SEC Adopts Compensation Committees and Compensation Adviser Rules
June 29, 2012
On June 20, 2012, the Securities and Exchange Commission implemented Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act by approving new rules that:
- Require all national securities exchanges to adopt listing standards addressing:
- The required independence of compensation committee members;
- The authority of compensation committees to retain, oversee, and pay compensation consultants, independent legal counsel, or other advisers; and
- The compensation committee’s obligation to consider the independence of any compensation consultant, legal counsel, or adviser; and
- Require proxy statement disclosure regarding any conflicts of interest raised by the work of any compensation consultant.
Listing Standards. New Exchange Act Rule 10C-1 instructs each national securities exchange to establish listing standards for compensation committees of issuers listing a class of equity securities on that exchange. New Rule 10C-1 requires the following with regard to the new listing standards to be adopted by the national securities exchanges:
- No Requirement for a Formal Board Committee. Under Rule 10C-1, national securities exchanges need not require that a listed issuer have a compensation committee or other functionally-equivalent committee. Rather, for most purposes, Rule 10C-1 defines a “compensation committee” broadly to include both committees that oversee executive compensation (whether or not so designated) and members of a listed issuer’s board of directors who oversee executive compensation on behalf of the board of directors (including in the absence of a formal committee).
It is important to note, however, that only formal board committees are covered by the provisions regarding the authority to hire compensation advisers and the obligation of the listed issuer to provide funding for compensation of those advisers.
- Independence. Each member of a listed issuer’s compensation committee must be a member of the board of directors of that issuer and otherwise independent. Rule 10C-1(b)(1) does not define independence; instead, it requires the exchanges to consider several factors in developing independence standards, including:
- The source of compensation of a member of the board of directors of an issuer, including any consulting, advisory, or other compensatory fee paid by the issuer; and
- Whether a director is affiliated with the issuer, a subsidiary of the issuer, or an affiliate of a subsidiary of the issuer
Unlike the independence standard for rules governing audit committee members, Rule 10C-1 gives greater flexibility to the exchanges to establish their own criteria for independence after taking into consideration the rule’s factors. There is no requirement that exchanges establish a uniform standard of independence.
- Compensation Consultants and Advisers. Rules 10C-1(b)(2) and (3) instruct each national securities exchange to create listing standards requiring that a listed issuer’s compensation committee have the authority to retain a compensation consultant, independent legal counsel, or other adviser. In this regard, the exchange’s rules must provide that:
- The compensation committee may, in its sole discretion, retain or obtain the advice of a compensation consultant, independent legal counsel, or other adviser;
- The compensation committee shall be directly responsible for the appointment, compensation and oversight of the work of any compensation consultant, independent legal counsel, or other adviser retained by the compensation committee; and
- Each listed issuer must provide for appropriate funding for payment of reasonable compensation, as determined by the compensation committee, to any compensation adviser retained by the compensation committee.
While there is no requirement that a compensation adviser be independent, Rule 10C-1(b)(4) directs the exchanges to establish listing standards requiring a listed issuer’s compensation committee to consider several factors regarding a compensation adviser’s independence prior to selecting an adviser, including:
- The provision of other services to the listed issuer by the person that employs the compensation adviser;
- The amount of fees received from the listed issuer by the person that employs the compensation adviser, as a percentage of the employer’s total revenue;
- The policies and procedures of the person that employs the compensation adviser that are designed to prevent conflicts of interest;
- Any business or personal relationship of the compensation adviser with a member of the compensation committee;
- Any stock of the listed issuer owned by the compensation adviser; and
- Any business or personal relationship between the executive officers of the issuer and the compensation adviser or the person employing the adviser.
Compensation committees need not, however, consider these six factors before consulting with or obtaining advice from in-house counsel. Further, listed issuers are not required to describe the process by which the compensation committee selects compensation advisers in their proxy statement disclosures.
- Opportunity to Cure Defects. The compensation committee listing standards adopted under Rule 10C-1 are required to provide listed issuers with the opportunity to cure any defects in compliance with those listing standards before the exchange may take any action to prohibit the continued listing of their equity securities. In this regard, Rule 10C-1 states that, where a board member ceases to comply with the independence standards for reasons outside of the control of the board member, this “cure period” may continue until the earlier of the next annual meeting of shareholders or one year after the occurrence of the event that caused the board member to be no longer independent.
- Exemptions. Rule 10C-1 establishes the following exemptions:
- General Exemptions. The following two categories of companies are exempt from all of the requirements of Rule 10C-1:
- Controlled companies, defined as listed companies in which more than 50% of the voting power for the election of directors is held by an individual, a group, or another company; and
- Smaller reporting companies, as defined in Exchange Act Rule 12b-2.
- Limited Exemptions. The following four categories of companies are exempt from the compensation committee independence requirements of Rule 10C-1:
- Limited partnerships;
- Companies in bankruptcy proceedings;
- Registered open-end management investment companies; and
- Foreign private issuers that provide annual disclosures to shareholders as to why they do not have an independent compensation committee.
- Issuer Exemptions. The national securities exchanges are provided with authority to exempt any category of issuer from the requirements of Rule 10C-1, taking into consideration the potential impact of the requirements on smaller reporting companies.
- Relationship Exemptions. The national securities exchanges are provided with authority to exempt particular relationships from the independence requirements applicable to compensation committee members, taking into consideration the size of the issuer and any other relevant factors.
Compensation Consultant Conflicts of Interest Disclosure. Item 407 of Regulation S-K currently requires companies subject to the proxy rules to provide disclosure concerning their compensation committees, the use of compensation consultants, and fees paid to compensation consultants. As revised, Item 407(e)(3) now also requires companies who have used the advice of a compensation consultant during the company’s last completed fiscal year to disclose:
- The compensation consultant’s assignment;
- Any conflicts of interest raised by the compensation consultant’s work; and
- If any conflicts of interest were present, how such conflicts were addressed.
- Rule 10C-1. Rule 10C-1 will take effect 30 days after publication in the Federal Register.
- Exchange Rules. The exchanges must submit proposed independence rules to the Commission for review and approval no later than 90 days after publication of Rule 10C-1 in the Federal Register. The exchanges must have rules approved by the Commission within one year after publication of Rule 10C-1 in the Federal Register.
- Revised Item 407(e)(3). Compliance with revised Item 407(e)(3) is required for any proxy or information statement for an annual meeting of shareholder at which directors will be elected occurring on or after January 1, 2013.
 As discussed above, only formal board committees that oversee executive compensation are covered by the requirements relating to the authority to retain compensation advisers and the requirements to fund the payment of these advisers.