- SEC Approves NASDAQ and NYSE Listing Standards on Compensation Committees and Advisers
- March 7, 2013
- Law Firm: Hinckley Allen Snyder LLP - Providence Office
The Securities and Exchange Commission ("SEC") has approved amendments to the NASDAQ Stock Market ("NASDAQ") and New York Stock Exchange ("NYSE") listing standards regarding the independence of compensation committees and the selection of their advisers. These new listing standards are substantially the same as those proposed by the exchanges in September 2012 in response to Rule 10C-1, which was promulgated by the SEC in June 2012. For a discussion of Rule 10C-1, which implemented Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the listing standards as originally proposed, please see our earlier Securities Updates.1
Changes to Initial Exchange Proposals
While the final listing standards as approved by the SEC do not differ substantively from the standards as initially proposed, there were a few notable changes:
Both exchanges added an exemption from the independence analysis for advisers whose role is limited to (i) consulting on a broad-based plan that does not discriminate in scope, terms, or operation in favor of executive officers or directors and that is available generally to all salaried employees, and/or (ii) providing information that either is not customized or is customized based on parameters that are not developed by the adviser, and about which the adviser does not provide advice.2 Accordingly, those advisers who merely provide general compensation surveys to compensation committees are not subject to the required independence review. However, the exchanges also clarified that the compensation committee must evaluate the independence of any outside legal counsel, including the company's regular securities and tax counsel, prior to such counsel being selected by or providing advice to the compensation committee. Only in-house counsel and compensation consultants who fit within the "limited role" exception are exempt from the independence evaluation requirement.
The NASDAQ revised its implementation timeline to conform to the timeline originally proposed by the NYSE. Now both NASDAQ-listed companies and NYSE-listed companies must comply with the compensation committee authority and charter requirements and the adviser independence analysis by July 1, 2013 and with the new compensation committee member independence standards no later than the company's first annual meeting after January 15, 2014 or by October 31, 2014, whichever is earlier.3
New NASDAQ Listing Standards
Compensation Committee Requirements. The NASDAQ listing standards now will require all NASDAQ-listed companies (including Smaller Reporting Companies) to have a separate compensation committee consisting of at least two members, each of whom must be an Independent Director (as defined in NASDAQ's current listing standards). The new rules eliminate the current option for a majority of Independent Directors to act in lieu of a compensation committee. Also, NASDAQ standards impose a "bright-line" prohibition on any compensatory payments to compensation committee members (other than director's fees or amounts received under a retirement plan for prior service, provided that such compensation is not contingent on continued service). This is the same independence standard that applies to audit committee members under Rule 10A-3 of the Securities Exchange Act of 1934 (the "Exchange Act"). There is no "look back" requirement or de minimis exception with respect to such compensatory payments.
In addition, in determining whether a director is eligible to serve on a compensation committee, the board must consider whether the director is affiliated with the issuer, a subsidiary of the issuer, or an affiliate of a subsidiary of the issuer to determine whether such affiliation would impair the director's independent judgment. Unlike the rules for audit committees, the NASDAQ standards do not impose a "bright line" test regarding affiliate status and, in response to comments, the NASDAQ has confirmed that affiliate status alone does not bar a director from being a committee member.
Compensation committees of NASDAQ-listed companies must have a formal written charter that specifies:
the scope of the committee's responsibilities and how it carries out those responsibilities, including structure, processes, and membership requirements;
its responsibility for determining, or recommending to the board for determination, the compensation of the CEO and all other executive officers;
that the CEO will not be present during voting or deliberations on his or her compensation;4 and
that the committee has the authority to find and retain compensation consultants, legal counsel, or other advisers, and it has the responsibility to consider certain independence factors before selecting such advisers, other than in-house legal counsel, and that the company will provide appropriate funding, as determined by the committee, for reasonable compensation to compensation advisers retained by the committee.
The compensation committee must review and reassess the charter annually.
