[authors: Todd B. Pfister, Patrick G. Quick, Aubrey V. Refuerzo]
On September 25, 2012,1 the NYSE released a proposal (Proposal), subject to approval by the SEC, regarding independence requirements for compensation committees of NYSE-listed companies (NYSE Compensation Committees) based on the final rules that the SEC adopted June 20, 2012 (SEC Rules).2 The SEC Rules require the NYSE, as well as other national securities exchanges, to adopt listing standards on three topics: (i) the independence of NYSE Compensation Committee members (Members); (ii) an NYSE Compensation Committee’s authority to retain its own compensation advisers; and (iii) consideration by an NYSE Compensation Committee of specified factors that could bear on the independence of compensation advisers.
The Proposal does not break any significant new ground. As discussed below, the NYSE is not proposing to add any new specific test that a Member must meet to qualify as independent for NYSE Compensation Committee purposes. Likewise, the NYSE rules relating to compensation adviser retention remain effectively unchanged. Finally, as the SEC Rules require, the Proposal would add a new requirement for an NYSE Compensation Committee to consider specified factors as they relate to compensation advisers; the Proposal mirrors the six factors in the SEC Rules but also provides that the NYSE Compensation Committee must consider “all factors relevant to that person’s independence from management.”
Importantly, as to a Member’s independence for NYSE Compensation Committee purposes, the Proposal does not contain any numerical tests or absolute prohibitions. In addition, the Proposal specifically provides that share ownership alone, no matter the percentage, would not require an affirmative finding that a Member is not independent.
Highlights of the Proposed NYSE Listing Standards
Independence of NYSE Compensation Committee Members
SEC Rules. The SEC Rules direct national securities exchanges to adopt listing standards that require each Member to be “independent” and to define the term “independent” in its standards.
NYSE Proposed Standards. The Proposal does not make any significant changes to the NYSE’s existing independence standards applicable to Members. The Proposal adds certain consideration requirements applicable to a board of directors (Board) of an NYSE-listed company (NYSE Company), but the NYSE did not propose a more stringent independence test like the one that applies to members of audit committees.
The NYSE Listed Company Manual (NYSE Manual) already requires Members to be independent. Specifically, the NYSE Manual currently provides that a Member does not qualify as “independent” unless a Board affirmatively determines that the Member has no material relationship with the NYSE Company. This subsection sets forth five “bright-line” tests to be used in making this determination, and the Proposal would not change any of these tests.
The Proposal would add subsection 303A.02(a)(ii) to the NYSE Manual, which would require that, in affirmatively determining the independence of any Member for NYSE Compensation Committee purposes, the Board must consider “all factors specifically relevant” to determining whether such Member has a relationship to the NYSE Company that is material to the Member’s ability to be independent from management in connection with the Member’s NYSE Compensation Committee duties, including but not limited to the following two factors cited in the SEC Rules:
The source of compensation of a director, including any consulting, advisory, or other compensatory fee paid by the NYSE Company to such member of the Board
Whether a director is affiliated with the NYSE Company, a subsidiary of the NYSE Company, or an affiliate of a subsidiary of the NYSE Company
The Proposal also makes clear that the NYSE will not dictate any specific numerical tests with respect to the factors in the proposed rule. In particular, a Board need not make an affirmative finding that a Member is not independent based solely on the fact that the Member (and/or the Member’s affiliates) hold in excess of a specific percentage of the NYSE Company’s outstanding shares. The NYSE re-affirmed its position that share ownership in an NYSE Company aligns the Member’s interests with those of its shareholders. Furthermore, the NYSE believes that the NYSE’s existing “bright-line” independence rules are sufficiently broad to encompass all forms of relationships that would negate a Member’s independence regarding the Member’s NYSE Compensation Committee duties.
However, the Proposal would, in commentary to the new rules, provide that when considering the sources of a Member’s compensation in this context, the Board should consider whether the Member receives compensation from any other source, including sources outside of the NYSE Company, that would impair the Member’s ability to make independent judgments about the NYSE Company’s compensation. The commentary also would state that the Board should consider whether an affiliate relationship places the Member under the direct or indirect control of the NYSE Company or its senior management, or creates a direct relationship between the Member and members of senior management, in each case of a nature that would impair the Member’s ability to make independent judgments about the NYSE Company’s compensation.
NYSE Compensation Committee Authority to Retain Advisers
SEC Rules. Under the SEC Rules, listing standards must require that (i) a compensation committee has the authority to retain its own compensation advisers, (ii) the compensation committee is directly responsible for the appointment, compensation, and oversight of each adviser that it retains, and (iii) a company provide appropriate funding to its compensation committee to allow the committee to pay reasonable compensation to advisers. The listing standards need not, however, require a compensation committee to retain its own advisers.
