On March 30, 2011, the Securities and Exchange Commission (the “SEC”) proposed rules (the “Proposed Rules”) to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) pertaining to compensation committee independence and the role and disclosure of compensation consultants and other advisers to the compensation committee. The Proposed Rules generally track the relevant provisions of the Dodd-Frank Act and require:

  •  National security exchanges (the “Exchanges”) registered under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), to adopt listing standards requiring each member of an Issuer’s compensation committee to be a member of the Issuer’s board of directors and to be “independent”;
  • The Exchanges to adopt listing standards providing an Issuer’s compensation committee the authority, in its sole discretion, to retain or obtain advice of, compensation consultants, independent legal counsel and other advisers (“Compensation Advisers”) and providing that an Issuer’s compensation committee must be directly responsible for the appointment, compensation and oversight of the work of any Compensation Adviser;
  • The Exchanges to adopt listing standards requiring an Issuer’s compensation committee to consider certain independence factors before selecting a Compensation Adviser;
  • and Each Issuer to disclose, in its proxy or any other information statement relating to a shareholder meeting at which directors are to be elected, whether its compensation committee has retained or obtained the advice of a compensation consultant, whether the work of the compensation consultant raised any conflicts of interest, and if so, the nature of the conflicts and how any such conflicts are being addressed.


Applicability of Listing Requirements. The Proposed Rules direct the Exchanges to adopt listing standards requiring members of a board’s compensation committee to be independent. The independence requirement applies not only to board committees formally designated as compensation committees, but also to any board committee performing functions typically performed by a compensation committee even if not formally designated as such. However, these listing standards would not apply if there is no formal board committee authorized to oversee executive compensation where, for example, individual independent directors oversee executive compensation in lieu of a board committee.

Compensation Committee Member Independence Factors. Under the Proposed Rules, each member of an Issuer’s compensation committee (or any other similarly tasked board committee) must be a member of the Issuer’s board, and must be “independent,” as defined in the listing standards of the respective Exchange. The Exchanges are directed to develop a definition of “independence” applicable to compensation committee members after considering relevant factors, which include the source of compensation of the board member, including any consulting, advisory, or other compensatory fee paid by the Issuer to such board member, and whether a board member is affiliated with the Issuer, a subsidiary of the Issuer or an affiliate of a subsidiary of the Issuer.

Existing Independence Requirements. Each Exchange will adopt its own independence factors but, for most Issuers, the practical effects of the new listing standards may be somewhat limited, considering other independence requirements to which Issuers are currently subject. Most Exchanges currently require directors on compensation committees to be “independent” under existing independence standards, which generally include bright-line tests that preclude a finding of independence based on certain compensation, employment, familial and other relationships that could interfere with the director’s exercise of independent judgment. In addition to complying with current Exchange listing standards, Issuers also maintain independent compensation committee members for preservation of tax deductibility of certain awards paid to executive officers under Section 162(m) of the Internal Revenue Code of 1986, as amended, and exemption from short-swing profit liability under Section 16(b) of the Exchange Act.

Compensation Committee vs. Audit Committee Independence Standards. The Proposed Rules do not establish any required independence standards, nor do they create any safe harbors for any particular relationships. The SEC noted that, unlike an Exchange’s independence standards that require audit committee members to satisfy certain minimum criteria prescribed by the Exchange Act, an Exchange’s independence criteria for compensation committee members may be crafted with greater flexibility. For instance, although affiliated directors are not permitted to serve on audit committees, an Exchange may decide that a parallel prohibition preventing affiliated directors from serving on compensation committees is not appropriate. This may be particularly relevant for directors who are affiliates of significant shareholders, such as private equity firms, who may desire to serve on the compensation committee of a portfolio company, and depending on the definition of independence established by the Exchanges, may be permitted to do so.


Under the Proposed Rules, the listing standards would require that an Issuer’s compensation committee be authorized but not required to retain or obtain advice from Compensation Advisers, which includes compensation consultants, independent legal counsel or other advisers. The SEC noted that, as with an audit committee’s authority to engage independent legal counsel, a compensation committee’s authority to hire independent legal counsel should not be construed as imposing a requirement to retain independent legal counsel, or precluding it from retaining non-independent legal counsel, or obtaining advice from in-house counsel or outside counsel retained by the Issuer. The Proposed Rules provide that a compensation committee must be directly responsible for the appointment, compensation and oversight of the work of the Compensation Adviser but is not required to implement or act consistently with its advice or recommendations. The Proposed Rules require an Issuer to provide appropriate funding for the payment of reasonable compensation to Compensation Advisers, as determined by the compensation committee.