Compensation Adviser Selection. The NASDAQ listing standards do not require a compensation committee to retain a compensation adviser. However, if the committee wishes to engage the services of an adviser, it must consider the following six factors, aimed at determining the independence of a prospective adviser, when selecting such adviser:
the provision of other services to the issuer by the adviser's employer;
the amount of fees received from the issuer by the adviser's employer, as a percentage of the employer's total revenue;
the policies and procedures of the adviser's employer that are designed to prevent conflicts of interest;
any business or personal relationship the adviser has with a member of the compensation committee;
any stock of the issuer owned by the adviser; and
any business or personal relationship the adviser or the adviser's employer has with an executive officer of the issuer.
NASDAQ-listed companies need consider only these six factors when evaluating adviser independence. There is no "catch-all" evaluation as required by the NYSE listing standards (described below). Furthermore, the standards do not require that compensation advisers be independent, only that the committee evaluate their independence using the six factors before they provide services.
Smaller Reporting Companies. Smaller Reporting Companies must have a compensation committee consisting of at least two Independent Directors (as defined in the NASDAQ's current listing standards) and a formal written compensation committee charter or board resolution that specifies the committee's responsibilities and authority. However, these directors are not subject to the other compensation committee eligibility requirements (relating to compensatory fees and affiliation) or the requirements relating to compensation advisers. Accordingly, the charters of, or resolutions establishing, such issuer's compensation committees need not contain provisions regarding compensation advisers, and the committee need not assess the charter or resolution annually. While the NASDAQ rules do not require Smaller Reporting Company charters to explicitly grant the compensation committee authority to select and retain compensation advisers, we would expect that most charters would include that authority, even if they do not specifically impose the independent analysis obligations on the committee.
The rules provide a phase-in period for companies that cease to be Smaller Reporting Companies based upon the date of its change of status under Rule 12b-2 under the Exchange Act. A company with a public float of $75 million or more as of the last business day of its most recently completed second fiscal quarter (the "Determination Date") will cease to be a Smaller Reporting Company as of the beginning of the fiscal year following the Determination Date (the "Start Date"). By six months from the Start Date, the company must comply with the provisions of the rule relating to the authority of the committee to retain compensation advisers, the requirement that the company fund such advisers, and the requirement that the committee consider the independence factors before selecting such advisers and must certify to the NASDAQ that it (i) has adopted a charter that contains the required provisions related to compensation advisers and (ii) has complied, or within the applicable phase-in schedule will comply, with the additional requirements regarding compensation committee composition. In addition, at least one member of its compensation committee must satisfy the enhanced independence standards (relating to compensatory fees and affiliation) within six months of the Start Date, a majority of the committee members must satisfy those requirements within nine months of the Start Date, and the entire committee must satisfy those requirements within 12 months of the Start Date.
NYSE Listing Standards
Compensation Committee Independence. The NYSE's current listing standards require an issuer to have a compensation committee but do not specify a minimum number of members. Under the new NYSE listing standards, a board must consider all factors specifically relevant to determining whether a director has a relationship to the issuer that is material to that director's ability to be independent from management relating to the duties of a compensation committee member. Specifically, the board must consider:
the source of compensation of a member of the issuer's board, including any consulting, advisory, or other compensatory fee paid by the issuer to such member, and
whether a member of the issuer's board is affiliated with the issuer, a subsidiary of the issuer, or an affiliate of a subsidiary of the issuer.
Unlike the NASDAQ, the NYSE has not established an absolute prohibition on compensatory payments.5 However, in response to comments, the NYSE stated that "excessive" director compensation may need to be evaluated in determining if a director's independence might be impaired. The NYSE also clarified that a single factor could disqualify a director from service on the compensation committee.
Compensation Adviser Selection. The NYSE listing standards require issuers, in connection with selecting compensation advisers (if such issuers choose to retain such advisers), to consider all factors relevant to the adviser's independence from management, including the six factors specified in the NASDAQ listing standards discussed above. Thus, an NYSE-listed company must consider any other factors that might bear on the adviser's independence. Again, nothing in the new standards requires a compensation adviser to be independent, only that the committee consider the six independence factors before selecting or receiving advice from such adviser.
