On June 20, 2012 the Securities and Exchange Commission adopted
rules under the Securities Exchange Act of 1934 (Exchange Act),
that direct the national securities exchanges to adopt listing
standards for public company boards of directors, compensation
committees, and compensation advisers. These rules implement
Section 10C of the Exchange Act enacted as part of 2010's
Dodd-Frank legislation. The SEC has amended its proxy disclosure
rules correspondingly to require new disclosures from companies
about their use of compensation consultants and conflicts of
interest.
LISTING STANDARDS
The new rules regarding listing standards will take effect 30
days after publication in the Federal Register. The exchanges will
then have 90 days after effectiveness to propose listing standards
that comply with the new rules and one year after effectiveness to
finalize the rules and receive approval from the SEC. Depending on
how fast the SEC and the exchanges work the new listing standards
could be in effect as soon as the 2013 proxy season. Once the new
listing standards are in effect, issuers listed on national
securities exchanges will have to comply with the specific
standards established by the exchange on which they are
listed.
This alert summarizes the SEC's directives to the exchanges,
but the particular compliance obligations of public companies will
depend on how the exchanges implement the new rules.
Independence Requirement
Under new Exchange Act Rule 10C-1(b)(1), the national securities
exchanges must adopt listing standards requiring each member of an
issuer's compensation committee to be an independent member of
the issuer's board of directors. In determining independence
requirements, the exchanges must consider factors including, but
not limited to,
- the source of compensation of a member of the board (including consulting, advisory or other compensatory fees) and
- whether a member of the board is an affiliate of the issuer, a subsidiary of the issuer or an affiliate of a subsidiary of the issuer.
In the absence of a compensation committee, these independence
requirements will also apply to members of the board who oversee
compensation on behalf of the board of directors.
Most exchanges already require directors who determine executive
compensation to be independent under existing listing standards.
This new rule is intended to allow the exchanges to develop their
own standards of independence for compensation committee members as
long as the above factors are considered. Interestingly, the SEC
seems willing to allow the exchanges to adopt standards that do not
prohibit all affiliates from serving on a compensation
committee.
After considering the specified factors, the exchanges may
determine that certain affiliates should be permitted to serve on a
compensation committee. The SEC advises that exchanges should
consider ties between the issuer and a director that may impair the
director's judgment as a member of the compensation
committee.
Authority and Funding
The new rules grant the compensation committee the authority,
similar to audit committees, to retain compensation consultants,
independent legal counsel or other compensation advisers and
require that the issuer provide for appropriate funding to
compensate such advisers. Exchange Act Rule 10C-1(b)(2) provides
that compensation committees have sole discretion as to whether or
not to retain or obtain compensation advisers and that the
compensation committee is directly responsible for the appointment,
compensation and oversight of any such adviser so retained. This
authority to retain advisers and the responsibility for their
oversight also applies to members of the board of directors who
oversee executive compensation matters in the absence of a
compensation committee.
Under the new rules, compensation committees are not required to
retain advisers, but are given the have the authority to do so.
Compensation committees are also not required to obtain advice from
independent advisers; compensation committees may receive advice
from in-house legal counsel, or from advisers retained by
management. Should a compensation committee decide to retain an
adviser, independent or not, Exchange Act Rule 10C-1(b)(3) provides
that issuers must provide for the payment of reasonable
compensation to any such compensation consultant or adviser
retained by the compensation committee.
In addition, Exchange Act Rule 10C-1(b)(2)(iii) specifies that the
compensation committees are not required to act consistently with
or implement the advice or recommendations of any adviser it
retains.
Adviser Independence
The listing standards of exchanges must also require
compensation committees, or board members who oversee executive
compensation matters in absence of a compensation committee, to
consider certain independence factors before engaging any
consultant or advisers. The exchanges may set their own list of
considerations, but such considerations must at least include the
following:
- Whether the compensation consulting company employing the compensation adviser is providing any other services to the issuer;
- The amount of fess received by the compensation consulting company who employs the compensation adviser, as a percentage of that company's total revenue;
- What policies and procedures have been adopted by the compensation consulting company employing the adviser to prevent conflicts of interest;
- Whether the compensation adviser has any business or personal relationship with a member of the compensation committee;
- The stock ownership of the issuer by the compensation adviser; and
- Whether the compensation adviser, or the compensation consulting company who employs the compensation adviser, has any business or personal relationship with an executive officer of the issuer.
These factors, and any other factors imposed by the exchanges, should be considered in their totality and no one factor should be considered a determinative factor of independence. If, after considering the factors, the compensation committee determines the compensation adviser is not independent, the compensation committee may still retain such adviser so long as the committee has considered all the required factors. The Commission also clarifies that the compensation committee would not have to consider these factors before receiving advice from the issuer's in-house counsel.
Exemptions
The listing standards for compensation committees and
compensation advisers do not apply to any controlled company
(typically majority owned) or "smaller reporting company"
(defined by the SEC as an issuer having a public float of less than
$75 million). The exchanges may also exempt other categories of
issuers with approval by the SEC.
PROXY DISCLOSURE
The proxy rules already require disclosure regarding any role
compensation consultants play in determining the compensation of
executive officers and directors (including the name of such
consultant and any fees paid). The SEC has now amended the proxy
rules to require additional disclosure with respect any
compensation consultant whose work has raised a conflict of
interest pursuant to the factors listed in Exchange Act Rule
10C-1(b)(iv) (discussed above). Pursuant to new Item 407(e)(3)(iv)
of Regulation S-K, issuers will be required to disclose the nature
of any conflict of interest and how the conflict is being
addressed. This disclosure is not required where there is only a
potential conflict of interest or the appearance of a conflict of
interest.
Issuers must comply with this disclosure requirement in any proxy
statement for any annual or special meeting of shareholders at
which directors will be elected occurring on or after January 1,
2013.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
