On September 25, 2012, the New York Stock Exchange (NYSE) and The NASDAQ Stock Market (Nasdaq) submitted proposed rule changes to the Securities and Exchange Commission (SEC) that would require equity issuers listed on their exchanges to comply with certain standards pertaining to the structure, authority, functioning and independence of compensation committees.

These proposals came in the wake of SEC rule changes issued on June 20, 2012, which directed all national securities exchanges that list equity securities and which are subject to SEC jurisdiction to amend their rules in conformity with Section 10C of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The entire Dodd-Frank Act was previously summarized in our July 2010 Securities Law Update entitled, “Summary of Corporate Governance Changes in the Dodd-Frank U.S. Financial Regulatory Reform Act,” archived on our Website at http://www.burnslev.com/apps/uploads/publications/Securities_Update_Dodd-Frank_July2010.pdf.

SEC Chairman Mary Schapiro said that the new listing standards pertinent to compensation committees would “help to enhance the board’s decision-making process on executive compensation matters [in public companies], particularly the selection, engagement and oversight of compensation advisers.” Schapiro also called attention to proxy disclosure rule changes that the SEC issued concerning the use of compensation consultants by issuers and related conflicts of interest.

The Dodd-Frank Act, the SEC listing standards applicable to securities exchanges, and the proposed rules submitted to the SEC by the NYSE and Nasdaq are all designed to accomplish the following objectives:

  • Provide independence standards for compensation committee members and, where no compensation committee exists, for individual directors responsible for compensation approval;
  • Establish the authority and responsibility of compensation committees with regard to hiring and oversight of compensation advisers, as well as a requirement for appropriate funding for those advisers (including consultants, legal counsel or other advisers);
  • Articulate factors relevant to assessing the independence of and potential conflicts of interest with compensation advisers, which must be considered prior to their engagement;
  • Provide for reasonable opportunity to cure any defects in compliance with compensation committee rules;
  • Provide for reasonable transition periods for compliance with the new rules; and
  • Allow specified exemptions from all or part of the new rules for certain types of issuers, as permitted by the Dodd-Frank Act.

Both exchanges also added requirements with respect to written compensation committee charters even though they were not required to do so by the SEC or the Dodd-Frank Act. Going a step further than the NYSE, Nasdaq proposed a requirement for equity issuers to establish and maintain a compensation committee as well, if they do not already have one.

This update provides a summary of the new SEC listing standards and related proxy disclosure requirements, as well as the proposed rule changes submitted to the SEC for approval by the NYSE and Nasdaq. For a full copy of the SEC Release no. 33-9330, which mandated new listing standards pertinent to compensation committees, go to: http://www.sec.gov/rules/final/2012/33-9330.pdf.

For a full copy of the NYSE submission to the SEC, go to: http://www.nyse.com/nysenotices/nyse/rule-filings/pdf;jsessionid=474035BE3B197D71B5150C5D1911BB0F?file_no=SR-NYSE-2012-49&seqnum=1.

For a full copy of the Nasdaq proposal, go to: http://nasdaq.cchwallstreet.com/NASDAQ/pdf/nasdaq-filings/2012/SR-NASDAQ-2012-109.pdf.

The NYSE proposed rules would go into effect July 1, 2013 and would require NYSE listed companies to comply with the new compensation committee independence standards on the earlier of (i) their first annual meetings after January 15, 2014 or (ii) October 31, 2014. The Nasdaq proposed rules would go into effect as follows: The rules relating to the responsibility and authority of compensation committees and the selection of compensation committee advisers would be effective immediately upon the effectiveness of the final rules, while the remaining rules, including those relating to the requirement to have a formal compensation committee and a written compensation committee charter, would have to be complied with by the earlier of (a) a Nasdaq company's second annual meeting held after the date of approval of the Nasdaq rules, or (b) December 31, 2014.

While each of the proposals submitted by the exchanges must be approved by the SEC and will go into effect only after the expiration of applicable transition periods as noted above, the SEC’s new proxy disclosure requirements are already final and must be followed in connection with any annual or special meeting of shareholders at which directors will be elected on or after January 1, 2013.

Issuers affected by the changes should also consider taking steps toward compliance now. Specifically, it would be wise to consider: the establishment and/or review of a compensation committee charter; an analysis of compensation committee and compensation adviser independence; and an assessment of any potential compensation adviser conflicts of interest.


