Nasdaq Proposes Listing Standards for Compensation Committees and Compensation Advisors

News Brief

By Cydney Posner

Nasdaq has also filed its proposed new listing standards for compensation committees and compensation advisors.  These proposed rules would become effective upon approval. As discussed below, proposed Rule 5605(d)(3), which requires compensation committees to have the specific responsibilities and authority, would be effective immediately. Otherwise, companies would need to comply with the remaining provisions of the amended listing rules by the earlier of (1) their second annual meeting held after the date of approval of this proposal or (2) December 31, 2014.

SEC Rule 10C-1 directs the exchanges to adopt listing standards for public company boards of directors and compensation advisers that address the following:

  • The independence of the members on a compensation committee;
  • The committee's authority to retain compensation advisers;
  • The committee's consideration of the independence of any compensation advisers; and
  • The committee's responsibility for the appointment, compensation and oversight of the work of any compensation adviser.

Requirement to Actually Have a Compensation Committee

In a major change (which will have almost no impact and affect only 25 companies), Nasdaq is finally conceding the need to require that listed companies have compensation committees. Currently, Nasdaq permits executive compensation to be determined either by an independent committee or by a majority of independent directors in a vote in which only independent directors participate. Although neither Dodd-Frank nor the SEC required this change, Nasdaq considered dedicated compensation committees to be especially important in light of "the heightened importance of compensation decisions in today's corporate governance environment." Nasdaq proposes to require that the compensation committee consist of at least two directors.

Compensation Committee Composition

Under the SEC rules, exchange listing standards must require that each member of a compensation committee be independent. The exchanges' definitions of independence must be developed after taking into account relevant factors, including, but not limited to, the following, which are similar to the special factors mandated for audit committee independence:

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

Unlike the requirements for audit committee independence, the compensation committee rules adopted by the SEC did not mandate that failure to satisfy them would necessarily disqualify a member. As a result, one big looming question had been whether the exchanges would adopt any absolute prohibitions or numerical tests. The answer from Nasdaq is, in part, "yes."

General Independence Definition

Nasdaq requires that the committee be composed solely of independent directors. Like the NYSE, Nasdaq has a two-part test for independence: in addition to a number of bright-line tests, the board must make an affirmative determination that the director has no relationship that, in the opinion of the board, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. There are no changes proposed to this standard. To comply with Rule 10C-1, Nasdaq has proposed two additional eligibility requirements regarding compensatory fees and affiliate status.

Additional Eligibility Requirement -- Compensatory Fees

Currently, Nasdaq rules would permit directors who receive from the listed company compensatory fees below the enumerated bright line thresholds to serve on the company's compensation committee. In contrast to the NYSE, however, Nasdaq concluded that "there is no compelling justification to have different independence standards for audit and compensation committee members with respect to the acceptance of compensatory fees." Accordingly, Nasdaq's proposal prohibits a compensation committee member from accepting directly or indirectly any consulting, advisory or other compensatory fee from an issuer or any subsidiary (except for board or committee service or as deferred comp for prior service under a retirement plan). There is no look-back period proposed, so that the prohibition would begin with the director's term of service on the committee.

Additional Eligibility Requirement -- Affiliation

Currently, Nasdaq's definition of independence does not expressly refer to affiliation, although the definition does exclude certain individuals who may be considered affiliates. In contrast to its conclusion with respect to compensatory fees, Nasdaq concluded that there was "no compelling policy justification for precluding all affiliates, such as owners of a Company, even those with very large stakes" from serving as compensation committee members. Accordingly, the blanket prohibition that applies to affiliates' serving on audit committees is not proposed to apply to compensation committee members, and a board "may conclude that it is appropriate for a director who is an affiliate to serve on the compensation committee." Like the NYSE, Nasdaq believes that interests of some affiliates, such as representatives of significant stockholders, are likely aligned with those of other stockholders in seeking appropriate executive compensation programs. Although no bright-line standard is imposed, companies must still consider affiliation in making eligibility determinations for compensation committee members. In making this eligibility determination, the board must specifically consider whether the director is affiliated with the company, a subsidiary of the company or an affiliate of a subsidiary of the company "to determine whether the affiliation would impair the director's judgment as a member of the compensation committee." Again, there is no "look-back" period, and, as a result, the board need only consider affiliation with respect to relationships that occur during the director's service as a compensation committee member.

Exceptional and Limited Circumstances Exception

Nasdaq proposes to retain its existing exception that allows a non-independent director to serve on the compensation committee under exceptional and limited circumstances. This exception would be available for a director who fails the new independence/ eligibility requirements. Under this exception, if a compensation committee consists of at least three members, one director who is not independent/eligible and meets certain other tests may serve on the compensation committee for up to two years if the board, under exceptional and limited circumstances, determines that the director's service on the committee is required by the best interests of the company and its stockholders. Disclosure is required.

Cure Period

SEC rules require the exchanges to establish procedures giving companies a reasonable opportunity to cure any defects that would be the basis for delisting for non-compliance with the new listing standards and allow the exchanges to provide that, if a member of a compensation committee ceases to be independent for reasons outside the member's reasonable control, that person, with notice by the company to the applicable exchange, may remain a compensation committee member until the earlier of the next annual meeting or one year from the occurrence of the event that caused the member to no longer be independent. As proposed by Nasdaq, if a company fails to comply because it has one vacancy on the compensation committee, or one committee member ceases to be independent due to circumstances beyond the member's reasonable control, the company has a cure period until the earlier of the next annual shareholders meeting or one year from the occurrence of the event that caused the noncompliance. However, if the annual shareholders meeting occurs no later than 180 days following the event that caused the noncompliance, the company will have instead 180 days from the event to regain compliance, thus providing least 180 days to cure noncompliance. Immediate notice to Nasdaq is required. (Note that the reference in the proposed rules is just to "independence," and it‘s not clear at this time whether Nasdaq intended to include by the other eligibility requirements as part of the reference.)

