In January 2013, the Securities and Exchange Commission approved amendments to the listing rules of the New York Stock Exchange (NYSE) and the Nasdaq Stock Market regarding the independence of compensation committee members and advisers (NYSE’s approved rule can be accessed here and Nasdaq’s approved rule can be accessed here).

The new NYSE and Nasdaq listing rules were adopted as required by Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act and SEC Rule 10C-1, which direct the national securities exchanges (including the NYSE and Nasdaq) 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

Rule 10C-1 directs the national securities exchanges 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 Rule 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, for example, the following:
    • The “Fees Factor”: The source of the director’s compensation, including any consulting, advisory or compensatory fee paid by the company to such director; and
    • The “Affiliation Factor”: 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 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 committee must consider, at a minimum, 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 from the 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 a member 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 the member’s reasonable control, the exchanges may grant that person, with notice by the listed company to the exchange, an opportunity to cure the event that caused the member to no longer be independent.

Overview of NYSE and Nasdaq Rules

Highlights of the new listing rules, which are discussed in more detail below, include the following:

  • The NYSE listing rules essentially adopt the minimum requirements of Rule 10C-1 and do 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 compensation may be determined by a majority of the independent members of the board), in addition to implementing the compensation committee director and adviser independence requirements under Rule 10C-1, Nasdaq’s new listing rules require listed companies to have an independent compensation committee composed of at least two members with a written charter covering certain key committee authority and responsibilities.
  • Nasdaq’s new listing rules specifically prohibit a compensation committee member from accepting, directly or indirectly, any consulting, advisory or other compensatory fee, other than for board service, from the listed company or any of its subsidiaries, consistent with the prohibition applicable to audit committee members. This restriction is more stringent than the requirements of Rule 10C-1 and the NYSE’s new listing rules.
  • As required by Rule 10C-1, both the NYSE’s and Nasdaq’s new listing rules provide that a compensation committee may retain or obtain the advice of a compensation consultant, independent legal counsel or other adviser, each of whom must be determined to be independent (considering the six factors set forth in Rule 10C-1). However, both the NYSE and Nasdaq listing rules provide that the compensation committee is not required to conduct a compensation adviser independence assessment with respect to (1) in-house counsel or (2) a compensation adviser that acts in a role limited to:
    • Consulting on any broad-based plan that does not discriminate in scope, terms or operation in favor of executive officers or directors and that is generally available to all salaried employees; and/or
    • Providing information that is not customized for a particular company or that is customized based on parameters that are not developed by the adviser, and about which the adviser does not provide advice.

This exception tracks the exception to the requirement to disclose the role of compensation consultants in determining or recommending the amount and form of executive and director compensation contained in Item 407(e)(3)(iii) of Regulation S-K.

NYSE Listing Rules

The NYSE amended its existing 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 directors must consider all factors relevant to determining whether a director has a material conflict of interest that would impair his or her ability to make independent judgments about the listed company’s executive compensation, including, but not limited to, the Fees Factor and the Affiliation Factor. The NYSE did not implement any additional factors for consideration or bright-line tests applicable to compensation committee members.
  • When considering the Affiliation Factor, the NYSE’s commentary to the new listing rules 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 and members of senior management, in each case, of a nature that would impair his or her ability to make 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, are in significant part already required by the NYSE’s existing compensation committee requirements. However, the NYSE adopted the Rule 10C-1 requirements verbatim in lieu of the existing requirements.
  • The compensation committee charter must state that the compensation committee may retain or obtain the advice of a compensation consultant, independent legal counsel or other adviser. Additionally, the listed company must provide for appropriate funding, as determined by the compensation committee, for payment of reasonable compensation to these independent advisers.
  • When engaging a compensation adviser, the compensation committee must consider the adviser’s independence based on the six independence factors specified in Rule 10C-1. However, no independence assessment is required with respect to in-house counsel or advisers for whom disclosure would not be required under Item 407(e)(3)(iii) of Regulation S-K.
  • The commentary to the new listing rules clarifies that the rules do not require a compensation consultant, legal counsel or other compensation adviser to be independent, only that the advice from, a compensation adviser.
  • The NYSE’s new listing rules include a cure provision allowing a compensation committee member 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 from the event that impaired the director’s independence. However, the NYSE’s new listing rule limits use of the cure provision to circumstances where the committee continues to have a majority of independent directors to ensure that the committee could not take any action without the agreement of one or more independent directors.
  • The NYSE’s existing exemptions from compliance 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 from bankruptcy or transferring their listings, are generally extended to the new compensation committee requirements.

