The SEC issued final rules implementing the provisions of the Dodd-Frank Act relating to listing standards for compensation committees.
On June 20, 2012, the SEC issued a final rule and rule amendments to the proxy disclosure rules (Rules) to implement the provisions of Section 952 of the Dodd-Frank Act, which added Section 10C to the Securities Exchange Act of 1934. Section 10C requires the SEC to adopt rules directing the national securities exchanges (Exchanges) to prohibit listing the equity securities of any company not in compliance with the compensation committee and compensation adviser requirements of Section 10C. The Rules closely track the requirements of Section 952 of the Dodd-Frank Act and Section 10C of the Exchange Act.
Definition of Compensation Committee
The Rules define "compensation committee" as follows:
For all purposes other than the authority to retain compensation advisers and the requirements of the company to fund payment of those advisers, as any committee of the board that performs functions typically performed by a compensation committee, including oversight of executive compensation, whether or not formally designated as a compensation committee, as well as, those members of a listed company's board who oversee executive compensation matters on behalf of the board in the absence of a formal committee.
For purposes of retaining and funding, as a formally designated compensation committee or any other board committee that has oversight of executive compensation or other functions typically performed by a compensation committee.
The Rules do not require listed companies to have a compensation committee.
Independence
Under new Rule 10C-1, the Exchanges must set listing standards requiring each member of a listed company's compensation committee to be independent. This term must be defined by the Exchanges after considering relevant factors, which must include:
The source of the director's compensation, including any consulting, advisory or other compensatory fee paid by the company to that director.
Whether the director is affiliated with the company, a subsidiary of the company or an affiliate of a subsidiary of the company.
The Rules do not require that the Exchanges decide on a uniform definition of independence or that these factors be adopted in the final definition.
These independence requirements do not apply to:
Limited partnerships.
Foreign private issuers that disclose in their annual reports why they do not have an independent compensation committee.
Companies in bankruptcy.
Open-end management investment companies.
The Rules also permit the Exchanges to exempt particular relationships from the independence requirements, as each Exchange determines is appropriate, taking into consideration the size of the company and any other relevant factors.
Rule 10C-1 also exempts controlled companies (defined as companies listed on an Exchange in which more than 50% of the voting power for the election of directors is held by an individual, group or other company) and smaller reporting companies from compliance with all of the new compensation committee listing standards and authorizes the Exchanges to exempt other categories of issuers. However, as with all listing standards, the Exchanges must seek the approval of the SEC before adopting any exemptions.
Advisers
In addition to these independence requirements, the Rules also direct the Exchanges to prohibit listing the equity securities of any company not in compliance with the following requirements relating to compensation committees and compensation advisers:
The compensation committee (which for this purpose excludes those members of a listed company's board of directors who oversee executive compensation matters in the absence of a formal committee) must have the authority, in its sole discretion, to retain or obtain the advice of compensation consultants, independent legal counsel and other advisers (compensation advisers). However, the Rules do not affirmatively require the committee to engage compensation advisers.
Before selecting any compensation adviser, the compensation committee must take into consideration these six factors affecting the independence of compensation advisers, as well as any other factors identified by the relevant Exchange in its listing standards:
provision of other services to the company by the person that employs the compensation adviser;
amount of fees paid by the company to the person that employs the compensation adviser, as a percentage of that person's total revenue;
policies and procedures of the person that employs the compensation adviser regarding the prevention of conflicts of interest;
any business or personal relationship of the compensation adviser with any member of the committee;
ownership by the compensation adviser of the company's stock; and
any business or personal relationship between the compensation adviser or the person that employs the compensation adviser and any executive officer of the company.
However, the Rules do not prohibit the committee from engaging an adviser that is not independent. The committee can select any adviser they prefer after considering the six factors itemized above.
The compensation committee must be directly responsible for the appointment, compensation and oversight of the work of any compensation adviser.
Each listed company must provide appropriate funding for the payment of reasonable compensation, as determined by the compensation committee (which for this purpose excludes those members of a listed company's board of directors who oversee executive compensation matters in the absence of a formal committee), to any compensation advisers.
Once an Exchange's new listing standards are in effect, a listed company must meet the standards so its shares can continue to trade on that Exchange. However, the Rules require the Exchange to give listed companies reasonable opportunity to cure any noncompliance with these standards.
Compensation Consultant Disclosure
The Rules also amend Item 407 of Regulation S-K to require, in any proxy or information statement relating to an annual meeting of shareholders at which directors are to be elected (or a special meeting in lieu of the annual meeting), additional disclosure regarding compensation consultant conflicts. Rather than integrating the new disclosure requirements with the existing compensation consultant disclosure provisions, as set out in the proposed rules, the SEC is retaining the existing disclosure trigger and requirements of Item 407(e)(3)(iii) and adding a new subparagraph to Item 407(e)(3) to require the disclosures mandated by Section 10C(c)(2)(B).
Under amended Item 407(e)(3), companies must:
Identify any compensation consultants involved in executive and director compensation (other than roles limited to consulting on broad-based plans available generally to all salaried employees without discriminating in favor of executive officers or directors).
State whether these consultants were engaged by the compensation committee or any other person.
Describe the nature and scope of the assignment and material elements of any instructions given.
Disclose aggregate fees paid for advice or recommendations on the amount or form of executive or director compensation and for any additional services if consultants provided both types of services and fees for additional services exceeded $120,000.
Disclose whether the work of compensation consultants raised any conflict of interest and, if so, the nature of the conflict of interest and how it is being addressed.
Effective Date
The Rules will take effect July 27, 2012. Each Exchange that lists equity securities must propose listing standards that comply with the new Rules by September 25, 2012. The new listing standards must be approved by the SEC by June 27, 2013.
The amended compensation consultant disclosure must be included in company proxy materials for any stockholders' meeting at which directors will be elected, beginning with meetings held on or after January 1, 2013.