HIGHLIGHTS:

  • The U.S. Securities and Exchange Commission (SEC) has approved a Nasdaq Stock Market rule requiring disclosure of third-party compensation to director candidates.
  • The new rule, Nasdaq Rule 5250(b)(3), will be effective with respect to certain definitive proxy or information statements and annual reports filed on or after Aug. 1, 2016.
  • The rule is a result of Nasdaq's concerns that third-party compensation arrangements could create conflicts of interest and raise questions regarding directors’ fulfillment of their fiduciary duties.

New Nasdaq Rule 5250(b)(3) is a result of increased activist shareholder efforts to place representatives on public company boards of directors. During the past several years, activist shareholders have sought to nominate directors at various companies to serve as their representatives and to advocate for their agendas. In this connection, it is not unusual to see these shareholders offering such directors additional compensation (i.e., in addition to the compensation provided to the director by the listed company itself) as remuneration for serving in this role. Nasdaq notes that these additional compensation arrangements vary, but may include compensating directors based on achieving benchmarks, such as an increase in share price over a fixed term.

Nasdaq has several concerns regarding these undisclosed compensation arrangements, including that they may lead to conflicts of interest among directors and call into question the ability of directors to fulfill their fiduciary duties. These arrangements may also tend to promote a focus on short-term results at the expense of long-term value creation.

Required Disclosure

Rule 5250(b)(3) requires a listed company to publicly disclose the material terms of all agreements or arrangements between any director or nominee for director, as well as any person or entity other than the listed company, relating to compensation or other payment in connection with that person's candidacy or service as a director. The terms "compensation" and "other payment" as used in the rule are intended to be construed broadly. They apply to agreements and arrangements that provide for non-cash compensation and other payment obligations, such as health insurance premiums or indemnification, made in connection with a person's candidacy or service as a director.

Disclosure of all such agreements and arrangements is required by no later than the date on which the listed company files or furnishes a definitive proxy or information statement in connection with the listed company's next shareholders' meeting at which directors are elected. If the listed company does not file proxy or information statements, disclosure of all such agreements and arrangements is required no later than when the listed company files its next annual report on Form 10-K or Form 20-F. A listed company may also satisfy this requirement by making the required disclosure on or through its website. Note that the rule does not separately require the initial disclosure of newly entered into agreements or arrangements (e.g., on a Form 8-K), provided that disclosure is made as described above, that is, on or through the listed company's website or in the listed company's specified U.S. Securities and Exchange Commission (SEC) filings.

The rule provides that a listed company does not need to make disclosure of agreements and arrangements that:

  1. relate only to reimbursement of expenses in connection with candidacy as a director;
  2. existed prior to the nominee's candidacy (including as an employee of the other person or entity) and the nominee's relationship with the third party has been publicly disclosed in a definitive proxy or information statement or annual report (such as in the director or nominee's biography); or
  3. have been disclosed in accordance with SEC rules under Item 5(b) of Schedule 14A (the proxy statement of the activist shareholder) or Item 5.02(d)(2) of Form 8-K in the current fiscal year (although such SEC required disclosure would not relieve a listed company of its annual disclosure obligations under the Nasdaq rule).

Agreement or Arrangement Not Disclosed

If a listed company discovers an agreement or arrangement that should have been disclosed pursuant to the rule but was not disclosed, then the listed company must promptly make the required disclosure by filing a Form 8-K or 6-K, where required by SEC rules, or by issuing a press release. The rule further states that such remedial disclosure, regardless of its timing, would not satisfy the annual disclosure requirements under the rule.

The rule further provides that if a listed company undertakes reasonable efforts to identify all such agreements or arrangements, including asking each director or nominee in a manner designed to allow timely disclosure, and makes the required remedial disclosure promptly if it discovers an undisclosed agreement or arrangement, then the listed company will not be considered deficient with respect to the rule. "Reasonable efforts" is not defined or clarified in the rule. The rule provides that in all other cases, the listed company must submit within 45 calendar days a plan sufficient to satisfy Nasdaq's staff that the listed company has adopted processes and procedures designed to identify and disclose relevant agreements or arrangements. If the listed company does not do so, it will be issued a staff delisting determination, which the listed company can appeal to a hearings panel pursuant to Rule 5815.

Nasdaq Listing Rule 5615 permits foreign private issuers to follow home country practice in lieu of certain corporate governance requirements of Nasdaq. Under the rule, the required disclosure of third-party payments to directors is included among the rule provisions where a foreign private issuer would be permitted to follow home country practice. To meet the conditions of Rule 5615, a foreign private issuer is required to submit to Nasdaq a written statement from an independent counsel in its home country certifying that the listed company's practices are not prohibited by the home country's laws. Additionally, in its annual filings with the SEC (or, in certain circumstances, on its website), a foreign private issuer is also required to disclose that it does not follow the rule's requirements and briefly state the home country practice it follows in lieu of these requirements.

For situations where disclosure is required, companies must make disclosures at least annually until the earlier of the resignation of the director or one year following the termination of the agreement or arrangement.

New York Stock Exchange (NYSE)

As of the date of this alert, the NYSE has not proposed a similar rule, although emerging best practices may result in non-Nasdaq companies providing equivalent information.