separate compensation committee on July 1, 2013, the expanded authority and responsibility discussed above must be given to the independent directors who oversee the compensation of the company's chief executive officer and other executive officers.
- Begin to assess compensation adviser independence by collecting conflicts information from advisers, and consider adviser independence under the new standards. Prior to the earlier of the company's first annual shareholders' meeting after January 15, 2014 or October 31, 2014, NYSE listed companies should:
- Affirmatively determine the independence of each compensation committee member under the new standards.
- Update D&O questionnaires, policies, and proxy statement disclosure to comply with the new standards.
Prior to the earlier of the company's first annual shareholders' meeting after January 15, 2014 or October 31, 2014, NASADQ listed companies should:
- Consider the independence of current compensation committee members under the new standards.
- Establish a separate compensation committee that complies with the new standards if they did not previously have one.
- Adopt a compensation committee charter or amend the current charter to comply with the new standards if they did not do so prior to July 1, 2013.
- Update D&O questionnaires, policies, and proxy statement disclosure to comply with the new standards.
NASDAQ listed companies must certify to NASDAQ that they have complied with the new standards within 30 days of the applicable compliance deadline. Finalizing the amendments to the listing standards to comply with Rule 10C-1 of the Exchange Act completes the rule making process required by Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Our prior article discussing Rule 10C-1 in detail can be found at http://www.drinkerbiddle.com/resources/publications/2012/Securities-Update-June-2012.
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.
