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SEC Directs National Exchanges to Adopt Listing Standards for Compensation Committees and Compensation Advisers and Updates Compensation Consultant Disclosure Requirements
06/28/2012
Bruce Newsome, Casey S. Cohn

As required under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), on June 20, 2012, the U.S. Securities and Exchange Commission (SEC) approved a rule that directs national securities exchanges to adopt listing standards for public company boards of directors and compensation advisers. See Release Nos. 33-9330 and 34-67220.

The new rule relates to the independence of compensation committee members, a compensation committee’s authority to retain compensation advisers, the committee’s consideration of the independence of any such advisers and the committee’s responsibility for the appointment, compensation and oversight of the work of any compensation adviser.

The SEC also adopted an amendment to the proxy disclosure rules related to disclosure of compensation consultant conflicts of interest. Under the new amendment, with respect to any compensation consultant that has played a role in determining or recommending the amount or form of executive and director compensation and whose work has raised any conflict of interest, companies will be required to disclose the nature of the conflict and how the conflict is being addressed.

Effective Dates

The new rule and amendment will take effect on July 27, 2012. The exchanges have until October 25, 2012 to propose the required listing standards, which must be approved by the SEC by July 27, 2013. However, issuers will be required to comply with the amendment to the proxy disclosure rules regarding compensation consultant conflicts of interest for any annual meeting (or special meeting in lieu of the annual meeting) at which directors will be elected occurring on or after January 1, 2013.

Background

Congress passed Dodd-Frank in 2010. Section 952 of Dodd-Frank requires the SEC to direct the exchanges to adopt certain “listing standards” relating to the independence of compensation committee members, a compensation committee’s authority to retain compensation advisers, and the committee’s responsibility for the appointment, compensation and work of any compensation adviser. These requirements are set forth in Section 10C of the Securities Exchange Act of 1934, as amended (Exchange Act).

In addition, the provision requires each company to disclose in its proxy material for an annual meeting of shareholders whether its compensation committee retained or obtained the advice of a compensation consultant, whether the work of the compensation consultant has raised any conflict of interest and, if so, the nature of the conflict and how the conflict is being addressed.

Independence of Compensation Committee Members

The SEC has adopted Rule 10C-1 under the Exchange Act, which requires the exchanges to adopt listing standards that require each member of a company’s compensation committee to be a member of the board of directors and to be independent. If a company does not have a compensation committee, the rule will apply to each director who oversees executive compensation matters on behalf of the board of directors. In developing a definition of independence, the exchanges are required to consider relevant factors, including, but not limited to:

  • the director’s source of compensation, including any consulting, advisory or other compensatory fee paid by the company; and
  • whether the director is affiliated with the company, a subsidiary of the company, or an affiliate of a subsidiary of the company.

Authority and Funding of the Compensation Committee

Rule 10C-1 also requires the exchanges to adopt listing standards providing that the compensation committee of a listed company (or the directors who oversee executive compensation matters on behalf of the board of directors in the case of a company that does not have a compensation committee):

  • may, in its sole discretion, retain or obtain the advice of a compensation adviser;
  • is directly responsible for the appointment, compensation and oversight of the work of any compensation advisers retained by it; and
  • must receive appropriate funding for the payment of reasonable compensation, as determined by the compensation committee, to any compensation advisers it retains.

The final rule does not require a compensation committee to be directly responsible for the appointment, compensation or oversight of compensation advisers that are not retained by the compensation committee, such as compensation consultants or legal counsel retained by management.

Compensation Adviser Selection

Rule 10C-1 also requires the exchanges to adopt listing standards providing that a compensation committee may select a compensation consultant, legal counsel or other adviser, other than in-house legal counsel, only after considering the following six independence factors:

  • the provision of other services to the issuer by the person (i.e., the company or firm) that employs the compensation consultant, legal counsel, or other adviser;
  • the amount of fees received from the issuer by the person that employs the compensation consultant, legal counsel, or other adviser, as a percentage of the total revenue of the person that employs the compensation consultant, legal counsel, or other adviser;
  • the policies and procedures of the person that employs the compensation consultant, legal counsel, or other adviser that are designed to prevent conflicts of interest;
  • any business or personal relationship of the compensation consultant, legal counsel, or other adviser with a member of the compensation committee;
  • any stock of the issuer owned by the compensation consultant, legal counsel, or other adviser; and
  • any business or personal relationships between the executive officers of the issuer and the compensation adviser or the person employing the compensation adviser.

It should be noted that the rule does not actually require compensation consultants to be independent, it simply requires that the compensation committee consider the enumerated independence factors in determining to retain the adviser. As described under “Compensation Consultant Conflicts of Interest Disclosure” below, disclosure regarding the conflict will be required in the company’s proxy statement.

Exemptions

Limited partnerships, companies in bankruptcy proceedings, registered open-end management investment companies, foreign private issuers that provide annual disclosures to shareholders of the reasons why the foreign private issuer does not have an independent compensation committee, controlled companies and smaller reporting companies are all exempt from the requirements described above.

Compensation Consultant Conflicts of Interest Disclosure

Exchange Act registrants subject to the federal proxy rules are already required by Item 407(e)(3)(iii) of Regulation S-K to disclose information about their use of compensation consultants, including specific information about fees paid to consultants. The SEC has adopted an amendment to Item 403(e)(3) of Regulation S-K. The amendment requires that, with respect to any compensation consultant that has played a role in determining or recommending the amount or form of executive and director compensation and whose work has raised a conflict of interest, companies will be required to disclose the nature of the conflict and how the conflict is being addressed. The disclosure will be required in any proxy or information statement for an annual meeting (or special meeting in lieu of an annual meeting) at which directors are to be elected. The disclosure will be required of all issuers subject to the proxy rules, including controlled companies, non-listed issuers and smaller reporting companies. The amendments include an instruction to Item 407(e)(3) noting that, in deciding whether there is a conflict of interest that may need to be disclosed, issuers should, at a minimum, consider the six factors the compensation committee is now required to consider in selecting the compensation consultant (described under “Compensation Adviser Selection” above).

Actions to Consider

  • Although the final compensation committee independence rules will not be established until the national securities exchanges propose, and the SEC approves, final listing standards, companies may want to consider the future application of these rules in appointing new compensation committee members so as to avoid the necessity of replacing such members when the new rules come out. Companies may also want to consider whether their 2013 D&O questionnaires elicit sufficient information from potential compensation committee members or independent directors regarding the factors described under “Independence of Compensation Committee Members” above.
  • If they do not already contain such provisions, companies should consider amending their compensation committee charters to set forth the committee’s authority and discretion with respect to the retention of compensation advisers, responsibility for the appointment, compensation and oversight of such advisers, and access to funding for such advisers, as described under “Authority and Funding of the Compensation Committee” above.
  • Companies may want to include a provision in their 2013 D&O questionnaires asking compensation committee members or independent directors and executive officers whether they have any business or personal relationship with any compensation consultant of the company or the compensation committee.
  • In retaining compensation consultants going forward, companies should anticipate the need to provide disclosure regarding compensation consultant conflicts of interest beginning in their 2013 proxy statements. Although the new rules do not prohibit companies from obtaining advice from compensation advisers who are not independent, companies should be cognizant of the disclosure they will be required to make regarding conflicts of interest. In particular, companies should consider the six independence factors described under “Compensation Adviser Selection” above in selecting advisers.
  • Compensation Committees may want to create a questionnaire for compensation consultants to complete including, at a minimum, the six independence factors described under “Compensation Adviser Selection” above.

If you have any questions about this topic, please contact a member of our Capital Markets and Securities Practice Group.