Alert July 18, 2016

Nasdaq Adopts “Golden Leash” Director Compensation Disclosure Requirement

Summary

Nasdaq has adopted a new rule that will require each listed company to publicly disclose the material terms of all agreements and arrangements between any director or nominee and any person or entity (other than the company) relating to cash and non-cash compensation or other payments in connection with that person’s service or candidacy as a director of the company.

The Nasdaq Stock Market LLC (Nasdaq) has adopted a new rule that will require each Nasdaq-listed company to publicly disclose compensation or other payments by third parties to any current director or nominee for director in connection with that person’s service on or candidacy for the company’s board of directors. Rule 5250(b)(3), which the SEC approved on July 1, 2016, is the third version of this rule, which Nasdaq originally filed with the SEC on January 28, 2016. Amendment No. 2 to the Nasdaq rulemaking proposal, as filed with the SEC on June 30, 2016, is available on the Nasdaq website. The SEC order approving the Nasdaq rule change, as published on the SEC web site on July 1, 2016, is available on the SEC website.

What disclosure does the rule require?

The new rule, Rule 5250(b)(3), will require each Nasdaq-listed company to publicly disclose the material terms of all agreements and arrangements between any director or nominee and any person or entity other than the company (referred to in the rule as a “third party”) relating to compensation or other payment in connection with the director’s service or the nominee’s candidacy as a director. The rule permits a foreign private issuer to follow its home country practice in lieu of the rule’s requirements, subject to the requirements of Nasdaq Rule 5615.

The disclosure should, at a minimum, identify the parties to the agreement or arrangement and the material terms of the compensation agreement or arrangement. Nasdaq has stated that it intends the rule to apply to agreements and arrangements whether or not the third party has a legal right to nominate a director.

What compensation does the rule require companies to disclose?

The terms “compensation” and “other payment” as used in the rule are not limited to cash payments. Nasdaq has stated that it intends the rule to be interpreted broadly and to apply to agreements and arrangements that provide for non-cash compensation and other payment obligations, such as health insurance premiums or indemnification, made in connection with a person’s candidacy or service as a director.

Are there exceptions to the new disclosure requirement?

The rule will not apply to agreements and arrangements that satisfy the following conditions:

  • the agreement or arrangement existed before the nominee’s candidacy and
  • the nominee’s relationship with the third party has been publicly disclosed, for example, pursuant to Items 402(a)(2) or 402(k) of Regulation S-K or in a director’s biographical summary included in periodic reports filed with the SEC.

As an example of an agreement or arrangement that would be subject to this exception, Nasdaq specifically cites a situation in which a director or nominee is employed by a private equity or venture capital firm, or a fund established by the firm, where employees are expected to and routinely serve on the boards of the fund’s portfolio companies and their remuneration is not materially affected by this service. If that director’s or nominee’s remuneration is materially increased in connection with that person’s service or candidacy as a director of the company, only the difference between the new and the previous level of compensation needs to be disclosed under the rule.

In addition, the rule does not apply to agreements and arrangements that relate only to reimbursement of expenses incurred in connection with candidacy as a director, whether or not the company has publicly disclosed the reimbursement arrangement.

How does the rule apply to material increases in remuneration under existing compensation arrangements?

Nasdaq has stated that for publicly disclosed agreements and arrangements that existed prior to a director’s service or a nominee’s candidacy and were therefore not required to be disclosed by the rule, if a director’s or nominee’s remuneration is thereafter materially increased specifically in connection with such person’s service or candidacy as a director of the company, the company is required to disclose only the difference between the new and the previous level of compensation or other payment obligation.

How would indemnification agreements or arrangements be treated under the rule?

Consistent with the text of the rule and statements by Nasdaq in Amendment No. 2, we expect that indemnification agreements and arrangements between a director or nominee and a third party, such as the director’s or nominee’s employer, will generally be treated as “compensation” and will therefore be subject to disclosure by the company. Companies should determine whether the indemnification agreement or arrangement has been previously disclosed. If it has, the interpretive guidance adopted by Nasdaq in connection with the rule provides that “for publicly disclosed agreements and arrangements that existed prior to the nominee’s candidacy and thus [are] not required to be disclosed in accordance with [the rule] but where the director’s or nominee’s remuneration is thereafter materially increased specifically in connection with such person’s candidacy or service as a director of the [c]ompany, only the difference between the new and previous level of compensation or other payment obligation needs to be disclosed.”

How would a director’s or nominee’s carried interest in a fund that is an investor in the company be treated under the rule?

