New NYSE and NASDAQ Listing Rules Raise the Accountability of Company Boards and Compensation Committees Through Flexible Standards

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1 New NYSE and NASDAQ Listing Rules Raise the Accountability of Company Boards and Compensation Committees Through Flexible Standards By Todd B. Pfister and Aubrey Refuerzo* On January 11, 2013, the U.S. Securities and Exchange Commission ( SEC ) approved final versions of New York Stock Exchange ( NYSE ) and NASDAQ Stock Market ( NASDAQ ) proposals to amend their respective listing standards with regard to the independence of compensation committees and any compensation consultant, legal counsel, or other advisors to compensation committees ( compensation advisers ). 1 This survey provides an overview of the new NYSE and NASDAQ listing standards, as well as a brief discussion of recommended actions for NYSE and NASDAQ listed companies ( listed companies ) to ensure compliance with these new standards. Some rules, including the evaluation of compensation committee advisers and compensation committee authority and charter documents by the listed companies, were effective on July 1, * Todd B. Pfister is a partner with Foley & Lardner LLP and a member of the firm s Transactional & Securities and Private Equity & Venture Capital Practices. He practices primarily in the areas of mergers and acquisitions, securities law, and general corporate and business law. Mr. Pfister has extensive experience counseling publicly held companies on corporate governance and compliance matters under federal and state securities laws. He also regularly structures and negotiates transactions in numerous industries and represents issuers and underwriters in public and private offerings of both debt and equity securities. Mr. Pfister can be reached at (312) or tpfister@foley.com. Aubrey Refuerzo is an associate with Foley & Lardner LLP. She focuses her practice on the representation of clients in securities offerings, private and public mergers and acquisitions, financing matters, real estate, corporate governance, and general corporate issues. Ms. Refuerzo can be reached at (312) or arefuerzo@foley.com. 1. Self-Regulatory Organizations; New York Stock Exchange LLC; Notice of Filing of Amendment No. 3, and Order Granting Accelerated Approval for Proposed Rule Change, as Modified by Amendment Nos. 1 and 3, to Amend the Listing Rules for Compensation Committees to Comply with Securities Exchange Act Rule 10C-1 and Make Other Related Changes, Exchange Act Release No , 78 Fed. Reg ( Jan. 22, 2013) [hereinafter NYSE Approval]; Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Notice of Filing of Amendment Nos. 1 and 2, and Order Granting Accelerated Approval of Proposed Rule Change as Modified by Amendment Nos. 1 and 2 to Amend the Listing Rules for Compensation Committees to Comply with Rule 10C-1 Under the Act and Make Other Related Changes Exchange Act Release No , 78 Fed. Reg ( Jan. 22, 2013) [hereinafter NASDAQ Approval]. 2. A summary of these regulatory actions appeared in Fed. Regulation of Sec. Comm., ABA Bus. Law Section, Regulatory Developments 2012, 68 BUS. LAW. 843, (2013). Our survey includes expanded discussion of the regulations and a comparison of exchange requirements. 135

2 136 The Business Lawyer; Vol. 69, November 2013 The changes made to each exchange s listing standards are not substantively drastic, but they will affect how compensation committees are formed and function, as they place new responsibilities on compensation committees and boards of directors ( boards ) at listed companies. While many of the NYSE changes to its listing standards were not substantive, the NYSE s factor-based approach to their independence standards nevertheless raises the level of accountability placed on boards and compensation committees of NYSE listed companies. The NASDAQ, in contrast, has increased the accountability of boards and compensation committees of NASDAQ listed companies by adding new rules with higher standards. Listed companies should act promptly to ensure they understand and make any necessary changes to comply with the applicable new listing standards. BACKGROUND Under section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, 3 the SEC was mandated to adopt rules directing the national securities exchanges and national securities associations to prohibit the listing of any equity security of a company that does not comply with compensation committee and compensation adviser independence requirements. In June 2012, the SEC adopted final rules ( SEC Rules ) 4 implementing section 952 by adopting new Rule 10C-1 5 ( Rule 10C-1 ) and amendments to Item 407 of Regulation S-K. 6 The NYSE and NASDAQ initially proposed new listing standards on September 25, 2012, final versions of which were approved by the SEC on January 11, The SEC Rules required the NYSE and NASDAQ to adopt listing standards on three topics: The independence of compensation committee members, based on standards that are more stringent than the test that applies to directors generally, but which need not be as stringent as the test that applies to audit committee members; 3. Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No , 124 Stat (2010) [hereinafter Dodd-Frank Act]. Section 902 of the Dodd-Frank Act added section 10C to the Securities Exchange Act of Stat at 1900 (codified at 15 U.S.C. 78j-3 (2012)). 4. Listing Standards for Compensation Committees, Securities Act Release No. 9330, 77 Fed. Reg ( June 27, 2012) [hereinafter SEC Rules Release]. 5. See 17 C.F.R C-1 (2013). 6. See id See supra note 1. The NYSE submitted its initial proposal for rule changes to comply with the SEC Rules on September 25, Proposed Rule Change by New York Stock Exchange, Exchange Act Release No , 77 Fed. Reg (Oct. 15, 2012) [hereinafter NYSE Initial Proposal]. The NYSE subsequently filed amendments to its proposed rule changes on October 1, 2012, December 4, 2012, and January 8, NYSE Approval, supra note 1, at NASDAQ submitted its initial proposal for rule changes to comply with the SEC Rules on September 25, Exchange Act Release No , 77 Fed. Reg (Oct. 15, 2012). NASDAQ filed Amendment 1 to the NASDAQ initial proposal on December 12, 2012, and Amendment 2 on January 4, NASDAQ Approval, supra note 1, at 4554.

