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.
Our colleagues Christopher C. Paci, Jason C.
Harmon, Joe C. Sorenson, and Christopher B. Edwards have prepared the
following summary of these new listing rules.
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
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
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:
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:
Compensation committee members: heightened
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:
In addition, the NYSE requires consideration of all
factors relevant to an adviser's independence. Nasdaq does not have a similar
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
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
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