Earlier this week, both the NYSE and Nasdaq submitted proposed rules to the Securities and Exchange Commission (SEC) setting forth the factors that they will use to determine independence for compensation committee members and compensation advisers. The proposed rules were required by SEC Rule 10C-1, which directed the securities exchanges to adopt rules requiring compliance with:
- compensation committee member independence standards, and
- rules requiring a review of the independence of certain compensation advisers retained by a compensation committee
as conditions to the listing of a company's equity
securities. SEC Rule 10C-1 did not require a uniform definition of
"independence." Instead, it permitted the securities
exchanges to establish their own standards for independence based
on relevant factors. See DP Alert dated
June 22, 2012.
The following is a summary of the proposed rules.
NYSE Proposed Rules on Independence of Compensation Committee Members
The NYSE's director independence standards are set forth in
Section 303A.02 of its Listed Company Manual. Section 303A.02(a)
currently provides that no director is independent unless the board
of directors affirmatively determines that he or she has no
material relationship with the listed company (directly or as a
partner, shareholder or officer of an entity that has a
relationship with the listed company). In addition, Section
303A.02(b) currently provides that a director may not be deemed to
be independent if he or she has a relationship with the listed
company that violates any one of five "bright line"
tests. 1
The NYSE is not proposing any changes to the "bright
line" tests set forth in Section 303A.02(b), which will
continue to be used to determine the independence of compensation
committee members. The NYSE is proposing, however, to expand
Section 303A.02(a) to provide that in affirmatively determining the
independence of a compensation committee member, the board of
directors must consider all factors specifically relevant to
determining whether a director has a relationship to the listed
company that is material to his or her ability to be independent
with management in connection with his or her duties as a
compensation committee member, including but not limited to:
- The director's source of compensation, including any consulting, advisory or compensatory fee paid by the listed company; and
- Whether the director is affiliated with the listed company, a subsidiary of the listed company or an affiliate of a subsidiary of the listed company.
The two above factors were explicitly enumerated in SEC Rule
10C-1.
In its proposed rule filing, the NYSE stated that compensation
committee members can be deemed independent even if they own stock
in the listed company. The NYSE said that it "does not view
the ownership of even a significant amount of stock, by itself, as
a bar to an independence find." It further stated that
"share ownership in the listed company aligns the
director's interests with those of unaffiliated shareholders,
as their stock ownership gives them the same economic interest in
ensuring that the listed company's executive compensation is
not excessive."
The receipt of director fees for service on a board will also not
preclude a director from being deemed independent for purposes of
serving on the compensation committee.2
Listed companies would have until the earlier of their first
annual meeting after January 15, 2014, or October 31, 2014, to
comply with new independence requirements for compensation
committee members. Exemptions from the compensation committee
independence requirements would apply to smaller reporting
companies, controlled companies, limited partnerships, companies in
bankruptcy, open-end management investment companies and foreign
private issuers that disclose in their annual reports filed with
the SEC the reasons why they do not have independent compensation
committees.
Nasdaq Proposed Rules on Independence of Compensation Committee Members
Nasdaq's rules regarding oversight of executive officer compensation are set forth in Listing Rule 5605(d). Nasdaq proposes to make sweeping changes to current Listing Rule 5605(d). In general, the proposed changes are as follows:
- Listed companies must have a compensation committee of at least two members, each of whom must be an independent director as defined under Nasdaq's listing rules. Although listed companies may continue to rely on Nasdaq's existing exception that allows certain non-independent directors to serve on a compensation committee, such exception will only be available under exceptional and limited circumstances.
- Compensation committee members must not directly or indirectly accept any consulting, advisory or other compensatory fee, other than for board service, from the listed company or any of its subsidiaries.
- In determining whether a director is eligible to serve on a compensation committee, the board must consider whether the director is affiliated with the listed company, its subsidiaries or an affiliate of a subsidiary of the listed company, to determine whether such affiliation would impair the director's judgment as a member of the compensation committee.
- Listed companies must adopt a formal, written compensation committee charter that must specify the compensation committee responsibilities and authority in SEC Rule 10C-1 relating to the (i) authority to retain compensation consultants, legal counsel and other compensation advisers; (ii) authority to fund such advisers; and (iii) responsibility to consider certain independence factors before selecting such advisers, other than in-house legal counsel.
- Listed companies must review and reassess the adequacy of the compensation committee charter on an annual basis.
- Listed companies that are smaller reporting companies must have a compensation committee comprised of at least two independent directors and a formal written compensation committee charter or board resolution that specifies the compensation committee's responsibilities and authority, but the smaller reporting companies are not required to adhere to the compensation committee eligibility requirements relating to compensatory fees and affiliation or the requirements relating to compensation consultants, legal counsel and other compensation advisers that Nasdaq is proposing to adopt under SEC Rule 10C-1.
Under the proposed rules, listed companies must have a standing
compensation committee and will no longer have the alternative of
having a majority of independent directors vote on compensation for
executive officers. Nasdaq considered whether such an alternative
was still appropriate "given the heightened importance of
compensation decisions in today's corporate governance
environment." Nasdaq decided to eliminate the alternative
because it "believes that there are benefits from a board
having a standing committee dedicated solely to oversight of
executive compensation. Specifically, directors on a standing
compensation committee may develop expertise in a Company's
executive compensation program in the same way that directors on a
standing audit committee develop expertise in a Company's
accounting and financial reporting processes. In addition, a formal
committee structure may help promote accountability to stockholders
for executive compensation decisions."
