New SEC Rule Requires Listing Standards for Compensation Committees and Compensation Advisers
The Securities and Exchange Commission has approved a rule that orders national securities exchanges to adopt listing standards for public company boards of directors and compensation advisers.
The new rule, required by the Dodd-Frank Wall Street Reform and Consumer Protection Act, requires exchange listing standards to address 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.
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.
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.
Once an exchange’s new listing standards are in effect, a listed company must meet the standards in order for its shares to continue trading on that exchange.
“This rule will help to enhance the board’s decision-making process on executive compensation matters, particularly the selection, engagement and oversight of compensation advisers, and will provide more transparency with respect to conflicts of interest of consultants engaged by boards,” said SEC Chairman Mary L. Schapiro.
The SEC also amended its proxy disclosure 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. No later than 90 days after effectiveness, each exchange that lists equity securities must propose listing standards that comply with the new rule. The new listing standards must be approved by the Commission within one year of the new rule becoming effective.
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.
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.
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.
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.
Rule 10C-1 requires the exchanges to exempt the following four categories of companies from the compensation committee independence requirements:
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.
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.