The New York Stock Exchange (the "NYSE") and the NASDAQ Stock Market ("Nasdaq") have now proposed rule changes to comply with Rule 10C-1 adopted by the SEC pursuant to Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act"). The NYSE’s proposing release, SR-2012-49, can be accessed here and Nasdaq’s proposing release, SR-2012-109, can be accessed here.

Section 952 of the Dodd-Frank Act directed the SEC to issue rules requiring the national securities exchanges to address the independence of compensation committee members and their advisers, to give committees the authority and funding to engage advisers, and to require listed companies to disclose conflicts of interest of compensation advisers. Exchange Act Rule 10C-1, which was effective on June 27, 2012, tracked the language of the statute, leaving the details to the exchanges. The SEC rules require the new listing standards to be approved by the SEC by June 27, 2013.

The NYSE and Nasdaq rule proposals are separate from the SEC’s proxy disclosure rule relating to the disclosure of conflicts of interest of compensation consultants. The disclosure rule, set out in Item 407(e)(3)(iv) of Regulation S-K, requires that reporting companies disclose the nature of any conflict of interest posed by a compensation consultant’s work relating to director or executive officer compensation and how that conflict is being addressed. The SEC did not define the term "conflict of interest" but added an instruction referring to the six compensation committee adviser independence factors described below for consideration in determining whether a conflict of interest exists. The requirement applies only for consultants otherwise identified in a company’s proxy statement under existing Item 407(e)(3)(iii), which among other things excludes consultants that only provide advice on broad-based compensation arrangements or that provide certain types of survey data, and does not apply to other committee advisors such as legal counsel. This rule applies to proxy statements for stockholder meetings for the election of directors occurring on or after January 1, 2013.

A summary of the proposed NYSE and Nasdaq rules follows.

NYSE Proposed Rules

Compensation Committee Member Independence

The NYSE rules generally require that listed companies have a compensation committee composed entirely of "independent directors." Section 303A.02 presently provides that a director will not qualify as independent unless the board of directors of the issuer affirmatively determines that the director has no material relationship with the listed company (either directly, or as a partner, stockholder or officer of an organization that has a relationship with the company). Additionally, Section 303A.02 provides that a director will not be independent if the director has a relationship with the company that violates any of five enumerated bright line tests set forth in the rule.

The proposal does not revise any of the bright-line tests. Instead, the NYSE proposes to include a new subsection to the independence standard which will require that the 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. Two factors specifically enumerated for consideration are:

  1. (i) the source of compensation of such director, including any consulting, advisory or other compensatory fee paid by the listed company to such director; and
  2. (ii) whether such director is affiliated with the listed company, a subsidiary of the listed company or an affiliate of a subsidiary of the listed company.

In its rule proposal, the NYSE indicated that it does not intend to prohibit a director from being determined to be independent solely on the basis that the director, or any of the director’s affiliates, is a stockholder of the listed company. In taking this position, the NYSE acknowledged that rather than adversely affecting a director’s ability to be independent from management as a compensation committee member, share ownership in the listed company aligns the director’s interests with those of unaffiliated stockholders, giving the director the same economic interest in ensuring that the listing company’s executive compensation is not excessive.

The NYSE proposal would provide for a cure period for events of non-compliance with the proposed compensation committee independence requirements. As proposed, if the company fails to comply with the committee composition requirements because a member of the committee ceases to be independent for reasons outside of his or her reasonable control, that person, with prompt notice to the NYSE and only so long as a majority of the members of the committee continue to be independent, may remain a member of the committee until the earlier of the next annual meeting or one year from the occurrence of the disqualifying event.

Compensation Committee Authority

Presently, the commentary to Section 303A.05 of the NYSE Manual provides that if a compensation consultant is to assist in the evaluation of director, chief executive officer or executive officer compensation, then a listed company’s compensation committee charter should give the committee the sole authority to retain and terminate the consulting firm, including the sole authority to approve the fee’s and other retention terms of the compensation consultant. The NYSE proposes to remove such guidance and replace it with a new clause (c) to Section 303A.05. This will require that the compensation committee’s charter include the specific authorizations contained in Exchange Act Rule 10C-1b(2) and (3) (consistent with prior NYSE guidance), which generally require that:

  1. the committee of a listed issuer have the sole discretion to retain or obtain the advice of not only a compensation consultant, but also independent legal counsel or other advisers;
  2. the committee must be directly responsible for the appointment, compensation and oversight of the work of such advisers; and
  3. the company must provide for appropriate funding, as determined by the committee, for payment of such advisers.