Under Nasdaq's current listing rules, a director may receive
compensatory fees below certain thresholds from a listed company
and still be considered independent. Audit committee members,
however, are prohibited from receiving any compensatory fees from a
listed company or its subsidiaries, with certain limited
exceptions, in order to be considered independent. In its proposed
rule filing, Nasdaq stated that "there is no compelling
justification to have different independence standards for audit
and compensation committee members with respect to the acceptance
of compensatory fees from a Company. Accordingly, Nasdaq proposes
to adopt the same standard for compensation committee members that
applies to audit committee members under Rule 10A-3 under the
Exchange Act with respect to compensatory fees." Consistent
with Rule 10A-3, compensatory fees do not include (i) fees received
as a member of the compensation committee, the board of directors
or any other board committee or (ii) fixed amounts of compensation
under a retirement plan (including deferred compensation) for prior
service with the listed company (provided that such compensation is
not contingent in any way on continued service). The prohibition on
compensatory fees does not include a "look-back" period
and begins when the director begins service on the compensation
committee.
With respect to effective dates, Nasdaq proposes that its rule
relating to compensation committees having the specific
compensation committee responsibilities and authority to comply
with SEC Rule 10C-1 relating to the (i) authority to retain
compensation consultants, legal counsel and other compensation
advisers; (ii) authority to fund such advisers; and (iii)
responsibility to consider certain independence factors before
selecting such advisers, other than in-house legal counsel, be
effective immediately. With respect to all other proposed rules,
listed companies would have to comply with them by the earlier of
(1) their second annual meeting held after the date of approval of
Nasdaq's amended listing rules or (2) December 31, 2014. A
listed company must certify to Nasdaq, no later than 30 days after
the implementation deadline applicable to it, that it has complied
with the amended listing rules on compensation committees (a form
will be provided by Nasdaq for this certification).
NYSE and Nasdaq Independence Factors for Compensation Advisers
Both the NYSE and Nasdaq are amending their rules to provide that compensation committees consider the factors set forth in SEC Rule 10C-1 to determine the independence of compensation consultants, legal counsel or other advisers retained by compensation committees. These factors are as follows:
- The provision of other services to the listed company by the person that employs the compensation consultant, legal counsel or other adviser.
- The amount of fees received from the listed company by the person that employs the compensation consultant, legal counsel or other adviser, as a percentage of the total revenue of the person that employs the compensation consultant, legal counsel or other adviser.
- The policies and procedures of the person that employs the compensation consultant, legal counsel or other adviser that are designed to prevent conflicts of interest.
- Any business or personal relationship of the compensation consultant, legal counsel or other adviser with a member of the compensation committee.
- Any stock of the listed company owned by the compensation consultant, legal counsel or other adviser.
- Any business or personal relationship of the compensation consultant, legal counsel, other adviser or the person employing the adviser with an executive officer of the listed company.
The NYSE's and Nasdaq's respective proposed rules would
not include any additional specific factors because both exchanges
believe the list of factors included in SEC Rule 10C-1(b)(4) is
comprehensive and provides compensation committees with the tools
to consider the independence of compensation advisers.
Consistent with SEC Rule 10C-1, the proposed rules do not require
compensation committees to retain independent compensation
advisers. Instead, compensation committees are only required to
conduct an independence analysis of compensation advisors.
Compensation committees may still receive advice from
non-independent counsel, such as internal counsel or outside
counsel retained by management, or from non-independent
compensation consultants or other advisers, including those engaged
by management.
Footnotes
1.The five "bright line" tests are as follows:
i.The director is, or has been within the last three years, an employee of the listed company, or an immediate family member is, or has been within the last three years, an executive officer of the listed company.
ii.The director or an immediate family member has received, during any 12-month period within the last three years, more than $120,000 in direct compensation from the listed company, other than director and committee fees and pension or other forms of deferred compensation for prior service (provided this compensation is not contingent in any way on continued service).
iii.The director (a) is a current partner or employee of a firm that is the listed company's internal or external auditor; (b) has an immediate family member who is either a current partner of such a firm or an employee of such a firm who personally worked on the listed company's audit; or (c) was, or has an immediate family member who was, a partner or employee of such a firm and personally worked on the listed company's audit within the last three years.
iv.The director or an immediate family member has been employed within the past three years as an executive officer of another company where any of the listed company's present executive officers at the same time served on that company's compensation committee.
v.The director is a current employee, or an immediate family member is a current executive officer, of a company that has made payments to, or received payments from, the listed company for property or services in an amount which, in any of the last three fiscal years, exceeds the greater of $1 million or 2 percent of the other company's consolidated gross revenues.
2. The NYSE stated that it "does not believe that it is appropriate to consider board compensation as part of the compensation committee independence determination with respect to individual directors. Non-executive directors devote considerable time to the affairs of the companies on whose boards they sit and eligible candidates would be difficult to find if board and committee service were unpaid in nature." Because all non-executive directors receive compensation for their services on the board, the NYSE "does not believe that an analysis of the board compensation of individual directors is a meaningful consideration in determining their independence for purposes of compensation committee service."
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