October 24, 2012
The New York Stock Exchange (“NYSE”) and NASDAQ Stock Market (“NASDAQ”) released their proposed compensation committee and compensation adviser independence listing standards on September 25, 2012. The proposed listing standards would implement the Securities and Exchange Commission (the “SEC”) rules adopted under Section 10C of the Securities Exchange Act of 1934 (the “Exchange Act”), as mandated by Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). The proposed NYSE listing standards (as amended on October 1 to correct a technical error) are available here. The proposed NASDAQ listing standards are available here. The proposals were published in the Federal Register on October 15, 2012, and comments are due by November 5, 2012. The stock exchanges must adopt final listing standards no later than June 27, 2013.
As adopted by the SEC, new Rule 10C-1 requires U.S. stock exchanges to adopt listing standards that: (1) establish heightened independence requirements for compensation committee members; (2) require issuers to grant compensation committees the authority to retain, be directly responsible for and pay for compensation advisers; and (3) require the compensation committee to assess the independence of any compensation adviser that provides advice to the committee. The SEC’s rules setting forth the requirements for NYSE’s and NASDAQ’s listing standards are described in more detail in our July 2, 2012 client alert, available here.
NYSE and NASDAQ have proposed different approaches with respect to independence standards for compensation committee members, each of which some companies might find problematic. As expected, neither the NYSE nor NASDAQ have specified additional factors, beyond those addressed in Dodd-Frank and under the SEC rules, for evaluating independence of compensation committee members or compensation advisers. However, NYSE’s proposal would mandate an open-ended inquiry into the independence of compensation committee members, while NASDAQ’s proposal would impose a bright-line independence element for compensation committee members. Separately, neither proposal provides helpful guidance on the scope of the SEC’s broad mandate requiring that compensation committees assess the independence of compensation consultants, outside legal counsel or other advisers prior to obtaining their advice, and neither exchange proposes a cure process in case a compensation committee fails to conduct an independence assessment in advance of receiving advice from a compensation adviser.
While the proposed listing standards in large part simply implement mandated standards under Dodd-Frank and the SEC’s rules, there are a number of nuances to how the exchanges have proposed to satisfy these requirements. We set forth below an explanation of the proposals and related observations that are relevant as companies consider whether to comment on the proposals, and we recommend steps that companies should take in anticipation of the rules being adopted. Because there is a short comment period and the rules have implications for the operation of compensation committees, companies should carefully study the proposals and consider submitting comments to their applicable exchange.
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Compensation Committee Member Independence |
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| SEC Requirement: The SEC’s rules require the stock exchanges to develop definitions of compensation committee member independence that take into account the two independence factors specified in Exchange Act Section 10C: (1) the source of compensation paid to directors serving on the compensation committee; and (2) whether a director is affiliated with the company, a subsidiary or an affiliate of a subsidiary.[1] Unlike the audit committee member independence rules required by Sarbanes-Oxley, Dodd-Frank and the SEC rules do not state that relationships covered by these criteria result in a director being deemed not independent, only that the securities exchanges “shall consider” the two criteria in implementing the compensation committee member independence listing standards. | |
| NYSE Proposal: NYSE currently has a listing standard requiring that listed companies have a compensation committee composed entirely of independent directors. | NASDAQ Proposal: Although not required under the SEC rules, NASDAQ is proposing to require that listed companies have compensation committees.[2] Under the proposed NASDAQ rule, the compensation committee must consist of at least two directors, each of whom must qualify as independent. |
| The proposed NYSE listing standard would require the board of directors, in affirmatively determining the independence of any director to serve on the compensation committee, to consider “all factors specifically relevant to determining whether a director has a relationship to the listed company which is material to that director’s ability to be independent from management in connection with the duties of a compensation committee member, including, but not limited to,” the two factors enumerated in Exchange Act Section 10C.[3] Directors serving on compensation committees also would have to satisfy the NYSE’s existing standards for director independence. | The proposed NASDAQ listing standard would provide that a director will not qualify as independent for service on the compensation committee if he or she has received, directly or indirectly, consulting, advisory or other compensatory fees from the issuer or a subsidiary of the issuer.[4] NASDAQ’s proposal states that it concluded that there is no compelling justification to have an independence standard for compensation committee members with respect to the acceptance of compensatory fees from a company that differs from its standard applicable to audit committee members. In addition, in determining whether a director is eligible to serve on the compensation committee, NASDAQ’s proposal would require a company’s board to consider whether the director is affiliated with the company and to determine whether such affiliation would impair the director’s judgment as a member of the compensation committee. No look-back would be required with respect to affiliate relationships that preceded a director’s service on the compensation committee. Directors serving on compensation committees also would have to satisfy NASDAQ’s existing standards for director independence. |
| With respect to directors who may be deemed affiliated through stock ownership, the NYSE release states that it believes share ownership aligns the interests of a compensation committee member with those of unaffiliated shareholders. | With respect to directors who may be deemed an affiliate through stock ownership, the NASDAQ release states that “it may be appropriate for certain affiliates, such as representatives of significant stockholders, to serve on compensation committees since their interests are likely aligned with those of other stockholders in seeking an appropriate executive compensation program.”[5] |
| Our Observations: We believe it is appropriate that both exchanges’ proposed listing standards apply to the board committee that determines executive compensation; if a separate board committee sets director compensation, the rules do not apply to that committee.
