On Jan. 11, 2013, the SEC approved the proposed listing standards of the NYSENasdaq and other exchanges relating to the independence of compensation committee members and their advisers.

The SEC approved the standards substantially as proposed in October 2012 (see related item here), including recent amendments to the proposals that made a few minor changes (including extending the phase-in schedule for issuers that cease to be smaller reporting companies and clarifying that assessing the independence of compensation advisers is not required for advisers whose roles are limited to consulting on broad-based, nondiscriminatory plans or providing noncustomized data).

The final standards impose new requirements on listed companies’ compensation committees relating to both (i) the independence of committee members themselves and (ii) the independence of the committee’s advisers. The standards relating to the independence of committee members themselves generally go into effect on the date of the listed company’s 2014 annual meeting (or Oct. 31, 2014, at the latest). The standards relating to the independence of the committee’s advisers go into effect on July 1, 2013.

Independence of Committee Members

The NYSE currently requires all listed companies to have a compensation committee composed entirely of independent directors. In considering independence for this purpose, in addition to the existing NYSE independence standards, the new standards will require any factors that may be material to a committee member’s ability to be independent from management in connection with his or her duties to be considered, including (i) the sources of the member’s compensation and (ii) any affiliate relationships between the member and the listed company, its subsidiaries or any affiliates of its subsidiaries.

The new Nasdaq standards are similar to the NYSE standards except that the new Nasdaq standards bar any director who receives any compensation (other than compensation for services as a director or deferred compensation from prior service) from the listed company or its affiliates from serving on the compensation committee. Also, for the first time, Nasdaq-listed companies will be required to have a compensation committee composed entirely of independent directors (previously, the majority of the independent members of the board could make executive compensation decisions).

Independence of Advisers

Both the new NYSE and the new Nasdaq standards require a compensation committee to have the authority, in its sole discretion, to retain or obtain the advice of any compensation consultant, independent legal counsel or other adviser and to be directly responsible for the appointment, compensation and oversight of any such adviser that the committee retains. Listed companies are now also required to provide appropriate funding, as determined by the committee, for payment of reasonable compensation to any compensation consultant, independent legal counsel or other adviser retained by the committee.

In addition, under both exchanges’ new standards, the compensation committee, before selecting or receiving advice from a compensation consultant (other than a consultant whose role is limited to consulting on broad-based, nondiscriminatory plans, or who provides only noncustomized data, each as described in Item 407(e)(iii) of Regulation S-K), legal counsel (other than in-house legal counsel) or other adviser (a “compensation adviser”), must review and take into consideration all factors relevant to the adviser’s independence from management, including:

  • whether the firm that employs the compensation adviser (or the firm’s affiliates) (the “advisory firm”) performs any additional services for the listed company;
  • the amount of fees payable to the advisory firm as a percentage of the advisory firm’s total revenues;
  • any policies or procedures of the advisory firm designed to prevent conflicts of interest;
  • any business or personal relationship that the compensation adviser has with any committee member;
  • whether the compensation adviser owns any stock of the listed company; and
  • any business or personal relationship that the compensation adviser or advisory firm has with any executive officer of the company.

However both exchanges were careful to emphasize that nothing requires the compensation adviser selected by the committee to actually be independent, and that the committee may select or receive advice from any compensation adviser it prefers, including one that is not independent, after considering the factors set forth above.

The SEC order approving the new standards indicates that the SEC expects compensation committees to periodically (at least once per year) reconsider the factors set forth above with respect to an adviser whom it has previously selected or from whom it continues to receive advice.

Next Steps

In light of the approaching compliance deadlines, listed companies should be considering a number of steps at this point, including:

  • Amending charters. The new requirements relating to the committee’s authority to retain advisers and oversee their work, and its obligation to examine their independence, are required under both exchanges’ new standards to be set forth in the committee’s charter. NYSE committees will generally need to amend their charters before July 1, 2013, to address these specific new requirements. Nasdaq committees technically have until the full compliance deadline in 2014 to adopt or amend their charters but most will want to accomplish this by the July 1, 2013, implementation deadline as well.
  • Revising D&O questionnaires. D&O questionnaires may need to be revised to capture the new independence requirements for committee members, as well as to gather information about any relationships between a listed company’s officers and directors and its compensation consultants. In a separate rule that is effective for the 2013 proxy season, the SEC now requires public issuers to disclose whether the work of any compensation consultant whose role is required to be disclosed in the company’s proxy statement involves any conflict of interest (based on the same six factors identified above), and if so, whether and how the conflict is being addressed. D&O questionnaires can help companies comply with this new disclosure requirement, as well as the new listing standards.
  • Implementing procedures for examining adviser independence. As of July 1, 2013, compensation committees will need to have procedures in place for examining the independence of any compensation advisers that the committee selects or receives advice from. “Receiving advice” could include a wide variety of activities. Companies should start now to examine which advisers may need to undergo this examination and what information may need to be gathered in advance in order to conduct it.