Listing Standards for Compensation Committees and Compensation Advisers

Background

In 2010, Congress passed the Dodd-Frank Act. Section 952 of the Act addresses the issue of executive compensation by focusing on the compensation committees formed by corporate boards as well as the compensation advisers that these committees retain.

Section 952 requires the SEC to direct the exchanges to adopt certain “listing standards” relating to the independence of the members on a compensation committee, the committee’s authority to retain compensation advisers, and the committee’s responsibility for the appointment, compensation and work of any compensation adviser. Once an exchange’s new listing standards are in effect, a listed company must meet these standards in order for its shares to continue trading on that exchange.

In addition, the provision requires each company to disclose in its proxy material for an annual meeting of shareholders whether its board’s compensation committee retained or obtained the advice of a compensation consultant. The provision also requires a company to disclose 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.

Requirements of the Rules

Independence of Compensation Committee Members

Under new Rule 10C-1, the exchanges are required 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. In developing a definition of independence, the exchanges will be required to consider relevant factors, including, but not limited to:

• The source of compensation of a member of the board of directors, including any consulting, advisory or other compensatory fee paid by the company to such director, and
   
• Whether a member of the board of directors of a company 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 requires the exchanges to adopt listing standards providing that the compensation committee of a listed company:

• May, in its sole discretion, retain or obtain the advice of a compensation adviser
   
• Is directly responsible for the appointment, compensation and oversight of compensation advisers, and
   
• Must be appropriately funded by the listed company.

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:

• Whether the compensation consulting company employing the compensation adviser is providing any other services to the company
   
• How much the compensation consulting company who employs the compensation adviser has received in fees from the company, as a percentage of that person’s total revenue
   
• What policies and procedures have been adopted by the compensation consulting company employing the compensation adviser to prevent conflicts of interest
   
• Whether the compensation adviser has any business or personal relationship with a member of the compensation committee
   
• Whether the compensation adviser owns any stock of the company, and
   
• Whether the compensation adviser or the person employing the adviser has any business or personal relationship with an executive officer of the issuer.

The exchanges themselves may impose additional factors.

Oversight by Board Members Outside of a Committee

These listing standards, with limited exceptions, will also apply to members of a listed company’s board of directors who, in the absence of a board committee, oversee executive compensation matters on behalf of the board of directors.

Exemptions

Rule 10C-1 requires the exchanges to exempt the following four categories of companies from the compensation committee independence requirements:

• Limited partnerships
   
• Companies in bankruptcy proceedings
   
• Open-end management investment companies registered under the Investment Company Act of 1940
   
• Any foreign private issuer that discloses in its annual report the reasons that the foreign private issuer does not have an independent compensation committee.

Rule 10C-1 authorizes the exchanges to exempt a particular relationship from the independence requirements applicable to compensation committee members.

Rule 10C-1 also exempts controlled companies and smaller reporting companies from all of the requirements of the new compensation committee listing standards and authorizes the exchanges to exempt other categories of issuers. As with all listing standards, the exchanges would need to seek the approval of the SEC before adopting any exemptions.

Compensation Consultant Conflicts of Interest Disclosure

Exchange Act registrants subject to the federal proxy rules already are required to disclose information about their use of compensation consultants, including specific information about fees paid to consultants. Under the new amendments to the proxy disclosure rules, 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.