Section 10C of the Dodd-Frank Act required the SEC to adopt rules directing the national securities exchanges and national securities associations (collectively, the “Exchanges”) to prohibit the listing of any equity security of an issuer that is not in compliance with Section 10C’s compensation committee and compensation adviser requirements.

Consequently, the SEC issued final rules on June 20, 2012, which directed the Exchanges to adopt listing standards applicable to “any committee of the board that performs functions typically performed by the compensation committee.” Rule 10C-1, the primary comprehensive rule for setting compensation committee and adviser standards, also required the Exchanges to adopt director independence standards applicable to “the listed members of an issuer’s board of directors who, in the absence of a board committee, oversee executive compensation matters.”

However the SEC did not require the Exchanges to apply their listing standards pertinent to a compensation committee’s authority to retain compensation advisers “to those directors who oversee executive compensation outside of the structure of a formal board committee.” The final rules also did not require the exchanges to mandate that listed issuers actually have a compensation committee.

1. Independence Requirements

Under the final SEC rules, the Exchanges were directed to establish listing standards requiring each member of a listed issuer’s compensation committee to be a member of the board of directors and to be independent.

The SEC also required the exchanges to consider relevant factors pertinent to an assessment of independence, including but not limited to:

  • A director’s source of compensation (including consulting fees); and
  • Whether a director is affiliated with the issuer, one of its subsidiaries or an affiliate of a subsidiary.

2. Authority and Responsibilities Regarding Compensation Advisers

The final SEC rules directed the Exchanges to adopt listing standards providing that:

  • The compensation committee may, in its sole discretion, retain or obtain the advice of a compensation adviser;
  • The compensation committee, which shall include those members of a listed issuer’s board who oversee executive compensation matters in the absence of a formal committee, shall be directly responsible for the appointment, compensation and oversight of the work of any compensation adviser retained by the committee; and
  • Each listed issuer must provide for appropriate funding for payment of reasonable compensation, as determined by the compensation committee, to any compensation adviser retained by the committee.

But the SEC explicitly refrained from requiring compensation committees to retain or obtain the advice of only independent advisers, allowing for consultation with in-house or outside counsel as well as any non-independent adviser. The SEC did not require a compensation committee to be directly responsible for appointment, compensation or oversight of advisers not retained by the committee either, such as compensation advisers retained by management.

3. Independence Factors in Choosing Compensation Advisers

The final SEC rules also directed the Exchanges to adopt listing standards that would require a compensation committee (or its functional equivalent) to take into account, prior to hiring a compensation adviser, six factors pertinent to the independence of such an adviser, including:

  • The provision of other services to the issuer by the person that employs the compensation consultant, adviser or legal counselor (all referred to hereafter as the “Adviser”);
  • The amount of fees received from the issuer by the person that employs the Adviser, as a percentage of the total revenue of the person employing the Adviser;
  • The policies and procedures of the person that employs the Adviser that are designed to prevent conflicts of interest;
  • Any business or personal relationship of the Adviser with a member of the compensation committee;
  • Any stock of the issuer owned by the Adviser; and
  • Any business or personal relationships between the executive officers of the issuer and the Adviser or the person employing the Adviser.

Based on public comments, the SEC decided to include an instruction to this rule, clarifying that a compensation committee need not consider these independence factors prior to consulting with any in-house counsel regarding compensation. Also, the final rule did not require listed issuers to describe the compensation committee’s process for selecting an Adviser.

4. Opportunity to Cure Defects

The SEC’s final rules stated that the Exchanges must have a procedure allowing for a reasonable opportunity to cure any defects in compensation committee or Adviser compliance that could result in delisting of an issuer’s securities. Noting that most of the Exchanges already have procedures for notice of and opportunity to cure other defects, the SEC clarified that such procedures must be established only to the extent they are not already in place, or must be explicitly extended to cover issues related to compensation committees and Advisers.

5. Exemptions

Pursuant to the provisions of the Dodd-Frank Act, the SEC also exempted certain types of issuers from the requirements of the new listing standards pertinent to compensation committee member independence. These exemptions apply to:

  • Limited partnerships;
  • Companies in bankruptcy proceedings;
  • Registered open-end management investment companies; and
  • Foreign private issuers that provide annual disclosures to shareholders of the reasons why they choose not to have an independent compensation committee.

