August 4, 2016
On August 1, 2016, the new rule on disclosure of third-party compensation for directors and nominees adopted by The NASDAQ Stock Market LLC ("NASDAQ") took effect. Disclosure will be required in connection with annual shareholder meetings after August 1. Accordingly, for NASDAQ companies with a calendar-year end, no action is immediately required, but they should have the rule on their radar screens as they begin preparations for the next annual meeting season. In addition, we anticipate that third-party compensation will continue to be a focal point for both NASDAQ and New York Stock Exchange (NYSE) companies due to current levels of shareholder activism and as public companies continue to adopt proxy access bylaws, which typically address these arrangements.
The final rule includes a number of welcome clarifications to NASDAQ’s proposal that address important aspects of the rule, including the timing of required disclosures and the rule’s application to directors designated by private equity firms, hedge funds and similar firms. The final rule also includes a new section of commentary that supplements the rule text. A copy of the final rule, which has been added as Rule 5250(b)(3), and the commentary, which is found in Interpretive Material (IM)-5250-2, appears at the end of this alert. NASDAQ filed several versions of the rule proposal with the Securities and Exchange Commission (SEC), and the SEC release approving the final proposal is available here.
Overview of the Final NASDAQ Rule
New NASDAQ Rule 5250(b)(3) requires companies to disclose "the material terms of all agreements and arrangements between any director or nominee for director, and any person or entity other than the Company (the "Third Party"), relating to compensation or other payment in connection with such person’s candidacy or service as a director of the Company." Disclosure must be made no later than the date on which the company files its definitive proxy statement for the next shareholder meeting at which directors are to be elected. The disclosure must be made in the proxy statement or via the company’s website.
Companies need not disclose:
Consistent with the proposed rule, the required disclosure must be made until the earlier of the director’s resignation from the board or one year after termination of the agreement or arrangement. The final rule also incorporates a "safe harbor" that protects companies if third-party compensation is not disclosed because a company is not aware of it. Companies would not be in violation of the rule if: (a) they make "reasonable efforts" to identify third-party compensation, including asking each director or nominee in a manner designed to allow timely disclosure; and (b) they disclose any compensation promptly upon discovering it "by filing a Form 8-K . . . where required by SEC rules, or by issuing a press release."
Important Clarifications in the Final NASDAQ Rule
The final rule includes a number of clarifications that were made over the course of several months during which the proposed rule was revised and subject to public comment.
Relationship to SEC Rules
The overlap between new Rule 5250(b)(3) was discussed at some length by the SEC in its release approving the rule, by NASDAQ and by those who commented on the rule proposal. Both the SEC and NASDAQ noted that there may be some overlap with existing SEC disclosure requirements. These requirements include:
In spite of this overlap, in a July 1 letter to the SEC, NASDAQ noted that the "nature, scope and timing of these required disclosures may not in all cases be the same" as the disclosure that would be required by NASDAQ Rule 5250(b)(3). The SEC, in its release approving Rule 5250(b)(3), observed that it is "not unusual" for national securities exchanges to adopt disclosure requirements that supplement or overlap with those applicable under the federal securities laws, and that "it is within the purview of a national securities exchange to impose heightened governance requirements." The SEC also observed that Rule 5250(b)(3) does not require separate disclosure when a company has made NASDAQ-compliant disclosure in its proxy statement under SEC rules.
Relationship to Director Independence
During the period when proposed Rule 5250(b)(3) was under consideration, NASDAQ also conducted a survey and sought feedback on whether to propose additional rules on various aspects of third-party compensation arrangements, including how they may impact independence. NASDAQ officials have since indicated that the exchange has no current plans to proceed with additional rulemaking in this area. However, in the rule proposal, NASDAQ reminded companies about its definition of "independence" for directors, noting that the definition excludes any director with any relationship that, in the opinion of the board, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. Accordingly, boards that are not already doing so should be sure to consider any third-party compensation arrangements in assessing the independence of directors and director candidates. NASDAQ’s rule on compensation committee independence (found in Rule 5605(d)(2)(A)) also specifically requires that boards consider this compensation in assessing whether directors meet the heightened independence criteria applicable to service on the compensation committee.
For NASDAQ companies, preparations for the next annual shareholder meeting will need to include consideration of how Rule 5250(b)(3) may be relevant for them and their directors. It remains to be seen whether the NYSE will follow NASDAQ’s lead and adopt its own rule on third-party director compensation arrangements. However, of relevance to all public companies, in the release approving the NASDAQ rule, the SEC observed that, in addition to certain line-item disclosure requirements of the federal securities laws that may apply (as listed above), the anti-fraud provisions of the proxy rules and Rule 10b-5 under the Securities Exchange Act of 1934 may mandate disclosure of third-party compensation in order to make statements included an SEC filing not misleading in light of the circumstances in which they were made.
In light of the new NASDAQ rule and the cautionary language in the SEC’s release, public companies should review their D&O questionnaires to confirm that the questions are appropriately drafted to obtain potentially relevant information required under both SEC rules and, for NASDAQ companies, new Rule 5250(b)(3). This includes non-cash arrangements and items such as indemnification. In addition, both NYSE and NASDAQ companies that have adopted proxy access, or that have advance notice bylaws or other bylaw provisions addressing third-party compensation, will want to confirm that their D&O questionnaires cover any information addressed in these bylaws.
