As annual meeting season approaches, so too does the first deadline for companies listed on the NASDAQ Stock Market (Nasdaq) to comply with amended compensation committee rules. Traditionally, evaluation of director independence of Nasdaq-listed companies differed for purposes of serving on an audit committee as compared to a compensation committee. Earlier this year, the Securities and Exchange Commission (SEC) approved Nasdaq’s proposed rule amendments to comply with certain requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank), including changes intended to conform the compensation committee independence standard to the existing audit committee standard. The first of these new requirements — compliance with Nasdaq Listing Rule 5605(d)(3) — is going into effect on July 1, 2013.

Advisors to Compensation Committees

Rule 5605(d)(3) requires the compensation committees of Nasdaq-listed companies to have specific responsibilities and authority with regard to compensation consultants, legal counsel, or other similar advisors to the compensation committee. Specifically, the compensation committee must have sole discretion to retain such advisors, must be directly responsible for oversight of their work, and must determine reasonable compensation to be paid to such advisors by the company. Additionally, and perhaps most significantly, Rule 5605(d)(3) dictates that a compensation committee may only select, or receive advice from, a compensation consultant, legal counsel, or other advisor after taking into consideration the following factors:

  • „„ the provision of other services to the company by the person that employs the compensation consultant, legal counsel or other advisor;
  • „„ the amount of fees received from the company by the person that employs the compensation consultant, legal counsel or other advisor, as a percentage of the total revenue of the person that employs the compensation consultant, legal counsel or other advisor;
  • „„ the policies and procedures of the person that employs the compensation consultant,
  • legal counsel or other advisor that are designed to prevent conflicts of interest;
  • „„ any business or personal relationship of the compensation consultant, legal counsel or other advisor with a member of the compensation committee;
  • „„ any stock of the company owned by the compensation consultant, legal counsel or other advisor; and
  • „„ any business or personal relationship of the compensation consultant, legal counsel, other advisor or the person employing the advisor with an executive officer of the company.

While the requirement to consider these factors does not preclude the engagement of a particular advisor, compensation committee members soon may question the desirability of relying on company regular outside counsel or other advisor who provide significant services to the company.

A number of immediate action items stem from Rule 5605(d) (3). First, Nasdaq-listed companies must implement policies and procedures to ensure that the compensation committee controls the process of engaging, and maintaining a relationship with, any third-party advisors to that committee; and that the compensation committee properly considers the six independence factors in the process of selecting such advisors. Second, although Nasdaq’s requirement to adopt a written compensation committee charter is not yet effective at this time, companies already having such a charter should consider amendments designed to memorialize the required policies and procedures. Finally, companies should consider developing procedures and checklists to ensure collection of the information necessary for the compensation committee to complete the consideration of the above-listed factors.

Additional Provisions

In adopting Rule 5605(d), Nasdaq stated that, in order to allow companies to revise their corporate governance policies and procedures in the course of their regular annual meeting schedules, companies will have until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014, to comply with all the remaining provisions of Rule 5605(d). There are three main provisions that call for additional action items.

First, all Nasdaq-listed companies must form a compensation committee comprised of at least two independent directors and adopt a formal, written compensation committee charter, the adequacy of which must be re-assessed annually by the compensation committee. The new (or amended) charter must include the specific committee responsibilities and authorities enumerated in Rule 5065(d) (1) and (3), except for “smaller reporting companies” (as defined by the SEC rules) which are exempt from certain provisions of Rule 5605(d).

Second, the new rules modify the independence test for compensation committee members requiring that the director not have received any compensation from the company, or any subsidiary of the company, other than for services as a director. This change brings the compensation committee test for independence in line with the existing audit committee independence standard.

Third, the board of directors must make a subjective determination as to whether a compensation committee member’s affiliations with the company would impair the director’s judgment as a member of the compensation committee. Nasdaq provided some guidance, that it does not believe that ownership of company stock, even in a controlling interest position, by itself, precludes a determination that a director is able to serve on the compensation committee.

Finally, each company must submit a one-time certification to Nasdaq, no later than 30 days after the final implementation deadline applicable to it in 2014, of its compliance with the amended rules.

Conclusion

Nasdaq-listed companies should address the immediate action items stemming from Rule 5605(d)(3) prior to the July 1, 2013 deadline by adopting appropriate resolutions of the board of directors or amendments to the charter of their compensation committee, as appropriate under the company’s applicable state corporate law and governing documents. At the same time, companies should evaluate their readiness for compliance with the additional provisions of Rule 5605(d), especially in view of the changes to the independence test for compensation committee members, to prepare for any necessary changes to the composition