Controlled companies were also exempted from these independence requirements, as well as other requirements of new Rule 10C-1 (such as provisions relating to Adviser independence and compensation committee authority and responsibility).

Smaller reporting companies, like controlled companies, were exempted from compliance with all of the provisions of new Rule 10C-1.


At the same time that the SEC announced its new directives to national securities Exchanges, it also issued a new rule pertinent to proxy disclosures about Advisers who have played any role in determining or recommending an amount or form of executive or director compensation.

Thus, with respect to annual or special meetings at which directors will be elected as of or after January 1, 2013, issuers will be required to disclose whether the work of such compensation Advisers has raised any conflict of interest, and if so, the nature of the conflict and how it is being addressed.

This requirement applies to all issuers subject to the proxy rules, including controlled companies, smaller reporting companies and non-listed issuers exempted from Rule 10C-1, and it applies to conflicts arising from either executive or director compensation. In deciding whether a conflict of interest must be disclosed, issuers must, at a minimum, consider the six factors to be used in assessing Adviser independence.

The SEC added that any compensation consulting work limited to broad-based, non-discriminatory plans and the provision of non-customized survey data would be exempt from its rules related to disclosure of Adviser-related conflicts.


In response to the SEC’s directives, the NYSE filed proposed rule changes that would amend various sections of the NYSE Listed Company Manual (the “Manual”) which provides listing standards for all NYSE issuers.

1. Compensation Committee Director Independence

The NYSE noted in its SEC filing that its existing director independence standards (Section 303A.02 of the Manual) already provide issuers with five “bright-line” tests that must be met by independent directors (pertaining to sources of compensation, relationships with executives and certain business affiliations with the issuer).

Nonetheless, the NYSE proposed to amend Section 303A.02, requiring that, in addition to consideration of the bright-line tests, an issuer’s “board of directors must consider all factors relevant to determining whether a director has a relationship with 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, including but not limited to, the two factors enumerated in [SEC] Rule 10C-1(b)(ii) [regarding director compensation and affiliations].”

The NYSE also reiterated a pronouncement by the SEC that “rather than adversely affecting a director’s ability to be independent from management… share ownership in the listed company aligns the director’s interests with those of unaffiliated shareholders” and thus, share ownership should not be considered adverse to independence.

2. Compensation Committee Authority Regarding Advisers

The NYSE proposed to adopt verbatim the requirements of SEC Rule 10C-1 regarding the compensation committee’s authority and responsibility with respect to Advisers.

Thus, as previously articulated:

  • The compensation committee would have sole discretion to retain or obtain the advice of an Adviser on compensation matters;
  • The compensation committee would be directly responsible for the appointment, compensation and oversight of the work of any Adviser it retains; and
  • The listed company would have to provide for appropriate funding, as determined by the compensation committee, for payment of reasonable compensation to the Adviser it has retained.

3. Compensation Adviser Independence Factors

The NYSE filing also proposed to include in its Manual a provision specifying that, before engaging an Adviser, the compensation committee must consider the six factors explicitly enumerated by the SEC as factors to be considered in choosing an independent Adviser.

Also proposed to be included in the Manual was an explicit statement that nothing in the provisions related to Advisers should be construed: (a) to require the compensation committee to act consistently with the advice of the Adviser; or (b) to affect the ability or obligation of the compensation committee to exercise its own judgment on compensation matters.

4. Cure Periods

A proposed amendment to Section 303A.00 of the Manual would provide a cure period as follows:

“If a listed company fails to comply with the compensation committee composition requirements because a member of the compensation committee ceases to be independent for reasons outside the board member’s control, that person, with prompt notice to the [NYSE] and only so long as a majority of the members of the compensation committee continue to be independent, may remain a member of the compensation committee until the earlier of the next annual shareholders’ meeting of the listed company or one year from the occurrence of the event that caused the member to be no longer independent.”

5. Transition Periods

The NYSE proposed to further amend Section 303A.00 to provide that listed companies would have until the earlier of either their first annual meeting after January 15, 2014, or October 31, 2014, to comply with the new director independence standards regarding compensation committees. Other proposed changes, including those related to compensation committee Advisers, would become operative on July 1, 2013.

