SEC Approves New Stock Exchange Listing Standards Concerning Compensation Committee Composition and Authority – Initial Compliance Deadline July 1, 2013

On January 11, 2013, the U.S. Securities and Exchange Commission (“SEC”) approved rule changes proposed by the NYSE[1], NYSE MKT[2]  and NASDAQ[3] establishing listing standards designed to promote the independence of compensation committee members and their consultants and advisers.  The new listing standards are required by Rule 10C-1 under the Securities Exchange Act of 1934, which was adopted pursuant to Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, as described in our Legal Alert dated July 3, 2012. 

Highlights of the new listing standards applicable to NYSE MKT and NASDAQ-listed issuers are summarized below.

NYSE MKT Listing Standards

Independence of Compensation Committee Members

NYSE MKT listing standards require that the compensation of the CEO and other executive officers be determined, or recommend to the full Board for determination, either by a compensation committee comprised solely of independent directors or by a majority of the independent directors.  The full Board must make an affirmative determination of each such director’s “independence” in accordance with the NYSE MKT Company Guide.  (In this Legal Alert, the term “compensation committee”, for an NYSE MKT-listed company, refers to either a separate standing compensation committee or, if none, to a majority of the independent directors.) 

The new NYSE MKT listing standards require that compensation committee member independence be determined by reference to both the existing director independence criteria set forth in Section 803(A)(2) of the Company Guide, as well as the new, heightened independence standards applicable to compensation committee members set forth in Section 805(c)(1).  For an issuer without a compensation committee, the Board would be required to determine that all independent directors meet the heightened independence criteria. 

The Board must consider all factors specifically relevant to determining whether a director has a relationship to the 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:

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

The NYSE MKT does not require that the Board consider any specific factors and did not establish any specific numerical or materiality tests with respect to the above factors.  The NYSE MKT noted that its existing “bright-line” independence tests for Board members are likely broad enough to cover the types of relationships which would generally be material to a director’s independence for purposes of compensation committee service.

Noting that stock ownership in the company likely aligns a director’s interests with those of unaffiliated stockholders on the issue of executive compensation, the NYSE MKT did not prohibit a determination of independence solely based on a significant stock ownership in the company by a director or his or her affiliate.   

Limited Exception and Cure Period

The NYSE MKT limited the current exception allowing one non-independent director to serve on the compensation committee under exceptional and limited circumstances, by making it applicable only to smaller reporting companies.  A company relying on this exception must make certain required disclosures regarding its reasons for doing so.  The new rules also provide a limited cure period where a compensation committee member ceases to be independent for reasons outside his or her reasonable control.  A company must promptly notify the NYSE MKT of its reliance on this provision.

Compensation Advisers

Under the new rules:

• the compensation committee must have the authority, in its sole discretion, to retain or obtain the advice of a compensation consultant, independent counsel or other adviser (collectively, “compensation advisers”);
• the compensation committee must be directly responsible for the appointment, compensation and oversight of the work of any compensation adviser retained by the committee; and
• the company must provide appropriate funding, as determined by the compensation committee, to pay a reasonable compensation to any compensation adviser retained by the committee.

Before selecting or receiving advice from a compensation adviser, other than in-house legal counsel or advisers whose role is limited to consulting on certain broad based plans or providing non-customized data for which no disclosure would be required under Regulation S-K Item 407(e)(3)(iii), the compensation committee must consider all factors relevant to that compensation adviser’s independence, including the six factors set forth in SEC Rule 10C-1.

The new NYSE MKT listing standards do not contain any additional factors or bright-line standards.  After conducting the requisite independence assessment, the compensation committee may retain any compensation advisers of its choosing, even those that are not independent.  The SEC has indicated that it expects compensation committees to conduct this independence assessment at least annually.

The new rules do not require a compensation committee to follow the advice of compensation advisers or otherwise affect the committee’s ability to exercise its independent judgment.

Exemptions

Certain classes of issuers, such as controlled companies, limited partnerships, companies in bankruptcy, asset-backed issuers, registered investment companies and companies listing only preferred or debt securities, are exempted from the new listing standards. 

Smaller reporting companies are exempt from the new listing standards pertaining to the independence of compensation committee members and advisers.  However, a smaller reporting company will be subject to the standards relating to the compensation committee’s authority and responsibility with respect to compensation advisers, and the listed company’s obligation to provide funding to compensate those advisers.  A company that ceases to be a smaller reporting company would have six months to comply with the new standards regarding compensation committee member independence and consideration of compensation adviser independence.

