|December 19, 2013|
Previously published on December 13, 2013
As you may recall, Nasdaq adopted a two-pronged compensation committee independence test in January as mandated by Dodd-Frank. The first, or compensation, prong is a bright-line rule that precludes a board’s determination of compensation committee independence for any director who accepts compensatory fees, other than for board service, from the company. The second, or affiliation, prong requires the board to consider whether a director is affiliated with the company or its subsidiaries, or their affiliates, prior to his or her appointment to the compensation committee. Recently, Nasdaq amended these rules to replace the compensation prong’s prohibition on the receipt of compensatory fees with a requirement that a company’s board of directors merely consider compensation paid by the company, together with all other sources of compensation of the director, when determining whether a director is truly “independent” for purposes of eligibility for compensation committee membership. The affiliation prong was largely unchanged by the amendments. These rules, as amended, will go into effect for companies by the earlier of: (i) their first annual meeting after January 15, 2014 or (ii) October 31, 2014.
What Does This Mean? Where Are We Now?
The best way to analyze what is left of NASDAQ’s compensation committee independence rules is to compare them to Nasdaq’s existing general independence requirements. In other words, how much overlap is there between the new rules and rules companies are already required to comply with? Is there really anything new?
In analyzing the compensation prong, let’s consider the two categories of compensation a director might receive: (1) compensation from the company and (2) compensation from third parties.
Category 1 - Under the amended rules, boards will be required to consider whether fees paid to a director by the company (i.e., director fees and amounts received for services) impairs a compensation committee member’s independence. Nasdaq rules already disqualify individuals from being independent if they received more than $120,000 from, or if they were employed by, the company in the last three years. So, existing independence standards swallow up everything the new rules might cover other than (1) board fees and (2) compensation that is less than $120,000 for services rendered in a non-employee capacity (a truly narrow category). Thus, the only new requirement resulting from the revised compensation prong is for boards to consider whether board fees are reasonable and whether any director is receiving compensation of less than $120,000 for non-employee-type services.
Category 2 - Under the amended rules, boards will also be required to consider if any compensation received from third parties somehow impairs a compensation committee member’s independence. Nasdaq already requires companies to consider “any relationship” which, in the opinion of the board, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. Compensation received from third parties is merely a subcategory of “any relationship” - meaning companies are already required to consider compensation received by third parties. Thus, there is simply no new requirement here.
Under the affiliation prong, the board must consider whether a director has a relationship with the company or its subsidiaries, or their affiliates, which is material to that director’s ability to be independent from management in connection with the duties of a compensation committee member. The analysis here is essentially the same as Category 2 above. Relationships with the company or its subsidiaries, or their affiliates, is another subcategory of “any relationship.” Again, there is simply no new requirement here. (Note that Nasdaq actually acknowledged in its proposing release that this prong would not constitute a substantive change from its existing independence rules.)
What To Do Now
1. Consider whether board fees and committee fees are reasonable.
2. Confirm that your D&O questionnaire asks questions that are broad enough to pick up any compensation a director receives from the company, not just compensation over $120,000.