The Securities and Exchange Commission (SEC) recently approved changes to the listing standards of the New York Stock Exchange (NYSE) and NASDAQ relating to the independence of compensation committee members and the responsibilities of compensation committees when selecting compensation consultants, legal counsel, and other advisers. The final listing standards are substantially the same as those proposed by the exchanges, but there are a couple of noteworthy changes.
These new listing standards are required by Rule 10C-1 under the Securities Exchange Act of 1934, which was adopted pursuant to Section 952 of the Dodd-Frank Act. Under the new listing standards, the independence of compensation committee members must be determined after taking into consideration relevant factors, which must include the source of a director’s compensation, and whether the director is affiliated with the issuer, a subsidiary of the issuer, or an affiliate of a subsidiary. The new listing standards also provide that the compensation committee must have authority to retain a compensation consultant, legal counsel or other adviser, and that the compensation committee will be directly responsible for the appointment, compensation and oversight of any such adviser. The issuer must also provide the compensation committee with appropriate funding for payment to advisers retained by the committee. Finally, the listing standards provide that the compensation committee may select a compensation consultant, legal counsel or other adviser only after the committee considers six specific “independence” factors set forth in Rule 10C-1. However, neither Rule 10C-1 nor the exchanges’ listing standards will preclude compensation committees from engaging, or receiving advice from, non-independent consultants or other advisers.
Key Changes From Proposed Listing Standards
Although the final listing standards are substantially the same as those proposed by the exchanges, a couple of changes are noteworthy.
- First, the implementation timeline was harmonized for both exchanges, so that NASDAQ-listed companies will not be required to comply with some of the new standards before NYSE-listed companies, as had been the case under NASDAQ’s original proposal.
- Second, both exchanges added a new exception to the requirement that compensation committees consider specified independence factors when engaging advisers. Under this new exception, compensation committees will not need to consider such factors for an adviser whose role is limited to the types of activities for which no disclosure is required under item 407(e)(3)(iii) of Regulation S-K, i.e., (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 for a particular company or that is customized based on parameters that are not developed by the adviser and about which the adviser does not provide advice. This requirement also does not apply to in-house counsel.
Key Differences Between NYSE and NASDAQ Standards
The new NYSE and NASDAQ listing standards are generally similar, and they also hew closely to the standards articulated in Rule 10C-1. For example, neither exchange altered or added to the six independence factors to be considered by compensation committees when selecting consultants and other advisers. Further, both exchanges retained Rule 10C-1’s flexible approach when considering a director’s affiliation with the issuer. Under both exchanges’ listing standards, for example, a director who owns a significant amount of the company’s stock (or is a representative of a significant stockholder) is not, per se, precluded from being deemed independent for purposes of serving on the compensation committee.
NASDAQ’s listing standards depart from the NYSE’s standards and from Rule 10C-1 in one important way. Rule 10C-1 (and the NYSE’s listing standard) provides that a director’s source of compensation is merely a factor to be considered by the Board in determining whether a director may be deemed independent for purposes of serving on the compensation committee. In contrast, NASDAQ’s listing standard precludes a finding of independence if the director accepts, directly or indirectly, any consulting, advisory or other compensatory fee from the company (other than Board and committee fees and fixed amounts under a retirement plan for prior service). The NASDAQ approach parallels Rule 10A-3 for members of the audit committee.
Also, NASDAQ listing standards now require, for the first time, all NASDAQ-listed companies to have a separate compensation committee of at least two members, and that such committee must have a charter addressing specified topics.
For both exchanges, the new standards regarding independence of compensation committee members must be complied with by the earlier of (i) the first annual meeting after January 15, 2014 or (ii) October 31, 2014. However, the new standards regarding the duties and authorities of compensation committees, including the requirement to consider specified independence factors before selecting consultants, legal counsel and other advisers, will become effective on July 1, 2013.
NASDAQ’s new standards requiring a separate compensation committee, and requiring such committee to have a written charter, must be complied with by the earlier of (i) the first annual meeting after January 15, 2014 or (ii) October 31, 2014. Further, each NASDAQ-listed issuer must submit a certification of compliance with such requirements within 30 days of such issuer’s implementation deadline.
There are a number of action items for listed companies and their compensation committees to consider.
- Compensation Committee Charter. The charter of the compensation committee should be revised, as necessary, to provide the committee with the appropriate authorities and powers articulated in the new listing standards, as well as to require the committee to undertake the required independence assessment for consultants and other advisers. Some companies may also wish to have the charter address the new independence requirement for members of the committee by referring, for example, to the new sections of the applicable listing standards. NYSE-listed issuers must have compliant charters in place by July 1, 2013, whereas NASDAQ-listed issuers have until the earlier of (i) the first annual meeting after January 15, 2014 or (ii) October 31, 2014 to comply.
- Procedures for Determining Independence of Compensation Committee Members. Existing policies and procedures regarding the Board’s determination of the independence of compensation committee members will need to be reviewed and revised, as applicable, so that they reflect the Board’s consideration of the factors set forth in the new listing standards. In addition, D&O Questionnaires used to prepare the annual report and proxy statement will need to be revised to include, for members of the compensation committee, questions responsive to the independence criteria in the new listing standards. Although the new independence standards will not apply until calendar year 2014, many companies are likely to include such questions in their D&O questionnaires for the 2013 proxy season.
- Procedures for Evaluating Independence of Advisers to Committee. The compensation committee’s policies and procedures for retaining advisers or obtaining advice from advisers will need to be reviewed and revised as necessary to ensure that the committee considers the independence of such advisers before retaining them or, in the case of advisers already engaged by management on behalf of the company, before obtaining advice from them. These procedures should reflect the six independence factors set forth in the new listing standards. It might be prudent to request such advisers to complete a questionnaire to elicit the information needed by the committee to conduct its independence evaluation, and the committee’s procedures should ensure that its process is appropriately documented.