Compliance Deadlines

NYSE MKT-listed companies will have until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014, to comply with the new listing standards relating to compensation committee member independence.  All other requirements of the new rules will take effect beginning July 1, 2013. 

NASDAQ Listing Standards

Requirement to Have Committee; Independence of Compensation Committee Members

Previously, NASDAQ permitted listed companies to have executive compensation determined, or recommended to the full Board for determination, either by a compensation committee composed solely of independent directors or by a majority of the independent directors.  The new listing standards require that all listed companies, including smaller reporting companies, have a standing compensation committee comprised of at least two members, each of whom must be “independent” (as defined in Rule 5605(a)(2)) and must meet the new, enhanced independence criteria described below. 

The NASDAQ listing standards prohibit a compensation committee member from accepting, directly or indirectly, any consulting, advisory or other compensatory fee from the company or any of its subsidiaries.  This is the same standard that NASDAQ applies to members of a listed company’s audit committee.  “Compensatory fees” would not include fees received for board or committee service, or the receipt of fixed amounts under a retirement plan, including deferred compensation, for prior service with the company (as long as the compensation is not in any way contingent on continued service).

In addition, the Board must consider whether a compensation committee member is “affiliated” with the company, a subsidiary, or an affiliate of a subsidiary, to determine whether any such affiliation would impair the member’s independent judgment.  The rules do not impose a bright-line prohibition on affiliation – rather, the Board must consider any such affiliation when determining the member’s independence.  Ownership of a significant amount of the company’s stock would not, by itself, preclude a finding that the individual may serve on the compensation committee. 

NASDAQ did not establish any specific numerical or materiality standards with respect to these independence factors, and the new rules do not require a listed company to consider any other specific factors.   

Limited Exception and Cure Period

A listed company may, in certain cases, still rely on the existing exception that allows one non-independent director to serve on the compensation committee under exceptional and limited circumstances.  A company relying on this exception must make certain required disclosures regarding its reasons for doing so.  The new rules also provide a limited cure period for a listed company that fails to comply with the compensation committee composition requirements due to a vacancy or a member ceasing to be independent for reasons beyond his or her reasonable control. 

Compensation Committee Charter Requirements

Previously, NASDAQ did not require that listed companies have a formal written compensation committee charter.  Under the new rules, a listed company (other than a smaller reporting company, discussed below) must adopt a formal written compensation committee charter and must review and reassess the adequacy of the charter on an annual basis.  The charter must specify:

• the scope of the committee’s responsibilities and how it carries out those responsibilities, including structure, processes and membership requirements;
• the committee’s responsibility for determining, or recommending to the board for determination, the compensation of the company’s CEO and other executive officers;
• that the CEO may not be present during voting or deliberations by the committee on his or her compensation; and
• the committee’s responsibilities and authority set forth in Rule 10C-1 relating to:

o        retaining compensation advisers;

o        appointing, compensating, and overseeing compensation advisers;

o        considering the requisite independence factors before selecting compensation advisers; and

o        receiving funding from the company to engage compensation advisers.

Smaller reporting companies may adopt either a formal written charter or a board resolution addressing only the first three bullet points above.  Such companies need not address the fourth bullet point or certify that they will review and reassess the adequacy of the charter (or board resolution) on an annual basis. 

Compensation Adviser Independence Factors

Before selecting a compensation adviser, other than in-house legal counsel or advisers whose role is limited to consulting on certain broad based plans or providing non-customized data for which no disclosure would be required under Regulation S-K Item 407(e)(3)(iii), a listed company’s compensation committee must consider the six independence factors specified in Rule 10C-1. 

NASDAQ did not adopt any specific additional factors or bright-line standards relating to the factors listed in Rule 10C-1.  After considering these independence factors, the compensation committee may retain any compensation adviser of its choosing, even one that is not independent.  The SEC has indicated that it expects compensation committees to conduct this independence assessment at least annually.

The new rules do not require a compensation committee to follow the advice of compensation advisers or otherwise affect the committee’s ability to exercise its independent judgment.

Exemptions

Smaller reporting companies are subject to the new NASDAQ listing standards, including the requirement to have a formal compensation committee comprised of at least two independent directors.  However, for smaller reporting companies, this determination may be based on the existing independence criteria contained in NASDAQ Rule 5605(a)(2), rather than the new, heightened independence criteria.  In addition, such companies are subject to less stringent requirements regarding the adoption of a written compensation committee charter as discussed above. 

The new rules do not apply to certain classes of issuers that are exempt from NASDAQ’s existing compensation-related listing rules, including asset-backed issuers, cooperatives, limited partnerships, registered management investment companies and controlled companies.