The Securities and Exchange Commission recently published the proposed NASDAQ listing rules to comply with the SEC's Rule 10C-1 under the Securities Exchange Act of 1934, as amended. Under Rule 10C-1, adopted as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, requires the national securities exchanges, including NASDAQ, generally to prohibit the listing of any equity security of an issuer that does not comply with specified requirements regarding compensation committees. This is an instance of Congress directing the SEC to direct the national securities exchanges to adopt legal requirements. The SEC is still in its review period applicable to, and is still accepting comments on, the proposed rules, but the rules might be approved within the next month. The effects of that approval are described below.
In brief, the proposed rules require that:
- a NASDAQ-listed issuer have a compensation committee that consists of two or more independent directors and has a written committee charter, subject to annual review;
- each compensation committee member satisfy NASDAQ's current independence standards and not accept (or have accepted while a committee member) any consulting, advisory, or other compensatory fee from the issuer, other than for board service; and
- the compensation committee (1) have the authority and resources to retain and pay compensation advisors, (2) assess or consider, when selecting any such advisor, the six independence factors set forth in Rule 10C-1, which indicate a conflict of interest on the part of such advisor, and (3) be responsible for overseeing and compensating its advisors.
That a NASDAQ-listed issuer has a compensation committee, with at least two independent directors, under a formal charter would be a new requirement. The existing NASDAQ rules permit a majority of independent directors, rather than a committee, to determine executive compensation, and even if there is a compensation committee, it may consist of only one director and may operate under board authorizing resolutions rather than under a charter. This new requirement may not have much impact however, because I believe that most NASDAQ-listed issuers already have a compensation committee with more than one member governed by a charter.
The proposed additional independence requirements for a compensation committee member would make the NASDAQ standard like the SEC's and NASDAQ's independence standard for an audit committee member, except that affiliation with the issuer would not automatically be disqualifying. The only compensation from an issuer that such member could accept would be fees for serving as a member of the board or any committee and fixed compensation under a retirement plan for prior service. This prohibition on compensation would not relate to any compensation received before service on the compensation committee. A director’s being an affiliate of the issuer would not render him or her non-independent under the proposed rules. But, consistent with Rule 10C-1, the NASDAQ rules would require the board to expressly consider whether the director is an affiliate, and if so, whether that affiliation would impair his or her judgment as a compensation committee member. If approved, the new rules would require the board of directors of each NASDAQ-listed issuer to evaluate each current and prospective compensation committee member according to the new independence standard.
The proposed NASDAQ requirements regarding the compensation committee's relationship with its compensation advisors are consistent with Rule 10C-1. Compensation advisors for this purpose include not only professionals described as compensation consultants, but also outside counsel and accountants or tax advisors that provide advice to the compensation committee. I suspect that the existing charters of most compensation committees of NASDAQ-listed issuers already have provisions addressing the requirements, except for the requirement to consider the six independence factors regarding compensation advisors. But if the proposed rules are approved, existing charters may require revision to expressly address the requirements. Apart from statements in the charter, under the proposed rules, a compensation committee would have to exercise some judgment about a few critical issues, including who constitutes an “advisor,” what constitutes “selecting” an advisor, and what constitutes “oversight” of an advisor.
By its terms, Rule 10C-1 does not apply to smaller reporting companies. The proposed NASDAQ rules are consistent, except that a smaller reporting company:
- must have a compensation committee composed of at least two independent directors, as defined under NASDAQ's current listing standards – the additional independence requirements, including the prohibition on compensation, would not apply;
- may, instead of adopting a formal written charter, adopt board resolutions that specify the compensation committee's authority and responsibility, and such resolutions (or charter, if adopted) need not be evaluated annually;
- and need not include in its compensation committee charter or board resolutions any of the specific authority or responsibility of the committee regarding its advisors.
If the proposed rules are approved by the SEC:
- the requirements concerning the compensation committee's (or if the issuer's independent directors determine executive compensation, those directors') relationship with its advisors would be effective immediately; and
- the other requirements would become effective on the earlier of (1) the issuer's second annual stockholders' meeting after the date of the SEC's approval and (2) December 31, 2014.
OUR TAKE: Because the proposed rules do not deviate materially from the Rule 10C-1 requirements, it appears likely that the SEC will approve them without significant amendment. Accordingly, it would be prudent for NASDAQ-listed issuers to begin to consider how they might address the new requirements, especially those regarding the independence of their compensation committee members, the content of their compensation committee charters, and the assessment of independence or conflicts of interest of their compensation committee advisors.