We also believe that it is appropriate that each exchange has recognized that affiliate status, and in particular affiliate status arising due to stock ownership, should not automatically disqualify an otherwise independent director from compensation committee service. NYSE companies should evaluate, and may wish to consider commenting on, how they will conduct the additional inquiry into “all factors specifically relevant” for assessing independence in connection with the duties of a compensation committee member. NASDAQ companies may wish to comment on any considerations for whether an independence standard that prohibits other compensation, comparable to the standard applicable to audit committee members, is or is not appropriate in the compensation committee context, and whether that standard would have any unintended consequences. |
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Compensation Committee Responsibilities |
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| SEC Requirement: The SEC rules required that the stock exchanges adopt listing standards mandating that listed companies’ compensation committees: (1) have the authority, in their sole discretion, to retain or obtain the advice of a compensation consultant, independent legal counsel or other adviser; (2) be directly responsible for the appointment, compensation, and oversight of the work of any compensation adviser they retain; and (3) receive “appropriate funding” as determined by the compensation committee from the company for payment of reasonable compensation to compensation advisers.[6] | |
| NYSE Proposal: NYSE proposes to amend its rules to specify additional compensation committee responsibilities, based on the requirements of the SEC’s rules. The NYSE’s proposed listing standards in this area were drafted largely “verbatim” from the SEC rules.[7] Commentary to the NYSE’s existing compensation committee listing standards[8] already requires the compensation committee charter to give the committee sole authority to retain and terminate a compensation consulting firm, including sole authority to approve the firm’s fees and other retention terms. The NYSE proposes to delete this commentary, since it would be superseded by the listing standard that tracks the SEC’s requirement on this topic. | NASDAQ Proposal: NASDAQ’s proposed listing standards would require that the compensation committee have the specific responsibilities and authority necessary to comply with the SEC’s rules, which the proposed listing standards cross reference, relating to the authority to retain and fund compensation consultants, independent legal counsel and other compensation advisers.[9] |
| The NYSE’s existing listing standards require the compensation committee to have a written charter setting forth certain specified responsibilities of the committee. This provision would be amended to require that the compensation committee’s charter expressly address the rights and responsibilities of the committee that are required under the SEC rules.
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Under the NASDAQ proposal, these authorities and responsibilities would have to be specified in the compensation committee’s charter. Notably, NASDAQ currently does not have any requirements as to the existence or terms of a compensation committee charter.