Existing transition periods for compliance with listing standards generally would also continue to be applied to compensation committee requirements, so that certain companies would have transitional grace periods, even after the 2014 deadlines, such as companies making initial public offerings (IPOs), companies which did not have common stock previously listed, companies listing in connection with a spin-off, companies listing upon emergence from bankruptcy, companies previously registered on another Exchange without similar requirements, and companies that cease to qualify as controlled companies or foreign private issuers. Those grace periods vary by category under current rules, which would remain unchanged.

Companies that cease to be smaller reporting companies and thereby become subject to compensation committee independence requirements would also benefit from another proposal by the NYSE. As proposed, a company that ceases to be a smaller reporting company would be permitted to comply with the independence requirements within six months of its “Smaller Company Determination Date.” However, such a company would have to comply with provisions relating to selection of Advisers as of and on the determination date.

6. Exemptions

The NYSE proposed to exempt smaller reporting companies from compliance with any of the new independence requirements for compensation committee service.

It also proposed to exempt from all of the proposed requirements each category of issuer that qualifies for a general or specific exemption under SEC Rule 10C-1. Thus, controlled companies, entities in bankruptcy, closed-end and open-end funds registered under the Investment Company Act of 1940, passive business organizations in the form of trusts, and issuers of only derivatives, special purpose securities or preferred stock would be exempt.

Such companies, the NYSE noted, generally are externally managed, do not have employees or consequent compensation issues, or have executive compensation policies and decisions set by an authority other than a board (such as a bankruptcy court).

The NYSE also proposed a general exemption from the new compensation committee requirements for foreign private issuers that follow a different home country practice. In a divergence from the SEC’s proxy disclosure rules, the NYSE did not separately require foreign private issuers to explain why they do not choose to comply with the new compensation committee rules, conjecturing that these issuers would simply state that they would not comply because their home country does not require it.

7. Compensation Committee Charters

While the Manual already has a provision pertinent to Compensation Committee Charter requirements, the NYSE proposed to add a further explicit requirement that the compensation committee charter of a listed issuer must address “the rights and responsibilities of the compensation committee.”


In response to the SEC’s directives, Nasdaq filed proposed rule changes that would amend various sections of the Nasdaq Listing Rules for Compensation Committees. A number of the proposals went a step further than required by the SEC.

1. Requirement to Establish a Compensation Committee

Nasdaq’s current listing rules require only that executive compensation be set or recommended by a compensation committee or by independent directors constituting a majority of the board’s independent directors. Furthermore, the SEC did not require the Exchanges to establish formal compensation committees in their listing standards.

Nonetheless, Nasdaq proposed to require its listed companies to have a standing compensation committee, stating that “responsibility for executive compensation decisions is one of the most important responsibilities entrusted to a board of directors.”

2. Compensation Committee Composition and Independence

Nasdaq’s current listing standards do not require more than one board member to participate in a compensation committee to the extent that one exists; however, the proposed listing rules would require a listed company to have at least two members on its compensation committee because of “the importance of compensation decisions to stockholders.”

The current rules already require a compensation committee to be comprised solely of independent directors, as defined in Nasdaq Listing Rule 5605(a)(2). The listing rules specify several categories of directors who cannot be considered independent (such as executive officers or people who have received specified amounts of compensation from the listed company). Nasdaq did not propose any change to these rules as they are consistent with the SEC’s imperatives.

Because the SEC rules required it, Nasdaq also considered the relevance of sources of compensation for compensation committee members. After reviewing its current rules, Nasdaq concluded that there was no compelling justification to have different standards for audit and compensation committee members with regard to acceptance of fees from a listed issuer.

Thus, Nasdaq proposed to prohibit compensation committee members from accepting, directly or indirectly, any compensatory fee from an issuer or its subsidiaries. However, Nasdaq did specify that such fees would not include ordinary fees received as a member of the board or the compensation committee, or amounts received as part of a retirement or deferred compensation plan for prior service.

