On September 25, 2012, the New York Stock Exchange (NYSE) and the Nasdaq Stock Market separately submitted to the Securities and Exchange Commission proposed amendments to their listing rules regarding the independence of compensation committeemembers and advisers. These proposals were submitted as directed by Rule 10C-1 adopted by the SEC pursuant to Section 952 of the Dodd Frank Wall Street Reform and Consumer Protection Act, which required the SEC to adopt rules directing the national securities exchanges to prohibit the listing of any equity security of a company that is not in compliance with the rule’s compensation committee director and adviser independence requirements.

SEC Rule 10C-1

In June 2012, the SEC adopted Rule 10C under the Securities Exchange Act of 1934 to implement Section 952 (Our Client Alert discussing Rule 10C-1 can be found here.) Rule 10C-1 directs the national securities exchanges (including NYSE and Nasdaq) to adopt the following listing standards:

  • Each member of a listed company’s compensation committee (including those members of the board who oversee executive compensation matters in the absence of a board committee) must be an “independent” director. Since 10C-1 does not define "independence," each exchange is required to develop its own definition of “independence” applicable to compensation committee members after considering relevant factors, including, without limitation, the following:
    • The source of the director’s compensation, including any consulting, advisory or compensatory fee paid by the company to such director; and
    • Whether the director is affiliated with the company, a subsidiary of the company, or an affiliate of a subsidiary of the company.
  • The compensation committee must have the power to retain or obtain the advice of a compensation adviser (which includes compensation consultants, independent legal counsel and other advisers).
  • The compensation committee must be directly responsible for the appointment, compensation and oversight of the and oversight of the work of any compensation adviser retained by the compensation committee.
  • The listed company must provide for appropriate funding, as determined by the compensation committee, for the payment of reasonable compensation to any compensation adviser retained by the compensation committee.
  • When considering engaging a compensation adviser the compensation committeemust consider, at aminimum, the following six specified independence factors:
    • The provision of other services to the listed company by the compensation adviser’s employer;
    • The amount of fees received fromthe listed company by the compensation adviser’s employer, as a percentage of the total revenue of the compensation adviser’s employer;
    • The policies and procedures of the compensation adviser’s employer that are designed to prevent conflicts of interest;
    • Any business or personal relationship of the compensation adviser with amember of the compensation committee;
    • Any stock of the listed company owned by the compensation adviser; and
    • Any business or personal relationship between the executive officers of the company and the compensation adviser or the compensation adviser’s employer.
  • If a member of the compensation committee ceases to be “independent” for reasons outside themember’s reasonable control, the exchangesmay grant that person, with notice by the listed company to the exchange, an opportunity to cure the event that caused themember to no longer be independent.

Overview of NYSE and Nasdaq Proposals

Highlights of the proposed rules, which are discussedmore particularly below, include the following:

  • The NYSE proposals essentially adopted theminimum requirements of Rule 10C-1 and did not expand on the director independence factors or any of the six compensation committee adviser independence factors specified in Rule 10C-1.
  • Because Nasdaq does not currently require that listed companies have an independent compensation committee (executive compensationmay be determined by amajority of the independentmembers of the board), in addition to implementing the compensation committee director and adviser independence requirements under Rule 10C-1, Nasdaq’s proposed rules would require listed companies to have an independent compensation committee composed of at least twomembers with a written charter covering certain key committee authority and responsibilities.
  • Nasdaq’s proposed rules would specifically prohibit a compensation committeemember from accepting, directly or indirectly, any consulting, advisory or other compensatory fee, other than for board service, fromthe listed company or any of its subsidiaries, consistent with the prohibition applicable to audit committeemembers. This restriction is more stringent than the requirements of Rule 10C-1 and the NYSE’s proposed amendments.
  • As required by Rule 10C-1, both the NYSE and Nasdaq proposals provide that a compensation committeemay retain or obtain the advice of a compensation consultant, independent legal counsel or other adviser, each of whommust be determined to be independent (considering the six factors set forth in Rule 10C-1).

NYSE Proposed Amendments

The NYSE proposes to amend its Corporate Governance Standards in its Listed Company Manual, which currently includes certain compensation committee requirements, to implement the requirements of Rule 10C-1, as described below:

  • When determining the independence of any director for service on the compensation committee, a listed company’s board of directorsmust consider all factors relevant to determining whether a director has amaterial conflict of interest that would impair his or her ability tomake independent judgments about the listed company’s executive compensation, including, but not limited to, the two specified Rule 10C-1 independence factors. The NYSE did not propose any additional factors for consideration or bright-line tests applicable to compensation committee members.

