Recently, the U.S. Securities and Exchange Commission (the "SEC") approved NASDAQ's new Rule 5250(b)(3), which requires NASDAQ-listed companies to publicly disclose any cash or non-cash payments made by third parties to any directors or director nominees in connection with their candidacy for, and/or their service on, a company's board of directors. Foreign private issuers will be required to comply with the new rules. The SEC approved concurrent amendments to NASDAQ Rule 5615 to provide that foreign private issuers subject to disclosure requirements regarding these types of compensation arrangements in their home countries will be permitted to follow those rules in lieu of the NASDAQ rules, with appropriate Form 6-K disclosure.
Analysis of the New Rules
The payments covered by the new rules, referred to as "golden leash" arrangements, include health insurance benefits, indemnification arrangements and payments, and other payments by a shareholder or shareholder groups to directors based on the achievement of corporate metrics or stock performance criteria. The new rules are intended to address any conflicts of interest that may arise in connection with such payments, including concerns that such payments may affect a director's ability to satisfy his or her fiduciary duties or cause a director to focus on short-term results at the expense of long-term strategies.
Under the new rules, each listed company must publicly disclose any "golden leash" arrangements either on the company's website or in its next proxy statement prepared for a shareholders' meeting at which directors are elected (or, if they do not file proxy or information statements, no later than when the company files its next annual report on Form 10-K or Form 20-F). The disclosure must be made no later than the date on which the company files or furnishes such proxy or information statement in connection with the next shareholders' meeting at which directors are elected. Such disclosure must be repeated annually until the earlier to occur of (i) a director's departure from the board, or (ii) one year after the termination of the compensation arrangement.
The "golden leash" rule provides that a company would not need to disclose agreements and arrangements that: (i) relate only to reimbursement of expenses in connection with candidacy as a director; (ii) existed prior to the nominee's candidacy (including as an employee of the other person or entity), where such nominee's relationship with a third party has been publicly disclosed in a definitive proxy or information statement or annual report; or (iii) have been disclosed under Item 5(b) of Schedule 14A of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), or Item 5.02(d)(2) of Form 8-K in the current fiscal year.
Newly executed agreements do not have to be disclosed separately at the time of entry into such agreement, but must be disclosed within the time periods required for disclosure in connection with the next following annual meeting, which depending on the timing of the appointment, may be a matter of only weeks or months later.
If a company discovers something that should have been disclosed but was not, prompt disclosure must be made either by filing a Form 8-K (or Form 6-K for foreign private issuers), or by issuing a press release. Companies will not be considered deficient if they have undertaken reasonable efforts to identify any such agreements, including by asking each director or nominee in a manner to allow timely disclosure. If a company fails to undertake such reasonable efforts and its disclosure is determined to be deficient, it will receive a deficiency notice from NASDAQ and must provide a plan to regain compliance within 45 calendar days of such deficiency notice.
How to Comply with the New Rules
Most public companies currently utilize director and officer questionnaires (a "D&O Questionnaire") to solicit information from directors and officers necessary to comply with existing SEC and NASDAQ disclosure rules relating to, among other things, beneficial ownership of securities, director independence and related person transactions. Most types of direct compensation arrangements for board service already would require disclosure under Items 401, 402 or 404 of Regulation S-K. However, indirect compensation arrangements such as compensation tied to performance benchmarks of the company that are structured to fall outside of the current SEC disclosure rules would be covered by the new NASDAQ rules.
Accordingly, NASDAQ listed companies should assess their existing forms of D&O Questionnaire to solicit additional information from directors and director nominees in respect of (i) their principal occupation and employment over the prior five years (currently designed to solicit biographical information under Item 401 of Regulation S-K and independence considerations under NASDAQ Rule 5605), and (ii) related person transactions (currently designed to solicit related person transactions under Item 404 of Regulation S-K and independence considerations under NASDAQ Rule 5605). In both cases, the form D&O Questionnaire should be expanded to solicit specific information covered by the new rules, which at a minimum, should include the following questions:
- Are you currently a party to any contract, arrangement or understanding, either oral or written, that relates directly or indirectly to your service as a director or director nominee of the company? If your answer yes, please provide a description and furnish a copy of any such written contract, arrangement or understanding.
- Has any person or entity furnished you, any affiliate or any member of your immediate family with any form of compensation, personal benefits or other remuneration, in each case that is directly or indirectly in connection with your service as a director or director nominee? Benefits would include, without limitation, health insurance benefits, perquisites, indemnification payments or arrangements, and any compensation payable in respect of any metrics or performance of the Company. If you answer yes, please provide an itemization of all such compensation, benefits or other form of remuneration, including a description of each item, the recipient and the amount and copies of any written contract, arrangement or understanding relating to such payments or benefits.
As the rules effectively grandfather existing arrangements subject to disclosure of material changes, it is important to solicit information with respect to any arrangements currently in place regardless of when entered into by the director or director nominee so that any changes to such arrangements can appropriately be disclosed in the future.
The new rules became effective on August 1, 2016 for shareholder meetings that occur on or after such date.
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