Noting that SEC Rule 10C-1 directed it to consider affiliations with an issuer in determining independence requirements for compensation committee members, Nasdaq concluded that it may be appropriate for certain affiliates, such as representatives of significant stockholders, to serve on compensation committees because their interests would likely be aligned with other stockholders. As a result, Nasdaq proposed that its listed companies’ boards should consider affiliation impacts on eligibility determinations for compensation committees, but proposed no bright-line rules around this factor.

3. Compensation Committee Charter Requirements

Although not required to do so, Nasdaq proposed that each of its listed companies should certify that: (i) it has adopted a formal written compensation committee charter; and (ii) its compensation committee will annually review the charter and reassess its adequacy.

Nasdaq also proposed that the content of the compensation committee charter must include:

  • The scope of the compensation committee’s responsibilities, and how it carries out those responsibilities;
  • The compensation 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;
  • A requirement that the chief executive officer of the company may not be present during the voting or deliberations by the compensation committee on his or her compensation; and
  • A pronouncement that the compensation committee has the specific compensation responsibilities and authority necessary to comply with SEC Rule 10C-1(b) as it relates to (i) authority to retain Advisers; (ii) authority to fund such Advisers; and (iii) responsibility to consider certain independence factors before selecting such advisors, other than in-house legal counsel.

4. Special Rules for Smaller Reporting Companies

Consistent with SEC Rule 10C-1, Nasdaq proposed to allow smaller reporting companies not to adhere to the new compensation committee independence requirements relating to compensatory fees and certain affiliations with the listed company.

Smaller reporting companies would still have to adopt some kind of written charter, or at least a board resolution with regard to the compensation committee’s responsibilities and authority generally, but such companies would be excused from the requirement to include specific language regarding the committee’s authority and responsibility pertinent to Advisers, as otherwise required under SEC Rule 10C-1. Smaller reporting companies would also be permitted not to conduct annual review and reassessment of any written charter or resolution.

5. Exceptions to Independence Requirements

Nasdaq proposed to retain an exception that allows a listed company to have a non-independent director on the compensation committee under “exceptional and limited circumstances” where the board determines that such individual’s membership on the committee is “required by the best interests of the company and its shareholders.”

6. Exemptions from Required Compliance

Nasdaq proposed that its existing exemptions from compensation-related listing rules remain essentially unchanged, as those rules already allow exemptions from compliance for: asset-backed issuers, other passive issuers, cooperatives, limited partnerships, management investment companies and controlled companies.

The current rules also provide that a foreign private issuer may follow its home country practices if that issuer discloses this fact in its annual reports and explains the home country practice. Unlike the NYSE, however, Nasdaq did propose to add an additional disclosure requirement applicable to a foreign private issuer, requiring it to disclose the reasons why it chose not to have an independent compensation committee, as defined by rule.

7. Cure Periods

Based on SEC Rule 10C-1, Nasdaq proposed that if a company fails to comply with the compensation committee composition requirements due to a vacancy, or due to one committee member ceasing to be independent for reasons beyond the member’s control, then the company should have a cure period to regain compliance lasting until the earlier of the next annual shareholders’ meeting or one year from the event causing non-compliance (the “Event”).

However, if the annual meeting occurs within 180 days or less of the Event, then the company would have a cure period of 180 days to regain compliance. This would guarantee that a company has at least six months to cure any compensation committee defects.

8. Timing, Phase-In Schedules and Transition Periods

Proposed Nasdaq Listing Rule 5605(d)(3), which requires compensation committees to have specific responsibilities and authority, would become effective immediately upon approval.

Under the Nasdaq proposal, listed companies would be required to comply with the remaining provisions of the amended listing rules by the earlier of: (i) their second annual meeting held after the date of approval of such rules by the SEC; or (ii) December 31, 2014.

Nasdaq also proposed approval of its “phase-in schedule” for requirements relating to compensation committee composition. This schedule applies to: companies listing in connection with an IPO; companies emerging from bankruptcy; and companies with new listing requirements because they cease to be controlled companies. Each such company would have a “phase-in” requirement of: (1) one independent director at the time of listing; (2) a majority of independent directors within 90 days of listing; and (3) all independent members within one year of listing.

Each listed company, under Nasdaq’s proposal, would have to certify no later than 30 days after the implementation deadline applicable to it, that it has complied with the amended listing rules pertinent to compensation committees. Nasdaq would provide its listed issuers with a verification form for this purpose.