In June 2012, the Securities Exchange Commission (the “SEC”) adopted new Rule 10C-1 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), in accordance with the mandate of Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Section 952 directed the SEC to require national security exchanges to establish listing standards prohibiting the listing of equity securities of an issuer that fails to comply with the requirements of new Section 10C of the Exchange Act relating to (i) compensation committee independence and the engagement of compensation advisers and (ii) compensation consultant conflicts of interests. A Dow Lohnes SEC Bulletin dated June 29, 2012 describing Rule 10C-1 is available here.
Both the NYSE and NASDAQ have recently submitted proposed rules to the SEC, and both proposals closely follow the guidelines in Rule 10C-1. Listed companies on both exchanges will be required to have a compensation committee, with a written charter, composed entirely of independent directors, subject to the same exemptions and transition periods that exist today. Compensation committees will be able to retain independent counsel or other advisers, have sole responsibility for the appointment of compensation consultants and advisers, and be solely responsible for the oversight of those consultants and advisers. Most listed issuers already have independent compensation committees with written charters that, in pertinent part, provide for the engagement and compensation of independent advisers. As a result, changes for most issuers will be around procedures for determining compensation committee member and adviser independence.
The NYSE has proposed amendments to Sections 303A.00, 303A.02(a) and 303A.05 of the NYSE’s Listed Company Manual.
Compensation Committee Independence. The NYSE generally believes that its existing independence standards in Section 303A.02(b) are broad enough to encompass the relationships between a director and an issuer that Rule 10C-1 prohibits. However, in order to more closely follow Rule 10C-1, the amendment to Section 303A.02(a) explicitly requires boards to consider a director’s existing relationships, including compensation received from the company and affiliated relationships with the company, in determining a director’s ability to exercise independent judgment when serving on the compensation committee.
Compensation Committee Responsibilities and Powers. NYSE Section 303A.05(b) already requires that compensation committees have the responsibilities and powers required by Rule 10C-1; however, the NYSE is proposing amendments to track Rule 10C-1(b)(2) and (3) verbatim for clarity. The NYSE also is adding a Section to 303A.05(c) that instructs compensation committees to consider the independence factors set forth in Rule 10C-1(b)(4) when selecting a compensation adviser.
Cure Periods. The NYSE requires that companies comply with the new rules by their first annual meeting after January 15, 2014 or by October 31, 2014, whichever is sooner. This includes ensuring that the compensation committee members and the compensation advisers meet the independence requirements of the rules. The NYSE is proposing a cure period for situations where a compensation committee member loses their independence for reasons beyond a member’s control that would allow them to stay on the committee until the next shareholder meeting or a year from the event that caused the loss of their independence status.
Exemptions. As permitted by Rule 10C-1, the NYSE will keep its existing exemptions, which, among other things, allow for certain types of companies, including controlled companies, to not have compensation committees. The NYSE is not proposing any new exemptions.
Similar to the NYSE rule changes, NASDAQ’s rule changes closely follow Rule 10C-1, with a few differences.
Compensation Committee Independence. NASDAQ proposes to require all companies to have a compensation committee composed of at least two independent directors (before this change, the committee could consist of one person and a formal committee was not even required as long as independent directors made executive compensation decisions). A director will not be independent for compensation committee purposes if they receive compensation from the company other than director fees or retirement benefits for past service. This standard also is applied in determining independence for audit committee service. NASDAQ is not instituting a bright-line test, a look back period or further requirements for compensation committee independence.
Compensation Committee Responsibilities and Powers. The compensation committee will be required to have all of the responsibilities and powers set out in Rule 10C-1.
Cure Periods. Companies must be compliant with proposed Rule 5605(d)(3), which covers compensation committee responsibilities and authority, including ensuring the independence of compensation advisers, effective immediately (i.e., upon approval by the SEC and publication in the federal register). Companies must be compliant with the rest of the rule changes by their second annual meeting after approval by the SEC or December 31, 2014, whichever is earlier. Like the NYSE, there also is a proposed cure period for situations where a compensation committee member is deemed to be no longer independent for reasons beyond a member’s control that would allow them to stay on the committee until the next shareholder meeting or a year from the event that caused the loss of their independence status.
Exemptions. NASDAQ also will keep its existing exemptions and transition periods for certain types of companies, such as controlled companies. NASDAQ is proposing a new exception to allow a non-independent director to be on compensation committees in exceptional situations for the best interest of the company and its shareholders. This exception is the same as one for audit committee service.