On January 11, 2013, the Securities and Exchange Commission (SEC) approved changes to the listing standards of national securities exchanges (including the New York Stock Exchange (NYSE) and NASDAQ Stock Market) which impose specific requirements related to the independence of compensation committee members, the assessment of the independence of compensation consultants and other advisers providing advice to the compensation committee, and the authority of compensation committees. These rules were adopted by the national securities exchanges in accordance with an SEC rule (Exchange Act Rule 10C-1) which was adopted pursuant to the Dodd-Frank Act.
NASDAQ companies will be required to certify, within 30 days after the applicable implementation deadline, that they have complied with these new listing standards. While NYSE companies are not subject to a similar certification requirement, NYSE companies are required to provide annual certifications confirming compliance with NYSE corporate governance listing standards.
A brief overview of these new rules is provided below, followed by answers to questions that are frequently being asked by our public company clients and friends in relation to these rules.
Independence of Compensation Committee Members
Both the NYSE and NASDAQ rules require that each member of the compensation committee be "independent," although there are certain differences between the NYSE and NASDAQ rules with respect to the specific nature of these independence standards. One area of similarity between the NYSE and NASDAQ rules is that the rules of both exchanges require that a board consider whether a compensation committee member is affiliated with the listed company or an affiliate or subsidiary of the listed company. The NASDAQ rules also require listed companies to have a compensation committee with at least two members and a compensation committee charter, neither of which were previously required under the NASDAQ rules (even though the vast majority of NASDAQ companies have compensation committees and compensation committee charters as a matter of practice).
This portion of these rules generally becomes effective on a listed company's first annual meeting occurring after January 15, 2014, or October 31, 2014, whichever is earlier.
Assessment of Independence of Compensation Committee Advisers
The NYSE and NASDAQ rules each provide that the compensation committee of a listed company may select or receive advice from a compensation consultant, legal counsel or other adviser only after the committee takes into consideration six factors related to the adviser's independence from management and the listed company, which are enumerated in the NYSE and NASDAQ rules and drawn from Exchange Act Rule 10C-1(b)(4) (the NYSE rules further require that the compensation committee consider any other factors relevant to the adviser's independence from management). These rules are applicable to any compensation consultant, legal counsel or other adviser who provides any services (whether or not the advice relates to executive compensation matters) to the compensation committee, and the requirement to conduct this assessment is not limited to compensation consultants or other advisers who are engaged directly by the compensation committee. The SEC has indicated that this assessment should be conducted on an annual basis. There are certain limited exceptions to the requirement that a compensation committee conduct such an assessment (for example, an independence assessment is not required with respect to in-house legal counsel).
This portion of these rules becomes effective on July 1, 2013.
Compensation Committee Authority
The NYSE and NASDAQ rules provide compensation committees with the authority to retain and consider the independence of their advisers, specifically requiring that listed companies comply with the following provisions (which must be included in the compensation committee's charter):
- Ensure that the compensation committee, in its sole discretion, has the authority to retain or obtain the advice of a compensation consultant or other adviser;
- Ensure that the compensation committee is directly responsible for the appointment, compensation and oversight of the work of any compensation consultant or other adviser retained by the compensation committee;
- Provide appropriate funding, as determined by the compensation committee, for the payment of reasonable compensation to a compensation consultant or other adviser retained by the compensation committee; and
- Provide that the compensation committee may select a compensation consultant or other adviser only after taking into consideration all factors related to that person’s independence from management, including the six factors referenced above.
As noted above, the NASDAQ rules also require for the first time that NASDAQ companies have compensation committee charters, which must include certain enumerated concepts specified in the new NASDAQ rules.
This portion of these rules becomes effective on July 1, 2013 (except that NASDAQ companies that do not have a compensation committee charter in place are not required to comply with these rules until their first annual meeting of stockholders occurring after January 15, 2014, or October 31, 2014, whichever is earlier).
Frequently Asked Questions
Will the new rules prohibit a board designee of a significant stockholder from serving on the compensation committee of a listed company?