Smaller Reporting Companies. Similar to the NASDAQ standards, the NYSE rules exempt compensation committees of Smaller Reporting Companies from having to consider the additional independence requirements as to compensatory fees and affiliation or to consider the additional independence factors for compensation advisers. However, unlike NASDAQ-listed companies, the compensation committee charter of an NYSE-listed Smaller Reporting Company must provide the committee with sole authority and funding for the retention of compensation advisers.
The NYSE rules provide a phase-in period for companies that cease to be Smaller Reporting Companies, similar to the NASDAQ provisions. Such companies must comply with the compensation adviser independence analysis requirements within six months from the Start Date. Such a company must also have at least one member of its compensation committee who meets the enhanced independence standards within six months of the Start Date, a majority of the committee members who meet those requirements within nine months of the Start Date. The entire committee must meet the enhanced independence requirements within 12 months of the Start Date.
The provisions of both the NASDAQ and NYSE listing standards relating to the authority of a compensation committee to retain compensation advisers, the company's obligation to fund such advisers, and the responsibility of the committee to consider independence factors before selecting such advisers must be assigned to the committee or the Independent Directors acting in lieu of a committee by July 1, 2013. Companies will have until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014 (the "Final Compliance Date"), to comply with the remaining provisions. NASDAQ-listed companies that do not have a compensation committee have until the Final Compliance Date to establish a compensation committee and adopt a charter that satisfies the new standards, but must act to grant the responsibilities and authorities related to compensation advisers to the Independent Directors who determine (or recommend to the board) executive compensation no later than July 1, 2013.
Now that the listing standards have been finalized, issuers should take the following actions:
Conduct a review of potential conflicts of interest with compensation consultants (as defined in Item 407(e)(3)(iv) of Regulation S-K), which must be disclosed in proxy statements for 2013 and subsequent years. This is required only for compensation consultants and not for the broader category of compensation advisers (defined in Rule 10C-1), which includes legal counsel and other advisers.
Identify any compensation advisers (as defined in Rule 10C-1), whether or not directly engaged by the compensation committee.
Develop processes and procedures to collect the necessary information to evaluate adviser independence (utilizing the six specified factors) and to conduct and document such evaluations prior to selection and at least annually thereafter for existing advisers.6
Revise compensation committee charters to ensure that the committee has the requisite authority and responsibilities imposed by the new standards. NYSE-listed issuers must have compliant charters in place by July 1, 2013, while NASDAQ-listed issuers have until the Final Compliance Date to comply (although the compensation committee or Independent Directors acting in lieu of a compensation committee must be granted authorities related to compensation advisers, through a board resolution or charter by July 1, 2013).
For NASDAQ-listed issuers (other than Smaller Reporting Companies) without an existing compensation committee, (i) grant the authorities related to compensation advisers no later than July 1, 2013 and (ii) establish a compensation committee that complies with the new listing standards and adopt a charter giving the committee the requisite authority and responsibilities by the Final Compliance Date.
Update director and officer questionnaires to ensure they are collecting information necessary to evaluate committee members under the new "independence" definition.
Review existing policies and procedures for the board's determinations of compensation committee member independence and revise them as necessary to reflect consideration of the factors in the new standards.
1. http://www.haslaw.com/securities/publications/sec-adopts-final-rules-on-listing-standards-for-compensation-committees-and-advisers/ and http://www.haslaw.com/publications/nasdaq-and-nyse-propose-rules-regarding-independence-of-compensation-committees-and-compensation-advisers/
2. This tracks the exception provided under Item 407(e)(3)(iii) of Regulation S-K relating to disclosure of compensation consultants' conflicts of interest.
3. A NASDAQ-listed company must certify compliance with the new listing standards within 30 days of the applicable implementation deadline.
4. This was a procedural requirement under the prior listing standards, but now must be stated in the charter.
5. The NYSE's general "independence" requirements (which still must be satisfied) do contain "bright line" tests related to compensation.
6. In approving the new listing standards, the SEC stated that it anticipated committees would conduct an adviser independence assessment at least annually.