The New York Stock Exchange and Nasdaq have proposed changes to their listing standards relating to compensation committees. The changes, which are mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act and related rules of the Securities and Exchange Commission, pertain to the independence of compensation committee members and their responsibilities when retaining advisers. The SEC must approve the new listing requirements in final form by June 30, 2013. There will be a transition period so that some of the new requirements will not come into effect until 2014.

Both of the exchanges propose to grant exemptions from the new requirements for controlled companies and foreign private issuers, including Canadian issuers under the MJDS (Multijurisdictional Disclosure System).

Notably, Nasdaq is proposing that compensation committee members be prevented from accepting, directly or indirectly, any consulting, advisory or other compensatory fee from the issuer or any subsidiary. This independence standard already applies to audit committee members under both U.S. and Canadian rules, but by contrast, the NYSE is not proposing to extend the prohibition to compensation committee members.

The NYSE and Nasdaq proposals differ in other respects as well, partly because the Dodd-Frank Act afforded the stock exchanges some discretion and partly because differences in the exchanges’ existing rules necessitate different approaches to implementing the Dodd-Frank mandate. It is possible, however, that during the SEC review period, the exchanges will modify their proposals to achieve greater conformity.  

NYSE Proposals

Independence of Compensation Committee Members

The NYSE already requires listed issuers to have fully independent compensation committees. Under the proposed changes, in determining the independence of a compensation committee member, the board of directors would, in addition to applying the existing independence tests, also have to consider any factors specifically relevant to determining whether the director has a relationship with the issuer that materially affects the director’s ability to be independent in carrying out the duties of a compensation committee member. The factors that the board of directors would have to consider include, but are not limited to

  • the sources of a director’s compensation, including any consulting, advisory or other compensatory fee from the issuer or from any other person or entity that would impair the director’s ability to make independent judgments about executive compensation; and
  • whether the director is affiliated with the issuer, a subsidiary or an affiliate of a subsidiary, and whether the affiliation places the director under the direct or indirect control of the issuer or its senior management or creates a relationship between the director and members of senior management that would impair the director’s ability to make independent judgments about executive compensation.

While a director’s stock ownership would be a factor to consider in the above analysis, the NYSE proposal affirms the exchange’s existing position that even a significant ownership stake does not preclude a finding of independence.

Advisers to Compensation Committees

The Dodd-Frank Act mandates that compensation committees be given the authority to retain, supervise and fund compensation consultants, independent legal counsel and other advisers. These requirements are largely already required under the NYSE’s standards. Therefore, the NYSE is proposing simply to reorganize its rules to clarify these responsibilities.

Advisers would not have to be independent, but before obtaining advice from an adviser (other than in-house legal counsel), compensation committees would have to consider any factors bearing upon the adviser’s independence, including the following:

  • other services that the adviser provides to the issuer;
  • the fees paid to the adviser in relation to the adviser’s total revenue;
  • the adviser’s policies and procedures in respect of conflicts of interest;
  • the adviser’s business or personal relationships with the issuer’s executive officers and compensation committee members; and
  • the adviser’s stock ownership in the issuer.

The SEC expects that compensation committees will need to create procedures for collecting and analyzing information about potential advisers before obtaining advice from them.

Implementation and Exemptions

The NYSE is proposing a transition period for the new compensation committee independence standards. Issuers would have to comply with these requirements by the earlier of their first annual meeting after January 15, 2014 or October 31, 2014. The requirements in respect of compensation committee advisers would be effective upon SEC approval, expected by June 30, 2013.

Existing exemptions for controlled companies and foreign private issuers would be maintained – that is,  foreign private issuers would have to disclose the significant differences between their own practices and the NYSE’s standards. In light of existing Canadian best practice guidelines and disclosure requirements pertaining to compensation committees and their advisers, we do not expect the NYSE’s rule changes, as proposed, to result in more burdensome "significant differences" disclosure for most cross-border issuers.  

Nasdaq Proposals

Independence of Compensation Committee Members

Under Nasdaq’s proposals, listed companies would now be required to have a fully independent compensation committee comprising at least two members; the currently available option of having a majority of the board’s independent directors fulfill this function would no longer be permitted.

In addition to satisfying Nasdaq’s existing tests for independence, compensation committee members would be prohibited from accepting, directly or indirectly, any consulting, advisory or other compensatory fee from the issuer or any subsidiary of the issuer. This rule also applies to audit committee members under U.S. and Canadian rules.

Like the NYSE, Nasdaq affirms in its proposal that significant stock ownership does not prevent a compensation committee member from being considered independent. However, boards of directors would have to consider, before determining that an affiliated director is independent, whether such affiliation would impair the person’s judgment as a member of the compensation committee.

Advisers to Compensation Committees

Compensation committees would need the authority to retain, supervise and fund compensation consultants, independent legal counsel and other advisers. These committees would also have to consider various independence factors before selecting such advisers (other than in-house legal counsel). The independence factors are the same as those listed above for NYSE-listed issuers.  

Implementation and Exemptions

Nasdaq is proposing a transition period for complying with the new rules on the independence of compensation committee members. Issuers would have to comply with these requirements by December 31, 2014 or by the issuer’s second annual meeting after the SEC’s approval, whichever is earlier. The new rules on compensation advisers would be effective upon the SEC’s approval, expected by June 30, 2013.

Existing exemptions from Nasdaq’s listing rules would be maintained – that is controlled companies and foreign private issuers would be exempt. Foreign private issuers would, as under Nasdaq’s current disclosure rules, have to describe each Nasdaq standard that they do not follow and the home country practice that they follow instead. More specifically, there would be a new requirement to disclose why a foreign private issuer does not have an independent compensation committee. Although most Canadian cross-border issuers do have independent compensation committees under Canadian best practices guidelines, the proposed Nasdaq prohibition on committee members receiving any form of compensation from the issuer (other than board and committee fees) differs from Canadian standards; and cross-border issuers that do not adopt the Nasdaq standard would have to provide the necessary disclosure.