On July 28, 2012, new SEC rules took effect relating to the composition of compensation committees, the use of compensation advisers by companies listed on national securities exchanges, and disclosure regarding compensation consultants’ conflicts of interest. These rules, proposed in March 2011, were adopted pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).


The Dodd-Frank Act added Section 10C to the Securities Exchange Act of 1934 (the “Exchange Act”). Section 10C requires that the SEC direct the national securities exchanges and associations to prohibit the listing of any company issuing equity securities, subject to limited exceptions, unless specific conditions are satisfied with respect to the authority of the compensation committee, the independence of the compensation committee’s members, and the consideration of specific factors relating to the independence of compensation consultants, legal counsel and other advisers retained by the compensation committee.

The SEC adopted new Rule 10C-1 to direct the national securities exchanges to adopt listing standards regarding compensation committees and the compensation advisers they retain. The national securities exchanges must now propose and adopt listing standards in accordance with the SEC’s final rules.

The SEC also amended Item 407 of Regulation S-K to require proxy statement disclosures regarding conflicts of interest of compensation consultants.

Compensation Committee IndependenceRule 10C-1 requires each national securities exchange to establish listing standards requiring that each member of an issuer’s compensation committee be an independent member of the board of directors. However, under these new listing standards, “independence” is to be defined by the exchanges after taking into consideration relevant factors, including (a) the source of compensation of each director and (b) whether the director is affiliated with the issuer, a subsidiary of the issuer, or an affiliate of a subsidiary.

Although the exchanges are directed to consider whether these factors should be used to define “independence” for compensation committee members, the exchanges are not required to include such factors in the definition, and the exchanges may consider other factors. The SEC has, therefore, provided the exchanges with greater discretion in determining the appropriate independence definition than is currently available with respect to the independence of audit committee members, as required pursuant to the Sarbanes-Oxley Act.

Compensation Committee and Advisers

Pursuant to Rule 10C-1, national securities exchanges must establish listing standards providing that the compensation committee of any listed company may, in its sole discretion, retain a compensation adviser, legal consultant or other adviser; and that the compensation committee will be directly responsible for the appointment, compensation, and oversight of such adviser. The issuer must also provide the compensation committee with appropriate funding for payment to such compensation committee advisers. The exchange listing standards must also provide that the compensation committee may only select a compensation consultant, legal counsel, or other adviser after considering the following independence factors:

  • whether the firm employing the adviser provides other services to the issuer;
  • the amount of fees received from the issuer by the firm employing the adviser, as a percentage of the firm’s total revenue;
  • the policies and procedures adopted by the firm employing the adviser to prevent conflicts of interest;
  • whether the adviser has any business or personal relationship with a member of the compensation committee;
  • whether the adviser owns any stock in the issuer; and
  • whether the adviser or firm employing the adviser has any business or personal relationship with an executive officer of the issuer.

Although these new listing standards may create a presumption that compensation committees should receive advice only from independent advisers, the listing standards will merely require the compensation committee to select an adviser after considering the aforementioned factors.

Exemptions and Applicability of Listing Standards

In accordance with Section 10C, the listing standards requirements do not apply to controlled companies, issuers of securities futures products cleared by a registered clearing agency or a clearing agency exempt from registration, or registered clearing agencies that issue standardized options. Section 10C and the SEC’s rules also exempt from the compensation committee member independence requirements: smaller reporting companies; limited partnerships; companies in bankruptcy proceedings; open-end management investment companies; and foreign private issuers, if the foreign private issuer discloses in its annual report why it does not have an independent compensation committee.

Conflict of Interest Disclosure

As required by the Dodd-Frank Act, the new rules expand current disclosure requirements regarding compensation consultants. Item 407(e)(3) of Regulation S-K will now require disclosure of any actual conflicts of interest resulting from the work of any compensation consultants retained by the compensation committee or by management. In contrast to the listing standards relating to advisers discussed above, this rule only applies to compensation consultants, and does not require disclosure of conflicts of interest of legal counsel or other advisers. In determining whether an actual conflict of interest exists, the new rule directs issuers to consider the six independence factors described above. In the event the work of a compensation consultant raises a conflict of interest, the issuer must disclose how the conflict was addressed.

Implementation Timeline

The exchanges must propose their listing standards by September 25, 2012. The proposed listing standards will be subject to further public comment, and must be adopted by the SEC no later than June 27, 2013.

Issuers must comply with the amended Item 407(e)(3) disclosure in any proxy statement for an annual meeting of shareholders at which directors will be elected occurring on or after January 1, 2013.

Practice Tips

In light of the new rules, public companies should consider the following practice tips:

  • Revisit their director and officer questionnaires for any shareholders meeting at which directors will be elected to be held after January 1, 2013, to be sure that their conflict-of-interest questions are sufficient to pick up the considerations addressed in the new rule.
  • Begin thinking about how they will create procedures for collecting and analyzing information about compensation consultants, legal counsel, and other advisors prior to receiving advice from them. Consider including appropriate conflict-of-interest representations in engagement letters.
  • Consider whether their compensation committee charter should be updated and revised in contemplation of the new rule and to reflect the new independence criteria.
  • Discuss with their compensation consultants whether there may be conflicts of interest that will need to be addressed in their 2013 proxy statements.
  • Monitor rule-making by the exchange on which their equity securities are listed in order to determine whether changes in compensation committee composition may be required under the rules that are proposed by that exchange.