Not necessarily. The new rules require that a board consider whether compensation committee members are affiliated with an affiliate of the company (such as a significant stockholder), and thus may subject a director designee of a significant stockholder serving on the compensation committee to increased scrutiny with respect to whether the designee is independent. However, there is not an express prohibition on affiliated directors serving on the compensation committee of listed issuers (by comparison, Exchange Act Rule 10A-3 prohibits "affiliated persons" from serving on the audit committee of a listed company). Instead, this is a facts and circumstances analysis, and the NASDAQ interpretative manual specifically notes that "it may be appropriate for certain affiliates, such as representatives of significant stockholders, to serve on compensation committees since their interests are likely aligned with those of other stockholders in seeking an appropriate executive compensation program."
Does a compensation consultant or other adviser need to be engaged by the compensation committee for the rules to be applicable?
No, the requirement to conduct an independence assessment applies to any adviser providing advice to the compensation committee, even if the adviser is engaged by management of the listed company rather than the compensation committee.
How does a company determine whether an adviser is providing services to the compensation committee?
The NYSE and NASDAQ rules are not clear, and this is a facts and circumstances determination. We believe that if a law firm is, for example, attending committee meetings or providing work product directly to the compensation committee, then an independence assessment needs to be conducted. By contrast, if a law firm solely interacts with in-house legal counsel, a listed company may be able to take the position that the law firm is not providing services to the compensation committee on the premise that any compensation-related advice provided to the compensation committee is the advice of in-house legal counsel, not the outside law firm.
Do the new rules require that compensation consultants, outside legal counsel and other advisers providing advice to the compensation committee be independent?
No, they only require that the compensation committee consider the independence of such advisers from management and the company, taking into account the specified six-factor test and (in the case of NYSE companies) other relevant factors.
Do the rules require that a compensation committee make an affirmative determination regarding whether an adviser is independent?
No, the rules do not include a requirement that compensation committees make a specific determination one way or another whether an adviser is independent (however, see below for a discussion of required proxy statement disclosure with respect to compensation consultants). Instead, the rules only require that a compensation committee consider the factors relevant to that person's independence, as noted above.
Do the rules require that the assessment by the compensation committee regarding the independence of a compensation consultant be publicly disclosed?
Under SEC rules that were in effect for the 2013 proxy season, public companies were required to disclose in their proxy statements whether the work of any compensation consultant raised any conflict of interest. Although the rules do not require companies to provide this disclosure if no conflicts exist, many public companies have provided affirmative disclosure that no conflict exists. We are not aware of any public companies to date that have disclosed in their proxy statement that a conflict of interest exists with respect to a compensation consultant.
Do the rules require that the assessment by the compensation committee regarding the independence of an adviser (other than a compensation consultant) be publicly disclosed?
Do the rules require that the assessment by the compensation committee regarding the independence of a compensation consultant or other adviser be documented?
No. However, we believe that it is advisable that the minutes of the applicable compensation committee meeting reflect the committee's consideration of the independence of compensation consultants and other applicable advisers.
Will the new rules require that listed companies amend their compensation committee charters?
Generally, yes, we expect that listed companies will be amending (if they have not already) their compensation committee charters to incorporate the specific requirements of the new rules. Although listed companies that have not yet amended their charters are likely to have certain concepts in their compensation committee charters consistent with the new rules, we believe it is advisable for listed companies to amend their compensation committee charters to include all of the enumerated provisions now required to be in compensation committee charters of listed companies under the new rules. In this process, we recommend that companies also give consideration to making sure that the description of the duties and processes of the compensation committee as reflected in the compensation committee charter is consistent with the company’s proxy statement disclosure (as well as actual practice) in light of the increasing scrutiny of executive compensation, including lawsuits brought against certain public companies this proxy season in advance of their annual meetings based on alleged deficient executive compensation disclosure.
Will the new rules require that listed companies update their director & officer questionnaires?
Yes, we expect that it will generally be advisable for listed companies to make certain (somewhat limited) changes to their director & officer questionnaires in light of these new rules, including to: (1) elicit information with respect to any business or personal relationships between directors and executive officers and a company's compensation consultant (and, possibly, other advisers to the compensation committee); and (2) add additional questions for compensation committee members related to the more detailed compensation committee independence standards in the new rules.