Companies listed on Nasdaq or the New York Stock Exchange must begin to comply with new rules governing compensation committees, those committees’ use of advisers and the independence of committee members. These new rules were adopted pursuant to a mandate in the Dodd-Frank Wall Street Reform and Consumer Protection Act. See our Advisory of July 9, 2012 for additional background on these rules.  

WHAT WILL NASDAQ-LISTED COMPANIES NEED TO DO?

The key provisions of Nasdaq’s new rules are as follows:

  • Compensation Committee. Nasdaq now requires that companies have a compensation committee consisting of at least two independent directors. Where previously compensation decisions could be made by a vote of the board of directors in which only independent directors voted, now a separate compensation committee is required.
  • Committee Charter. The compensation committee must adopt a formal, written charter specifying the committee’s responsibilities and authority, including (1) its authority to retain legal counsel and compensation consultants and other advisers; (2) its authority to fund such advisers, with such funds to be provided by the company; (3) its responsibility to consider certain independence factors before selecting such advisers; and (4) that the CEO may not be present during voting or deliberations regarding his or her compensation.
  • Determination of Independence. The independence of a director for service on a compensation committee will be judged under two new factors (that are in addition to Nasdaq’s existing independence criteria): (1) whether such director accepts any advisory, consulting or other compensatory fees other than for board service; and (2) whether such director is affiliated with the company, a subsidiary of the company or an affiliate of a subsidiary of the company. Nasdaq determined, however, that affiliation with the company, a subsidiary of the company, or an affiliate of a subsidiary of the company should not necessarily prohibit service on the compensation committee; it should, however, be a factor considered in determining independence. The new rules provide for a limited cure period due to non-compliance resulting from a vacancy or a committee member’s becoming non-independent due to circumstances beyond such member’s reasonable control.
  • Compensation Committee Advisers. Before choosing an adviser, the committee must consider six factors relevant to the adviser’s independence. Note that “adviser” is a broader term than “compensation consultant” and can include legal advisers as well as other advisers. These factors are: (1) other services provided by the adviser’s employer to the company; (2) the amount of fees received by the adviser’s employer from the company as a percentage of the adviser’s employer’s total revenues; (3) the internal policies and procedures of the adviser’s employer directed toward the prevention of conflicts; (4) any business or personal relationship between the adviser and any members of the committee; (5) any stock of the company owned by the adviser (or his or her immediate family members); and (6) any business or personal relationship between the adviser or his or her employer and an executive officer of the company. An adviser need not be independent, but these factors must be considered by the committee in choosing advisers. As described further in our Advisory of July 9, 2012, related SEC rules require proxy statement disclosure about any conflicts of interest raised as a result of these six factors when receiving the advice of consultants (but not as to other advisers). To the extent that an adviser is providing information that is not customized for the company or consulting on a compensation plan that would apply to all company employees, and not only executives, this independence analysis need not be made.
  • Exemptions for Smaller Reporting Companies and Foreign Issuers. Smaller reporting companies (as defined under SEC rules) are not required to comply with the enhanced requirements described above pertaining to the independence of members of compensation committees. Nor must such companies include in their compensation committee charters a grant of authority to retain compensation advisers, a requirement that the company fund such advisers, or a requirement that independence factors be considered with respect to such advisers. In addition, Nasdaq has decided to maintain its current rule that foreign private issuers may follow their home country practice in lieu of Nasdaq’s compensation-related listing standards if the foreign private issuer discloses in its annual reports filed with the SEC each requirement that it does not follow and describes the home country practice followed in lieu of such requirements. However, the new rules provide that if a foreign private issuer does not have an independent compensation committee, it must disclose the reasons why it does not have such a committee.
  • Effective Dates. By July 1, 2013, companies must comply with the rules relating to the authority of a compensation committee to retain compensation advisers, to fund such advisers, and to consider such advisers’ independence. Starting with the earlier of (1) a company’s first annual stockholders meeting after January 15, 2014 or (2) October 31, 2014, the remaining new provisions pertaining to compensation committees must be implemented.