Nasdaq Listing Rules

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

  • Listed companies must 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 rule change eliminates Nasdaq's current alternative, which allows executive officer compensation to be determined, or recommended to the board for determination, by a majority of the Independent Directors in a vote in which only Independent Directors participate.
  • Nasdaq’s new listing rules require that compensation committee members must not accept directly or indirectly any consulting, advisory or other compensatory fee, other than for board service, from the listed company or any subsidiary thereof for purposes of the Fees Factor, consistent with Nasdaq’s existing requirements governing audit committee independence. The new listing rule does not include a “look-back” period, meaning that the prohibition on the receipt of compensatory fees by a compensation committee member will begin with the member’s term of service on the compensation committee (although compensation committee members must still qualify as Independent Directors, which includes a three-year “look-back” period for compensatory arrangements).
  • In considering the Affiliation Factor, boards of listed companies must also consider whether a director 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 applies 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. The compensation committee charter must also 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 and membership 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 company may 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’s membership on the committee is required by the best interests of the company and its stockholders. A listed company relying on this exception must make certain disclosures and a member appointed under this exception may not serve longer than two years. Nasdaq will allow a listed company to use this exception even for a director who does not meet the new Rule 10C-1 independence requirements.
  • The compensation committee must have the authority to retain compensation consultants, independent legal counsel and other compensation advisers, and be provided funding to pay the reasonable compensation of such advisers.
  • The compensation committee must have the 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. However, similar to the NYSE listing rules, no compensation adviser independence assessment is required with respect to in-house counsel or advisers for whom disclosure would not be required under Item 407(e)(3)(iii) of Regulation S-K.
  • Nasdaq will apply its existing cure period applicable to noncompliance with the majority Independent Director requirement to noncompliance with the new compensation committee independence requirement, so long as the noncompliance is as a result of a vacancy on the committee or one compensation committee member 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, it must provide notice to Nasdaq.
  • Nasdaq’s new listing rules require that prior to engaging a compensation adviser, the compensation committee must consider the six independence factors specified in Rule 10C-1 in assessing the adviser’s independence. As mentioned above, no independence assessment is required with respect to in-house counsel or advisers for whom a determination would not be required under Item 407(e)(3)(iii) of Regulation S-K.
  • The Nasdaq listing rules clarify that they do not require a compensation consultant, legal counsel or other compensation adviser to be independent; rather, the compensation committee must only consider the six independence factors before selecting, or receiving advice from, a compensation adviser.
  • Nasdaq’s existing exemptions from compliance 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 from bankruptcy or transferring their listings, are generally extended to the new compensation committee requirements.

Impact on Foreign Private Issuers

The NYSE’s new listing rules do not amend its existing listing rules regarding Foreign Private Issuers, which 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 Form 20-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 from those followed by domestic NYSE-listed companies.

Nasdaq’s new listing rules regarding Foreign Private Issuers are similar to the NYSE’s listing rules. However, Nasdaq’s new listing 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. These Foreign Private Issuers must disclose in their annual reports on Form 20-F filed with the SEC (or on their website if they do not file annual reports with the SEC) the reasons why they do not have such a committee.

Impact on Smaller Reporting Companies

Under both the NYSE and Nasdaq listing rules, Smaller Reporting Companies must have a compensation committee comprised of at least two independent directors and a formal written charter (or under the Nasdaq listing rules, a board resolution) that specifies the committee’s responsibilities and authority, although Nasdaq’s listing rules do not require annual review of the charter (or resolution).

However, the NYSE and Nasdaq listing rules exempt Smaller Reporting Companies from the heightened compensation committee eligibility requirements relating to compensatory fees and affiliation, and the independence requirements relating to compensation advisers. While the NYSE listing rules 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 listing rules do not require a Smaller Reporting Company’s compensation committee charter to include these items.

Additionally, the NYSE and Nasdaq listing rules set forth a new transition provision for companies that cease to be Smaller Reporting Companies and become subject to the compensation committee independence requirements. NYSE and Nasdaq amended their proposed rules to conform their compliance phase-in schedules in the new listing rules and will base the compliance transition periods on the effective date of a company’s change in status.

Effective Dates

Certain elements of the NYSE and Nasdaq listing rules become effective on July 1, 2013, including provisions 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 (in the case of an existing Nasdaq listed company, whether it has an existing compensation committee or relies on a majority of Independent Directors alternative and whether or not it has a written compensation committee charter).

NYSE and Nasdaq-listed companies must comply with the compensation committee director independence requirements by the earlier of (1) their first annual meeting held after January 15, 2014; or (2) October 31, 2014. During the transition period until the new rules apply, a listed company must continue to comply with the corresponding provisions, if any, in the current listing rules.

A Nasdaq-listed company must certify to Nasdaq, no later than 30 days after the final implementation deadline applicable to it, that it has complied with the listing rules on compensation committees. Nasdaq has provided a form for this certification.