Changes are operative on August 1, 2016
5250. Obligations for Companies Listed on The Nasdaq Stock Market
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(b) Obligation to Make Public Disclosure
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(3) Disclosure of Third Party Director and Nominee Compensation
Companies must disclose all agreements and arrangements in accordance with this rule by no later than the date on which the Company files or furnishes a proxy or information statement subject to Regulation 14A or 14C under the Act in connection with the Company’s next shareholders’ meeting at which directors are elected (or, if they do not file proxy or information statements, no later than when the Company files its next Form 10-K or Form 20-F).
(A) A Company shall disclose either on or through the Company’s website or in the proxy or information statement for the next shareholders’ meeting at which directors are elected (or, if the Company does not file proxy or information statements, in its Form 10-K or 20-F), the material terms of all agreements and arrangements between any director or nominee for director, and any person or entity other than the Company (the "Third Party"), relating to compensation or other payment in connection with such person’s candidacy or service as a director of the Company. A Company need not disclose pursuant to this rule agreements and arrangements that: (i) relate only to reimbursement of expenses in connection with candidacy as a director; (ii) existed prior to the nominee’s candidacy (including as an employee of the other person or entity) and the nominee’s relationship with the Third Party has been publicly disclosed in a proxy or information statement or annual report (such as in the director or nominee’s biography); or (iii) have been disclosed under Item 5(b) of Schedule 14A of the Act or Item 5.02(d)(2) of Form 8-K in the current fiscal year. Disclosure pursuant to Commission rule shall not relieve a Company of its annual obligation to make disclosure under subparagraph (B).
(B) A Company must make the disclosure required in subparagraph (A) at least annually until the earlier of the resignation of the director or one year following the termination of the agreement or arrangement.
(C) If a Company discovers an agreement or arrangement that should have been disclosed pursuant to subparagraph (A) but was not, the Company must promptly make the required disclosure by filing a Form 8-K or 6-K, where required by SEC rules, or by issuing a press release. Remedial disclosure under this subparagraph, regardless of its timing, does not satisfy the annual disclosure requirements under subparagraph (B).
(D) A Company shall not be considered deficient with respect to this paragraph for purposes of Rule 5810 if the Company has undertaken reasonable efforts to identify all such agreements or arrangements, including asking each director or nominee in a manner designed to allow timely disclosure, and makes the disclosure required by subparagraph (C) promptly upon discovery of the agreement or arrangement. In all other cases, the Company must submit a plan sufficient to satisfy Nasdaq staff that the Company has adopted processes and procedures designed to identify and disclose relevant agreements or arrangements.
(E) A Foreign Private Issuer may follow its home country practice in lieu of the requirements of Rule 5250(b)(3) by utilizing the process described in Rule 5615(a)(3).
IM-5250-2. Disclosure of Third Party Director and Nominee Compensation
Rule 5250(b)(3) requires listed companies to publicly disclose the material terms of all agreements and arrangements between any director or nominee and any person or entity (other than the Company) relating to compensation or other payment in connection with that person’s candidacy or service as a director. The terms "compensation" and "other payment" as used in this rule are not limited to cash payments and are intended to be construed broadly.
Subject to exceptions provided in the rule, the disclosure must be made on or through the Company’s website or in the proxy or information statement for the next shareholders’ meeting at which directors are elected in order to provide shareholders with information and sufficient time to help them make meaningful voting decisions. A Company posting the requisite disclosure on or through its website must make it publicly available no later than the date on which the Company files a proxy or information statement in connection with such shareholders’ meeting (or, if they do not file proxy or information statements, no later than when the Company files its next Form 10-K or Form 20-F). Disclosure made available on the Company’s website or through it by hyperlinking to another website, must be continuously accessible. If the website hosting the disclosure subsequently becomes inaccessible or that hyperlink inoperable, the company must promptly restore it or make other disclosure in accordance with this rule.
Rule 5250(b)(3) does not separately require the initial disclosure of newly entered into agreements or arrangements, provided that disclosure is made pursuant to this rule for the next shareholders’ meeting at which directors are elected. In addition, for publicly disclosed agreements and arrangements that existed prior to the nominee’s candidacy and thus not required to be disclosed in accordance with Rule 5250(b)(3)(A)(ii) but where the director or nominee’s remuneration is thereafter materially increased specifically in connection with such person’s candidacy or service as a director of the Company, only the difference between the new and previous level of compensation or other payment obligation needs be disclosed.
All references in this rule to proxy or information statements are to the definitive versions thereof.
Adopted July 1, 2016 (SR-NASDAQ-2016-013), operative Aug. 1, 2016.
 See July 1, 2016 Letter from A. David Strandberg III of NASDAQ to Brent J. Fields of the SEC, available at https://www.sec.gov/comments/sr-nasdaq-2016-013/nasdaq2016013-12.pdf.
Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any lawyer in the firm’s Securities Regulation and Corporate Governance practice group, or any of the following practice leaders and members:
Ronald O. Mueller – Washington, D.C. (202-955-8671, [email protected])
James J. Moloney - Orange County, CA (949-451-4343, [email protected])
Elizabeth Ising – Washington, D.C. (202-955-8287, [email protected])
Lori Zyskowski – New York (212-351-2309, [email protected])
Gillian McPhee – Washington, D.C. (202-955-8201, [email protected])
Dennis Friedman – New York (212-351-3900, [email protected])
John F. Olson - Washington, D.C. (202-955-8522, [email protected])
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