By Cydney Posner
Nasdaq has submitted a new rule proposal to the SEC (not yet posted on the SEC's website) to amend its rules related to compensation committees. Generally, the proposal would bring the Nasdaq requirements for committee composition in sync with those applicable to NYSE companies.
You might recall that SEC Rule 10C-1 required the exchanges to adopt listing standards for compensation committee independence mandating, as a baseline, that committee members be selected only after consideration of 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 to such member of the board of directors." Each exchange was permitted to adopt rules that imposed additional or more exacting requirements. Only Nasdaq decided to exceed the minimal requirements. As a result, there is one key difference between the Nasdaq and NYSE compensation committee rules: Nasdaq prohibited the receipt of any compensatory fees by compensation committee members (similar to the prohibition applicable to audit committee members), while the NYSE required only that compensation be considered as a factor. Since adoption of the rule, however, Nasdaq has received feedback from companies indicating that the prohibition on compensatory fees was too burdensome and that "this additional burden could influence a company's choice of listing venue." Not surprisingly, the specter of losing business was apparently enough to drive Nasdaq to now propose to amend Rule 5605(d)(2)(A) and IM-5605-6 to replace the prohibition on the receipt of compensatory fees by committee members with the more lenient requirement that the board instead consider the receipt of compensatory fees when determining committee eligibility.
The proposed changes would make the Nasdaq rule remarkably similar to those of the NYSE. Under the proposed amendment, "in affirmatively determining the independence of any director who will serve on the compensation committee of a board of directors, the board of directors must consider all factors specifically relevant to determining whether a director has a relationship to the Company which is material to that director's ability to be independent from management in connection with the duties of a compensation committee member, including, but not limited to:
(i) the source of compensation of such director, including any consulting, advisory or other compensatory fee paid by the Company to such director; and
ii) whether such director is affiliated with the Company, a subsidiary of the Company or an affiliate of a subsidiary of the Company."
Notably, the proposed new test "clarifies" the importance of independence "from management," a concept that was emphasized in the NYSE listing standards. (In addition, you may recall that, in the SEC's adopting release, the SEC suggested that the exchanges "might conclude" that the definition of independence should address business or personal relationships between a compensation committee member and executive officers of the listed company, although the SEC included no such mandate.) Similarly, the proposed revised interpretive material makes clear that the lens through which compensation must be evaluated is whether the compensation could affect judgments regarding executive compensation. The proposed revised IM indicates that, "when considering the sources of a director's compensation for this purpose, the board should consider whether the director receives compensation from any person or entity that would impair the director's ability to make independent judgments about the Company's executive compensation." The proposed revised interpretation also expands on the same concept when discussing the consideration of affiliate status: when considering affiliate relationships, "the board should consider whether the affiliate relationship places the director under the direct or indirect control of the Company or its senior management, or creates a direct relationship between the director and members of senior management, in each case of a nature that would impair the director's ability to make independent judgments about the Company's executive compensation."
The proposed IM also notes that references to the "Company" must include any parent or subsidiary of the company, with the phrase "parent or subsidiary" intended to cover controlled and consolidated entities.
Interestingly, Nasdaq also proposes to delete the current exception from the definition of compensatory fees for fees received as a director or committee member and the receipt of fixed amounts of compensation under a retirement plan for prior service with the company. As a consequence, these fees, in aggregate with all other sources of compensation of the director, would be considered in determining whether they might impair the director's judgment on the committee. The proposal states that none of the other exchanges exempts any types of fees from the analysis of compensation committee eligibility. In addition, Nasdaq received comments during the rulemaking process arguing that boards should consider the fees paid to directors for their board or committee service, which, presumably, could also influence a director's judgments and independence from management. For example, the AFL-CIO argued in its comment letter that "[h]igh director fees relative to other sources of income can compromise director objectivity. Highly paid directors also may be more inclined to approve large executive pay packages."
The proposal maintains that, because committee members must also be independent under the general independence definition, boards "would be required to consider, based on the company's and the director's unique circumstances, whether the receipt of any fees, even fees below [the caps set in the general independence definition], would impair the director's ability to make independent judgments about the company's executive compensation, and therefore render the director ineligible to serve on the compensation committee." (Note, however, that, in the general independence definition, the specific limitation related to the receipt of compensation expressly excludes directors' fees.)
Because companies are required to comply with the compensation committee composition aspects of the rules by the earlier of the first annual meeting after January 15, 2014, or October 31, 2014, Nasdaq is requesting immediate effectiveness of the proposed rule change.