Although this situation is not specifically dealt with in the rule or the related Nasdaq interpretive materials and is not mentioned in Amendment No. 2, we believe that an indirect interest such as a carried interest in a fund (or in the general partner or managing member entity of such a fund) that is an investor in a broad portfolio of companies that includes the company for which an individual serves or has been nominated to serve as a director will generally not be treated as compensation or a payment “in connection with” that person’s service or candidacy as a director. The treatment of a carried interest under the rule in other circumstances we think would ultimately depend on the structure of the specific carried interest, however.

How will companies make the required disclosure?

A company can make the required disclosure either (1) on or through its website or (2) in its definitive proxy or information statement for the next shareholders’ meeting at which directors are to be elected. If the company does not file proxy or information statements, the company may provide this disclosure in its Form 10-K.

If a company chooses to make the required disclosure on or through its website, it may make the required disclosure available either on its website or through its website by hyperlinking to another website, which must be continuously accessible. If that website subsequently becomes inaccessible or that hyperlink becomes inoperable, the company must promptly restore it or make other disclosure in accordance with the rule.

If a company provides disclosure that is sufficient to comply with the rule in a proxy or information statement in order to satisfy SEC proxy disclosure requirements, the company’s disclosure obligations under the rule are satisfied, regardless of the reason for which the company made the disclosure.

What is the effective date of the rule?

The rule will become effective on July 31, 2016. Nasdaq will notify listed companies of the effective date.

When must companies first make the required disclosure?

Companies listed on the Nasdaq Stock Market at the time the rule becomes effective or initially listed thereafter must disclose all agreements and arrangements that are subject to the rule no later than the date on which the company files or furnishes a proxy or information statement in connection with the company’s next shareholders’ meeting at which directors are elected (or, if the company does not file proxy or information statements, no later than when the company files its next Form 10-K).

On an ongoing basis, when must companies make the required disclosure?

If the company chooses to provide the new disclosure in its proxy or information statement, the rule does not require the company to provide this disclosure until the company files its definitive proxy or information statement in connection with a shareholders’ meeting at which directors will be elected. As discussed in the next question and answer, there is no obligation to disclose compensation agreements or arrangements that are subject to the rule between the filing dates of a company’s definitive proxy or information statement (or Form 10-K, if the company does not file proxy or information statements).

The company must make the required disclosure at least annually until the earlier of the resignation of the director or one year following the termination of the agreement or arrangement that was subject to the rule.

Does the rule require disclosure when new compensation arrangements subject to the rule are entered into or amended?

The rule requires disclosure only in connection with a company’s shareholder meetings at which directors are to be elected. It does not require disclosure of newly entered into agreements or arrangements until the company makes this disclosure.

What steps should companies take to comply with the rule?

Companies should modify their disclosure policies and procedures to ensure that they have taken reasonable steps to ensure that they disclose the information required by the rule at the appropriate time and by the required means. Nasdaq stated in Amendment No. 2 that this would include “asking each director or nominee [about any agreements and arrangements that may be subject to the new disclosure requirement] in a manner designed to allow timely disclosure” by the company. At a minimum, therefore, Nasdaq-listed companies should revise their director and officer questionnaires (including any questionnaires used for director nominees) to solicit information about any agreements or arrangements that the company may be required to disclose under the rule.

What are the consequences if a company discovers that it has not complied with the rule?

If a company determines that it should have disclosed an agreement or arrangement that is subject to the rule, the company must promptly make the required disclosure by issuing a press release or, where required by SEC rules, by filing a Form 8-K. Disclosure on the company’s website does not appear to satisfy the company’s disclosure obligations in this case. This remedial disclosure does not affect the company’s ongoing annual disclosure obligations under the rule.

If a company has taken reasonable efforts to identify all agreements and arrangements that are subject to the rule, the rule provides that the company will not be deficient under the rule if the company promptly makes the required disclosure in the manner described in the preceding paragraph when it discovers an undisclosed arrangement that is subject to the rule. Nasdaq has indicated that “reasonable efforts” includes “asking each director or nominee in a manner designed to allow timely disclosure.” However, such remedial disclosure, regardless of its timing, does not affect the company’s ongoing annual disclosure requirements under the rule.

In cases where a company is considered deficient (for example, because it did not take reasonable efforts to identify agreements and arrangements that are subject to the rule), Nasdaq will allow companies that are deemed deficient under the rule 45 calendar days to submit a plan that satisfies Nasdaq staff that the company has adopted processes and procedures designed to identify and disclose relevant agreements and arrangements in the future. This 45 calendar day period is consistent with the remedial periods for curing deficiencies under most other Nasdaq rules that allow a company to submit a plan to regain compliance. If the company does not submit a plan that is acceptable to Nasdaq within the 45 calendar day period, Nasdaq will issue a Staff Delisting Determination, which the company could appeal under applicable Nasdaq rules.