With the proxy and annual reporting season just around the corner, public companies need to be alert to this year’s regulatory developments. Below is a summary of current and anticipated changes that may impact reporting requirements in the coming year.
New Dodd-Frank Rules
Compensation Committee and Compensation Adviser Independence
In June 2013, the SEC approved the New York Stock Exchange’s (“NYSE”) and NASDAQ’s rules relating to compensation committees and compensation advisor independence listing standards contemplated by Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”) and Rule 10C-1. The new rules establish independence requirements for compensation committee members while requiring the committees to analyze potential conflicts of interest on the part of compensation consultants, legal advisers and other compensation advisers. The NYSE and NASDAQ rules, while not identical, are similar in many respects.
Independence of Compensation Committee Members
NYSE. The NYSE rules now require the board of directors to consider the following when addressing the independence of any director who will serve on the compensation committee:
all factors specifically relevant to determining whether a director has a relationship to the listed company which is material to the director’s ability to be independent from management in the execution of his or her duties as a compensation committee member, including, but not limited to:
the source of compensation of such director, including any consulting, advisory or other compensatory fee paid by the listed company to the director; and
whether the director is affiliated with the listed company, a subsidiary or affiliate.
NASDAQ. NASDAQ listed companies were not previously required to have a compensation committee. Under the new NASDAQ rules, listed companies must establish a standing compensation committee, consisting of at least two members, with a written charter. Members must be independent directors.
When determining the independence of a director who will serve on the compensation committee, a company’s board must consider the source of compensation of the director, including consulting, advisory or other compensatory fees paid by the company (including any consolidated parent and subsidiary entities) to the director and whether any compensation that the director receives from any person or entity would impair his or her ability to make independent judgments about the company’s executive compensation. “Compensation” of the director is not subject to any exceptions (e.g. for retirement benefits or other deferred compensation) and covers any compensation received by the director from the company, including directors’ fees.
In addition, companies must also consider whether the director is affiliated with the company, a subsidiary or an affiliate of a subsidiary to determine whether such affiliation would impair the director's judgment as a member of the compensation committee.
Neither the NYSE nor NASDAQ rules make receipt of any type of compensation, a bar to serving on the committee if the board is satisfied that the director meets the independence requirements. Similarly, affiliate status is not a bar to independence either. When considering the director’s affiliation with the company for purposes of independence, companies should document (e.g. in the board’s minutes) their consideration of whether the affiliate relationship places the director under the direct or indirect control of the 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 company’s executive compensation.
Compensation Adviser Requirements
Under both the NYSE’s and NASDAQ’s new listing rules, compensation committees are required to assess the independence of compensation advisers, which include not only compensation consultants, but also legal counsel and other advisers that provide advice to the compensation committee. The compensation committee does not, however, need to evaluate the independence of in-house counsel that provides advice or any compensation advisers that provide services to any broad-based plan.
The compensation committee may select, or receive advice from, a compensation consultant, legal counsel or other adviser only after taking into consideration the following factors:
the provision of other services to the company by the employer of the adviser;
the amount of fees received from the company by the employer of the adviser, as a percentage of the total revenue of the person that employs the adviser;
the policies and procedures of the employer of the adviser that are designed to prevent conflicts of interest;
any business or personal relationship of the adviser with a member of the compensation committee;
any stock of the company owned by the adviser; and
any business or personal relationship of the adviser or the person employing the adviser with an executive officer of the company.
While the NASDAQ rule only requires consideration of these six enumerated factors NYSE rule requires consideration of all relevant factors. However, it would be wise for every compensation committee, regardless of which exchange the company is listed on, to consider all relevant factors and to document such consideration in the minutes of the meeting.
NASDAQ Certification Requirement
NASDAQ companies must certify their compliance with the new compensation committee rules to NASDAQ no later than 30 days after the earlier of the company’s first annual meetings after January 15, 2014 or October 31, 2014. It is expected that NASDAQ will make the appropriate certification form for this purpose available on the NASDAQ website by early 2014.
The new NYSE and NASDAQ listing standards relating to (i) the authority of a compensation committee to retain compensation consultants, legal counsel and other compensation advisers, (ii) the funding for such advisers, and (iii) the responsibility of the committee to consider independence factors before selecting or receiving advice from such advisers are already effective.
The remaining provisions of the listing rules, including compensation committee member independence and the adoption of a formal committee charter that complies with the new listing rules, will need to be in place by the earlier of the first annual meetings that occurs after January 15, 2014 or October 31, 2014.
ISS 2014 Proxy Policies
The leading proxy advisory firm, Institutional Shareholder Services Inc. (“ISS”), annually issues policies which can impact companies’ proxy materials. Some of the most significant ISS policies relating to the 2014 proxy season are listed below.
Board Responsiveness to Majority-Supported Shareholder Proposals
In last year’s update, ISS announced, beginning in 2014, the trigger for evaluating a board’s response to a shareholder proposal would be if such proposal received the affirmative vote of a majority of the shares cast in the previous year.
In the 2014 policy update, ISS confirmed it will fully implement the 2013 update with minor changes. First, ISS clarified vote recommendations on director elections with respect to majority-supported shareholders proposals will be made on a fact specific case-by-case basis. ISS also modified the factors it will look to in analyzing a board’s responsiveness to a majority-supported shareholder proposal. Specifically, ISS will add to the list of factors to consider the board’s rationale for acting, or failing to act, on such a proposal as provided in the proxy statement. The ISS believes boards should either implement majority-supported shareholder proposals or explain less-than-full implementation in its proxy.
The full 2014 ISS Policy Update can be found here.
Pay-for-Performance Quantitative Screen
ISS also proposed to simplify the pay-for-performance quantitative screen. Under current ISS policy, when analyzing pay-for-performance alignment, one of the factors ISS considers is the relative degree of alignment (“RDA”) between the company’s total shareholder return rank and the CEO’s total pay rank within a peer group, measured over a one-year and three-year period.
In an effort to decrease the effects of volatility and the timing of equity awards under the current policy, going forward ISS will calculate the RDA measured over a single three-year period, eliminating the consideration of the one-year period.
Pending and Future Changes
Long awaited rules regarding pay for performance, claw-back policies and hedging policies still have not been proposed by the SEC. A summary of those topics can be found in last year’s proxy update. However, in September 2013 the SEC published proposed CEO pay ratio rules pursuant to a Dodd-Frank mandate.
Proposed Pay Ratio Disclosure Rules
Pay ratio disclosure will not be required for the 2014 proxy season, and the final rule is unlikely to require action until 2016. However, public companies should familiarize themselves with the proposal. More information can be found here.
Under the proposal, public companies would have to disclose the median of the annual total compensation of all employees other than the chief executive officer, the annual total compensation of the chief executive officer and the ratio of these amounts. As proposed, smaller reporting companies would not be subject to the pay ratio requirement.