Consistent with Rule 10C-1(b)(2), commentary to new Section 303A.05(c) will specifically provide that there is no requirement that a committee implement or act consistently with the advice or recommendations of the compensation consultant, independent legal counsel or other adviser, and that nothing in the rule will affect the ability of the committee to exercise its own judgment in fulfilling its duties.

NASDAQ Proposed Rules

Compensation Committee Member Independence

Nasdaq Listing Rule 5605(d) currently provides the standards for determination of executive compensation by a listed company. Nasdaq proposes to significantly revise these requirements, to require, among other things, that executive compensation of each listed company be determined by a compensation committee comprised of:

  1. at least two independent directors (with independence determined under the existing standards and application of the bright line tests); and
  2. directors that do not accept, directly or indirectly, any consulting, advisory or other compensatory fee from the listed company, with compensatory fees excluding:
    1. fees received as a member of the compensation committee, the board of directors or any other board committee, and
    2. fixed amounts of compensation under a retirement plan (including deferred compensation) for prior service with the listed company (so long as such compensation is not contingent in any way on continued service).

This requirement does not "look back" to previously received compensation, only applying to current or ongoing fee arrangements.

In addition to the above requirements, in determining whether a director is eligible to serve on the committee, boards of directors must consider whether such director has any affiliation with the listed company, a subsidiary of the listed company or an affiliate of a subsidiary of the listed company that would impair the director’s judgment as a member of the compensation committee. In commentary, Nasdaq indicated that ownership of company stock would not, by itself, prevent a finding of independence, even if constituting "control," stating that it may be appropriate for representatives of significant stockholders to serve, "since their interests are likely aligned with those of other stockholders in seeking an appropriate executive compensation program."

Nasdaq has retained an existing exception that permits certain directors not satisfying the independence, compensation and affiliation requirements described above to serve on the compensation committee of a listed company. Under the exception, if the committee consists of at least three members, one member is permitted to not satisfy such requirements, provided that the director is neither an executive officer or employee of the company, nor a family member of an executive officer, and under exceptional and limited circumstances, the board of directors determines that such director’s membership is required by the best interests of the company and its stockholders. A director appointed under this exception may not serve longer than two years, and the company must disclose, either on its website or in its next proxy statement, the nature of the relationship and the reasons for the determination. Additionally, Instruction 1 to Item 407(a) of Regulation S-K requires disclosure of the use of the exception and why it is applicable to the company.

The Nasdaq rule proposal would eliminate the present ability of a majority of the independent directors on the board of directors to make executive compensation determinations in a vote in which only independent directors participate.

Under Nasdaq’s proposal, if a company fails to comply with the committee composition requirements due to one vacancy, or one member ceases to be independent due to circumstances beyond his or her reasonable control, the company can regain compliance by the earlier of the next annual meeting or one year from the occurrence of the disqualifying event. However, if the annual meeting occurs no later than 180 days following the disqualifying event, the company instead has 180 days from such event to regain compliance. This provides a company at least 180 days to cure noncompliance and would typically allow a company to regain compliance in connection with its next annual meeting. The company must provide notice to Nasdaq immediately upon learning of the disqualifying event or circumstance.

Compensation Committee Charter and Power to Retain Advisers

Under the present Nasdaq rules, there is no requirement that a listed company have a compensation committee charter. Under the proposal, each listed company will be required to adopt a compensation committee charter, which must include:

  1. the scope of the compensation committee’s responsibilities, and how it carries out those responsibilities, including structure, processes and membership requirements;
  2. 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;
  3. 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
  4. the specific compensation committee responsibilities and authority set forth in proposed Nasdaq Listing Rule 5605(d)(3), which implements the requirements of Exchange Act Rule 10C-1(b)(2) and (3) (the authority of compensation committees to retain and pay advisers and the adviser independence factors, described below).

In addition to the above requirements, Nasdaq proposes that each listed company certify that it has adopted a formal written compensation committee charter and that the compensation committee will review and reassess the adequacy of the written charter on an annual basis.