3 NYSE and NASDAQ Listing Rules Raise the Accountability of Company Boards 137 A compensation committee s authority to retain its own compensation advisers and the committee s responsibility for the appointment, compensation, and oversight of each adviser that it retains (although the listing standards need not require a committee to retain its own advisers); and A requirement that a compensation committee consider specified factors that could bear on the independence of each adviser that assists the committee, whether or not the committee retained the adviser (although there is no requirement that a compensation committee only use advisers that are in fact independent in the sense that they do not present questions under any of the factors, and there is no related disclosure obligation regarding compensation adviser selection). OVERVIEW: HIGHER STANDARDS FOR LISTED COMPANIES NYSE. The new NYSE listing standards do not break significant new ground. The new NYSE listing standards do not add any new specific test that an NYSE compensation committee member must meet in order to qualify as being independent for NYSE compensation committee purposes. Importantly, and consistent with the existing listing standards, the new NYSE listing standards do not contain any numerical tests or absolute prohibitions on compensation committee member qualifications. In addition, the new NYSE listing standards specifically provide that share ownership alone, no matter the percentage, would not require an affirmative finding that a compensation committee member is not independent. 8 The new NYSE listing standards do, however, place more responsibility on NYSE listed company boards by requiring the consideration of all relevant factors as part of an independence determination for compensation committee members. 9 The NYSE listing standards relating to the authority and responsibilities of NYSE compensation committees with respect to the oversight of compensation advisers also remain effectively unchanged. Furthermore, the specified factors in the SEC Rules regarding compensation adviser independence considerations that have been incorporated by the NYSE into its listing standards are substantively similar to the existing independence factors in the NYSE listing standards. 10 The new NYSE listing standards, however, also provide that the NYSE compensation committee must consider all factors relevant to that person s independence from management as part of an independence determination for compensation advisers. 11 This catch-all provision arguably places a higher burden on NYSE listed company boards than would another bright-line rule. Thus, for both compensation committee member and compensation adviser independence determinations, the NYSE requires each NYSE listed company 8. NYSE Approval, supra note 1, at N.Y. STOCK EXCHANGE, LISTED COMPANY MANUAL 303A.02(a)(ii) (2013) [hereinafter NYSE MANUAL]. 10. See NYSE Approval, supra note 1, at NYSE MANUAL, supra note 9, 303A.05(c)(iv).

4 138 The Business Lawyer; Vol. 69, November 2013 to determine and, in effect, to be able to defend a list of all factors relevant to such company. NASDAQ. While the newly approved NYSE listing standards largely follow the standards and requirements outlined in the SEC Rules, the changes that NASDAQ adopted go beyond, in some cases, what the SEC Rules require. As amended, the NASDAQ Listing Rules 12 ( NASDAQ Rules ) relating to compensation committees, among other things: require NASDAQ listed companies to have compensation committees (as existing NYSE listing standards already require); raise the independence standards for compensation committee members, in some cases applying the heightened independence standards established for audit committees; and require compensation committees to have charters establishing specified rules and standards (as existing NYSE listing standards also already require). With regard to factors that may bear on the independence of compensation committee advisors, NASDAQ adopted the factors set forth in the SEC Rules and did not materially change or add to these factors. NEW LISTING STANDARDS INDEPENDENCE OF COMPENSATION COMMITTEE MEMBERS The SEC Rules directed national securities exchanges to adopt listing standards that require each compensation committee member to be independent and to define the term independent in its listing standards. The SEC Rules specifically require that listed companies consider the following two factors: The source of compensation of a director, including any consulting, advisory, or other compensatory fee paid by the listed company to such member of the board; and Whether a director is affiliated with the listed company, a subsidiary of the listed company, or an affiliate of a subsidiary of the listed company. 13 NYSE. The new NYSE listing standards add certain consideration requirements, including the two SEC factors listed above, but the NYSE did not impose a more stringent independence test like the one that applies to members of audit committees. 14 The NYSE listing standards already require compensation committee members to be independent. Specifically, the current listing standards provide that a compensation committee member does not qualify as independent unless a board affirmatively determines that the member has no material relationship with the NYSE listed company based on five bright-line tests. 15 The new NYSE listing standards do not change any of these tests. 12. NASDAQ STOCK MARKET, NASDAQ LISTING RULES (2013) [hereinafter NASDAQ Rules]. 13. See 17 C.F.R C-1 (2013). 14. NYSE MANUAL, supra note 9, 303A Under NYSE Manual 303A.02(a), the tests are (i) the director is, or has been within the last three years, an employee of the listed company, or an immediate family member is, or has been within the last three years, an executive officer, of

