The Securities and Exchange Commission (SEC) has recently issued proposed rules implementing the provisions of Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) concerning the independence of compensation committees and compensation advisers of public companies with listed securities. For most large public companies, the proposed rules should not result in significant changes to current practices for evaluating the independence of compensation committee members and compensation advisers. However, the proposed rules may impact current disclosures regarding compensation advisers.

Independence of Compensation Committee Members

The proposed rules direct the national securities exchanges (e.g., NYSE, Nasdaq) to establish listing standards that would require each member of a listed issuer’s compensation committee (if any) to be “independent.” Although the new rules do not define “independence,” they do list the following as factors that the exchanges should take into consideration when establishing the listing standards:  

  • The source of compensation of a member of the issuer’s board of directors, including any consulting, advisory or other compensatory fee paid by the issuer to such member 
  • Whether a member of the issuer’s board of directors is affiliated with the issuer, a subsidiary of the issuer, or an affiliate of a subsidiary of an issuer  

Under the proposed rules, controlled companies, 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 the foreign private issuer does not have an independent compensation committee would be exempt from these independence requirements. The proposed rules also permit the national securities exchanges to exempt particular relationships from these independence requirements, based on the size of the issuer and any other relevant factors.

The listing standards to be established by the national securities exchanges may provide an issuer with the opportunity to cure a defect in the independence of a compensation committee member if that individual ceases to be independent for reasons beyond his or her control. The cure provision may allow that individual to remain a compensation committee member 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.

Independence of Compensation Advisers

Section 952 of the Dodd-Frank Act makes the compensation committee responsible for the appointment, compensation and oversight of work done by compensation advisers, which includes compensation consultants, independent legal counsel and other advisers. The proposed rules require that the compensation committee consider, at a minimum, the following factors in determining a compensation adviser’s independence:  

  • The provision of other services to the issuer by the person that employs the compensation adviser  
  • 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  
  • The policies and procedures of the person that employs the compensation adviser that are designed to prevent conflicts of interest  
  • Any business or personal relationship of the compensation adviser with a member of the compensation committee  
  • Any stock of the issuer owned by the compensation adviser  

The proposed rules clarify that a compensation committee is not required to retain an independent compensation adviser. In addition, the proposed rules are not intended to prevent the compensation committee from conferring with in-house legal counsel or the company’s outside counsel, or from retaining non-independent counsel.  

Enhanced Disclosure Requirements

The proposed rules would enhance current SEC disclosure requirements regarding compensation consultants and conflicts of interest under Item 407 of Regulation S-K. The proposed rules would require additional disclosure as to:  

  • Whether the compensation committee has retained or obtained the advice of a compensation consultant  
  • Whether the work of the compensation consultant has raised any conflict of interest, and if so, the nature of the conflict and how the conflict is being addressed  

The enhanced disclosure must be provided for proxy and information statements for annual meetings (or a special meeting in lieu of an annual meeting) at which directors are being elected. The enhanced disclosure would apply regardless of whether the compensation consultant provides advice with respect to only broad-based plans or non-customized benchmark data (both are exemptions under the current SEC disclosure requirements).  

Few Changes Required for Larger Companies

Most large public companies already have compensation committees comprised of “independent” directors for purposes of complying with federal securities1 and tax2 laws, as well as national securities exchange requirements.3 In addition, many large public companies have already adopted practices concerning the independence of compensation advisers in response to stricter SEC requirements and pressure from institutional shareholder advisory groups and activist shareholders. Thus, the proposed rules should not result in significant changes to such companies’ current practices.

Looking Ahead

The SEC expects to finalize the rules sometime this fall. The national securities exchanges must have final rules in place no later than one year following the publication date of the final SEC rules. The SEC disclosure rules are expected to take effect with respect to proxy or information statements filed after the effective date for the national securities exchanges to implement the new SEC rules, and accordingly, the earliest the new rules would be in force is the 2012 proxy season.

Once the listing standards are issued, large public companies will need to confirm that no additional changes are needed with respect to their current practices. Smaller public companies that have not implemented independence standards for compensation committees and compensation advisers should also begin to evaluate measures designed to satisfy the SEC rules and applicable listing standards, with an eye to any exemptions or modified listing standards that might apply to smaller issuers. All public companies should begin to review the new disclosure requirements to evaluate how the new rules might affect their current disclosures.