Exchanges Still Responsible for Key Details, Including Definition of Independence, and Have 90 Days to Propose Rules

New Disclosure Requirement on Compensation Consultant Conflicts of Interest Will Apply to 2013 Proxy Statements


On Wednesday, the Securities and Exchange Commission issued final rules to implement Section 952 of the Dodd-Frank Act, under which the SEC must direct national securities exchanges to incorporate compensation committee and compensation adviser independence requirements into their equity listing standards. The national securities exchanges will have 90 days from publication of the final rules in the Federal Register to submit their own proposed listing standards to the SEC and one year from publication to issue final listing standards. Like the proposed rules, the final rules leave most of the important details, including the definition of “independence,” to the exchanges to propose.

The final rules also implement the Section 952 requirements for disclosure about compensation consultants, which will generally apply to U.S. proxies filed in 2013, in a simpler manner than had originally been proposed. A small number of additional changes and SEC guidance are summarized below.


Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted on July 21, 2010, directs the SEC to issue rules requiring national securities exchanges to prohibit the listing of any equity security unless each member of the issuer’s compensation committee is “independent.” The exchanges must also require compensation committees to actively consider the independence of any compensation advisers, such as consultants and lawyers. Listed companies must disclose any conflicts of interest of compensation consultants providing advice to their compensation committees and give their compensation committees authority and appropriate funding to engage independent advisers.

No change to statutory considerations for “independence” definition. Under Section 952, in formulating a definition of compensation committee member “independence,” the national securities exchanges must consider (1) the source of the director’s compensation, including any consulting, advisory or other fees paid by the listed company, and (2) whether the director is affiliated with the listed company or a subsidiary or affiliate. Like the proposed rules, the final rules do not specify any additional factors. The final rules also re-confirm that an exchange may determine that affiliation with a significant investor is not a bar to independence for compensation committee purposes.

Additional compensation adviser “independence factor.” Section 952 states that, under the exchanges’ revised listing standards, a compensation committee will be able to select a compensation consultant or other adviser, such as legal counsel, only after considering the following “independence factors”:

  • the provision of other services to the listed company by the consultant or other adviser;
  • the amount of fees received from the listed company by the consultant or other adviser, as a percentage of the total revenue of the consultant or other adviser;
  • the policies and procedures of the consultant or other adviser that are designed to prevent conflicts of interest;
  • any business or personal relationship of the consultant or other adviser with a member of the compensation committee; and
  • any stock of the listed company owned by the consultant or other adviser.

In the final rules the SEC introduced a sixth independence factor:

  • any business or personal relationships between the executive officers of the issuer and the compensation adviser or the person employing the adviser.

Listed companies will therefore need to incorporate this factor into future reviews of compensation adviser independence. The exchanges’ proposals for revised listing standards may also provide more detail to help guide these reviews.1

Application in the Absence of a Formal Committee Structure. The final rules, like the proposed rules, apply to any committee of the board that performs functions typically performed by a compensation committee, whether or not the committee performs other functions or is formally designated as a compensation committee. Unlike the proposed rules, however, the final rules generally apply to the board members who, in the absence of a formal committee, oversee executive compensation matters.2

Exemptions for Certain Types of Issuers. As with the proposed rules, the final rules do not apply the independence standards to controlled companies, to companies listing only debt securities, or to foreign private issuers that disclose in their annual reports the reasons why they do not have an independent compensation committee. The final rules also exempt “smaller reporting companies” (as defined in the SEC rules) from the independence requirements.

Transition periods for newly listed issuers authorized. Although the final rules do not specify any particular transition period for newly listed issuers, the SEC confirmed, in response to comments from the NYSE and our firm, that “the exemptive authority provided to the exchanges under the final rule permits them to propose appropriate transition periods,” which would ease access to public markets by private companies that need time to fully implement a public company governance structure.

Conflict of interest proxy disclosure simplified. Section 952 provides that reporting companies must disclose in their proxy statements whether:

  • the compensation committee retained or obtained the advice of a consultant; and
  • the work of the compensation consultant has raised any conflict of interest and, if so, the nature of the conflict and how the conflict is being addressed.

The SEC concluded that the first of these disclosure requirements did not necessitate any rule changes, because it is adequately addressed by the existing requirement to disclose “any role of compensation consultants in determining or recommending the amount or form of executive and director compensation.”3 This approach (unlike the more significant revisions in the proposed rules) has the effect of preserving the existing broad-based plans exception, under which disclosure is not required in the case of a compensation consultant engaged solely in connection with non-discriminatory, broad-based plans or engaged to provide non-customized benchmark data. Reporting companies will likely welcome this approach, since it requires fewer changes to existing protocols for collecting, analyzing and disclosing this information.

The requirement that reporting companies disclose the nature of any conflict of interest posed by a compensation consultant’s work and how the conflict is being addressed has been added as a new, separate clause to the existing SEC rule. This new proxy disclosure requirement was effected through a change in the SEC’s disclosure rules and does not require implementation by the stock exchanges. It will apply to proxy statements for shareholder meetings at which directors will be elected occurring on or after January 1, 2013. This disclosure requirement applies to all companies subject to the proxy rules, including controlled companies and smaller reporting companies.