5 NYSE and NASDAQ Listing Rules Raise the Accountability of Company Boards 139 The new NYSE listing standards do, however, add subsection 303A.02(a)(ii), which requires that, in affirmatively determining the independence of any compensation committee member, the board consider all factors specifically relevant to determining whether such member has a relationship to the NYSE listed company that is material to the member s ability to be independent from management in connection with the member s NYSE compensation committee duties, including, but not limited to, the two SEC factors listed above. 16 The new NYSE listing standards make clear that the NYSE will not dictate any specific numerical tests with respect to the two factors. In particular, a board need not make an affirmative finding that a compensation committee member is not independent based solely on the fact that the member (and/or the member s affiliates) hold in excess of a specific percentage of the NYSE listed company s outstanding shares. The NYSE reaffirmed its position that share ownership in an NYSE listed company aligns the compensation committee member s interests with those of its shareholders. 17 The NYSE believes that its existing bright-line independence listing standards, along with an NYSE listed company s obligation to consider all factors specifically relevant, are sufficiently broad to encompass all forms of relationships that would negate a compensation committee member s independence regarding the member s committee duties. The catch-all consideration, in effect, requires NYSE listed companies first to determine which factors, in addition to those specified in the listing standards, are relevant to the company, and then to consider all such factors. The commentary to the new NYSE listing standards provides that, when considering the sources of a compensation committee member s compensation in this context, the board should consider whether the member receives compensation from any other source, including sources outside of the NYSE listed company, that would impair the member s ability to make independent judgments the listed company, (ii) the director has received, or has an immediate family member who has received, during any 12-month period within the last three years, more than $120,000 in direct compensation from the listed company, other than director and committee fees and pension or other forms of deferred compensation for prior service (provided such compensation is not contingent in any way on continued service), (iii) (A) the director is a current partner or employee of a firm that is the listed company s internal or external auditor, (B) the director has an immediate family member who is a current partner of such a firm, (C) the director has an immediate family member who is a current employee of such a firm and personally works on the listed company s audit or (D) the director or an immediate family member was within the last three years a partner or employee of such a firm and personally worked on the listed company s audit within that time, (iv) the director or an immediate family member is, or has been within the last three years, employed as an executive officer of another company where any of the listed company s present executive officers at the same time serve on that company s compensation committee or (v) the director is a current employee, or an immediate family member is a current executive officer, of a company that has made payments to, or received payments from, the listed company for property or services in an amount which, in any of the last three fiscal years, exceeds the greater of $1 million, or 2 percent of such other company s consolidated gross revenues. NYSE MANUAL, supra note 9, 303A.02(a). 16. Id. 303A.02(a)(ii). 17. Id. 303A.02(a) cmt.

6 140 The Business Lawyer; Vol. 69, November 2013 about the NYSE listed company s compensation. 18 The commentary also states that the board should consider whether an affiliate relationship places the compensation committee member under the direct or indirect control of the NYSE listed company or its senior management, or creates a direct relationship between the member and members of senior management, in each case of a nature that would impair the member s ability to make independent judgments about the NYSE listed company s compensation. 19 The Board of an NYSE listed company must consider these factors in determining the independence of compensation committee members beginning the earlier of (i) such company s first annual meeting of shareholders held after January 15, 2014, or (ii) October 31, NASDAQ. Although not required to do so under the SEC Rules, the new NASDAQ Rules require NASDAQ listed companies, including smaller reporting companies, 21 to have a compensation committee consisting of at least two members of the board, each of whom must be an independent director as defined in the NASDAQ Rules. The new NASDAQ Rules effect this requirement by eliminating the ability of a NASDAQ listed company to have independent directors vote to approve compensation as members of the board rather than acting as a committee. 22 The new NASDAQ Rules also incorporate the two SEC factors listed above, but do so in two different ways. Under the existing NASDAQ Rules, a board is already required to make an affirmative determination that an independent director does not have any relationship that, in the opinion of the board, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. 23 Presumably, for a director who will serve as a member 18. Id. 19. Id. 20. NYSE Approval, supra note 1, at Under 17 C.F.R b-2, a smaller reporting company means: an issuer that is not an investment company, an asset-backed issuer (as defined in of this chapter), or a majority-owned subsidiary of a parent that is not a smaller reporting company and that: (1) Had a public float of less than $75 million as of the last business day of its most recently completed second fiscal quarter, computed by multiplying the aggregate worldwide number of shares of its voting and non-voting common equity held by non-affiliates by the price at which the common equity was last sold, or the average of the bid and asked prices of common equity, in the principal market for the common equity; or (2) In the case of an initial registration statement under the Securities Act or Exchange Act for shares of its common equity, had a public float of less than $75 million as of a date within 30 days of the date of the filing of the registration statement, computed by multiplying the aggregate worldwide number of such shares held by non-affiliates before the registration plus, in the case of a Securities Act registration statement, the number of such shares included in the registration statement by the estimated public offering price of the shares; or (3) In the case of an issuer whose public float as calculated under paragraph (1) or (2) of this definition was zero, had annual revenues of less than $50 million during the most recently completed fiscal year for which audited financial statements are available. 17 C.F.R b-2 (2013). 22. NASDAQ Rules, supra note 12, 5605(d)(2). 23. Id. 5605(a)(2).