When considering any affiliate relationship a director has for purposes of compensation committee service, the proposed commentary provides that 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 andmembers of senior management, in each case, of a nature that would impair his or her ability tomake independent judgments about the listed company’s executive compensation.

  • The Rule 10C-1 requirement that the compensation committee have the authority to engage, oversee and compensate compensation consultants, independent legal counsel and other advisers, is in significant part already required by the NYSE’s existing compensation committee requirements. However, the NYSE proposes to adopt the Rule 10C-1 requirements verbatimin lieu of the existing requirements.
  • The compensation committee charter must state that the compensation committeemay retain or obtain the advice of a compensation consultant, independent legal counsel or other adviser. Additionally, the listed companymust provide for appropriate funding, as determined by the compensation committee, for payment of reasonable compensation to these independent advisers.
  • When engaging a compensation adviser (other than in-house counsel), the compensation committeemust determine the adviser’s independence, considering the six independence factors specified in Rule 10C-1.
  • The NYSE’s proposed amendment includes a “cure” provision allowing a compensation committeemember who ceases to be independent for reasons outside his or her reasonable control to remain on the committee until the earlier of the next annual meeting or one year fromthe event that impaired the director’s independence. However, the NYSE proposal limits use of the cure provision to circumstances where the committee continues to have a majority of independent directors to ensure that the applicable committee could not take any action without the agreement of one or more independent directors.
  • The NYSE’s existing exemptions fromcompliance with its corporate governance requirements applicable to controlled companies, Foreign Private Issuers and Smaller Reporting Companies, and phase-in schedules for compliance with its corporate governance requirements applicable to IPO companies, spin-off companies and companies emerging frombankruptcy or transferring their listings, compliance are generally extended to the new compensation committee requirements.

Nasdaq Proposed Amendments

In connection with implementing Rule 10C-1, Nasdaq also reviewed its current corporate governance requirements relating to executive compensation and proposed a number of changes in addition to the requirements of Rule 10C-1, as described below:

  • Listed companiesmust have a compensation committee consisting of at least two members, each of whom must be an “Independent Director” as defined under Nasdaq’s current listing rules. While not required by Rule 10C-1 , this proposed amendment eliminates from Nasdaq’s current listing rules an alternative which allows executive officer compensation be determined, or recommended to the board for determination, by Independent Directors constituting amajority of the Independent Directors in a vote in which only Independent Directors participate.
  • Nasdaq proposed that compensation committeemembersmust not accept directly or indirectly any consulting, advisory or other compensatory fee, other than for board service, fromthe listed company or any subsidiary thereof, consistent with Nasdaq’s existing requirements governing audit committee independence. The proposed rule does not include a “look-back” period, meaning that the prohibition on the receipt of compensatory fees by a compensation committeemember will begin with themember’s termof service on the compensation committee (although compensation committeemembersmust still qualify as Independent Directors, which includes a three-year “look-back” period) for compensatory arrangements.
  • In determining the independence of compensation committeemembers, boards of listed companiesmust also consider whether amember is affiliated with the issuer, a subsidiary of the issuer or an affiliate of a subsidiary of the issuer. As with the compensation prohibition, no “look-back” period will apply to the “affiliate” determination.
  • Listed companies must adopt a formal, written compensation committee charter (to be reviewed on at least an annual basis) that specifies the compensation committee responsibilities and authority required by Rule 10C-1 relating to the (1) authority to retain compensation consultants, independent legal counsel and other compensation advisers; (2) authority to fund such advisers; and (3) responsibility to consider certain independence factors before selecting such advisers, other than in-house legal counsel. Additionally, Nasdaq proposes that the compensation committee charter must specify:
    • the scope of the committee’s responsibilities (which includes the committee’s authority to retain compensation advisers), and how it carries out those responsibilities, including structure, processes andmembership requirements;
    • the committee’s responsibility for determining, or recommending to the board for determination, the compensation of the chief executive officer and all other “Executive Officers”; and
    • that the chief executive officer of the listed companymay not be present during voting or deliberations by the compensation committee on his or her compensation.
  • Listed companies may continue to rely on Nasdaq’s existing exception that allows certain non- Independent Directors to serve on a compensation committee under “exceptional and limited circumstances”. Under this exception, if a compensation committee consists of at least three members, one director, who is not an Independent Director and is not currently an “Executive Officer” or employee of a “Family Member” of an Executive Officer,may be appointed to the compensation committee if the board, under “exceptional and limited circumstances,” determines that such individual’smembership on the committee is required by the best interests of the company and its stockholders. A listed company relying on this exception mustmake certain disclosures and amember appointed under this exceptionmay not serve longer than two years. Nasdaq proposed that it would allow a listed company to use this exception even for a director who does notmeet the new Rule 10C-1 requirements.
  • The compensation committee must have the authority to retain compensation consultants, independent legal counsel and other compensation advisers, together with being provided funding to pay the reasonable compensation of such advisers.
  • The compensation committeemust have responsibility to consider certain independence factors (including the six compensation committee adviser independence factors specified in Rule 10C-1) before selecting compensation advisers, other than in-house legal counsel.
  • Nasdaq proposes to apply its existing cure period applicable to noncompliance with the majority Independent Director requirement to noncompliance with the compensation committee independence requirement as a result of a vacancy on the committee or one compensation committeemember ceasing to be independent due to circumstances beyond his or her reasonable control. Generally, a company has at least 180 days to cure noncompliance. If a company relies on this cure period, itmust provide notice to Nasdaq.
  • Nasdaq’s existing exemptions fromcompliance with its corporate governance requirements applicable to controlled companies, Foreign Private Issuers and Smaller Reporting Companies, and phase-in schedules for compliance with its corporate governance requirements applicable to IPO companies, spin-off companies and companies emerging frombankruptcy or transferring their listings, are generally extended to the new compensation committee requirements.