NYSE and Nasdaq Compensation Adviser Independence Rules

Exchange Act Rule 10C-1(b)(4) requires that registered national securities exchanges and national securities associations adopt rules requiring that compensation committees of listed companies consider six specified factors pertaining to the independence of a compensation consultant, legal counsel or other adviser to the compensation committee, before selecting any such adviser. The factors for compensation committee consideration are:

  1. the provision of other services to the issuer by the person that employs the compensation consultant, legal counsel or other adviser (collectively, the "Adviser");
  2. the amount of fees received from the issuer by the Adviser, as a percentage of the total revenue of the person that employs the Adviser;
  3. the policies and procedures of the Adviser that are designed to prevent conflicts of interest;
  4. any business or personal relationship of the compensation consultant, legal counsel or other adviser with a member of the compensation committee;
  5. any stock of the issuer owned by the compensation consultant, legal counsel or other adviser; and
  6. any business or personal relationship of the Adviser with an executive officer of the issuer.

Both the NYSE and Nasdaq propose to require that compensation committees consider all of the above factors prior to retaining any compensation consultant, legal counsel (other than in-house legal counsel) or other adviser. Nasdaq specifically noted that committees are not required to retain independent advisers – only that they must consider the six factors listed above. Additionally, compensation committees of NYSE listed companies must also consider any other factors relevant to an adviser’s independence from management.

Compliance Dates and Exemptions


The NYSE proposes that listed companies not be required to comply with the heightened director independence standards for compensation committee members until the earlier of a listed company’s first annual meeting after January 15, 2014 or October 31, 2014. The other changes (expanded committee responsibilities with respect to advisers) would take effect on July 1, 2013.

The NYSE has indicated that controlled companies, limited partnerships, companies in bankruptcy, closed-end and open-end funds registered under the Investment Company Act of 1940, issuers with only preferred stock listed and foreign private issuers that follow home country rules be exempted from the proposed rules. Additionally, the NYSE proposes to exempt smaller reporting companies from the new compensation committee independence requirements and the required compensation committee consideration of the independence factors prior to retaining a compensation adviser.


Nasdaq proposes that issuers be required to comply with the compensation committee responsibilities and authority proposed changes immediately upon SEC approval. The proposal provides that, to the extent a listed company does not have a compensation committee, the rule would apply to the independent directors who determine executive compensation (or who recommend executive compensation to the full board). Nasdaq further proposes that the remaining provisions of the listing rules on compensation committees take effect upon the earlier of (i) the second annual meeting of a listed company held after the date of the SEC’s approval of such rules, or (ii) December 31, 2014. Each Nasdaq listed company will be required to certify to Nasdaq within 30 days after the implementation deadline applicable to the listed company, on a new form that Nasdaq will provide, that the listed company has complied with the amended listing rules on compensation committees.

Nasdaq proposes that asset-backed issuers and other passive issuers, cooperatives, limited partnerships, management investment companies and controlled companies be exempt from the new listing rules, which is consistent with Nasdaq’s current practice for rules regarding compensation committees. Nasdaq also proposes to continue to allow foreign private issuers to follow their home country practice in lieu of the revised listing rules relating to compensation committees if the foreign private issuer provides the currently required disclosure in its annual reports filed with the SEC (or its website if it is not required to file an annual report with the SEC) regarding its home country practices, as well as provides additional disclosure in such filing or on its website as to why it does not have an independent compensation committee, if applicable.

Nasdaq proposes that smaller reporting companies will be required to have a compensation committee comprised of two independent directors and to adopt formal written compensation committee charters or in lieu thereof, board resolutions (which is unique to smaller reporting companies under the rules). However, Nasdaq proposes that smaller reporting companies not be required to comply with the remaining new rule proposals, including the prohibition on compensation committee members accepting directly or indirectly any consulting, advisory or other compensatory fee from an issuer and the examination of affiliate status when determining compensation committee member eligibility.

Action Items

Although the proposed rules are not yet effective, Nasdaq rules will be effective upon SEC approval and NYSE rules are expected to become effective sometime next year. Accordingly, companies should consider taking steps to prepare for the new rules, including:

  • Evaluate the independence of compensation committee members in light of the proposed standards;
  • Review and prepare proposed amendments to compensation committee charters;
  • Establish diligence procedures to identify any actual or potential conflicts of interest involving committee consultants, counsel and other advisers, such as supplementing director & officer questionnaires, preparing questionnaires for advisers and requiring advisers to address conflicts in connection with engagements or when rendering advice.

Readers should note that the recent rule changes regarding disclosure of compensation consultant conflicts of interest (referred to in the introduction to this bulletin) are already effective for proxy statements relating to annual meetings occurring on or after January 1, 2013. Accordingly, affected companies should implement diligence procedures with respect to compensation consultants to determine if there are any required disclosures.