NYSE/NASDAQ Update

by Snell & Wilmer
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SEC APPROVES FINAL RULES ON COMPENSATION COMMITTEE LISTING STANDARDS

On January 11, 2013, the SEC approved the NYSE and NASDAQ listing standards implementing Exchange Act Rule 10C-1, which directs the exchanges to prohibit the listing of an equity security of a company that does not comply with the SEC’s rules regarding the independence of compensation committees and their advisers. Notably, however, there was concern that the NASDAQ’s bright-line rule prohibiting members of a compensation committee from receiving certain types of compensation would potentially burden NASDAQ companies seeking to recruit eligible directors. Specifically, NASDAQ received feedback from listed companies and others that the bright-line rule created a burden on issuers because in some industries, such as in energy and banking, directors do de minimus amounts of business with the issuer and these directors would automatically become ineligible under the final rule. As a result, on November 26, 2013, NASDAQ proposed a series of immediately effective amendments to its rules, bringing them more in line with the final NYSE rules. The final rules, as amended, are discussed below.

Final Listing Standards

Rule 10C-1

Rule 10C-1 outlines certain factors (set forth in the chart below) that compensation committees must take into account when considering the independence of its members and of its compensation advisers (which includes compensation consultants, legal counsel or other advisers, but excludes in-house legal counsel).

Factors Relating to Independence of Compensation Committee Members:

Factors Relating to Independence of Compensation Advisers:

• A director’s source of compensation, including any consulting, advisory or compensatory fee paid by the company; and

• Whether a director is affiliated with the company, a subsidiary of the company, or an affiliate of a subsidiary of the company.

• Whether the employer of the compensation adviser provides other services to the registrant;

• The amount of fees received from the registrant by the employer firm of the compensation adviser as a percentage of such firm’s total revenue;

• The policies and procedures of the compensation adviser’s employer that are designed to prevent conflicts of interest;

• Any business or personal relationship of the compensation adviser with a member of the compensation committee;

• Whether the compensation adviser owns any stock of the registrant; and

• Any business or personal relationship between the executive officers of the registrant and the compensation adviser or the employer of the compensation adviser.

Under Rule 10C-1, the compensation committee is also required to be directly responsible for the appointment, compensation and oversight of compensation advisers. Additionally, each company must provide its compensation committee with appropriate funding for the payment of “reasonable compensation” to compensation advisers.

NYSE and NASDAQ Final Rules

Most of the provisions of NASDAQ and NYSE rules require compliance by the earlier of (i) the registrant’s first annual meeting after January 14, 2014 or (ii) October 31, 2014. 

Compensation Adviser Independence Determinations

Both NASDAQ and NYSE companies are required to determine whether compensation advisers are independent from the management of the company using the six factors set forth in Rule 10C-1 (discussed above). Notably, Rule 10C-1 and the new exchange rules do not require a compensation committee to follow the recommendations of compensation advisers or otherwise impact the responsibility of a compensation committee to exercise its own independent judgment in the exercise of its duties. 

Comparative Summary of the Final Rules
Listed companies should carefully review the new rules as they consider how to approach the 2014 proxy season and how to address the issues set forth above. The following chart sets forth a comparative summary of the final compensation committee member and advisers independence standards for NASDAQ and NYSE.

Compensation Committee Independence[1]

NASDAQ

NYSE

The board is required to consider all factors specifically relevant to determining whether a director has a relationship to the listed company that 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 Rule 10C-1 (as set forth above).

Compensation: The commentary provides that the board should consider whether the director receives any compensation that would impair the director’s ability to make independent judgments about the listed company’s executive compensation.

Affiliates: The commentary provides that stock ownership, even of a controlling interest, does not automatically preclude independence. The commentary also provides that the board should consider whether the relationship places the director under direct or indirect control of the listed company or its senior management, or creates a direct relationship between the director and members of senior management, in each case of a nature that would impair the director’s ability to make independent judgments about the listed company’s executive compensation.

