On June 20, 2012, the U.S. Securities and Exchange Commission (SEC) adopted a new rule directing national securities exchanges to adopt listing standards to: (1) impose independence requirements on compensation committee members; (2) require companies to authorize compensation committees to retain compensation consultants and other advisers; and (3) require compensation committees to assess the independence of any consultant, legal counsel, or other adviser selected by the committee.

In addition, the SEC also amended disclosure rules under Item 407 of Regulation S-K. The new provision requires companies to disclose in their proxy statements whether a conflict of interest was raised by any work performed by a compensation consultant, and if so, to disclose the nature of the conflict and how it was addressed.

Independence of Compensation Committee Members

Under new Rule 10C-1, exchanges are required to adopt listing standards that require each member of an issuer’s compensation committee to be independent. Relevant factors in developing definitions of independence include:

  • The source of the compensation of compensation committee members (including any consulting, advisory, or other compensatory fee paid by the company); and
  • Whether a compensation committee member is affiliated with the issuer, a subsidiary, or an affiliate of a subsidiary of the issuer.

Authority of the Compensation Committee

The SEC requires the exchanges to adopt listing standards providing that the compensation committee of a listed company:

  • Has the authority and sole discretion to retain or obtain the advice of a compensation adviser (compensation consultants, independent legal counsel, and other advisers);
  • Is directly responsible for the appointment, compensation, and oversight of such compensation advisers retained by the compensation committee; and
  • Must be appropriately funded by the listed company.

Independence of Compensation Advisers

Rule 10C-1 also requires the exchanges to adopt listing standards providing that a compensation committee may select a compensation consultant, legal counsel, or other adviser, other than in-house legal counsel, only after considering the following independence factors:

  • Whether the compensation consulting company employing the compensation adviser is providing any other services to the issuer;
  • The amount of fees the compensation consulting company that employs the compensation adviser has received from the issuer, as a percentage of the total revenue of the consulting company that employs the compensation adviser;
  • What policies and procedures have been adopted by the compensation consulting company employing the compensation adviser to prevent conflicts of interest;
  • Whether the compensation adviser has any business or personal relationship with a member of the compensation committee of the issuer;
  • Whether the compensation adviser owns any stock of the issuer; and
  • Whether the compensation adviser or the person employing the adviser has any business or personal relationship with an executive officer of the issuer.

The exchanges themselves may impose additional factors.

Oversight by Board Members Outside of a Committee

These listing standards, with limited exceptions, will also apply to members of a listed company’s board of directors who, in the absence of a board committee, oversee executive compensation matters on behalf of the board of directors.

Amended Proxy Disclosure Rules

Companies subject to the federal proxy rules already are required to disclose information about their use of compensation consultants and the fees paid to these consultants. Under the amended rules, with respect to any compensation consultant that has played a role in determining or recommending the amount or form of executive and director compensation and whose work has raised any conflict of interest, companies will be required to disclose the nature of the conflict and how the conflict is being addressed.

Effective Dates

These rules took effect on July 27, 2012. Each exchange that lists equity securities must propose listing standards that comply with the new rule by September 25, 2012, and must adopt final listing standards no later than June 27, 2013. The new disclosure obligation concerning compensation consultant conflict of interest applies to proxy statements for annual meetings at which directors will be elected occurring on or after January 1, 2013.

Companies listed on national securities exchanges should reevaluate the independence of their compensation committee members and compensation advisers in light of the new rules. Companies will also need to develop or modify procedures to determine relationships between issuers and compensation committee members and compensation advisers and to identify conflicts of interest between issuers and compensation advisers.