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As part of its proposal to require listed companies to have a compensation committee, NASDAQ proposes to require that companies adopt a formal written compensation committee charter. In addition to stating the compensation committee’s authority and responsibilities over the matters required under the SEC’s rules, as addressed above, the committee’s charter would be required to specify:
NASDAQ listed companies would be required to certify that they have adopted a compensation committee charter and that the compensation committee will “review and reassess” the adequacy of the charter on an annual basis.[10] This requirement is based on an existing NASDAQ requirement applicable to audit committees, except that NASDAQ is proposing to amend the audit committee requirement to provide, consistent with its compensation committee proposal, that companies certify the committee “will” assess (instead of has assessed) the adequacy of its charter.[11] |
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| Our Observations: The NYSE proposals would not impose requirements on the compensation committee beyond what Section 952 of Dodd-Frank and the SEC rules require in terms of the authority of the compensation committee. While NASDAQ’s proposal includes new requirements for compensation committees beyond those mandated by Dodd-Frank and the SEC, and require those responsibilities to be stated in the committee’s charter, we do not expect that the proposal should create compliance burdens, because the new requirements relate to matters that typically are addressed in compensation committee charters and are consistent with the processes that NASDAQ’s listing standards already require with respect to the determination of CEO and other executive officer compensation. | |
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Assessing the Independence of Compensation Advisers |
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| SEC Requirement: The SEC rules required the stock exchanges to adopt listing standards stating that a compensation committee “may select” a compensation consultant, legal counsel or other adviser only after taking into account six enumerated independence factors, along with any other factors identified by the stock exchanges.[12] An instruction to the SEC rule states that this requirement applies to any compensation consultant, legal counsel or other adviser that “provides advice” to the compensation committee, including advisers that were selected or retained by management, other than in-house legal counsel. Those six independence factors are:
1. The provision of other services to the issuer by the firm that employs the compensation adviser; 2. The amount of fees received from the issuer by the firm that employs the compensation adviser, as a percentage of the total revenue of the firm that employs the compensation adviser; 3. The policies and procedures of the firm that employs the compensation adviser that are designed to prevent conflicts of interest; 4. Any business or personal relationship of the compensation adviser with a member of the compensation committee; 5. Any stock of the issuer owned by the compensation adviser or the adviser’s immediate family members; and 6. Any business or personal relationship of the compensation adviser or the firm employing the adviser with an executive officer of the issuer. The SEC rules do not prohibit a committee from receiving advice from advisers that the committee determines are not independent, and do not impose any new disclosure requirements with respect to such advisers or their independence (beyond the existing disclosure requirements applicable to certain compensation consultants). |
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| NYSE Proposal: As with the other compensation committee responsibilities required under the SEC’s rules, the NYSE’s proposed listing standards set forth verbatim the language from the SEC’s rule requiring that the compensation committee “may select” an adviser only after evaluating the adviser’s independence, except that the NYSE’s rule does not repeat the SEC’s instruction interpreting the standard as applying to any adviser that “provides advice” to the committee. The NYSE stated that it considered the six factors set forth in the SEC rule as “very comprehensive” and therefore its proposed rules do not identify any additional factors that must be considered. However, the NYSE’s proposal frames the six factors as a non-exclusive list and in addition broadly requires the compensation committee to take into consideration “all factors relevant” to assessing an adviser’s independence from management.[13] The NYSE’s proposal would require the compensation committee’s charter to expressly address the committee’s responsibility to perform the adviser independence assessment. | NASDAQ Proposal: As with the other compensation committee responsibilities required under the SEC’s rules, NASDAQ’s proposed listing standards cross-reference the SEC’s rule requiring that the committee must assess the independence of any compensation consultant, legal counsel or other adviser (other than in-house legal counsel) before it obtains the advice of any such adviser. In contrast to the NYSE’s approach, NASDAQ rules would not require the committee to consider any factors other than the six required by the SEC’s rules, which NASDAQ’s proposal states would elicit “broad and sufficient” information to determine whether compensation advisers are independent. NASDAQ’s proposal would require the compensation committee’s charter to expressly address the committee’s responsibility to perform the adviser independence assessment.[14] |
Our Observations: As we stated when the SEC adopted its rules and expansively interpreted the independence assessments to apply to any adviser that “provides advice” to the committee, we expect this independence assessment requirement to be the most burdensome aspect of the SEC’s, and thus of the stock exchanges’, rulemaking under Section 10C. Given the potential burdens of this requirement, companies should consider how and to whom the requirement will apply in the context of their compensation committee’s processes, and may wish to submit comments on or seek interpretive advice on the scope of the independence assessments as part of the rule adoption process. Companies may wish to request interpretive guidance on issues such as:
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Opportunity to Cure |
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| SEC Requirement: The SEC’s rules state that the stock exchanges’ listing standards must provide appropriate procedures for a listed issuer to have a reasonable opportunity to cure any defects that would be the basis for prohibiting the company’s initial or continued listing under the compensation committee listing requirements. Paralleling its rules with respect to audit committee member independence, the SEC’s rules specifically provided that the listing standards may provide that, if a compensation committee member ceases to be independent for reasons beyond the member’s reasonable control and the company informs its stock exchange, that member may remain on the compensation committee until the earlier of (1) the next annual meeting, or (2) one year from the occurrence of the event that caused the member to be no longer independent. | |
| NYSE Proposal: As permitted by the SEC’s rules, the NYSE proposes that if a compensation committee member ceases to meet the new definition of compensation committee independence for reasons outside the member’s reasonable control, the member can stay on the committee until the earlier of (1) the next annual meeting or (2) one year from the date when the member ceased to be independent.[15] The NYSE has proposed limiting this cure provision to situations in which a majority of the compensation committee remains independent. | NASDAQ Proposal: As permitted by the SEC’s rules, NASDAQ proposes that if a compensation committee member ceases to meet the new definition of compensation committee independence for reasons outside the member’s reasonable control, the member would be permitted to remain a member of the compensation committee until the earlier of (1) the next annual meeting or (2) one year from date when the member ceased to be independent.[16] NASDAQ also would provide that companies have a minimum of 180 days to cure noncompliance. Unlike the proposed NYSE rule, the proposed NASDAQ rule would not limit the cure provision to situations in which a majority of the compensation committee remains independent.
