Each of the U.S. stock exchanges has recently proposed new corporate governance listing standards for compensation committee independence and compensation adviser matters. These standards address the requirements of Rule 10C-1 under the Exchange Act, enacted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. This memorandum gives a brief overview of those requirements, which were summarized in more detail in our June 2012 client alert, and then summarizes how each exchange has proposed to address them.

In addition, NASDAQ is eliminating the option for a listed company to avoid having a standing independent compensation committee so long as its executives’ compensation is determined by vote of a majority of a company’s independent directors. It will also now require its listed companies’ compensation committees to adopt a formal written charter. Neither of these changes was required by Dodd-Frank or the SEC, but they bring NASDAQ rules in line with NYSE rules and current governance practices.

The SEC published each exchange’s proposal in the Federal Register on October 15, 2012. Final approval is likely by the end of November.

SEC Requirements

First, Rule 10C-1 generally requires that the stock exchanges adopt listing rules requiring each member of a listed company’s compensation committee to be an independent director. In determining the independence of compensation committee members, the exchanges are to consider “relevant factors,” including but not limited to (a) the source of compensation of the director, including any consulting, advisory or other fee paid by the issuer to the director, and (b) whether the director is affiliated with the issuer, a subsidiary of the issuer, or an affiliate of a subsidiary.

Second, listed company compensation committees must have the authority to retain or obtain the advice of independent compensation consultants, independent legal counsel and other advisers. Compensation committees must be directly responsible for the appointment, compensation and oversight of these advisers, and the listed company must provide the appropriate funding for payment of reasonable compensation to them.

Third, listed company compensation committees may select compensation consultants, legal counsel (other than in-house counsel) or other advisers only after considering six factors identified by the SEC in its final rules, as well as any other factors identified by the relevant stock exchange.1

Rule 10C-1 also adopted certain disclosure rules for proxy statements covering compensation consultant conflicts of interest, which were not subject to further stock exchange rulemaking and are not addressed here.


Committee Member Independence. New York Stock Exchange listing rules currently require that for any director to qualify as “independent,” the board must affirmatively determine that the director has no material relationship with the listed company, in addition to meeting certain bright line tests. The NYSE proposes to require that, in affirmatively determining the independence of any person who will serve on the compensation committee of a listed company’s board of directors, the board must consider all factors specifically relevant to determining whether a director has a relationship to the listed company which is material to that director’s ability to be independent from management in connection with the duties of a compensation committee member. These considerations must include, but are not limited to, the two factors relating to compensation and affiliation described above.

In its commentary, the NYSE notes that when considering the sources of a director’s compensation, the board should consider whether the director receives compensation from any person or entity that would impair his or her ability to make independent judgments about the listed company’s executive compensation. Similarly, when considering any affiliate relationship a director has with the company, the board should consider whether the 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 and members of senior management, in each case in a way that would impair his or her ability to make independent judgments about the listed company’s executive compensation.

The NYSE explains that stock ownership by a director or his or her affiliates in any amount should not automatically prohibit a finding of independence. The exchange noted that for purposes of a director’s oversight of executive compensation levels, share ownership in a listed company aligns the director’s interests with that of unaffiliated shareholders.

Committee Authority. NYSE rules already cover the substance of the requirements relating to a compensation committee’s authority to retain advisers and the company’s obligation to provide funding. For the sake of clarity, the NYSE proposes to adopt the language of the SEC rule verbatim, and to move the substantive requirements out of the committee charter requirements, where they now reside, into a separate section.

Adviser Independence Considerations. The NYSE has not proposed to adopt any additional factors that a compensation committee must consider in retaining compensation consultants, legal counsel or other advisers, beyond the six factors identified by the SEC. The NYSE concluded that the list of factors enumerated in the SEC rules is suitably comprehensive.

Transition and Cure Periods. The NYSE proposes that listed companies would have until their first annual meeting after January 15, 2014, but not later than October 31, 2014, to comply with the new committee independence standards. Newly listed companies may also continue to avail themselves of a transition period. Where a compensation committee member ceases to meet the independence requirements for reasons outside of his or her control, but the committee continues to have a majority of independent members, the director may remain on the committee until the earlier of the next annual meeting or one year from the occurrence of the event.

Smaller Reporting Companies. NYSE-listed companies that qualify as smaller reporting companies under SEC rules will not be required to comply with the new independence tests for compensation committee members relating to compensatory fees and affiliation. They must still comply with the requirements relating to the committee’s authority regarding compensation advisers, but are not required to explicitly consider the six independence considerations prior to retaining advisers.

NASDAQ Stock Market

Committee and Charter Requirements. As an alternative to having a formal compensation committee, NASDAQ-listed companies may currently make executive compensation decisions by vote of their independent directors. Under the new rules, this alternative will be eliminated, and listed companies will be required to establish and maintain a standing committee of at least two members dedicated solely to the oversight of executive compensation. Given the importance of compensation decisions in today’s governance environment, and the small number of listed companies that do not use a standing compensation committee,2 NASDAQ decided that the independent director alternative was no longer appropriate.

Similarly, NASDAQ listed companies are currently not required to have a formal written compensation committee charter. NASDAQ now proposes to require each listed company to have a formal charter that addresses the scope of the committee’s responsibilities, including its responsibilities for determining or recommending CEO and other executive officer compensation, and how it carries out those responsibilities (including the new requirements described under “Committee Authority” below). The charter must also provide that the chief executive officer not be present for deliberations or voting concerning his or her compensation. Companies will have to certify that they will review and assess the adequacy of the charter on an annual basis.

