SEC Adopts New Rules Requiring Revised Listing Standards for Compensation Committees and Compensation Advisers

By Cydney Posner

The SEC has just adopted, without an open meeting, new rules for Compensation Committees and Compensation Advisers, as required by Dodd-Frank.  (To expedite, the summary below is derived primarily from the press release and will be supplemented as appropriate by additional information from the final rule release.)  Note that, in light of the fact that Nasdaq's current rules do not require a listed company to have a compensation committee, the 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.

The rule directs the national securities 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.

The SEC also amended the proxy rules to require new disclosures from companies about their use of compensation consultants and conflicts of interest.

The new rule and rule amendments will take effect 30 days after publication in the Federal Register. Exchanges will be required to propose compliant listing standards within 90 days after effectiveness and the standards must be approved by the SEC within one year after effectiveness of these rules.

Independence of Compensation Committee Members

Under new Rule 10C-1, listing standards must require that each member of a compensation committee be independent. The definition 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 a member of the board, including any consulting, advisory or other compensatory fee paid by the company to such director, and
• Whether a member of the board of a company is affiliated with the company, a subsidiary of the company or an affiliate of a subsidiary of the company

(Surprisingly, none of the factors relates to a director's relationship to management.)

Authority and Funding of the Compensation Committee

Rule 10C-1 requires that the compensation committee of a listed company be permitted, in its sole discretion, to retain or obtain the advice of a compensation adviser, must be directly responsible for the appointment, compensation and oversight of compensation advisers and must be appropriately funded by the listed company.

Compensation Adviser Selection

Compensation committees may select compensation consultant, legal counsel or other advisers, 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 that 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 may impose additional factors.

Exemptions

Controlled companies and smaller reporting companies will be exempt from all of the requirements of the new listing standards. The exchanges may also exempt other categories of issuers, subject to SEC approval. In addition, the following four categories of listed companies will be exempt 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; and
• Any foreign private issuer that discloses in its annual report the reasons that the foreign private issuer does not have an independent compensation committee.

The exchanges may adopt  other exemptions for particular relationships.

Compensation Consultant Conflicts of Interest Disclosure

In addition to the current disclosure requirements regarding use of compensation consultants, the new amendments will also require proxy disclosure regarding the nature of  any compensation consultant conflict of interest and how the conflict is being addressed, if the compensation consultant has played a role in determining or recommending the amount or form of executive and director compensation and the consultant's work has raised any conflict of interest.

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