United States: SEC/SRO Update - November 2012

SEC Issues New JOBS Act Guidance on Emerging Growth Companies 

On September 28, the Securities and Exchange Commission (SEC) issued additional frequently asked questions (FAQs) as part of its guidance on Title I of the Jumpstart Our Business Startups Act (the JOBS Act) related to emerging growth companies.

Most of the FAQs cover issues related to M&A activities of, and financial information presented by, emerging growth companies. For example, the SEC clarified that an emerging growth company may use test-the-waters communications with Qualified Institutional Buyers (QIBs) and institutional accredited investors in connection with an exchange offer or merger. An emerging growth company may also use the confidential submission process to submit a draft registration statement for an exchange offer or merger that constitutes its initial public offering of common equity securities.

The SEC provided guidance related to instances when an emerging growth company may or may not present only two years of financial information. For instance, if a target company that does not qualify as a smaller reporting company is to be acquired by an emerging growth company that is not a shell company and that will present only two years of its financial statements in its registration statement for the exchange offer or merger, the emerging growth company may presents only two years of financial statements for the target company in its registration statement. However, the SEC clarified that an emerging growth company that is not a smaller reporting company is required to present three years of financial statements in its registration statement on Form 10 or Form 20-F under the Securities Exchange Act of 1934. The JOBS Act accommodation, which permits two years of financial statements, applies only to the Securities Act registration statement for the initial public offering of common equity securities.

In addition, the FAQs specified that the SEC would not object if an issuer that lost its emerging growth company status does not present, in subsequently filed registration statements and periodic reports, selected financial data or a ratio of earnings-to-fixed-charges for periods prior to the earliest audited period presented in its initial registration statement.

The SEC also indicated that an issuer, which is not currently required to file Exchange Act reports but was once an Exchange Act reporting company and is now planning to conduct a public offering of its common equity securities, can take advantage of the benefits of emerging growth company status, even though its initial public offering of common equity securities occurred on or before December 8, 2011. However, this position is not available to an issuer that has had the Exchange Act registration revoked pursuant to §12(j) of the Exchange Act.

NASDAQ Compensation Committee Rules Will Become a Mini-Me of Its Audit Committee Rules

Background Information and Effective Dates

On September 25, the NASDAQ Stock Market LLC (Nasdaq) proposed changes to its listing standards related to compensation committees. Nasdaq proposed new compensation committee rules in response to the SEC's Rule 10C-1, which became effective on July 27, 2012 and which, in its turn, was promulgated in response to § 952 of the Dodd-Frank Act that required the SEC to direct the national securities exchanges to prohibit the listing of any equity security of an issuer, subject to certain exemptions, that does not comply with the Act's requirements relating to compensation committees and compensation advisers.

Proposed Nasdaq Listing Rule 5605(d)(3), which requires compensation committees to have the specific responsibilities and authority necessary to comply with Rule 10C-1(b)(2), (3) and (4)(i)-(vi) under the Securities Exchange Act of 1934, will be effective immediately upon the SEC's approval of the Nasdaq's proposal as discussed below under Compensation Committee Responsibilities.

Nasdaq-listed companies must comply with the remaining amended listing rules by the earlier of: (i) their second annual meeting held after the date of approval of the proposed rules; or (ii) December 31, 2014. A company must certify to Nasdaq, no later than 30 days after the implementation deadline applicable to it, that it complied with the amended listing rules on compensation committees. (Nasdaq will provide a form for this certification). During the transition period, companies that are not yet required to comply with the amended listing rules on compensation committees must continue to comply with Nasdaq's existing listing rules, which have been redesignated as Listing Rule 5605A(d) and IM-5605A-6 in Nasdaq's proposal.

Compensation Committee Composition and Charter

Generally, Nasdaq's proposal has almost closed the bridge between its compensation committee and audit committee rules, and many requirements applicable to audit committees of Nasdaq-listed companies are now applicable to their compensation committees. Please see below a chart comparing Nasdaq's current compensation committee rules, its proposed compensation committee rules and current audit committee rules.

Contents of the Compensation Committee Charter

Under the Nasdaq's proposal, the compensation committee charter must specify the following:

• the scope of the compensation committee's responsibilities, and how it carries out those responsibilities, including structure, processes and membership requirements;
• the compensation committee's responsibility for determining, or recommending to the board for determination, the compensation of the executive officers of the company;
• that the chief executive officer of the company may not be present during voting or deliberations by the compensation committee on his or her compensation; and
• the specific compensation committee responsibilities and authority set forth in proposed Nasdaq Listing Rule 5605(d)(3).

These matters represent a combination of (i) some of the requirements applicable to the audit committee charter and (ii) compensation committee responsibilities under current Nasdaq rules.

Smaller reporting companies may adopt either a formal written compensation committee charter or a board resolution that specifies the committee's responsibilities and authority, except for the matters set forth in proposed Nasdaq Listing Rule 5605(d)(3).

Compensation Committee Responsibilities

Proposed Nasdaq Listing Rule 5605(d)(3) states that a compensation committee must possess the specific compensation committee responsibilities and authority necessary to comply with Rule 10C-1(b)(2), (3) and (4)(i)-(vi) under the Act relating to the: (i) authority to retain compensation consultants, independent legal counsel and other compensation advisers; (ii) authority to fund such advisers; and (iii) responsibility to consider certain independence factors before selecting such advisers (other than in-house legal counsel).