Proposed Standards. The existing NYSE listing standards already substantially incorporate these SEC Rule provisions (in subsection 303A.05(b)). Nevertheless, largely for the sake of clarity, the NYSE has proposed to adopt the SEC Rule provisions verbatim as proposed new subsection 303A.05(c). Subsection 303A.05(b), in turn, would be revised to state that the NYSE Compensation Committee charter must provide for the specified powers.
NYSE Compensation Committee Review of Factors Impacting Compensation Adviser Independence
SEC Rules. The SEC Rules direct national securities exchanges to adopt listing standards that require a compensation committee to take into consideration specified factors that could bear on the independence of any compensation consultant, legal counsel, or other advisers (Compensation Advisers) to the committee, including Compensation Advisers that the compensation committee retains or that management retains (but excluding in-house legal counsel).
Proposed Standards. The NYSE proposes to adopt essentially verbatim the list of six factors set forth in the SEC Rules and not add any additional specific factors. While not adding any additional specific factors, however, subsection 303A.05(c), as proposed, would be broader in scope than what the SEC Rules require because it would compel an NYSE Compensation Committee to consider all factors relevant to that Compensation Adviser’s independence from management prior to selecting the Compensation Adviser as an adviser to the committee. Specifically, the NYSE Compensation Committee must consider the following six factors when making this selection:
The provision of other services to the NYSE Company by the employer of the Compensation Adviser (Advisory Employer)
The amount of fees received from the NYSE Company by the Advisory Employer as a percentage of the total revenue of the Advisory Employer
The Advisory Employer’s policies and procedures designed to prevent conflicts of interest
Business or personal relationships of the Compensation Adviser with Members
Business or personal relationships of the Advisory Employer or the Compensation Adviser with executive officers of the NYSE Company
Any stock in the NYSE Company owned by the Compensation Adviser
The Proposal requires that the NYSE Compensation Committee undertake this analysis prior to selecting any Compensation Adviser. The Proposal does not expand upon the requirement to consider all relevant factors in commentary to the rule or elsewhere in the Proposal. The broad language arguably makes it more difficult for an NYSE Compensation Committee to satisfy the requirement than would have been the case if the committee could simply have focused on the six factors. However, the NYSE’s director independence rules have long required the Board to consider all factors impacting director independence, and as noted above, the Proposal uses similar language in describing the requirement that applies to Member independence.
The Proposal does not specifically address many questions relating to the new requirement and the six factors, which include the following:
How often must the NYSE Compensation Committee consider the factors as to any given Compensation Adviser?
Where a Compensation Adviser works with others in an Advisory Employer, as to which employees of the Advisory Employer must the NYSE Compensation Committee consider the factors?
As to what period must the NYSE Compensation Committee consider fees?
What relationships are relevant? And how can an Advisory Employer have personal relationships with individuals?
How should stock ownership be calculated for the final factor?
The factors listed above are required considerations, but there will be no requirement that an NYSE Compensation Committee only use Compensation Advisers that are independent so long as the NYSE Compensation Committee undertakes such analysis for each Compensation Adviser. Consistent with the SEC Rules, the Proposal would not require that an NYSE Compensation Committee engage in such analysis with respect to in-house legal counsel, as the committee is on notice that in-house legal counsel are not disinterested.
The Proposal also would include, consistent with the SEC Rules, an express statement to the effect that an NYSE Compensation Committee is not required to implement or act consistently with the advice or recommendations of retained advisers and that factors to be considered by the NYSE Compensation Committee do not affect the ability or obligation of the NYSE Compensation Committee to exercise its own judgment in the fulfillment of its duties.
In response to comments, the NYSE expressly considered, but did not propose, a disclosure requirement relating to Compensation Advisers. The relevant commenter also had proposed requiring, with respect to outside counsel that the NYSE Compensation Committee hired, the same disclosure that SEC rules require with respect to the nature of any conflict that arises from the engagement of a compensation consultant. The NYSE did not believe that it was necessary to establish additional disclosure requirements. With respect to disclosure of any conflicts of interest that may arise with respect to outside counsel that the committee hired, the NYSE stated its belief that the rigorous conflict of interest requirements applicable to attorneys adequately address the commenter’s concerns.
SEC Rules. The SEC Rules require exchange rules to include appropriate procedures for listed issuers to have a reasonable opportunity to cure any non-compliance with the new listing standards. Specifically, if a Member ceases to be independent in accordance with the new requirements for reasons outside the Member’s reasonable control, then the Member, with notice by the issuer to the exchange, may remain a Member until the earlier of the next annual meeting or one year from the occurrence of the event that caused the Member to be no longer independent.
