SEC Approves NYSE and NASDAQ Rules on Compensation Committees and Advisers

by Manatt, Phelps & Phillips, LLP

The Securities and Exchange Commission has approved new listing requirements promulgated by the New York Stock Exchange and the NASDAQ Stock Market relating to the composition and oversight provided by compensation committees.  The listing requirements, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act, impose new obligations for compensation committees in connection with the retention and oversight of compensation committee advisers, as well as revise the independence criteria for compensation committee members themselves.

Public companies must focus on two specific compliance dates in connection with evaluation and assessment of the new rules: 

  • July 1, 2013 - the date for compliance with the new rules relating to compensation committee adviser independence and adoption of any required compensation committee charter amendments.
  • First annual meeting date after January 15, 2014, or October 31, 2014, whichever first occurs - the date for compliance with the new rules relating to compensation committee members meeting the appropriate independence requirements after review of any conflicts of interest.

Standards for Compensation Committee Independence 
Under the new NYSE and NASDAQ listing standards, companies must have compensation committees composed entirely of independent directors.  The NYSE and NASDAQ use both the general independence criteria already included in the exchanges' listing standards for boards of directors, as well as new compensation committee-specific criteria.

The new NYSE standards require that in determining the eligibility of compensation committee members, the issuer's board of directors should consider the sources of compensation of the director and whether the director is affiliated with the company.  With respect to the source of compensation, the company's board should consider whether the director receives compensation from any person or entity that would impair the director's ability to make independent judgments about executive compensation at the company.  In considering the director's affiliations with the company, boards must consider whether any affiliate relationships with the company place the director under the direct or indirect control of the listed company or its senior management, or create a direct relationship between the director and members of senior management of a nature that would impair the director's ability to make independent judgments regarding executive compensation at the company.  Affiliate status due to stock ownership is not an automatic bar on membership on the compensation committee.

The NASDAQ standards now require all listed companies to have a standing compensation committee with at least two members, a significant change from previous rules, as NASDAQ formerly allowed compensation decisions to be made by the independent directors of a public company.  In addition, the new standards prohibit a compensation committee member from accepting directly or indirectly ANY consulting, advisory or other fees from the company, other than director fees and fixed-fee payments under a retirement plan.  This is also a significant deviation from previous NASDAQ rules, where directors serving on compensation committees could still qualify as "independent" even if they accepted up to $120,000 of consulting or other advisory fees.  Although affiliate status due to stock ownership is not an automatic bar on compensation committee membership, issuers must consider whether such affiliate status would impair the director's judgment as a member of the compensation committee.

Rules on Compensation Advisers
The new NYSE and NASDAQ listing standards both impose the following requirements on their compensation committees: 

  • The compensation committee must have sole discretion in retaining compensation advisers.
  • The compensation committee must be directly responsible for the appointment, compensation, and oversight of compensation advisers.
  • The issuer must provide funding for the reasonable compensation of compensation advisers.
  • In considering a compensation adviser, consultant or counsel, the compensation committee must take into account the following six criteria for independence:
          1.  The adviser’s or the adviser’s firm’s provision of other services to the company. 
  2.  Any business or personal relationships between the compensation adviser and members of the compensation committee.
  3.  Any business or personal relationships between the company’s executive officers and the compensation adviser or the compensation adviser’s firm.
  4.  The compensation adviser’s ownership of issuer’s stock.
  5.  The amount of fees received from the company by the compensation adviser’s firm, as a proportion of the firm’s revenue.
  6.  Conflict of interest policies and procedures of the compensation adviser’s firm.

Listed companies must ensure that these powers and provisions are incorporated into compensation committee charters.  Although compensation committees are required to evaluate the independence of their compensation consultants, neither the NYSE nor the NASDAQ prohibits a compensation committee from retaining an adviser ultimately determined not to be independent.  Furthermore, both the NYSE and NASDAQ specify that compensation committees are not required to undertake an "independence" analysis for consultants, counsel or other advisers whose role is limited to (i) advising on broad-based employee benefit plans that do not discriminate in scope, terms or operation in favor of executive officers, or (ii) providing advice that either is not customized for a particular issuer or that is customized based on parameters that are not developed by the adviser and about which the adviser does not provide advice.

Exemptions.  The new standards will not apply to companies that are already exempt from compensation committee requirements, such as passive business organizations and issuers whose only listed equity is preferred stock.  The compensation committee member independence requirements will not apply to limited partnerships, companies in bankruptcy, registered open-end management investment companies, foreign private issuers who meet certain disclosure requirements, and smaller reporting companies.  The new compensation committee standards and compensation adviser standards will not apply to controlled companies, certain issuers of securities future products, or registered clearing agencies that issue standardized options.

Timing.  All listed companies on the NYSE and the NASDAQ must comply with the compensation committee adviser requirements by July 1, 2013.  NYSE- and NASDAQ-listed companies will be required to comply with the new listing standards on committee member independence by the earlier of the company's first annual meeting after January 15, 2014, or October 31, 2014.  In addition, public companies will have to certify compliance with the new compensation committee rules to their respective exchanges.

Next Steps.  Companies should work with their in-house and external counsel to ensure compliance with the new compensation committee rules in the requisite timeframes.  In many cases, companies will have to amend their compensation committee charters and engage in an independence analysis for both advisers and members of the compensation committee.


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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