On January 11, 2013, the Securities and Exchange Commission (the “SEC”) approved new listing standards relating to compensation committees proposed by the New York Stock Exchange (the “NYSE”) and the NASDAQ Stock Market (“Nasdaq”) to comply with Rule 10C-1 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The standards were adopted substantially as proposed by the exchanges in September 2012. The new standards implement the mandate of Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which added new Section 10C to the Exchange Act and directed the SEC to require national security exchanges to establish listing standards prohibiting the listing of equity securities of an issuer that fails to comply with Section 10C’s requirements relating to (i) compensation committee independence, (ii) the engagement of compensation advisors and (iii) compensation consultant conflicts of interest.
Compensation Committee Independence and Composition. Rule 10C-1 was adopted by the SEC in June 2012 and directs national exchanges to establish listing standards requiring that the members of an issuer’s compensation committee be members of the board of directors of the issuer and independent. To determine whether a director is “independent,” Rule 10C-1 directs the exchanges to consider relevant factors including, but not limited, to (i) a director’s source of compensation, including any consulting, advisory or other compensatory fee paid by the issuer to a director, and (ii) whether a director is affiliated with the issuer, a subsidiary of the issuer or an affiliate of a subsidiary of the issuer. The new NYSE standards require an issuer’s board to consider all factors relevant to determining whether a compensation committee member has a relationship that is material to such director’s ability to remain independent from the issuer’s management, including the specific Rule 10C-1 factors identified above and existing NYSE independence requirements. Nasdaq’s new standards also direct boards to consider a director’s affiliation with the issuer, its subsidiaries and affiliates of subsidiaries of the issuer and go farther than the NYSE by expressly prohibiting compensation committee members from directly or indirectly receiving any consulting, advisory or other compensatory fees from the issuer or its subsidiaries, other than fees for serving as a director or fixed compensation, including deferred compensation, under a retirement plan for prior service, provided that such compensation is not contingent on continued service. The standards adopted by both exchanges clarify that a director’s ownership of stock of the issuer will not, by itself, disqualify a director from serving on the compensation committee. Consistent with the NYSE’s existing listing standards, Nasdaq added a requirement that issuers have a standing compensation committee consisting of at least two independent directors, with a formal, written charter specifying the committee’s responsibilities and authority that is reviewed annually. Previously, Nasdaq’s listing standards allowed a committee of one or more independent directors or a majority of the independent directors of the board to determine executive officer compensation.
Authority to Engage Compensation Advisors and Related Requirements. Consistent with Rule 10C-1, the NYSE and Nasdaq now require that the compensation committees be (i) empowered to retain or obtain the advice of compensation consultants, independent legal counsel and other compensation advisors, (ii) directly responsible for the appointment, compensation and oversight of the work of any such retained advisors, and (iii) provided with appropriate funding for payment of reasonable compensation to any such retained advisors. Additionally, both exchanges require that, prior to retaining a compensation advisor, the compensation committee take into consideration the following factors bearing on the independence of the advisor:
- other services provided to the issuer by the person that employs the compensation advisor;
- fees paid by the issuer to the person that employs the compensation advisor, as a percentage of the total revenue of the person that employs the compensation advisor;
- policies and procedures of the person that employs the compensation advisor designed to prevent conflicts of interest;
- any business or personal relationship of the compensation advisor with a member of the compensation committee;
- any business or personal relationship of the compensation advisor or person who employs the advisor with an executive of the issuer; and
- any stock of the issuer owned by the individual compensation advisor, not the company that employs the advisor.
While compensation committees must consider the foregoing factors prior to selecting or seeking advice from an advisor, the new standards do not establish a requirement that the advisor in question be deemed independent. Additionally, compensation committees are not required to consider the above-listed factors with respect to in-house legal counsel or any compensation advisor whose role is limited to (i) consulting on any broad-based plan that does not discriminate in scope, terms or operation in favor of executive officers or directors of the issuer and that is available generally to all salaried employees or (ii) providing information that is not customized for a particular issuer or is customized based on parameters that are not developed by the compensation advisor and about which the compensation advisor does not provide advice.
Opportunity to Cure Defects. If a compensation committee member ceases to be independent for reasons outside of his or her control, the NYSE permits that director to remain a member of the compensation committee until the earlier of the issuer’s next annual shareholder’s meeting or one year from the occurrence of the event that caused the director to cease to be independent, provided that (i) the issuer promptly notifies the NYSE that the director has ceased to be independent and (ii) a majority of the members of the compensation committee remain independent. The opportunity to cure provided by Nasdaq mirrors the NYSE and, if the disqualifying event occurs less than 180 days prior to the issuer’s next annual shareholder’s meeting, then the issuer has 180 days from the disqualifying event to cure the defect.
Exemptions. Rule 10C-1 establishes a general exemption from its requirements for controlled companies and small reporting companies, although certain exchange certification and transition rules apply to smaller reporting companies, Rule 10C-1 also excepts from the compensation committee independence requirements (i) issuers that are limited partnerships, (ii) companies in bankruptcy, (iii) open-ended management investment companies registered under the Investment Company Act of 1940 (the “Investment Company Act”), and (iv) foreign private issuers that disclose in their annual reports the reasons that such issuers do not have an independent compensation committee. The new standards adopted by the NYSE also do not apply to closed end funds registered under the Investment Company Act), companies whose only listed equity security is preferred stock, and foreign private issuers that follow their home country corporate governance practices, provided that such issuers disclose the significant ways in which their corporate governance practices differ from those followed by domestic issuers. Nasdaq’s new standards also do not apply to asset backed issuers, cooperatives, limited partnerships, registered management investment companies, closed-end funds registered under the Investment Company Act and other companies that do not have a board of directors or a body serving in a similar capacity and whose activities are restricted to passively owning or holding securities or other assets for the benefit of or on behalf of its shareholders. Nasdaq also exempts foreign private issuers that follow their home country corporate governance practices, provided that such companies disclose each Nasdaq listing requirement that they do not satisfy and describe their applicable home country practice.
Effective Dates. Generally, the new NYSE standards will become effective on July 1, 2013 and issuers will have to comply with the compensation committee independence requirements as of the earlier of (i) their first annual meeting after January 15, 2014 or (ii) October 31, 2014. Issuers listed on Nasdaq must comply with its new standards relating to compensation committee retention, compensation, oversight and funding of advisors and analysis of advisor independence beginning July 1, 2013, and issuers will have until the earlier of (i) their first annual meeting after January 15, 2014 or (ii) October 31, 2014 to comply with the remainder of the new standards. Finally, Nasdaq issuers must certify compliance with the applicable requirements within 30 days of the applicable compliance deadline.