Earlier this year, the SEC approved changes to the listing standards of several national securities exchanges, including the New York Stock Exchange and the NASDAQ Stock Market, to implement SEC Rule 10C-1 under the Exchange Act. As discussed in the SEC Updates we issued on June 29, 2012 and October 4, 2012, which are available here and here, Rule 10C-1 directs the national securities exchanges to establish listing standards concerning the independence of compensation committee members, the authority of compensation committees to engage advisers, and the factors that compensation committees must consider before selecting an adviser to assess the adviser’s independence. The first compliance deadline under the NYSE and NASDAQ standards is July 1 of this year. Listed companies will have to complete additional compliance actions in 2014.
Actions required by July 1, 2013
By July 1, companies listed on the NYSE and NASDAQ must ensure that they have granted their compensation committees, or (in the case of NASDAQ-listed companies without compensation committees) the independent directors making executive compensation decisions, the authority and responsibilities required by the new standards.
NYSE-listed companies. The NYSE has long required that its listed companies maintain compensation committees that act under written charters. By July 1, those charters will have to reflect the following authority and responsibilities:
- The committee must have the sole discretion to retain or obtain the advice of a consultant, independent legal counsel or other adviser.
- The committee must be directly responsible for the appointment, compensation and oversight of the work of any consultant, independent legal counsel or other adviser retained by the committee.
- The committee must have the authority to determine and receive funding from the company for reasonable compensation to any consultant, independent legal counsel or other adviser retained by the committee.
- Before selecting or receiving advice from any consultant, legal counsel (other than in-house counsel) or other adviser, the committee must consider all factors relevant to the adviser’s independence from management, including the six independence factors enumerated in new Section 303A.05(c) of the NYSE listed company manual.
The charters of many NYSE compensation committees already address most of the foregoing matters in some fashion and accordingly may require little revision to address the new authority and responsibilities. The NYSE staff informally has advised that the NYSE listing standards do not require the charter to identify specifically the six factors that relate to the adviser independence assessment so long as the charter contains a general reference to the committee’s duty to consider the factors set forth in the listing standards.
NASDAQ-listed companies. Unlike the NYSE, NASDAQ historically has not required its listed companies to maintain a formal compensation committee, instead permitting executive compensation to be determined or recommended either by a compensation committee or a majority of the independent directors of the board. That will change in 2014, when NASDAQ-listed companies will be required to form and maintain a formal compensation committee. By July 1 of this year, however, compensation committees of NASDAQ-listed companies or, if no compensation committee has been established, the independent directors that oversee executive compensation must be granted expanded authority and responsibilities. The new authority and responsibilities generally are the same as those that must be conferred upon compensation committees of NYSE-listed companies, except that NASDAQ permits the adviser independence assessment to be based solely on the six specific independence factors, and does not require consideration of additional factors relevant to independence.
A NASDAQ-listed company’s review must focus on ensuring that the grant of corporate authority, whether in a committee charter or other board action, is sufficient under the corporate law applicable to the company for the compensation committee or independent directors to discharge the enhanced obligations. The new NASDAQ listing standards do not require that a committee charter or similar document set forth the new authority and responsibilities by the July 1 deadline. NASDAQ requires only that a compensation committee (or the independent directors, if no compensation committee has been established) have the authority and responsibilities.
NASDAQ does not specify how the authority and responsibilities must be granted. Accordingly, companies have leeway in determining how to ensure compliance by July 1. For example, if a compensation committee operates under a charter, it may undertake the same type of review of the charter that should be conducted by the compensation committee of an NYSE-listed company. On the other hand, if a board has no compensation committee, it may be necessary for the board to adopt resolutions or supplement existing ones to ensure that the independent directors who oversee executive compensation have the authority and responsibilities required under the new standards. The new authority and responsibilities will have to be reflected in the compensation committee charter once the company forms a committee under the new standards. The NASDAQ staff has taken a position consistent with that of the NYSE staff in informally advising that the NASDAQ listing standards do not require the charter to identify specifically the six factors that relate to the adviser independence assessment so long as the charter contains a general reference to the committee’s duty to consider the factors set forth in the listing standards.
Actions required beginning July 1, 2013
Beginning on July 1, both NYSE and NASDAQ listing standards will require that compensation committees assess the independence of their advisers. The assessment of an adviser must take place before the committee selects or receives advice from that adviser. The new requirement raises a number of considerations.