Proposed Standards. The NYSE proposes to adopt the SEC Rule cure provision (as part of Section 303A.00). Importantly, the Proposal would limit the use of this cure provision to circumstances where the NYSE Compensation Committee would continue to have a majority of independent directors (excluding the Member who is determined to be no longer independent).
The NYSE proposes to have the new listing standards effective July 1, 2013, but NYSE Companies would have until the earlier of (i) their first annual meeting held after January 15, 2014 or (ii) October 31, 2014, to comply with the new director independence standards for NYSE Compensation Committees contained in subsection 303A.02(a)(ii).
The Proposal provides an exemption for all categories of issuers that are currently exempt from the NYSE’s existing NYSE Compensation Committee requirements, including controlled companies, limited partnerships and companies in bankruptcy, closed-end and open-end funds registered under the 1940 Act, passive business organizations in the form of trusts (such as royalty trusts), derivatives and special purpose securities (as described in Sections 703.19 and 703.20 of the NYSE Manual), and issuers whose only listed equity security is a preferred stock.
Smaller reporting companies are not required to comply with the proposed NYSE rules regarding Member independence standards or Compensation Adviser independence considerations, but must comply with all other proposed NYSE rules regarding the authority and responsibilities of NYSE Compensation Committees.
Actions NYSE Companies Should Take Now
NYSE Companies should begin taking steps now to ensure that they will be able to comply with the new listing standards promptly, assuming that they are approved by the SEC, including the following:
1. Review current NYSE Compensation Committee membership in light of the proposed membership standards. NYSE Companies should pay special attention to the sources of compensation of Members, including any consulting, advisory, or other compensatory fees paid by the NYSE Company or any other source to any Member. An NYSE Company also should focus on whether a Member is affiliated with the NYSE Company, a subsidiary of the NYSE Company, or an affiliate of a subsidiary of the NYSE Company. In addition to these two factors, the Board must consider all factors relevant to each Member’s independence. A Board has broad discretion to determine how the specified factors and any other relevant factors may affect a Member’s independence, but it should be able to show that the specified factors and any other relevant factors were carefully considered. In particular, a Board should be able to justify why fees or affiliations would not disqualify a Member from being independent.
2. Review current arrangements with Compensation Advisers for problematic facts. An NYSE Compensation Committee should explore whether consideration of all relevant factors as to each of its current Compensation Advisers might present problematic facts and ensure that engagement of future Compensation Advisers includes consideration of all relevant factors, including each of the factors set forth in the Proposal.
An NYSE Company or its NYSE Compensation Committee should obtain from Compensation Advisers adequate information to enable the NYSE Company or NYSE Compensation Committee to consider all relevant factors, including the enumerated factors. The NYSE Company or NYSE Compensation Committee may then consider whether there is information as to any Compensation Adviser that the committee did not already know that is likely to trouble the NYSE Compensation Committee, keeping in mind that there is no requirement that an NYSE Compensation Committee only use Compensation Advisers that are in fact independent in the sense that they do not present questions under any of the factors. If the NYSE Company, rather than its NYSE Compensation Committee, is generally involved in this preliminary work, then the NYSE Company should nonetheless advise the NYSE Compensation Committee of the new rules and perhaps seek preliminary feedback. Of course, if the preliminary work raises valid concerns, then the NYSE Company and its NYSE Compensation Committee will need to consider what actions to take to address the situation.
3. Review current NYSE Compensation Committee charter regarding committee authority to retain advisers. The Proposal does not significantly alter the NYSE’s current listing standards with regard to this subject matter, but an NYSE Company should confirm that its NYSE Compensation Committee charter expressly provides that (i) the NYSE Compensation Committee has the authority to retain its own compensation advisers, (ii) the NYSE Compensation Committee is directly responsible for the appointment, compensation, and oversight of each adviser that it retains, and (iii) the NYSE Company must provide appropriate funding to the NYSE Compensation Committee.
4. Review engagement arrangements with Compensation Advisers that the Committee has retained. Furthermore, given that an NYSE Company’s Compensation Committee is directly responsible for the appointment, compensation, and oversight of the work of any Compensation Advisers that the NYSE Compensation Committee retains, the NYSE Company should review the relationships with any Compensation Advisers that the NYSE Compensation Committee retains to ensure the proper level of committee involvement.
1The Proposal was amended on October 1, 2012 solely with regard Exhibit 5, Section 303A.00 under the heading, “Transition Periods for Compensation Committee Requirements.”
2The SEC Rules regarding Compensation Committees are discussed in more detail in Foley & Lardner LLP’s Legal News Alert on this topic dated June 25, 2012. The SEC Rules were adopted in response to the mandate of Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.