Background Information and Effective Dates
On September 25, the NASDAQ Stock Market LLC (Nasdaq) proposed changes to its listing standards related to compensation committees. Nasdaq proposed new compensation committee rules in response to the SEC’s Rule 10C-1, which became effective on July 27, 2012 and which, in its turn, was promulgated in response to § 952 of the Dodd-Frank Act that required the SEC to direct the national securities exchanges to prohibit the listing of any equity security of an issuer, subject to certain exemptions, that does not comply with the Act’s requirements relating to compensation committees and compensation advisers.
Proposed Nasdaq Listing Rule 5605(d)(3), which requires compensation committees to have the specific responsibilities and authority necessary to comply with Rule 10C-1(b)(2), (3) and (4)(i)-(vi) under the Securities Exchange Act of 1934, will be effective immediately upon the SEC’s approval of the Nasdaq’s proposal as discussed below under Compensation Committee Responsibilities.
Nasdaq-listed companies must comply with the remaining amended listing rules by the earlier of: (i) their second annual meeting held after the date of approval of the proposed rules; or (ii) December 31, 2014. A company must certify to Nasdaq, no later than 30 days after the implementation deadline applicable to it, that it complied with the amended listing rules on compensation committees. (Nasdaq will provide a form for this certification). During the transition period, companies that are not yet required to comply with the amended listing rules on compensation committees must continue to comply with Nasdaq’s existing listing rules, which have been redesignated as Listing Rule 5605A(d) and IM-5605A-6 in Nasdaq’s proposal.
Compensation Committee Composition and Charter
Generally, Nasdaq’s proposal has almost closed the bridge between its compensation committee and audit committee rules, and many requirements applicable to audit committees of Nasdaq-listed companies are now applicable to their compensation committees. Please see below a chart comparing Nasdaq’s current compensation committee rules, its proposed compensation committee rules and current audit committee rules.
Click here to view the table.
Contents of the Compensation Committee Charter
Under the Nasdaq’s proposal, the compensation committee charter must specify the following:
- the scope of the compensation committee’s responsibilities, and how it carries out those responsibilities, including structure, processes and membership requirements;
- the compensation committee’s responsibility for determining, or recommending to the board for determination, the compensation of the executive officers of the company;
- that the chief executive officer of the company may not be present during voting or deliberations by the compensation committee on his or her compensation; and
- the specific compensation committee responsibilities and authority set forth in proposed Nasdaq Listing Rule 5605(d)(3).
These matters represent a combination of (i) some of the requirements applicable to the audit committee charter and (ii) compensation committee responsibilities under current Nasdaq rules.
Smaller reporting companies may adopt either a formal written compensation committee charter or a board resolution that specifies the committee’s responsibilities and authority, except for the matters set forth in proposed Nasdaq Listing Rule 5605(d)(3).
Compensation Committee Responsibilities
Proposed Nasdaq Listing Rule 5605(d)(3) states that a compensation committee must possess the specific compensation committee responsibilities and authority necessary to comply with Rule 10C-1(b)(2), (3) and (4)(i)-(vi) under the Act relating to the: (i) authority to retain compensation consultants, independent legal counsel and other compensation advisers; (ii) authority to fund such advisers; and (iii) responsibility to consider certain independence factors before selecting such advisers (other than in-house legal counsel).
Because this rule will be effective upon the SEC approval of the Nasdaq’s proposal, Nasdaq-listed companies should consider now whether to grant these specific responsibilities and authority through an amendment to the company’s charter, a resolution or other board action. To the extent a company does not have a compensation committee, the provisions of this rule will apply to the independent directors who determine, or recommend to the board for determination, the compensation of the executive officers of the company. While Nasdaq proposes that companies must eventually have a written compensation committee charter that includes, among other items, these responsibilities and authority, companies may implement such a charter on the schedule discussed above. Smaller reporting companies are exempt from this requirement.
What Should We Do Now?
