In September 2012, the New York Stock Exchange (NYSE) and the NASDAQ Stock Market (Nasdaq) proposed rules relating to the independence of compensation committee members and the selection of compensation committee consultants and advisors. The rules were proposed to comply with Rule 10C-1, which was adopted by the Securities and Exchange Commission (SEC) to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Under Rule 10C-1, stock exchanges and national securities associations (the "Exchanges") are required to adopt listing standards addressing:
- the independence of compensation committee members;
- the compensation committee's authority to retain, compensate and oversee compensation advisers; and
- the consideration of the independence of any compensation advisers.
COMPENSATION COMMITTEE INDEPENDENCE
Rule 10C-1 directs the Exchanges to require that listed companies' compensation committee members be independent directors and to develop a definition of independence after considering relevant factors, including, but not limited to:
- the source of compensation of the director (other than standard director fees), including any consulting, advisory or other compensatory fee paid by the issuer to the director; and
- whether the director is affiliated with the issuer, a subsidiary of the issuer or an affiliate of a subsidiary of the issuer.
Existing NYSE rules already require that a listed company have a compensation committee composed entirely of independent directors. The proposed NYSE definition for determining the independence of directors serving on the compensation committee expands upon its existing definition of independent director. In addition to the requirement that the board determine affirmatively that the director has no material relationship with the company, including that he or she has not been involved in certain specified types of relationships, the board would also need to consider all factors specifically relevant to determining whether a director has a relationship with the company that is material to the director's ability to be independent from management in connection with the duties of a compensation committee member, including, but not limited to, the two factors set forth above. In contrast to the Nasdaq proposals discussed below, the NYSE has not proposed to prohibit compensation committee members from receiving any compensatory payments and instead proposed commentary indicating that, in determining independence, a board should consider whether a director receives compensation from any source that impairs his or her ability to make independent judgments regarding compensation (the NYSE would also leave intact its current $120,000 bright-line threshold above which compensation renders a director not independent).
Existing Nasdaq rules do not require listed companies to have a compensation committee. The proposed Nasdaq rules would require issuers to have a compensation committee with at least two members, each of whom is independent, and a formal written charter. The proposed rules also would eliminate the current option of having independent directors constituting a majority of the independent directors on an issuer's board determine executive officer compensation. The proposed definition of independence for compensation committee members would expand upon Nasdaq's existing definition of director independence, under which the board must make an affirmative determination that the director has no relationship that would interfere with the exercise of independent judgment in carrying out the responsibilities of a director, and certain specified types of relationships preclude such a determination. For compensation committee members, the board would also need to consider the factors from Rule 10C-1 set forth above and could not find a director independent if he or she accepted, directly or indirectly, any consulting, advisory or other compensatory fee from the issuer or any subsidiary thereof. The proposed prohibition on the acceptance of such fees is not subject to any look-back period and would begin only upon the start of the director's term of service on the compensation committee.
Both the NYSE and Nasdaq have indicated that they do not intend to adopt absolute prohibitions against affiliates of the issuer, such as significant stockholders, serving on its compensation committee since these representatives may have interests aligned with other stockholders in maintaining appropriate executive compensation programs.
COMPENSATION COMMITTEE ADVISORS
As adopted, Rule 10C-1 also requires the Exchanges to include, as part of their listing standards, the following requirements regarding advisors to the compensation committee, as well as any other factors considered relevant by the Exchanges:
- the issuer must provide the compensation committee with full authority to retain or obtain a compensation consultant, independent legal counsel or other advisor;
- the compensation committee must be directly responsible for the appointment, compensation and oversight of those advisors;
- the compensation committee must be provided with appropriate funding from the issuer, as determined by the compensation committee, to compensate those advisors; and
the compensation committee must take into consideration the following factors that affect the independence of those advisors:
- the provision of other services to the issuer by the person who employs the advisor;
- the amount of fees received from the issuer by the person who employs the advisor;
- the policies and procedures of the person that employs the advisor designed to prevent conflicts of interest;
- any business or personal relationships of the advisor with a member of the compensation committee;
- any stock of the issuer owned by the advisor; and
- any business or personal relationships of the advisor or the person who employs the advisor with an executive officer of the issuer.
Neither the NYSE nor Nasdaq proposed any additional factors related to the independence of compensation committee advisors that must be considered in connection with their appointment beyond those listed above. The NYSE and Nasdaq proposals state that nothing requires a compensation committee to retain independent advisors, only that the factors listed above be considered when retaining an advisor. Additionally, both state that issuers do not need to review these factors when obtaining advice from in-house legal counsel.
EXEMPTIONS FOR CERTAIN ISSUERS
Under Rule 10C-1, the Exchanges are authorized to exempt specific categories of issuers from the requirements related to compensation committees and their advisors. The NYSE and Nasdaq have generally proposed to exempt from the new compensation committee requirements those issuers presently exempt from their current compensation committee rules, including controlled companies, limited partnerships and companies in bankruptcy, funds registered under the Investment Company Act of 1940, passive business trusts and issuers who list only derivatives, special purpose securities or preferred stock. The proposed rules of both the NYSE and Nasdaq will continue to allow foreign private issuers to follow their home country rule regarding compensation committees, but require such foreign private issuers to disclose differences in corporate governance practices (if they exist) and, for Nasdaq only, why such foreign private issuers do not have compensation committees.
Additionally, both the NYSE and Nasdaq propose to exempt smaller reporting companies from the additional proposed independence requirements for compensation committees and compensation committee advisors, while still requiring such issuers to have compensation committees meeting the general independent director standards.
The NYSE and Nasdaq proposals would allow directors to remain members of compensation committees if they lose independent status until the earlier of the next annual meeting or one year from the occurrence of the event that caused the director to no longer be independent. The ability to cure is contingent upon the director losing independence for reasons outside the director's reasonable control and providing notice of such an occurrence to the NYSE or Nasdaq. The NYSE proposes to limit the ability to cure to circumstances in which a compensation committee would still have a majority of independent directors. Under Nasdaq's proposal, if the next annual shareholders meeting occurs no later than 180 days following an event of noncompliance, an issuer would have 180 days to cure.
The NYSE has proposed that issuers would have until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014, to comply with the new rules.
Nasdaq has proposed that rules relating to compensation committee responsibilities and authority be effective immediately and that issuers must comply with the rules regarding director independence and the establishment of formal compensation committees by the earlier of their second annual meeting held after the date of approval of Nasdaq's amended listing rules or December 31, 2014.