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| The NYSE’s proposal differs from its approach in addressing its audit committee listing standards, where the NYSE only states in commentary that it will apply the requirements of the SEC’s Rule 10A-3 in a manner consistent with guidance provided by the Securities and Exchange Commission in SEC Release No. 34-47654 (April 1, 2003).[17] | NASDAQ’s proposal providing an opportunity to cure noncompliance with the proposed compensation committee member independence rules parallels its rule providing an opportunity to cure noncompliance with the requirement that a majority of its board qualify as independent directors.[18] |
| Our Observations: Neither the NYSE’s nor NASDAQ’s proposal would provide companies an opportunity to cure noncompliance with aspects of the new rules other than the compensation committee independence requirement. Because the SEC rules required the exchanges to permit companies to cure noncompliance with “any” of the compensation committee listing requirements, companies may wish to comment during the comment period on whether they will be given an opportunity to cure noncompliance with the requirement to assess the independence of compensation advisers in advance of receiving their advice, or with other aspects of the proposed listing standards. | |
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Effective Dates |
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| SEC Requirement: The SEC’s rules require the stock exchanges to adopt final listing standards no later than June 27, 2013, but do not mandate when the listing standards must take effect. As noted above, the exchanges’ proposals are subject to public comment and could be amended or revised before becoming final. The SEC must approve the exchanges’ proposals before they can take effect. | |
| NYSE Proposal: The NYSE’s proposes that the new listing standards become operative on July 1, 2013. For the compensation committee member independence requirements, the NYSE has proposed a transition period under which companies would have until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014, to comply with the new compensation committee member independence rules. Existing compensation committee independence standards would continue to apply pending the transition to the new independence standards. | NASDAQ Proposal: NASDAQ proposed that the listing standards related to the compensation committee’s authority to retain compensation advisers and to fund such advisers, and its responsibility to assess the independence of such advisers, be effective immediately upon adoption. NASDAQ proposed that the remaining proposed compensation committee listing standards, including the requirement to have a compensation committee, the compensation committee independence requirement, and the requirement that the committee’s authority and responsibilities be specified in a written charter, must be satisfied by the earlier of a company’s second annual meeting held after the date the SEC approves the amended listing rules or December 31, 2014. |
| NYSE proposes to exempt certain categories of issuers from the compensation committee requirements, including controlled companies, limited partnerships, companies in bankruptcy, and issuers whose only listed equity security is a preferred stock. NYSE would also exempt foreign private issuers that follow home country practice. | NASDAQ proposes that its existing exemptions from the compensation-related listing rules, available for controlled companies and limited partnerships, among others, continue to apply with respect to the proposed new compensation committee listing standards. NASDAQ would also exempt foreign private issuers that follow home country practice. |
| Our Observations: The exchanges’ proposed transition periods for satisfying the compensation committee member independence requirements should allow more than sufficient time for most companies to make any needed changes or additions to their compensation committee membership. However, NASDAQ companies should be aware that certain of the listing standards are proposed to become effective “immediately” upon approval of the listing standards by the SEC, and it is not clear that companies will know the final content of the NASDAQ listing standards before they are approved by the SEC. NYSE companies may have a similar issue depending on when the SEC approves the NYSE proposal, which proposes to require compliance on July 1, 2013. Companies may wish to comment on whether additional time would be helpful to comply with any of these other requirements, given that the SEC’s rules but do not mandate an effective date for the new listing standards, only that the exchanges have final rules approved by the SEC no later than June 27, 2013. | |
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What Companies Should Do Now |
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| All companies should carefully review their applicable exchange’s proposal, consider the practical implications of the proposals for their compensation committees, and determine whether to comment on any aspects of the proposals. As noted above, comments are due to the exchanges by November 5, 2012, although the exchanges typically will consider comments received after the deadline.