7 NYSE and NASDAQ Listing Rules Raise the Accountability of Company Boards 141 of the compensation committee, the board would need to take into account responsibilities in his or her role on the compensation committee. The NASDAQ Rules currently specify certain categories of directors that cannot qualify as independent directors, which categories do not change under the new NASDAQ Rules. Under the new NASDAQ Rules, however, NASDAQ adopted additional independence standards applicable to compensation committee members based on the sources of compensation and affiliated-status factors that the SEC Rules enumerate. 24 With regard to sources of director compensation, the new NASDAQ Rules apply to compensation committee members the same standard that currently applies to audit committee members under SEC Rule 10A-3 25 (which rule is incorporated into Rule 5605(c)(2)(A)(ii) of the NASDAQ Rules) and, thus, prohibit compensation committee members from accepting, directly or indirectly, any consulting, advisory, or other compensatory fees (other than solely for board service and certain fixed amounts of compensation under a retirement plan 26 ) from the NASDAQ listed company or any subsidiary of the NASDAQ listed company. Also similar to SEC Rule 10A-3, the prohibition on a compensation committee member s receipt of fees does not include a look-back period; rather, the prohibition would apply as of the commencement of the director s service on the compensation committee. 27 This prohibition is in contrast to the existing NASDAQ Rules, which allow an independent director (including a director serving as a compensation committee member) to receive a limited amount of compensation from the NASDAQ listed company and its subsidiaries. 28 Regarding the affiliated-status factor, the new NASDAQ Rules do not prohibit a compensation committee member from having an affiliation with the NASDAQ listed company; rather, in determining whether a director is eligible to be a compensation committee member, the board must consider whether any such affiliation would impair the director s judgment as a compensation committee member. 29 NASDAQ did not adopt any bright-line tests or prohibitions regarding this factor. In particular, a board need not make an affirmative finding that a compensation committee member is not independent based solely on the fact that the member (and/or the member s affiliates) hold in excess of a specific percentage of the NASDAQ listed company s outstanding shares. NASDAQ considered whether to apply the same standards to compensation committee members as it currently applies to audit committee members, which standards prohibit affiliates from being audit committee members and include as affiliates persons having beneficial ownership of more than 10 percent of any class of voting shares of the NASDAQ listed company. 30 NASDAQ concluded, however, that such a blank prohibition would 24. Id. 25. See 17 C.F.R A-3 (2013). 26. NASDAQ Rules, supra note 12, 5605(d)(2)(A). 27. NASDAQ Approval, supra note 1, at NASDAQ Rules, supra note 12, 5605(d)(2)(A). 29. NASDAQ Approval, supra note 1, at Id.

8 142 The Business Lawyer; Vol. 69, November 2013 be inappropriate for compensation committees since it may be appropriate for certain affiliates, such as representatives of significant stockholders, to serve on compensation committees since their interests are likely aligned with those of other stockholders in seeking an appropriate executive compensation program. 31 NASDAQ re-affirmed its position that share ownership in a NASDAQ listed company aligns the compensation committee member s interests with those of the NASDAQ listed company s shareholders and, thus, that it may be appropriate for such persons to serve as compensation committee members. No look-back period applies with regard to the affiliated-status factor; hence, a board will only be required to consider a compensation committee member s affiliations that exist at and after the start of his or her service as a committee member. 32 NASDAQ deemed these standards to be sufficient to ensure a compensation committee member s independence and, therefore, did not adopt any additional factors. The new NASDAQ Rules maintain NASDAQ s existing exception allowing certain non-independent directors to serve on a compensation committee under exceptional and limited circumstances. 33 Furthermore, if a NASDAQ listed company were to fail to comply in certain circumstances with the compensation committee requirements, it may rely on the existing cure-period provision in the NASDAQ Rules, which provision remains unchanged and is applicable to the new NASDAQ Rules. 34 These new NASDAQ Rules will take effect upon the earlier of (i) a NASDAQ listed company s first annual meeting of shareholders held after January 15, 2014, or (ii) October 31, LISTED COMPANY CHARTER AND COMPENSATION COMMITTEE AUTHORITY TO RETAIN ADVISERS The SEC Rules require that (i) a compensation committee have the authority to retain its own compensation advisers and be directly responsible for the 31. NASDAQ Rules, supra note 12, 5605(d)(2)(A). 32. NASDAQ Approval, supra note 1, at NASDAQ Rules, supra note 12, 5605(d)(3) ( If a Compensation Committee has at least three members, one director who is not independent and not an executive officer, employee or family member of an executive officer may be appointed as a Member if the Board, under exceptional and limited circumstances, determines that such individual s membership on the committee is required by the best interests of the company and its shareholders. ). 34. NASDAQ Rules 5605(b)(1)(A) sets forth the applicable cure provision: If a Company fails to comply with this requirement due to one vacancy, or one director ceases to be independent due to circumstances beyond their reasonable control, the Company shall regain compliance with the requirement by the earlier of its next annual shareholders meeting or one year from the occurrence of the event that caused the failure to comply with this requirement; provided, however, that if the annual shareholders meeting occurs no later than 180 days following the event that caused the failure to comply with this requirement, the Company shall instead have 180 days from such event to regain compliance. A Company relying on this provision shall provide notice to NASDAQ immediately upon learning of the event or circumstance that caused the noncompliance. Id. 5605(b)(1)(A). 35. NASDAQ Approval, supra note 1, at 4568.