WHAT WILL NYSE-LISTED COMPANIES NEED TO DO?

NYSE’s new rules governing compensation committees parallel those of Nasdaq, with several key differences. NYSE, for example, already required that its listed companies maintain chartered compensation committees consisting entirely of independent directors. Its new rules, however, amend the operating procedures for such committees, as follows:

  • Committee Charter. The new rules specify that the charter of the committee must provide for (1) the committee’s authority to retain legal counsel and compensation consultants and other advisers; (2) its authority to fund such advisers, with such funds to be provided by the company; and (3) its responsibility to consider certain independence factors before selecting such advisers.
  • Determination of Independence. The board of directors must determine the independence of a director for service on a compensation committee by considering all factors relevant to determining if a potential member has a relationship with the company including, but not limited to: (1) whether such director accepts any advisory, consulting or other compensatory fees other than for board service; and (2) whether non-independent due to circumstances beyond such member’s reasonable control.
  • Compensation Committee Advisers. Before choosing an adviser, the committee must consider six factors relevant to the adviser’s independence. Note that “adviser” is a broader term than “compensation consultant” and can include legal advisers as well as other advisers. These factors are: (1) other services provided by the adviser’s employer to the company; (2) the amount of fees received by the adviser’s employer from the company as a percentage of the adviser’s employer’s total revenues; (3) the internal policies and procedures of the adviser’s employer directed toward the prevention of conflicts; (4) any business or personal relationship between the adviser and any members of the committee; (5) any stock of the company owned by the adviser (or his or her immediate family members); and (6) any business or personal relationship between the adviser or his or her employer and an executive officer of the company. An adviser need not be independent, but these factors must be considered by the committee in choosing advisers. As described further in our Advisory of July 9, 2012, related SEC rules require proxy statement disclosure about any conflicts of interest raised as a result of these six factors when receiving the advice of consultants (but not as to other advisers). To the extent that an adviser is providing information that is not customized for the company or consulting on a compensation plan that would apply to all company employees, and not only executives, this independence analysis need not be made.
  • Exemptions for Smaller Reporting Companies and Foreign Issuers. Smaller reporting companies (as defined under SEC rules) are not required to comply with the enhanced requirements described above pertaining to the independence of members of compensation committees. Nor must such companies include in their compensation committee charters a grant of authority to retain compensation advisers, a requirement that the company fund such advisers, or a requirement that independence factors be considered with respect to such advisers. In addition, Nasdaq has decided to maintain its current rule that foreign private issuers may follow their home country practice in lieu of Nasdaq’s compensation-related listing standards if the foreign private issuer discloses in its annual reports filed with the SEC each requirement that it does not follow and describes the home country practice followed in lieu of such requirements. However, the new rules provide that if a foreign private issuer does not have an independent compensation committee, it must disclose the reasons why it does not have such a committee.
  • Effective Dates. By July 1, 2013, companies must comply with the rules relating to the authority of a compensation committee to retain compensation advisers, to fund such advisers, and to consider such advisers’ independence. Starting with the earlier of (1) a company’s first annual stockholders meeting after January 15, 2014 or (2) October 31, 2014, the remaining new provisions pertaining to compensation committees must be implemented.  

WHAT WILL NYSE-LISTED COMPANIES NEED TO DO?