Compensation Committee Charter

Under the proposal, each company would be required to certify that it has adopted a formal written compensation committee charter and that the compensation committee will review and reassess the adequacy of the formal written charter annually. The charter must specify the following:

  • the scope of the compensation committee's responsibilities, and how it carries out those responsibilities, including structure, processes and membership requirements;
  • the compensation committee's responsibility for determining, or recommending to the board for determination, the compensation of the CEO and all other executive officers;
  • that the CEO may not be present during voting or deliberations by the compensation committee on his or her compensation; and
  • the specific compensation committee responsibilities and authority set forth in proposed Nasdaq Listing Rule 5605(d)(3) (related to authority to engage consultants and counsel, funding of advisers and requirement to consider the independence of consultants and counsel).

Independence of Consultants and Counsel

SEC Rule 10C-1 provides that compensation committees are not required to select consultants, counsel or other advisers that are "independent," but instead, in making their selections, compensation committees must take into account the following six factors, which bear upon independence:

  • the provision of other services to the company by the employer of the compensation consultant, counsel or other adviser (referred to as the "advisory firm," as distinguished from the individual adviser);
  • the amount of fees received from the company by the advisory firm, as a percentage of the advisory firm's total revenue;
  • the advisory firm's policies and procedures that are designed to prevent conflicts of interest;
  • any business or personal relationship of the compensation consultant, counsel or other adviser with a member of the compensation committee;
  • any stock of the company owned by the compensation consultant, counsel or other adviser; and
  • any business or personal relationship between an executive officer of the company and the compensation consultant, counsel, other adviser or the advisory firm.

Nasdaq concluded that these six independence factors were adequate and did not propose any additional factors. Nasdaq also emphasized that a "compensation committee is not required to retain an independent compensation adviser; rather, a compensation committee is required only to conduct the independence analysis described in Rule 10C-1 before selecting a compensation adviser."


SEC rules provide an exemption from the listing standard requirements for smaller reporting companies and controlled companies (defined as companies in which more than 50% of voting power in the election of directors is held by an individual, a group or another company). In addition, SEC rules exempt from the compensation committee member independence listing standards limited partnerships, companies in bankruptcy, registered open-end management investment companies and foreign private issuers that disclose annually the reasons that they do not have independent compensation committees. Nasdaq's current listing rules include exemptions for asset-backed issuers and other passive issuers, cooperatives, limited partnerships, management investment companies and controlled companies; Nasdaq proposes that these existing exemptions from the compensation-related listing rules remain generally unchanged. Nasdaq also proposes that foreign private issuers continue to be allowed to follow their home country practices in lieu of Nasdaq's revised listing rules relating to compensation committees if they provide the required disclosure.

Smaller Reporting Companies

Although Nasdaq proposes to require smaller reporting companies to have a compensation committee composed of at least two independent directors, independence would be defined under Nasdaq's existing listing rules, and smaller reporting companies would not need to adhere to the new requirements relating to compensatory fees and affiliation. Similarly, smaller reporting companies would be required to adopt a formal written compensation committee charter or board resolution that includes the same content as other companies; however, they would not need to incorporate into their charters or board resolutions the language in Rule 10C-1 regarding authority to retain and fund compensation consultants and counsel and responsibility to consider the independence of advisers and counsel, nor would they be to review and reassess the adequacy of the charter or board resolutions annually.

Phase-In Schedules

Nasdaq also does not propose to modify its existing listing rules for phase-in schedules (generally, permitting a gradual step-by-step transition to a completely independent committee within one year of listing) for companies listing in connection with an IPO, companies emerging from bankruptcy and companies ceasing to be controlled companies. Nasdaq proposes to clarify that these schedules allow phase-in compliance with the minimum size and independent committee requirement and the additional eligibility requirements adopted pursuant to Rule 10C-1. Nasdaq also proposes to apply the same phase-in schedule to companies ceasing to be smaller reporting companies that applies to a company listing in connection with an IPO. The phase in would apply to the additional eligibility requirements relating to compensatory fees and affiliation, but not to the committee size or "solely independent" requirement. This phase-in schedule would start on the due date of the SEC filing in which the company is required to report that it is not a smaller reporting company. No change to the phase in is proposed for companies transferring from other markets. None of these phase-in schedules applies to the requirement to adopt a formal written compensation committee charter that meets the specified requirements.

Effective Dates/Transition

Under the Nasdaq proposal, Rule 5605(d)(3), relating to the authority to retain and fund compensation consultants and counsel and responsibility to consider independence factors before selecting advisers, would be effective immediately. (For the 25 companies that do not have compensation committees, the provisions apply to the independent directors who determine compensation.) Depending on state law, companies could impose these responsibilities and grant this authority through a charter, resolution or other board action. Ultimately, however, this authority must be included in the company's committee charter in accordance with the transition rules applicable to the remaining new provisions. Nasdaq proposes that companies must comply with the remaining provisions of the amended listing rules by the earlier of (1) their second annual meeting held after the date of approval of Nasdaq's amended listing rules or (2) December 31, 2014. Companies will be required to certify to Nasdaq, within 30 days after the applicable implementation deadline, that they have complied with the amended listing rules on compensation committees. Graciously, Nasdaq will provide the form of certification.

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