9 NYSE and NASDAQ Listing Rules Raise the Accountability of Company Boards 143 appointment, compensation, and oversight of each adviser that it retains, and (ii) a company provide appropriate funding to its compensation committee to allow the committee to pay reasonable compensation to its advisors. 36 NYSE. Existing NYSE listing standard subsection 303A.05(b) already substantially reflected the SEC Rule provisions. Nevertheless, largely for the sake of clarity, the NYSE adopted the SEC Rule provisions verbatim as new subsection 303A.05(c). Subsection 303A.05(b), in turn, was revised to state that the compensation committee charter must provide for the specified powers. The new NYSE listing standards do not, however, require a compensation committee to retain its own advisors. Compensation committee charters of NYSE listed companies were required to meet these standards as of July 1, NASDAQ. Similar to the new NYSE listing standards, the new NASDAQ listing standards also incorporate the above SEC factors and do not mandate that a compensation committee retain its own advisors. Although not required by the SEC Rules, the new NASDAQ Rules require each NASDAQ listed company to adopt a formal, written compensation committee charter, which charter must be adopted by the earlier of (i) the company s first annual meeting of shareholders held after January 15, 2014, or (ii) October 31, A NASDAQ listed company s compensation committee charter must specify the following: The scope of the compensation committee s responsibilities, and how it carries out those responsibilities, including structure, processes, and membership requirements; The compensation committee s responsibility for determining, or recommending to the board for determination, the compensation of the chief executive officer and all other executive officers of the NASDAQ listed company; That the chief executive officer of the NASDAQ listed company may not be present during voting or deliberations by the compensation committee on his or her compensation; and That a compensation committee must have the specific compensation committee responsibilities and authority necessary to comply with SEC Rules relating to: (i) the authority to retain compensation consultants, independent legal counsel, and other compensation advisers; (ii) the authority to fund such advisors; and (iii) the responsibility to consider certain independence factors before selecting such advisors, other than in-house legal counsel SEC Rules Release, supra note 4, at Id. 38. NASDAQ Rules, supra note 12, 5605(d)(1). 39. NASDAQ Approval, supra note 1, at 4556.

10 144 The Business Lawyer; Vol. 69, November 2013 The first three of these compensation committee charter requirements for NASDAQ listed companies are based on existing NASDAQ Rules applicable to compensation committees (or committees currently performing functions typically performed by compensation committees) and, therefore, should not require any new action on the part of a NASDAQ listed company s board or compensation committee (unless, of course, the compensation committee is newly formed). 40 The final compensation committee charter requirement is modeled after NASDAQ Rule 5605(c)(1)(D) related to audit committee charters and, thus, introduces new authority requirements and responsibilities for compensation committees. 41 Compliance with the final compensation committee charter requirement requires action on the part of a board prior to the deadline to ensure that the compensation committee charter explicitly provides the compensation committee with such authority and responsibilities. Importantly, a NASDAQ listed company must, no later than thirty days after the final implementation deadline applicable to the company, submit to NASDAQ certification, on a form provided by NASDAQ, that the company has complied with the new NASDAQ Rules. 42 COMPENSATION COMMITTEE REVIEW OF FACTORS IMPACTING COMPENSATION ADVISER INDEPENDENCE The SEC Rules require a compensation committee to take into consideration the following factors that could bear on the independence of any compensation advisers, including compensation advisers that a compensation committee or management of a listed company retains: The provision of other services to the listed company by the employer of the compensation adviser ( advisory employer ); The amount of fees received from the listed company by the advisory employer as a percentage of the total revenue of the advisory employer; The advisory employer s policies and procedures designed to prevent conflicts of interest; Business or personal relationships of the compensation adviser with compensation committee members; Any stock in the listed company owned by the compensation adviser; and Business or personal relationships of the advisory employer or the compensation adviser with executive officers of the listed company These requirements are based on existing NASDAQ Rules 5605(c)(1)(A), 5605(d)(1) and (2), and 5605(d)(1), respectively. 41. NASDAQ Approval, supra note 1, at NASDAQ Rules, supra note 12, 5605(d)(6) C.F.R C-1 (2013).