Because this rule will be effective upon the SEC approval of the Nasdaq's proposal, Nasdaq-listed companies should consider now whether to grant these specific responsibilities and authority through an amendment to the company's charter, a resolution or other board action. To the extent a company does not have a compensation committee, the provisions of this rule will apply to the independent directors who determine, or recommend to the board for determination, the compensation of the executive officers of the company. While Nasdaq proposes that companies must eventually have a written compensation committee charter that includes, among other items, these responsibilities and authority, companies may implement such a charter on the schedule discussed above. Smaller reporting companies are exempt from this requirement.

What Should We Do Now?

Below is a list of suggested action items in connection with Nasdaq's proposals:

1. If you do not have a compensation committee and a majority of independent directors is making, or recommending to the board, compensation decisions related to executive officers of the company, start evaluating potential candidates for compensation committee membership.
2. If you have a compensation committee consisting of one director, start evaluating potential candidates to expand the compensation committee to two members, as suggested by the SEC, or even to three members in order to avoid giving each director a veto power.
    
3. Consider whether existing members of the compensation committee or potential members of the compensation committee are getting any compensatory fees from the company or any of its subsidiaries, or are affiliated with the company or a subsidiary of the company or an affiliate of a subsidiary of the company. Evaluate whether any changes to the current composition of the compensation committee are necessary. 
4. Implement new responsibilities and authority applicable to compensation committees, or independent directors involved in compensation decisions, relating to: (i) authority to retain compensation consultants, independent legal counsel and other compensation advisers; (ii) authority to fund such advisers; and (iii) responsibility to consider certain independence factors before selecting such advisers through a charter amendment or board resolution.
    
5. Draft a new, or revise an existing, compensation committee charter.

NYSE Proposes New Rules Related to Compensation Committee and Committee Adviser Independence

The New York Stock Exchange (NYSE) recently filed proposed rule changes with the SEC related to compensation committee independence and the hiring of compensation advisers. The NYSE proposed such rules to comply with Exchange Act Rule 10C-1 adopted in June. Rule 10C-1 requires national securities exchanges to adopt listing standards which effectuate the compensation committee and committee adviser independence requirements of § 952 of the Dodd-Frank Act. The NYSE's proposed rules do not expand upon or vary much from the SEC rules. Set forth below is a summary of the NYSE's proposed rules: 

Compensation Committee Independence

The NYSE proposed rules do not establish any new bright-line standards specific to compensation committee independence. Instead, the NYSE proposed rules require that, in affirmatively determining the independence of any director who will serve on a compensation committee, a listed company's board "consider all factors specifically relevant to determining whether a director has a relationship to the listed company which is material to that director's ability to be independent from management in connection with the duties of a compensation committee member, including, but not limited to, the two factors explicitly enumerated in Rule 10C-1(b)(ii)":

• the source of the director's compensation, including any consulting, advisory or other compensatory fee paid by the listed company to such director; and
• whether the director has an affiliate relationship with the listed company, a subsidiary of the listed company or an affiliate of a subsidiary of the listed company.

The proposing release specifically provides that the NYSE does not believe that board compensation should be considered as part of the independence determination. Further, commentary to the proposed NYSE rules provides that

Compensation Committee Adviser Independence

The NYSE proposed rules related to compensation committee advisers provide that prior to hiring a compensation adviser, the compensation committee must consider the six factors set forth in Rule 10C-1(b)(4). The NYSE proposed rules do not add any factors for a compensation committee to consider prior to hiring an adviser, as the "Exchange believes that the list included in Rule 10C-1(b)(4) is very comprehensive and the proposed listing standard would also require the compensation committee to consider any other factors that would be relevant to the adviser's independence from management."

Listed companies will have until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014, to comply with the new director independence standards with respect to compensation committees. The other proposed rules, including those related to compensation committee advisers, will become effective on July 1, 2013.

The NYSE's proposed new rules are subject to SEC review and comment. We believe it is unlikely that the SEC will have many objections to the proposed rules, as they essentially mirror the SEC's rules. In light of the NYSE proposed rules, NYSE listed companies should be reviewing their compensation committee charters, the composition of the compensation committee and their relationships with the compensation advisers in order to identify whether any modifications or changes may be in order to comply with the coming NYSE standards.

SEC Issues Letter to New Investment Advisers Regarding Presence Exams

On October 9, the Office of Compliance Inspections and Examinations (OCIE) of the SEC issued a letter directed to senior officers of newly registered investment advisers that manage private equity funds introducing them to the National Exam Program (NEP). The letter explains that the NEP is launching an initiative to conduct Presence Exams, which are focused, risk-based examinations of investment advisers to private funds. In the letter, the SEC explains that the Presence Exams initiative will take place over the next two years and will be comprised of three phases: engagement, examination and reporting.

Engagement Phase—The NEP is currently engaged in an outreach program to inform newly registered investment advisers about their obligations under the Investment Advisers Act of 1940 (the Advisers Act). As part of such outreach, the NEP has published various materials, including staff letters, risk alerts, special studies and speeches. The letter contains a list of some of these resources and their reference links.

Examination Phase—The letter states that the NEP staff will contact advisers separately if and when they are selected for an examination. If an adviser is selected for examination, the NEP staff will review one or more of the following higher risk areas: marketing, portfolio management, conflicts of interest, safety of client assets and valuation. Upon completion of an on-site examination, the NEP staff may send the investment adviser a letter (i) indicating that the exam has concluded without findings; or (ii) describing the deficiencies identified and asking the firm to take corrective action. Serious deficiencies may be referred to the Division of Enforcement of the SEC or other regulators.

Reporting Phase—Upon completion of the examination phase, the NEP will report its observations, such as common practices and industry trends, to the SEC and the public.

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.