Companies also should consider revising their director and officer questionnaires to include questions that will assist in identifying relationships that may bear upon the independence of compensation committee members. Companies may wish also to revise their director and officer questionnaires to include questions that will assist in identifying relationships that may bear upon the independence of compensation consultants and other compensation advisers. In this regard, it is helpful to note that the factors that appear likely to apply for purposes of assessing the independence of compensation advisers are identical to the factors that must be assessed for purposes of evaluating the existence of any compensation consultant conflicts of interest under recently adopted Regulation S-K Item 407(e)(3)(iv). Companies should evaluate which advisers may be called on to provide advice to the compensation committee during the coming year, and begin a dialogue with such advisers regarding how they will present to the company and the compensation committee the information that is relevant for assessing their independence. |
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| NYSE Companies: | NASDAQ Companies: |
| Given the broad and vague independence inquiries proposed by the NYSE, NYSE companies should consider whether there are factors other than those specified under Dodd-Frank and the SEC’s rules that could be viewed as affecting either a director’s independence for purposes of serving on the compensation committee or an adviser’s independence. If so, companies should seek clarification on the application of the NYSE’s proposed independence rules in advance of the rules being finalized, especially if the proposed standards could have unintended results. | Given NASDAQ’s proposed bright-line test for compensation committee independence, NASDAQ companies should assess whether any existing or expected future compensation committee member could be disqualified as a result of any direct or indirect compensation arrangements.
The relatively small number of NASDAQ companies that do not currently have a separate compensation committee should plan on establishing one. |
| NYSE companies should review their compensation committee charters to determine what amendments might be necessary to specifically address the new responsibilities specified under SEC rule 10C-1(b)(2) through (4), and should anticipate possibly needing to approve such amendments before July 1, 2013. | All NASDAQ companies should review their compensation committee charters to determine what amendments might be necessary to specifically address the matters, authority and responsibilities that NASDAQ proposes to require. Although NASDAQ’s proposal provides a grace period for amending the committee’s charter to specifically address these matters, in light of its proposal that the committee must actually have the specified responsibilities and authority immediately upon adoption of the proposed rules, companies may need to act quickly once the NASDAQ rules are finalized.
While we expect that the proposed amendment that would require companies to certify that their audit committee “will evaluate” its charter annually will not require an amendment to most audit committees’ charters, NASDAQ companies should review their audit committee charter to confirm that no amendment is required. |
[1] Rule 10C-1(b)(1)(ii) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
[2] Proposed NASDAQ Listed Company Rule 5605(d)(2). NASDAQ listing standards currently allow compensation of executive officers to be determined, or recommended to the board for determination, either by independent directors constituting a majority of the board’s independent directors in a vote in which only independent directors participate, or a compensation committee comprised solely of independent directors. The NASDAQ rule proposal states that virtually all of its listed companies currently have an independent compensation committee.
[3] Proposed NYSE Listed Company Manual Section 303A.02(a)(ii).
[4] Proposed NASDAQ Listed Company Rule 5605(d)(2)(A).
[5] Proposed NASDAQ Interpretive Materials 5605-6.
[6] Exchange Act Rule 10C-1(b)(2)-(3).
[7] Proposed NYSE Listed Company Manual Section 303A.05(c).
[8] Commentary to NYSE Listed Company Manual Section 303A.05.
[9] Proposed Listed Company NASDAQ Rule 5605(d)(1)(D).
[10] Proposed Listed Company NASDAQ Rule 5605(d)(1).
[11] Proposed Listed Company NASDAQ Rule 5605(c)(1).
[12] Exchange Act Rule 10C-1(b)(4)(i)-(vi).
[13] Proposed NYSE Listed Company Manual Section 303A.05(c)(iv).
[14] Proposed NASDAQ Listed Company Rule 5605(d)(1)(D).
[15] Proposed NYSE Listed Company Manual Section 303A.00.
[16] Proposed NASDAQ Listed Company Rule 5605(d)(4).
[17] NYSE Listed Company Manual Section 303A.06.
[18] NASDAQ Listed Company Rule 5605(b)(2).
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Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you work, or any of the following:
John F. Olson – Washington, D.C. (202-955-8522, [email protected])
Brian J. Lane – Washington, D.C. (202-887-3646, [email protected])
Ronald O. Mueller – Washington, D.C. (202-955-8671, [email protected])
Amy L. Goodman – Washington, D.C. (202-955-8653, [email protected])
James J. Moloney – Orange County (949-451-4343, [email protected])
Elizabeth Ising – Washington, D.C. (202-955-8287, [email protected])
Stephen W. Fackler – Palo Alto and New York (650-849-5385 and 212-351-2392, [email protected])
Michael J. Collins – Washington, D.C. (202-887-3551, [email protected])
Sean C. Feller – Los Angeles (213-229-7579, [email protected])
Gillian McPhee – Washington, D.C. (202-955-8201, [email protected])
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