11 NYSE and NASDAQ Listing Rules Raise the Accountability of Company Boards 145 In commentary to the SEC Rules, the SEC stated that the factors should be considered in their totality and that no one factor should be viewed as a determinative factor of independence. 44 Furthermore, the SEC clarified that compensation committees may select any Compensation Adviser they prefer, including ones that are not independent, after considering the six independence factors outlined in the final rule. 45 Neither the NYSE nor NASDAQ requires selection of a compensation adviser who is determined to be independent. As a result, the requirements under the SEC Rules and the revised listing rules affect the compensation committee s review of the independence and potential conflicts of compensation advisers, but do not dictate the outcome of the selection process. NYSE. The NYSE adopted essentially verbatim the forgoing six factors set forth in the SEC Rules and did not add any additional specific factors. While not adding any additional specific factors, subsection 303A.05(c) is broader in scope than what the SEC Rules require because it compels an NYSE compensation committee to consider all factors relevant to that Compensation Adviser s independence from management prior to selecting the Compensation Adviser as an adviser to the committee. 46 The new NYSE listing standards require that the NYSE compensation committee undertake this analysis prior to selecting any compensation adviser. Although not stated in the new NYSE listing standards, the SEC order approving the new listing standards indicates that the SEC anticipates that a compensation committee will conduct the required independence assessment not less than annually. 47 The broad language arguably makes it more difficult for a compensation committee to satisfy the requirement than would have been the case if the committee could simply have focused on the six factors. However, the NYSE s director independence listing standards have long required the board to consider all factors impacting director independence, and as noted above, the new NYSE listing standards use similar language in describing the requirement that applies to compensation committee member independence. The six factors listed above are required considerations, but commentary to the new NYSE listing standards confirms that a compensation committee may use compensation advisers that are not independent so long as the compensation committee undertakes such analysis for each compensation adviser. 48 Consistent with the SEC Rules, the new NYSE listing standards do not require that a compensation committee engage in such analysis with respect to in-house legal counsel, as the committee is on notice that in-house legal counsel are not disinterested. 49 Similarly, no such independence analysis is required with respect to a 44. Id. 45. Id. 46. NYSE MANUAL, supra note 9, 303A.05(c)(iv). 47. NYSE Approval, supra note 1, at NYSE MANUAL, supra note 9, 303A.05(c)(iv). 49. The first amendment to the NASDAQ proposal deleted the word independent prior to legal counsel in NASDAQ Rule 5605(d)(3), thus clarifying that compensation committees of

12 146 The Business Lawyer; Vol. 69, November 2013 compensation adviser whose role is limited to (a) consulting on any broad-based plan that does not discriminate in scope, terms, or operation in favor of executive officers or directors and that is generally available to all salaried employees, or (b) providing information that is not customized for a particular company or that is customized based on parameters that are not developed by the adviser and about which the adviser does not provide advice. 50 The new NYSE listing standards also include, consistent with the SEC Rules, an express statement that a compensation committee is not required to implement or act consistently with the advice or recommendations of retained advisors and that the factors to be considered by the compensation committee do not affect the ability or obligation of the compensation committee to exercise its own judgment in the fulfillment of its duties. 51 In response to multiple comments, the NYSE expressly considered, but did not impose, a disclosure requirement relating to compensation advisers. 52 One commenter specifically proposed requiring, with respect to outside counsel that the compensation committee hires, the same disclosure that SEC rules require with respect to the nature of any conflict that arises from the engagement of a compensation consultant. 53 The NYSE did not believe that it was necessary to establish additional disclosure requirements. With respect to disclosure of any conflicts of interest that may arise with respect to outside counsel that the committee hires, the NYSE stated its belief that the rigorous conflict of interest requirements applicable to attorneys adequately address the commenter s concerns. 54 As of July 1, 2013, an NYSE listed company compensation committee is no longer permitted to select, or receive advice from, an adviser unless it has conducted an independence assessment as required by the new NYSE listing standards. 55 NASDAQ. In line with the SEC Rules, the new NASDAQ Rules require the compensation committee of a NASDAQ listed company to take into consideration specified factors that could bear on the independence of any compensation advisers to the committee, including compensation advisers that the compensation committee retains or that management retains. 56 As of July 1, 2013, a compensation committee is no longer allowed to select, or receive advice from, a compensation adviser unless it has conducted an independence assessment as NASDAQ listed companies are required to consider the independence factors specified in SEC Rule 10C-1(4)(i) (vi) when selecting, or receiving advice from, any legal counsel (except in-house legal counsel). NASDAQ Approval, supra note 1, at NYSE MANUAL, supra note 9, 303A.05. These two limited exceptions for certain compensation advisers essentially track the exception set forth in Item 407(e)(3)(iii) of Regulation S-K to the disclosure requirements regarding a compensation committee s role in determining or recommending the amount and form of executive and director compensation. 51. NYSE Approval, supra note 1, at NYSE Initial Proposal, supra note 7, at Id. 54. Id. 55. NYSE Approval, supra note 1, at NASDAQ Rules, supra note 12, 5605(d)(3).