Below is a list of suggested action items in connection with Nasdaq’s proposals:
- If you do not have a compensation committee and a majority of independent directors is making, or recommending to the board, compensation decisions related to executive officers of the company, start evaluating potential candidates for compensation committee membership.
- If you have a compensation committee consisting of one director, start evaluating potential candidates to expand the compensation committee to two members, as suggested by the SEC, or even to three members in order to avoid giving each director a veto power.
- Consider whether existing members of the compensation committee or potential members of the compensation committee are getting any compensatory fees from the company or any of its subsidiaries, or are affiliated with the company or a subsidiary of the company or an affiliate of a subsidiary of the company. Evaluate whether any changes to the current composition of the compensation committee are necessary.
- Implement new responsibilities and authority applicable to compensation committees, or independent directors involved in compensation decisions, relating to: (i) authority to retain compensation consultants, independent legal counsel and other compensation advisers; (ii) authority to fund such advisers; and (iii) responsibility to consider certain independence factors before selecting such advisers through a charter amendment or board resolution.
- Draft a new, or revise an existing, compensation committee charter.
NYSE Proposes New Rules Related to Compensation Committee and Committee Adviser Independence
The New York Stock Exchange (NYSE) recently filed proposed rule changes with the SEC related to compensation committee independence and the hiring of compensation advisers. The NYSE proposed such rules to comply with Exchange Act Rule 10C-1 adopted in June. Rule 10C-1 requires national securities exchanges to adopt listing standards which effectuate the compensation committee and committee adviser independence requirements of § 952 of the Dodd-Frank Act. The NYSE’s proposed rules do not expand upon or vary much from the SEC rules. Set forth below is a summary of the NYSE’s proposed rules:
Compensation Committee Independence
The NYSE proposed rules do not establish any new bright-line standards specific to compensation committee independence. Instead, the NYSE proposed rules require that, in affirmatively determining the independence of any director who will serve on a compensation committee, a listed company’s board “consider all factors specifically relevant to determining whether a director has a relationship to 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 explicitly enumerated in Rule 10C-1(b)(ii)”:
- the source of the director’s compensation, including any consulting, advisory or other compensatory fee paid by the listed company to such director; and
- whether the director has an affiliate relationship with the listed company, a subsidiary of the listed company or an affiliate of a subsidiary of the listed company.
The proposing release specifically provides that the NYSE does not believe that board compensation should be considered as part of the independence determination. Further, commentary to the proposed NYSE rules provides that
the board should consider whether the director receives compensation from any person or entity that would impair his ability to make independent judgments about the listed company’s executive compensation. Similarly, when considering any affiliate relationship a director has with the company, a subsidiary of the company, or an affiliate of a subsidiary of the company, in determining his independence for purposes of compensation committee service, …the board should consider whether the affiliate relationship places the director under the direct or indirect control of the listed company or its senior management, or creates a direct relationship between the director and members of senior management, in each case of a nature that would impair his ability to make independent judgments about the listed company’s executive compensation.
Compensation Committee Adviser Independence
The NYSE proposed rules related to compensation committee advisers provide that prior to hiring a compensation adviser, the compensation committee must consider the six factors set forth in Rule 10C-1(b)(4). The NYSE proposed rules do not add any factors for a compensation committee to consider prior to hiring an adviser, as the “Exchange believes that the list included in Rule 10C-1(b)(4) is very comprehensive and the proposed listing standard would also require the compensation committee to consider any other factors that would be relevant to the adviser’s independence from management.”
Listed companies will have until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014, to comply with the new director independence standards with respect to compensation committees. The other proposed rules, including those related to compensation committee advisers, will become effective on July 1, 2013.
The NYSE’s proposed new rules are subject to SEC review and comment. We believe it is unlikely that the SEC will have many objections to the proposed rules, as they essentially mirror the SEC’s rules. In light of the NYSE proposed rules, NYSE listed companies should be reviewing their compensation committee charters, the composition of the compensation committee and their relationships with the compensation advisers in order to identify whether any modifications or changes may be in order to comply with the coming NYSE standards.