Boards of directors and compensation committees of public companies will want to consider the impact of recently proposed listing requirements issued by the New York Stock Exchange (NYSE) and The Nasdaq Stock Market (Nasdaq) (discussed in our October 9, 2012 client alert). These new listing requirement proposals are designed to comply with the rules adopted by the SEC (also discussed in the client alert), as required under the Dodd-Frank Wall Street Reform and Consumer Protection Act. The new rules, once adopted, will likely require changes in the committee’s procedures and decision-making process, at least with respect to the appointment and retention of outside advisors to compensation committees.
The NYSE Rules Will Be Effective, in Part, in July 2013 If Approved by Then, and the Nasdaq Rules Will Be Effective, in Part, Immediately on Approval
The proposed rules may change prior to final approval by the SEC. The NYSE listing rule relating to the determination of the independence of advisors (and the expansion/clarification of existing rules pertaining to the retention and funding of such advisors) is effective July 1, 2013, with the provisions relating to the heightened independence requirements for compensation committee members effective on the earlier of the first annual meeting after January 15, 2014, or October 31, 2014. Nasdaq listing rules on the authority to retain, the requirement to fund, and the requirement to determine the independence of compensation committee advisors will be effective on the adoption of the final listing standards, with all other provisions effective by the earlier of the second annual meeting after the adoption of the final listing standards or December 31, 2014.
In addition to implementing the rules adopted by the SEC, Nasdaq’s proposal would require listed companies to have a standing compensation committee consisting of at least two directors, all of whom must be independent, with a formal written charter. The NYSE already requires listed companies to have an independent standing compensation committee with a formal written charter.
To Prepare, Companies Will Want to:
- Obtain disclosure from outside advisors as to their independence, a request which may require those advisors to put into effect or update internal procedures to identify possible conflicts.
- Make sure that they have enough directors who meet the independence criteria for the audit and the compensation committees.
- Review their compensation committee charter and determine how to amend it or adopt one.
- If the board does not currently have a compensation committee, identify which independent directors are best suited to serve on the committee and who the chair will be.
Who Can Be On the Compensation Committee Once the Rules Are Effective?
The board will need to determine whether each member of the compensation committee meets the proposed heightened independence criteria for compensation committee members, who must also be “independent directors” under the existing NYSE/Nasdaq rules. Under both the Nasdaq and the NYSE proposed rules, the board will need to review the sources of compensation and affiliations of proposed compensation committee members. Although the specifics for the heightened NYSE and Nasdaq requirements for independence differ, neither the Nasdaq nor the NYSE proposed rules include a requirement that the board determine that a director is not independent for compensation committee purposes based on any specified level of stock ownership of the listed company or any similar bright-line test.
Nasdaq’s proposed rules require that a director does not meet the requirements for independence to serve on the compensation committee if the director accepts, directly or indirectly, any compensatory fee from the listed company or subsidiary other than for service as a director, or non-contingent fixed amounts under a retirement plan or deferred compensation plan relating to prior service. This is the same standard required for audit committee members. Directors who continue to receive consulting fees or other compensation will no longer be eligible to serve on the compensation committee. With respect to affiliate relationships, boards are to consider whether the director is affiliated with the company, a subsidiary of the company, or an affiliate of a subsidiary to determine whether such affiliation would impair the director’s judgment as a member of the compensation committee.
NYSE’s proposed rules specify that the board consider all factors specifically relevant to determining whether a director has a relationship to the listed company which is material to the director’s ability to be independent from management in connection with the duties of a member of the compensation committee, including (i) the source of the director’s compensation (including any consulting, advisory or other compensatory fee paid by the listed company to such director), in order to determine whether the director receives compensation from any person or entity, or (ii) whether having such an 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, which, in either (i) or (ii), would impair the director’s ability to make independent judgments about the listed company’s executive compensation.
- Companies will want to review their D&O questionnaire to be sure that the information requested provides the board with sufficient information to make, and document, these determinations.
- Companies will also want to determine what, if any, additional information not required by the rules should be included as a matter of “best practices.”