13 NYSE and NASDAQ Listing Rules Raise the Accountability of Company Boards 147 the new NASDAQ Rules require. 57 The SEC order approving the new NASDAQ Rules indicates that compensation committees should conduct the required independence assessment not less than annually. 58 NASDAQ adopted exclusively the list of six factors set forth in the SEC Rules and did not impose any specific additional factors. The new NASDAQ Rules do not, in fact, specify the six factors; rather, NASDAQ Rule 5605(d)(3) simply requires a NASDAQ listed company to give its compensation committee the responsibility to consider the six factors enumerated in the SEC Rules before selecting compensation advisers. 59 The new NASDAQ Rules make clear that, consistent with SEC Rule 10C-1(b)(2)(iii), compensation committees are not required to implement or act consistently with the advice or recommendations of retained compensation advisers. 60 Moreover, the six factors that the compensation committee must consider do not affect the ability or obligation of the compensation committee to exercise its own judgment in the fulfillment of its duties. Further, the new NASDAQ Rules expressly state that a compensation committee is not precluded from selecting or receiving advice from a compensation adviser that is not independent. 61 As with NYSE Listed Companies, a NASDAQ listed company need not conduct such independence assessment with respect to in-house legal counsel or any compensation adviser whose role is limited to: (a) consulting on any broad-based plan that does not discriminate in scope, terms, or operation in favor of executive officers or directors and that is generally available to all salaried employees; or (b) providing information that is not customized for a particular company or that is customized based on parameters that are not developed by the adviser, and about which the adviser does not provide advice. 62 CURE PERIODS AND PHASE-IN COMPLIANCE SEC Rule 10C-1 requires the rules of an exchange to provide for appropriate procedures for a listed company to have a reasonable opportunity to cure any defects that would be the basis for the exchange, under SEC Rule 10C-1, to prohibit the listed company s listing. 63 SEC Rule 10C-1 also specifies that, with respect to the independence standards adopted in accordance with the requirements of the rule, an exchange may provide a cure period until the earlier of the next annual shareholders meeting of the listed company or one year from the occurrence of the event that caused the member to be no longer independent NASDAQ Approval, supra note 1, at Id. at NASDAQ Rules, supra note 12, 5605(d)(3). 60. Id. 61. Id. 62. Id. 63. See 17 C.F.R C-1 (2013). 64. Id.

14 148 The Business Lawyer; Vol. 69, November 2013 NYSE. Under the new NYSE listing standards, if a compensation committee member ceases to be independent in accordance with the new NYSE listing standards for reasons outside the member s reasonable control, then the member, with notice by the NYSE listed company to the NYSE, may remain a member until the earlier of the next annual meeting of shareholders or one year from the occurrence of the event that caused the member to be no longer independent. 65 The new NYSE listing standards, however, would limit the use of this cure provision to circumstances where the compensation committee would continue to have a majority of independent directors. 66 The NYSE indicates that this requirement would address any actual or apparent conflict of interest resulting from a non-independent director s service on the compensation committee. 67 A company relying on the cure period must promptly notify the NYSE. 68 NASDAQ. NASDAQ s cure period pertaining to its new listing standards is the same as the cure period currently provided in NASDAQ s rules for noncompliance with the requirement that a majority of board members be independent. Under the existing NASDAQ rules, [I]f a listed company fails to comply with the compensation committee composition requirements due to one vacancy, or if one compensation committee member ceases to be independent due to circumstances beyond the member s reasonable control, the company must regain compliance by the earlier of the next annual shareholders meeting or one year from the occurrence of the event that caused the noncompliance. However, if the annual shareholders meeting occurs no later than 180 days following the event that caused the noncompliance, the company instead has 180 days from the event to regain compliance. 69 As explained by NASDAQ, this provides a company at least 180 days to cure noncompliance and would typically allow a company to regain compliance in connection with its next annual meeting. Any company relying on this rule must notify NASDAQ immediately upon learning of the event or circumstance that caused the non-compliance. 70 Under the new NASDAQ Rules, NASDAQ s existing phase-in schedules for compensation-related listing rules, applicable to companies listing on NASDAQ in connection with an initial public offering, NASDAQ listed companies emerging from bankruptcy, and NASDAQ listed companies ceasing to be controlled companies, would remain generally unchanged. 71 The new NASDAQ Rules clarify that such a NASDAQ listed company could phase in compliance with the minimum compensation committee size requirement and additional compensation committee member eligibility requirements in reliance on these schedules NYSE MANUAL, supra note 9, 303A Id. 67. NYSE Initial Proposal, supra note 7, at NYSE MANUAL, supra note 9, 303A NASDAQ Rules, supra note 12, 5605(d)(4). 70. Id. 5605(b)(1)(A). 71. Id. 5615(b). 72. Id.

15 NYSE and NASDAQ Listing Rules Raise the Accountability of Company Boards 149 EXEMPTIONS NYSE. The new NYSE listing standards provide an exemption for all categories of listed companies that are currently exempt from the NYSE s existing compensation committee requirements, including controlled companies, limited partnerships, and companies in bankruptcy, closed-end and open-end funds registered under the Investment Company Act of 1940, passive business organizations in the form of trusts (such as royalty trusts), derivatives and special purpose securities (as described in sections and of the NYSE Listed Company Manual), and listed companies whose only listed equity security is a preferred stock. 73 NASDAQ. The new NASDAQ Rules also provide an exemption for all categories of listed companies that are currently exempt from NASDAQ s existing compensation committee requirements, including asset-backed issuers and other passive issuers, cooperatives, limited partnerships, management investment companies and controlled companies, as well as foreign private issuers that provide the disclosures already required in the NASDAQ Rules. 74 SMALLER REPORTING COMPANIES NYSE. Smaller reporting companies are not required to comply with the new NYSE listing standards regarding compensation committee member independence standards or compensation adviser independence considerations, but must comply with all other new NYSE listing standards regarding the authority and responsibilities of compensation committees. 75 Pursuant to the amendment to the initial NYSE proposal, dated January 8, 2013, the start date of the sixmonth transition period for complying with the new NYSE listing standards applicable to companies exiting smaller reporting company status begins on the date on which the company actually ceases to be a smaller reporting company. 76 NASDAQ. The new NASDAQ listing standards provide that smaller reporting companies would not be required to adhere to the higher independence standards for compensation committee members or to consider the six factors enumerated in the SEC Rules before selecting compensation advisers (although a smaller reporting company would be required to have a compensation committee and a compensation committee charter or Board resolution that specifies the committee s responsibilities and authority). 77 A NASDAQ listed company ceasing to be a smaller reporting company will be allowed six months (as opposed to the originally proposed thirty days) to certify that it has adopted a formal written compensation committee charter, which includes the compensation committee 73. NYSE MANUAL, supra note 9, 303A NASDAQ Rules, supra note 12, NYSE MANUAL, supra note 9, 303A NYSE Approval, supra note 1, at NASDAQ Approval, supra note 1, at 4567.