NASDAQ’s rules also provide a limited exception from the independence standards in “exceptional and limited circumstances” where a director’s membership on the compensation committee is in the best interests of the company and its stockholders. However, a director appointed under such circumstances cannot serve on the compensation committee for more than two years.

The board is required to consider all factors specifically relevant to determining whether a director has a relationship to the listed company that 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 Rule 10C-1 (as set forth above).

Compensation: The commentary provides that the board should consider whether the director receives any compensation that would impair the director’s ability to make independent judgments about the listed company’s executive compensation.

Affiliates: The commentary provides that stock ownership, even a significant amount, does not automatically preclude independence. The commentary also provides that the board should consider whether the relationship places the director under direct or indirect control of the listed company or its senior management, or creates a direct relationship between the director and members of senior management, in each case of a nature that would impair the director’s ability to make independent judgments about the listed company’s executive compensation.

Compensation Adviser Independence

NASDAQ

NYSE

The compensation committee must consider the six factors set forth in Rule 10C-1 before selecting, or receiving advice from, compensation advisers. In contrast to the NYSE rule, the NASDAQ rule does not require the compensation committee to consider any other factors.

As discussed above, Rule 303A.05(c) tracks the language of Rule 10C-1 almost verbatim in requiring that compensation committees consider the same six factors as those set forth in Rule 10C-1 when selecting compensation advisers. However, in contrast to the NASDAQ rule, the NYSE’s rule frames the six factors as a non-exhaustive list, providing that compensation committees must consider “all factors relevant” to that person’s independence from management.

Cure Periods

NASDAQ

NYSE

If a compensation committee fails to comply due to a vacancy or a compensation committee member ceases to meet the independence standards for reasons outside his reasonable control, he would be permitted to remain a member of the compensation committee until the earlier of (i) the next annual meeting or (ii) one year from date when the member ceased to be independent. However, if a company’s annual meeting is within 180 days of the event that caused noncompliance, the company will instead have 180 days to cure the noncompliance.

If a compensation committee member ceases to meet the independence standards for reasons outside his reasonable control, he would be permitted to remain a member of the compensation committee until the earlier of (i) the next annual meeting or (ii) one year from date when the member ceased to be independent. 

The rule limits the cure provision to situations where a majority of the compensation committee remains independent.

Smaller Reporting Companies

NASDAQ

NYSE

Generally exempted, except for the following:

  1. The company must have, and certify to having, a compensation committee of at least two members, each of whom must be an independent director;
  2. The company may rely on the “limited and exceptional circumstances” exception (discussed above) to the independence standards;
  3. The company may rely on the cure period; and
  4. The company must certify to having adopted a formal written charter or board resolutions that specifies the same authority and responsibilities, except for those set forth in Rule 10C-1 relating to compensation advisers.

Smaller reporting companies exempted from the following:

  1. Rule 303A.02(a)(ii) relating to the additional compensation committee member independence standards; and
  2. Rule 303A.05(c)(iv) relating to the independence considerations for compensation advisers.

SEC APPROVES NYSE ONE-YEAR INTERNAL AUDIT TRANSITION PERIOD FOR NEW LISTINGS

On August 22, 2013, the SEC approved an amendment to NYSE Rule 303A.00 providing any company listing as part of an IPO (or first-time registration of common stock under the Securities Exchange Act of 1934), or as part of a carve-out or spin-off transaction with a one-year period for compliance with the internal audit function requirement.

The NYSE requires that listed companies must have an internal audit function to provide management and the audit committee with ongoing assessments of the company’s risk management process and system of internal control. The rule allows this function to be outsourced to a third-party other than its independent auditor. The NYSE rule also provides that any company listing with the NYSE upon transferring from another national securities exchange that does not have an internal audit requirement has one-year from the date of listing with the NYSE to comply with 303A.07(c). Although NASDAQ proposed an internal audit function rule, it withdrew its proposal on May 7, 2013 after receiving negative feedback about the burden it would impose upon the many emerging public companies that list with the NASDAQ.[2]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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