Determination of adviser status. The first step in the assessment process is determining whether a proposed adviser is an “adviser” within the meaning of the listing standards. The listing standards provide limited guidance on this topic. Both the NYSE and NASDAQ exclude from the independence assessment requirement any consultant to the committee whose role is limited to (1) consulting on broad-based plans that do not discriminate in scope, terms or operation in favor of executives or directors and that are available generally to salaried employees, or (2) providing information that is not customized or that is customized based on parameters not developed by the adviser and on which the adviser does not provide advice. This exclusion is consistent with Regulation S-K Item 407(e)(3)(iii), which excludes these same consultants from the regulation’s requirement to disclose the role of compensation consultants.
Beyond the exclusion discussed above, there is little specific guidance on which to rely in making the adviser status determination. Recent informal statements by members of the SEC staff confirm that advice to the committee includes both direct and indirect advice and that the determination of whether a person is providing advice to the committee should take into account all relevant facts and circumstances. Under a facts-and-circumstances assessment, an adviser retained directly by the compensation committee for any purpose almost certainly would be deemed to be advising the committee and therefore to be subject to assessment. In contrast, where company management solicits the views of an outside adviser on a particular matter and then formulates advice to the compensation committee based on those views, the outside adviser should not be subject to assessment. In light of the range of potential variations on these two situations, in-house counsel should coordinate with the committee and the relevant outside advisers to ensure that all parties concur on the identification of those advisers whose independence the committee should assess.
Frequency of assessment. Neither the NYSE nor NASDAQ has issued guidance on how often an adviser’s independence should be assessed. It should be sufficient, however, to conduct the assessment on an annual basis unless a material change in circumstances raises a question as to the continuing validity of the prior assessment. Accordingly, if a compensation committee already has conducted an assessment of its compensation consultant for the 2013 year (for example, in connection with the compensation consultant conflict-of-interest disclosure requirement under Regulation S-K Item 407(e)(3)(iv)), another assessment of the consultant’s independence for the current year should not be required after July 1. Rather, committees should include the adviser assessment as part of their annual compliance process, subject to undertaking interim assessments in connection with a new engagement or a material change in circumstances warranting an interim assessment of an existing adviser.
Considerations for use of non-independent advisers. Although compensation committees must assess the independence of their advisers, nothing in the new listing standards precludes committees from receiving advice from any advisers selected by them, whether or not the advisers are independent. However, if a committee is advised by a compensation consultant that is determined not to be independent, the company may be required to disclose the lack of independence as a potential conflict of interest in its proxy statement under Regulation S-K Item 407(e)(3)(iv). This disclosure requirement applies only to compensation consultants, and does not extend to legal counsel and other advisers who are not compensation consultants.
Actions required for 2014
Beginning in 2014, the new NYSE and NASDAQ standards will require compensation committees to be composed solely of directors who meet enhanced independence standards. Listed companies must comply with this requirement by October 31, 2014 or, if earlier, the date of the company’s first annual meeting after January 15, 2014.
NYSE-listed companies. By the applicable effective date, boards of companies listed on the NYSE will have to determine whether the members of the compensation committee satisfy the enhanced independence standards. For NYSE-listed companies, the evaluation will require a consideration of all factors specifically relevant to determining whether a committee member has a relationship with the company that is material to the member’s ability to be independent from management in connection with the director’s duties on the compensation committee. The non-exclusive list of relevant factors includes:
- The source of the committee member’s compensation, including any consulting, advisory or other compensatory fee paid by the listed company to the director; and
- Whether the committee member is affiliated with the listed company or any of its subsidiaries or affiliates.
NASDAQ-listed companies. By the applicable effective date, each NASDAQ-listed company must have a compensation committee, each member of which must satisfy the enhanced independence standards. The enhanced independence standards:
- Prohibit a committee member from receiving any form of consulting, advisory or other compensatory fees, other than fees provided for service on the board or committees and amounts received under retirement plans that are not contingent on continued service; and
- Require the board to consider whether a committee member is affiliated with the company, its subsidiaries or its affiliates and, if so, whether the affiliation would impair the director’s judgment as a member of the compensation committee.
Companies listed on either the NYSE or NASDAQ will need to evaluate existing or proposed committee members under the enhanced independence standards well in advance of the applicable effective date. Early evaluation will afford the company time to implement any necessary adjustments to the composition of the compensation committee or the board of directors. Supplementing the company’s annual director and officer questionnaire, or preparing an independent questionnaire if appropriate, is likely the easiest way to elicit information from directors to determine their eligibility to serve on the compensation committee under the new standards.