16 150 The Business Lawyer; Vol. 69, November 2013 responsibility and authority requirements under the new NASDAQ Rules. 78 In addition, any such company will be allowed to phase in a fully compliant compensation committee, particularly as such compliance relates to the compensation committee member independence requirements pertaining to the receipt of compensatory fees and affiliations. 79 ACTIONS NYSE LISTED COMPANIES SHOULD TAKE NOW NYSE listed companies should act promptly to ensure timely compliance with the new NYSE listing standards, including taking the following steps: 1. Review current arrangements with compensation advisers under the six factors and other relevant factors that may bear on independence. An NYSE listed company should review arrangements with current compensation advisers and carefully consider each of the six factors enumerated in SEC Rule 10C-1(b)(4) and incorporated into the new NYSE Rules. An NYSE listed company also should be thinking about what other factors could be relevant to its choice of compensation advisers, particularly in light of the nature of the company. NYSE listed companies should keep in mind that this rule became effective July 1, 2013 (i.e., as of July 1, 2013, a compensation committee may no longer select, or receive advice from, an adviser unless it has conducted this independence assessment with respect to the adviser). An NYSE listed company or its compensation committee should obtain from compensation advisers adequate information to enable the compensation committee to consider all relevant factors, including the six enumerated factors. The compensation committee may then determine whether there is information as to any compensation adviser that concerns the committee, keeping in mind that there is no requirement that a compensation committee only use compensation advisers that are in fact independent. If the NYSE listed company, rather than its compensation committee, is generally involved in gathering information, then the company should advise the compensation committee of the new NYSE listing standards, share relevant information and seek feedback. Ultimately, the committee will need to make the assessment. If the information raises valid concerns, then the compensation committee will need to consider what actions to take to address the situation. 2. Review engagement arrangements between compensation committees and compensation advisers. Given that an NYSE listed company s compensation committee is directly responsible for the appointment, compensation, and oversight of the work of any compensation advisers that 78. Id. at Id.

17 NYSE and NASDAQ Listing Rules Raise the Accountability of Company Boards 151 the compensation committee retains, the NYSE listed company should review the relationships between its compensation committee and its compensation advisers to ensure the proper level of committee involvement. 3. Review current compensation committee charter and ensure that it contains provisions regarding committee authority to retain advisors. The new NYSE listing standards do not significantly alter the NYSE s current listing standards with regard to this subject matter, but an NYSE listed company should confirm that its compensation committee charter expressly provides that (i) the compensation committee has the authority to retain its own compensation advisers, (ii) the compensation committee is directly responsible for the appointment, compensation, and oversight of each adviser that it retains and (iii) the NYSE listed company must provide appropriate funding to the compensation committee. If a compensation committee charter does not expressly provide for such authority or any of these responsibilities, appropriate provisions must be immediately incorporated into the compensation committee charter as such requirements became effective July 1, This will likely require board action and, perhaps, action by one or more board committees. 4. Review current compensation committee membership in light of the new membership standards, which will be effective the earlier of (i) an NYSE listed company s first annual meeting of shareholders held after January 15, 2014, or (ii) October 31, NYSE listed companies should pay special attention to the sources of compensation of compensation committee members, including any consulting, advisory, or other compensatory fees paid by the NYSE listed company or any other source to any member. An NYSE listed company also should focus on whether a compensation committee member is affiliated with the NYSE listed company, a subsidiary of the NYSE listed company, or an affiliate of a subsidiary of the NYSE listed company. In addition to these two factors, the board must consider all other factors relevant to each compensation committee member s independence. A board has broad discretion to determine how the specified factors and any other relevant factors may affect a compensation committee member s independence, but it should be able to show that it considered the specified factors and any other relevant factors. In particular, a board should be able to justify why fees or affiliations would, or would not, disqualify a compensation committee member. Such factors must be addressed no later than the earlier of (i) an NYSE listed company s first annual meeting of shareholders after January 15, 2014, or (ii) October 31, Generally speaking, an NYSE listed company will need to address these factors prior to preparing and sending its proxy materials for its 2014 annual meeting of shareholders.

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