On March 30, 2011, the SEC proposed rules to implement Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank"). Section 952 adds Section 10C to the Exchange Act and requires the SEC to direct the national securities exchanges to adopt listing standards relating to the independence of the members of a compensation committee, the committee's authority to retain compensation advisers, and the committee's responsibility for the appointment, compensation and work of any compensation adviser. Although there are certain exemptions, after an exchange's new listing standards are in effect, a listed company will be required to meet these standards in order for its shares to continue trading on that exchange.

Currently, companies listed on U.S. exchanges must meet exchange and SEC rules that cover much of the same information required by Section 952. For example, Item 407 of Regulation S-K already requires companies to disclose their determinations of director independence, as well as any role of compensation consultants in determining or recommending the amount or form of executive and director compensation. Accordingly, it is unclear whether Section 952 mandates more stringent requirements where the existing rules already address the requirements of Section 952.

In accordance with Section 10C, the rules, once adopted, would require the exchanges to establish listing standards that require each member of a listed issuer's compensation committee to be a member of the board of directors and to be independent. Section 10C does not define "independent," but states that "independent" is to be defined by the exchanges after considering relevant factors, which include:

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

These factors are similar to the factors used in determining whether audit committee members are independent under Sarbanes-Oxley, although the exchanges have more flexibility under Section 10C which only requires that they "consider" these factors in drafting the new independence rules. The audit committee independence requirements of Section 10A(m) prohibit board members who have received fees from the issuer or are affiliates of the issuer from serving on the audit committee.

Additionally, Section 10C requires the SEC to adopt rules directing the exchanges to prohibit the listing of any security of an issuer not in compliance with the following requirements relating to compensation committees and compensation advisers:

  • Each compensation committee must have the authority, in its sole discretion, to retain or obtain the advice of compensation consultants, independent legal counsel and other advisers.
  • Before selecting any compensation adviser, the compensation committee must take into consideration specific factors identified by the SEC that affect the independence of compensation advisers, including:
    • whether the compensation consulting company employing the compensation consultant is providing other services to the company
    • the amount of fees received from the company by the compensation consulting company who employs the compensation consultant, as a percentage of total revenue of the compensation consulting company
    • the compensation consulting company's policies and procedures that are designed to prevent conflicts of interest
    • any business or personal relationship of the compensation consultant with a member of the compensation committee
    • any stock of the company owned by the compensation consultant
  • The compensation committee must be directly responsible for the appointment, compensation and oversight of the work of any compensation adviser.
  • Each listed issuer must provide appropriate funding for the payment of reasonable compensation, as determined by the compensation committee, to compensation advisers.

As required by Section 10C, the proposed rules direct the exchanges to exempt the following categories of companies from the compensation committee independence requirements:

  • controlled companies
  • limited partnerships
  • companies in bankruptcy proceedings
  • open-end management investment companies registered under the Investment Company Act
  • foreign private issuers that provide annual disclosures to shareholders of the reasons why the foreign private issuer does not have an independent compensation committee

Lastly, Section 10C requires each issuer to disclose in any proxy or contest solicitation material for an annual meeting of shareholders (or a special meeting in lieu of the annual meeting): whether the issuer's compensation committee retained or obtained the advice of a compensation consultant; and whether the work of the compensation consultant has raised any conflict of interest, and, if so, the nature of the conflict and how it is being addressed.

Comments on the proposed rules must be received by the SEC on or before April 29, 2011. Although Dodd-Frank did not provide a specific deadline by which the listing standards promulgated by the exchanges must be in effect, the SEC has proposed that each exchange provide its proposed rules to the SEC no later than 90 days after publication of the final SEC rules in the Federal Register. Further, the SEC has proposed that each exchange would need to have final rules or rule amendments that comply with the SEC's final rules approved by the SEC no later than one year after publication of the SEC's final rules in the Federal Register.