Compensation Adviser Independence Factors. Compensation Advisers are not required to be independent, but may be selected by the compensation committee only after consideration of “competitively neutral” independence factors which must include the following, along with any additional factors that the Exchange may require: (1) the provision of other services to the Issuer by the person that employs the Compensation Adviser; (2) the amount of fees received from the Issuer by the person that employs the Compensation Adviser, as a percentage of the total revenue of the person that employs the Compensation Adviser; (3) the policies and procedures of the person that employs the Compensation Adviser that are designed to prevent conflicts of interest; (4) any business or personal relationship of the Compensation Adviser with a member of the compensation committee; and (5) any stock of the Issuer owned by the Compensation Adviser.

Opportunity to Cure Defects. The Exchanges are required to adopt definite procedures and time periods, if not already existing, for compliance with listing requirements established pursuant to the Proposed Rules. In the event that a compensation committee member ceases to be independent for reasons outside the member’s reasonable control, an Exchange’s rule may provide that the formerly independent member, with notice by the Issuer to the applicable Exchange, may remain on the compensation committee until the earlier of the next annual meeting of the Issuer or one year from the occurrence of the event that caused the member to no longer be independent.


The Proposed Rules require that Issuers make certain compensation consultant and conflict of interest disclosures in proxy and information statements for its annual meeting (or special meeting in lieu of the annual meeting) at which directors are to be elected. More specifically, Issuers must disclose whether the compensation committee retained or obtained the advice of a compensation consultant during its last completed fiscal year, whether the consultant’s work raised any conflicts of interest, and if so, the nature of the conflicts and how such conflicts are being addressed. Because of the similarities between the new disclosure requirements and the disclosures currently required under Item 407 of Regularion S-K, the SEC decided to integrate the new requirements into Item 407.

Triggering of Disclosure Requirement. Under the Proposed Rules, the disclosure requirement is triggered if a compensation committee has retained, or obtained advice from, a compensation consultant. For this purpose, a compensation committee will be deemed to have “obtained advise” whenever the committee requests or receives advice from a compensation consultant, regardless of whether there is a formal engagement of the consultant, a client relationship between the compensation consultant and the compensation committee, or any payment of fees to the consultant for its advice. Unlike the current Item 407, there will be no exclusion from the disclosure requirement when a consultant provides only advice on broad-based plans or provides non-customized benchmark data. However, the exemption from the fee disclosure for consultants providing only such services or providing other services not in excess of $120,000 in the previous year remains.

Conflict of Interest Disclosure. The SEC does not provide a definition of “conflict of interest” in the Proposed Rules. However, an instruction to the Proposed Rules suggests that Issuers should consider the five independence factors used by its compensation committee for the selection of a Compensation Adviser to determine whether there is a conflict of interest requiring disclosure. In addition to the above listed independence factors and any other factors which may be established by the Exchanges, the Issuer must also consider the specific facts and circumstances relating to a consultant’s engagement in determining whether or not there is a conflict of interest requiring disclosure under the Proposed Rules.

If the compensation committee determines there is a conflict of interest requiring disclosure, the Issuer must provide a clear, concise and understandable description of the specific conflict and how it has been addressed. A general description of the Issuer’s conflict of interest policies and procedures will not be sufficient disclosure.


Controlled companies (i.e., companies owned 50% or more by a single investor or group of investors), limited partnerships, companies in bankruptcy proceedings, open-end registered investment companies and certain foreign private issuers are expressly exempt from complying with the listing standards adopted by the Exchanges pursuant to the Proposed Rules. Additionally, the Exchanges are permitted to propose exemptions to the listing standards for specific categories of Issuers.


Comments on the Proposed Rules are due by April 29, 2011. The Dodd-Frank Act requires the SEC to issue final rules no later than July 16, 2011. Exchanges are required, within 90 days following the publication of the SEC final rules in the Federal Register, to provide the SEC with their proposed rules, which must be approved by the SEC. The Exchanges are required to issue final rules approved by the SEC within one year after the SEC final rules are published in the Federal Register.

The disclosure requirements regarding compensation consultants will not be required to be included in any proxy or information statement filed before the effective date of the rules implementing those provisions of the Dodd-Frank Act.