NYSE’s new rules governing compensation committees parallel those of Nasdaq, with several key differences. NYSE, for example, already required that its listed companies maintain chartered compensation committees consisting entirely of independent directors. Its new rules, however, amend the operating procedures for such committees, as follows:

  • Committee Charter. The new rules specify that the charter of the committee must provide for (1) the committee’s authority to retain legal counsel and compensation consultants and other advisers; (2) its authority to fund such advisers, with such funds to be provided by the company; and (3) its responsibility to consider certain independence factors before selecting such advisers.
  • Determination of Independence. The board of directors must determine the independence of a director for service on a compensation committee by considering all factors relevant to determining if a potential member has a relationship with the company including, but not limited to: (1) whether such director accepts any advisory, consulting or other compensatory fees other than for board service; and (2) whether such director is affiliated with the company, a subsidiary of the company or an affiliate of a subsidiary of the company. NYSE chose, however, not to implement any bright-line rules regarding independence of directors, as it determined that its existing bright-lines rules governing such matters were sufficiently broad. The new rules provide for a limited cure period due to non-compliance following a committee member’s becoming non-independent due to circumstances beyond such member’s reasonable control.
  • Compensation Committee Advisers. NYSE adopted the same “six factor test” of adviser independence promulgated by the SEC and followed by Nasdaq. Thus, before choosing a compensation adviser, the committee must consider the following six factors pertaining to the adviser’s independence: (1) other services provided by the adviser’s employer to the company; (2) the amount of fees received by the adviser’s employer from the company as a percentage of the adviser’s employer’s total revenues; (3) the internal policies and procedures of the adviser’s employer directed toward the prevention of conflicts; (4) any business or personal relationship between the adviser and any members of the committee; (5) any stock of the company owned by the adviser (or his or her immediate family members); and (6) any business or personal relationship between the adviser or his or her employer and an executive officer of the company. An adviser need not be independent, but these factors must be considered prior to the committee’s choosing one. To the extent, however, that an adviser is providing information that is not customized for the company or consulting on a compensation plan that would apply to all company employees, and not just executives, this independence analysis need not be made.
  • Exemptions for Smaller Reporting Companies and Foreign Issuers. Smaller reporting companies are not required to comply with NYSE’s enhanced requirements pertaining to the independence of members of compensation committees. Nor are such companies’ committees required to consider independence factors before selecting compensation advisers. In addition, NYSE has maintained its existing rule that foreign private issuers may follow their home country practice in lieu of NYSE’s compensation-related listing standards if the foreign private issuer discloses in its annual reports filed with the SEC the manner in which its corporate governance practices differ from those followed by domestic NYSE companies.
  • Effective Dates. By July 1, 2013, companies must comply with all the new rules other than those pertaining to the independence of compensation committee members. Starting with the earlier of (1) a company’s first annual meeting of stockholders after January 15, 2014 or (2) October 31, 2014, the new standards for independence of compensation committee members must be implemented.  

WHAT ELSE SHOULD COMPANIES BE DOING TO HELP THEMSELVES COMPLY WITH THE NEW RULES?

With respect to these new listing standards, companies listed on Nasdaq or NYSE should also consider the following:

  • Diligence/Questioning of Advisers. Companies should increase their diligence of, and dialogue with, their compensation advisers and consultants. Listed companies must plan to address the independence factors with such advisers and consultants, and the advisers and consultants must in turn be prepared to respond to the necessary questions. In anticipation of the new rules, companies and compensation committees have begun sending written questionnaires to advisers and consultants to solicit information necessary to evaluate potential conflicts of interest. Companies should be prepared to use the information gathered to disclose in their 2013 proxy statements whether the work of a compensation consultant has raised any conflict of interest.
  • D&O Questionnaire Updates. Companies should revise their director and officer questionnaires to gather information regarding personal relationships of directors and officers with compensation advisers and consultants, and ensure they capture the information necessary to assess independence under the new rules.
  • Committee Membership Analysis. Companies should analyze the membership of their compensation committees to ensure all members meet the new independence requirements and, if not, start planning to reconstitute the committee and, if necessary, recruit new directors. If a Nasdaq-listed company does not already have a compensation committee, it should form one.
  • Review Committee Charters. Companies should review the charters of their compensation committees to ensure that they permit the committee to hire advisers and provide that the committee will consider the six independence factors described in the new rules before engaging such advisers.