Alert June 26, 2012

SEC Adopts Final Rules for Dodd-Frank Exchange Listing Standards Governing Compensation Committees

The SEC issued a final rule (the “Final Rule”) and a final amendment to the proxy rules (the “Proxy Rules Amendment”) that are designed to implement provisions of Section 952 of the Dodd-Frank Act, which added new Section 10C to the Securities Exchange Act of 1934 (“1934 Act”).  Section 10C requires the SEC to adopt rules directing the national securities exchanges and national securities associations (collectively referred to in this article as “national securities exchanges”) to prohibit the initial or continued listing of any equity security of an issuer that is not in compliance with Section 10C’s requirements regarding compensation committees and compensation consultants, legal counsel and other advisers (“compensation advisers”).  The Final Rule directs national securities exchanges to establish listing standards that impose independence standards on a compensation committee’s members, require a compensation committee to have the authority to engage, oversee and compensate compensation advisers and require compensation committees to consider independence-related factors before selecting or obtaining advice from compensation advisers other than in-house legal counsel.  The Proxy Rules Amendment revises the disclosure requirements for proxy materials relating to the election of directors at an annual meeting to include additional disclosures regarding the use of compensation advisers and related conflicts of interest. 

Current SEC rules do not require, and the Final Rule does not mandate, that an issuer establish a compensation committee or a committee that performs functions typically assigned to a compensation committee.  However, current national securities exchange listing standards generally require listed issuers either to have a compensation committee or to have independent directors determine, recommend or oversee specified executive compensation matters. 

Principal provisions of the Final Rule and the Proxy Rules Amendment are summarized below.

Final Rule

“Compensation Committee”.  The SEC’s proposal did not define the “compensation committee” to which Section 10C’s mandated listing standards should apply.  In response to public comment on the proposal, the Final Rule defines “compensation committee” as (1) any formally designated compensation committee, (2) 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, and (3) in the absence of any committee in either of the foregoing categories, those members of a listed company’s board who oversee executive compensation matters on behalf of the board.

Compensation Committee Independence.  The Final Rule requires national securities exchanges to establish listing standards that require each member of a listed issuer’s compensation committee to be a member of the board of directors and be “independent.”  Independence for this purpose is not defined by federal statute or by the Final Rule but is to be defined by the national securities exchanges after taking into consideration “relevant factors,” including (1) the source of compensation paid to a director including any consulting, advisory, or other compensatory fee paid by the issuer, and (2) whether a director is affiliated with the issuer, a subsidiary of the issuer, or an affiliate of a subsidiary of the issuer. 

Compensation Advisers.  Under the Final Rule, a national securities exchange’s listing standards must include the following requirements: (1) a compensation committee must have the authority, in its sole discretion, to retain or obtain the advice of compensation advisers; (2) a compensation committee must be directly responsible for the appointment, compensation and oversight of the work of any compensation adviser it retains; (3) a compensation committee must take into consideration specific factors relating to the adviser’s independence identified by the SEC and any additional factors identified by a national securities exchange as part of its listing standards before either selecting a compensation adviser or obtaining advice from any compensation adviser other than in-house legal counsel; and (4) a listed issuer must provide appropriate funding for the payment of reasonable compensation, as determined by its compensation committee, to compensation advisers retained by the compensation committee.  Requirements (1) and (4) do not apply to directors who oversee executive compensation matters outside a formal board committee structure.

Exemptions.  The Final Rule does not apply to (1) controlled companies; (2) smaller reporting companies; and (3) the listing of certain security futures products and certain standardized options.  A national securities exchange may also choose to exempt from its listing standards adopted pursuant to the Final Rule such categories of issuers as it deems appropriate, taking into account, among other relevant factors, the potential impact of the listing standards on smaller reporting issuers.  In addition, the following types of issuers are not subject to the Final Rule’s independence requirements for compensation committee members: (a) limited partnerships; (b) companies in bankruptcy proceedings; (c) registered open-end management investment companies (mutual funds); and (d) certain foreign private issuers. 

Effective and Compliance Dates.  The Final Rule will become effective 30 days following its publication in the Federal Register.  Each national securities exchange must submit to the SEC, no later than 90 days following publication of the Final Rule in the Federal Register, proposed rule changes that comply with the Final Rule.  Each national securities exchange must have final rules or rule amendments that comply with the Final Rule approved by the SEC no later than one year following publication of the Final Rule in the Federal Register.

Proxy Rules Amendment

Section 10C(c)(2) of the 1934 Act requires the SEC to adopt new proxy disclosure requirements concerning the use of compensation consultants and related conflicts of interest.  The Proxy Rules Amendment implements this mandate by adding to Item 407(e) of Regulation S-K a disclosure requirement regarding any conflicts of interest raised by the use of a compensation consultant.  Item 407 applies to issuers registered under the 1934 Act, other than registered investment companies, with respect to any proxy or information statement relating to an annual meeting of shareholders at which directors are to be elected (or special meeting in lieu of an annual meeting).  Issuers must comply with the Proxy Rules Amendment in any proxy or information statement for an annual meeting of shareholders (or a special meeting in lieu of an annual meeting) at which directors will be elected occurring on or after January 1, 2013.