Impact on Foreign Private Issuers

The NYSE’s current listing rules provide that a Foreign Private Issuer may follow its home country practice in lieu of the NYSE’s compensation-related listing rules if the Foreign Private Issuer discloses in its annual reports on Form20-F filed with the SEC (or on its website if it does not file annual reports with the SEC) the significant ways the home country practice followed by the company differs fromthose followed by domestic NYSE listed companies. The NYSE’s proposed rules do not amend these existing listing rules.

Nasdaq’s existing listing rules regarding Foreign Private Issuers are similar to the NYSE’s existing rules. However, Nasdaq’s proposed rules add an additional disclosure requirement for any Foreign Private Issuer that follows its home country practice in lieu of the Nasdaq requirement to have an independent compensation committee to disclose in its annual reports filed with the SEC (or on its website if it does not file annual reports with the SEC) the reasons why it does not have such a committee.

Impact on Smaller Reporting Companies

Under both the NYSE existing and Nasdaq proposed rules, “Smaller Reporting Companies” (as defined in Rule 12b-2 under the Exchange Act)must have a compensation committee comprised of at least two independent directors and a formal written charter (or under the Nasdaq proposed rules, a board resolution) that specifies the committee’s responsibilities and authority, although Nasdaq’s proposed rules would not require annual review of the charter (or resolution).

However, the NYSE and Nasdaq proposed rules would exempt Smaller Reporting Companies fromthe heightened compensation committee eligibility requirements relating to compensatory fees and affiliation, and the independence requirements relating to compensation advisers. While the NYSE proposed rules would require Smaller Reporting Companies to provide for the compensation committee’s authority and funding to engage compensation advisers in its compensation committee charter, the Nasdaq proposed rules would not require a Smaller Reporting Company’s compensation committee charter to include these items.

Additionally, the NYSE proposal sets forth a new transition provision for companies that cease to be Smaller Reporting Companies and become subject to the compensation committee independence requirements set forth in the proposed rule, while Nasdaq proposes to extend the same phase-in schedule as applies to IPO companies to companies that cease to be Smaller Reporting Companies.

Proposed Effective Dates

As proposed, the NYSE rules would become effective on July 1, 2013, but listed companies would have until the earlier of (1) their first annual meeting after January 15, 2014, or (2) October 31, 2014, to comply with the new compensation committee director and adviser independence standards.

Certain elements of the Nasdaq proposed rules will be effective upon SEC approval, whereas other amendments will become effective at later dates. The proposed effective dates for the Nasdaq rules are as follows:

  • Nasdaq’s proposed rules relating to the compensation committee’s (1) authority to retain compensation advisers; (2) authority to fund such advisers; and (3) responsibility to consider certain independence factors before selecting such advisers, other than in-house legal counsel, would be effective immediately on the date of adoption whether a listed company has an existing compensation committee or relies on amajority of Independent Directors alternative and whether or not it has a written compensation committee charter.
  • Nasdaq proposes that listed companiesmust comply with the remaining provisions of the amended listing rules by the earlier of (1) their second annual meeting held after the date Nasdaq’s amended listing rules are approved; or (2) December 31, 2014.
  • A listed company must certify to Nasdaq, no later than 30 days after the implementation deadline applicable to it, that it has complied with the amended listing rules on compensation committees. Nasdaq will provide companies with a formfor this certification.

Comments on the proposalsmust be submitted on or before [the 21st day after the proposed rules are published in the Federal Register].