- Since “cure periods” apply in limited circumstances and for a limited time after the determination of non-compliance with the independence requirements, a board will want to periodically review the independence of compensation committee members to be sure that, if a mistake has been made, it can be cured in a timely fashion.
- Nasdaq-listed companies will need to appoint a compensation committee if they have not already done so (currently such companies are required to have either an independent compensation committee or have compensation for executive officers decided by a majority of the independent directors on the board).
What Does the Compensation Committee Need to Do—and Document—in Its Choice of Compensation Consultants, Independent Legal Counsel or Other Advisors?
Some compensation committees retain their own compensation consultants to advise on all executive compensation decisions; some retain such consultants only in specific circumstances such as large multiyear equity grants and new plans and agreements; and some rely on counsel to the company or in-house counsel. The proposed rules do not require that a compensation committee retain either its own advisor or counsel, but the rules will change the process for retention if the committee chooses to retain an advisor or counsel. Under the Dodd-Frank Act and these proposed rules, the compensation committee advisor, and the listed company must provide appropriate funding (as determined by the compensation committee) for payment of reasonable compensation to such advisor. The compensation committee must be directly responsible for the appointment, compensation and oversight of the work of any compensation consultant, independent legal counsel and other advisor retained by the committee. (Existing NYSE rules already require that the compensation committee have the authority to retain advisors and that companies fund such advisors, and the NYSE clarifies these requirements in its proposed rules.)
In hiring or retaining an advisor (other than in-house counsel), the compensation committee must consider six specified factors regarding independence. These factors are: (i) whether the advisor’s firm provides other services to the listed company, (ii) the amount of fees received by the advisor’s firm from the listed company as a percentage of revenue of the advisor’s firm, (iii) conflict of interest policies and procedures of the advisor’s firm, (iv) any business or personal relationships between the advisor and members of the compensation committee, (v) any stock ownership by the advisor in the listed company, and (vi) any business or personal relationships between the advisor or the advisor’s firm and an executive officer of the listed company. As under the SEC rule, these proposed rules do not include any materiality standard or other threshold for any of these factors, but require the compensation committee to consider all facts and circumstances relevant to the six factors. The NYSE proposed rules also require the compensation committee to consider any other factors that would be relevant to the advisor’s independence from management.
- Committees will want to obtain a report from potential consultants or independent counsel tracking these six factors. Committees may also want to verify with its human resources and legal and compliance group any information regarding engagements of the advisor’s firm, and obtain periodic updates.
- Companies may want to provide members of the compensation committee and executive officers with a questionnaire in order to determine any relationships with existing or proposed advisors or their employers.
A committee engaging an advisor will want to:
- Carefully document relevant information considered for each of the independence factors.
- Consider how this engagement and the review of factors will be disclosed in the proxy statement.
Can a Company Still Use Its Current Compensation Committee Charter?
- Nasdaq-listed companies which do have not charters will want to start preparing them to comply with the Nasdaq proposal.
- Companies which have compensation charters will want to review them to make sure that they reflect the new rules on the committee’s responsibility to engage, compensate and oversee advisors, funding for advisors and required procedures for advisor independence determinations.
What Other Issues Should Companies Be Aware of?
- An independent committee is required for purposes of tax deductibility of performance and other awards under section 162(m) of the Internal Revenue Code and exemption from the shortswing liability rules of section 16(b). Since determinations of independence are not identical to the listing rules, companies will want to be sure that the compensation committee continues to meet the requirements of each of these provisions.
- Companies implementing a compensation committee for the first time will want to review plan documents to be sure that they reflect any changes needed as a result of the new compensation committee.
Are Any Listed Companies Exempt from These Rules?
Both the NYSE and Nasdaq exempt certain types of listed companies from part or all of the requirements (discussed in our client alert). Smaller reporting companies, certain foreign issuers, companies in bankruptcy, limited partnerships, controlled companies and certain management investment companies will want to review the applicability of these rules—and transition rules for companies changing status—to their situation.
Proxy advisors and shareholder advocacy groups will continue to scrutinize executive compensation decisions, equity awards and any perceived lack of independence of compensation committee members or advisors. Thus, although the listing rule proposals may change based on the comment process and SEC review, companies affected by the proposed listing rules will want to start considering