Committee Member Independence. Under NASDAQ’s proposed rules, compensation committee members would be prohibited from accepting any consulting, advisory or other compensatory fee from the listed company or any subsidiary, other than for board service or fixed amounts received under a retirement plan for prior service. In addition, in determining whether the director is eligible to serve on the compensation committee, the board must consider whether the director is affiliated with the listed company, a subsidiary or an affiliate of a subsidiary, to determine whether the affiliation would impair the director’s judgment as a member of the compensation committee.

NASDAQ’s proposed approach thus represents a bright line prohibition under the independence standards relating to outside compensation of directors, and echoes the requirements for audit committee member independence under Exchange Act Rule 10A-3 and related exchange rules. This is different from the potentially more flexible NYSE proposed standard, which would merely take compensation into consideration.

Similar to the NYSE proposal for compensation committee membership, but unlike the audit committee requirements, affiliation with the listed company is only a consideration, and not automatically a disqualifying factor. While a board may determine otherwise based upon the circumstances, NASDAQ does not believe that ownership of stock by itself precludes a board finding that it is appropriate for a director to serve on a compensation committee. NASDAQ stated that it could identify no compelling policy justification for precluding all affiliates, even those with large stakes in a listed company, from serving on the compensation committee.

Committee Authority. NASDAQ will require any listed company’s compensation committee to have the specific responsibilities and authority necessary to comply with Rule 10C-1, including the authority to retain consultants, independent counsel or other advisers; the authority to fund those advisers; and the responsibility to consider certain independence factors before selecting such advisers (other than in-house counsel). The committee charter will also be required to specify these authorities and responsibilities.

Adviser Independence Considerations. Like the NYSE, NASDAQ has not proposed to adopt any additional factors that a compensation committee must consider before retaining compensation consultants, legal counsel or other advisers, beyond the six factors identified by the SEC.

Transition and Cure Periods. Companies will need to comply with the committee authority and responsibility requirements immediately upon the approval of the rule changes by the SEC. The remaining rule changes will apply by the earlier of December 31, 2014, or the second annual meeting after the approval by the SEC. Until a company is required to comply with the amended listing rules, it must continue to comply with the existing rules.

Where a NASDAQ listed company fails to comply with the compensation committee independence requirements due to one vacancy, or one member ceases to meet the independence requirements for reasons outside of his or her control, the company will be required to regain compliance by the earlier of the next annual meeting or one year from the occurrence of the event. If the next annual meeting is within 180 days of the event that caused the non-compliance, the company will instead have 180 days to regain compliance.

In addition, listed companies will continue to be able to rely on the existing NASDAQ exception that allows certain non-independent directors to serve on a compensation committee under “exceptional and limited circumstances.”

Smaller Reporting Companies. NASDAQ-listed companies that qualify as smaller reporting companies must have a compensation committee composed of at least two independent directors, and a formal committee charter or board resolution that outlines the committee’s responsibilities and authority. They will not be required to satisfy the proposed eligibility requirements for compensation committees relating to compensatory fees and affiliation, and their compensation committee charters or authorizing board resolutions need not specifically address the committee’s authorities relating to the engagement of compensation advisers or the consideration of their independence.


The NYSE MKT, which was called the American Stock Exchange prior to becoming part of the NYSE Euronext group, has proposed rules that generally follow the NYSE rule proposals summarized above. Thus, in determining the independence of compensation committee members, a listed company’s board must consider all factors relevant to whether a director has a relationship to the company that is material to the director’s ability to be independent from management in fulfilling the duties of a compensation committee member, including the source of any compensation received by the director, and whether the director is affiliated with the company. Outside compensation will not be an absolute bar to independence. The committee must also have the responsibilities and authority relating to compensation advisers specified under Rule 10C-1. The cure and transition periods generally mirror those of NYSE’s proposal.

Like NASDAQ, the NYSE MKT does not currently require that a listed company have a standing compensation committee, so long as compensation of executives is determined by a majority of the independent directors. Unlike NASDAQ, the NYSE MKT has not proposed to eliminate this alternative. If a NYSE MKT listed company does not have a standing compensation committee, the rules would apply to the independent directors of the listed company individually and as a group.

What Companies Should Do Now

Most companies are likely to find that the rules will beget procedural but not substantive changes. The widest impact may be that compensation committees will be required specifically to consider each of the six independence factors enumerated in the rules prior to selecting an outside compensation consultant or adviser. Some of these considerations involve information that will not be apparent to the listed company without additional input from the advisers themselves, such as fees as a percentage of total revenue, the adviser’s conflict of interest policies and stock ownership. Many compensation committees may decide to solicit questionnaires from their advisers to help document their compliance with the requirements. This applies to legal counsel as well as compensation consultants, including the issuer’s regular outside counsel (but not in-house counsel). Companies should document this inquiry and, where advisers are consulted on an ongoing basis, revisit it at reasonable intervals.

NASDAQ companies who have been operating without a standing compensation committee will need to establish such a committee. Likewise, any compensation committees that have been operating without a formal charter would need to establish one. Listed companies with compensation committee members who accept any outside compensation unrelated to board service will need to consider how that compensation affects the director’s eligibility, even for NYSE companies where it will not be an outright prohibition.

The adoption of these new rules also serves as an opportunity for listed companies on any exchange to revisit their compensation committee charters in order to make sure they are up to date. For example, while it is already a NASDAQ requirement that CEOs be absent from committee or board deliberations over their own compensation, this will now need to be memorialized in the charter.

In addition, standard director and officer (D&O) questionnaires will need to be updated to solicit information that will assist a board in evaluating compensation committee member independence, in particular regarding sources of compensation and affiliation with the listed company.

Most listed companies will find that the new rules will not require a reinvention of the manner in which they set executive compensation. At a minimum, however, closer attention will need to be given to the annual independence determinations relating to compensation committee members, and some additional procedural steps will need to be taken before compensation committees seek the advice of outside advisers, including consultants and legal counsel.