Final Stock Exchange Rules for Compensation Committees and Advisers

Final Stock Exchange Rules for Compensation Committees and Advisers SEC Approves NYSE and Nasdaq Revised Listing Standards; Board Action Required by July 1, 2013 with Regard to Compensation Committee Authority over Compensation Advisers SUMMARY On January 11, 2013, the SEC approved revisions to the equity listing standards of the New York Stock Exchange, the Nasdaq Stock Market and a number of other exchanges relating to compensation committee and compensation adviser independence. These revisions were proposed by the exchanges in September 2012 in response to SEC rules issued under the Dodd-Frank Wall Street Reform and Consumer Protection Act. Under the final NYSE and Nasdaq rules, all U.S.-listed companies must expand the authority of their compensation committees with respect to the oversight of compensation consultants, outside legal counsel and other advisers to the committee by July 1, 2013, and thereafter a compensation committee may select or receive advice from an adviser only after conducting an independence assessment. The primary difference between the proposed rules and the final rules, other than the alignment of effective dates, is that the final NYSE and Nasdaq rules do not require the compensation committee to assess independence in the case of a compensation adviser that merely consults on broad-based plans or provides non-customized or issuer-specified information. Consistent with the proposed rules, compensation committee members of both NYSE- and Nasdaq-listed companies will be subject to enhanced independence standards and the Nasdaq rules will, for the first time, require listed companies to have a standing compensation committee and written compensation committee charter. The Nasdaq compensation committee independence rules are more restrictive than the NYSE rules in that the receipt by a compensation committee member of compensatory fees from the company (other than for board service or fixed amounts under a retirement plan that are not contingent New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney www.sullcrom.com

on future service) will be a bar to independence under the Nasdaq rules, but will only be a factor for the board to consider under the NYSE rules. The rules relating to compensation committee authority and responsibilities, including assessing the independence of advisers, will take effect on July 1, 2013, and by that date NYSE-listed companies must update their compensation committee charters to reflect the committee s increased authority and responsibility. The remaining provisions of the rules, including Nasdaq s requirement that issuers have a standing compensation committee and written compensation committee charter and the NYSE and Nasdaq independence rules for compensation committee members, will take effect on the date of the Company s 2014 annual meeting or, if earlier, October 31, 2014. BACKGROUND Pursuant to Section 952 of the Dodd-Frank Act, the SEC adopted Rule 10C-1 under the Securities Exchange Act of 1934 in June 2012. Rule 10C-1 directs national securities exchanges to prohibit the listing of any equity security of any issuer that fails to: require each member of the issuer s compensation committee to be independent ; grant the compensation committee the authority to obtain the advice of independent advisers, for which the issuer must provide appropriate funding; and require compensation committees to consider the independence of any compensation advisers. The NYSE, Nasdaq and certain other securities exchanges 1 filed proposed rule changes in September 2012, which were published for comment by the SEC in October 2012. 2 Through subsequent amendments, the proposals were harmonized in certain ways, including as to their effective dates. 3 Following a public comment period and a review of comment letters on the proposed rule changes, the SEC approved the rule proposals as amended. 1 2 3 This publication focuses on the NYSE and Nasdaq rules, as these represent the vast majority of common stock listings in the U.S. The SEC has also approved revised compensation committee rules for the BATS Exchange, Inc., NASDAQ OMX, BX, Inc., Chicago Stock Exchange, Inc., Chicago Board Options Exchange, Incorporation, National Stock Exchange, NYSE MKT LLC and NYSE Arca LLC. For additional background on the initial NYSE and Nasdaq proposals, please see our publication, dated October 2, 2012, entitled Exchanges Propose Compensation Committee Independence Standards. Each of the NYSE and Nasdaq filed amendments to its proposals. Nasdaq filed amendments on December 12, 2012 and January 4, 2013. The NYSE filed amendments on October 1, 2012, December 4, 2012 (which was later withdrawn) and January 8, 2013. -2-

EXCLUSIONS FOR INVESTMENT COMPANIES, NON-U.S.-LISTED COMPANIES AND OTHERS Companies that are currently exempt from the compensation committee and independence requirements under NYSE or Nasdaq rules will continue to be exempt from such requirements. This would include, among others, controlled companies, certain passive issuers, limited partnerships, investment companies and companies in bankruptcy. In particular, both open-end and closed-end funds are exempt from all provisions of the new rules. A foreign private issuer that follows home country practices is automatically exempt from the relevant requirements if the issuer discloses, in its annual report to shareholders or on its website, any significant ways in which its corporate governance practices differ from those followed by domestic companies under applicable listing standards. The Nasdaq rules will also require foreign private issuers to disclose in their annual report the reason why they do not have an independent compensation committee. Additionally, the rules exempt smaller reporting companies (as defined in SEC rules) from certain of the heightened independence standards and the new requirements relating to compensation committee advisers. Smaller reporting companies will, however, be subject to: the new Nasdaq requirement for a standing compensation committee with a formal written charter; existing governance listing standards, including the requirement that compensation committee members be independent directors, as currently defined; and NYSE requirements with respect to the compensation committee s authority and funding to engage compensation advisers, but not the requirement to consider certain enumerated independence factors. DETAILS OF REVISED NYSE AND NASDAQ RULES Compensation Committee Charters. NYSE rules already require, and the new Nasdaq rules will require, that listed companies have a standing compensation committee and a formal written compensation committee charter. Under Nasdaq rules, the charter, which must be reviewed by the Compensation Committee on an annual basis, must specify: the scope of the committee s responsibilities and how it carries out those responsibilities; the committee s responsibility for determining, or recommending to the board for determination, executive officer compensation; that the chief executive officer may not be present during voting or deliberations by the committee on his or her compensation; and the specific compensation committee responsibilities as to authority over retaining and compensating compensation consultants, outside legal counsel and other compensation advisers ( Advisers ) and responsibility to assess Adviser independence before selecting or receiving advice from an Adviser. -3-

The NYSE rule changes expand the current requirements for compensation committee charters to require the inclusion of language giving the committee authority over retaining and compensating Advisers and responsibility to assess Adviser independence before selecting or receiving advice from an Adviser. Compensation Committee Director Independence Requirements. In determining whether a director is independent 4 for purposes of participation on the compensation committee, the NYSE rules will require that the board consider all factors specifically relevant to determining whether the director has a relationship to the listed company that 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, the following two factors: Whether a source of the director s compensation would impair the director s ability to make independent judgments about the company s executive compensation. Whether any 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 listed company s executive compensation. The Nasdaq rules will require that compensation committee members be deemed independent by the Board under existing independence standards and that, as part of its assessment of a director s independence, the board must consider whether the director is affiliated with the company, its subsidiaries or an affiliate of the company or its subsidiaries such that the director s judgment as a member of the compensation committee would be impaired. The NYSE rules do not impose any bright-line rules with regards to the independence determination. The Nasdaq rules, however, will prohibit a compensation committee member from directly or indirectly accepting any consulting, advisory or other compensatory fee 5 from the issuer or any subsidiary during the director s term on the compensation committee. This Nasdaq prohibition will not have a look-back requirement; only compensatory fees received while a member of the compensation committee will impair independence. The final NYSE and Nasdaq rules both make clear that the board may determine that a compensation committee member is independent despite the director, or an affiliate of the director, having a significant 4 5 In determining whether a director is an Independent Director, current NYSE and Nasdaq listing standards enumerate certain bright-line tests and also require that the listed company s board make an affirmative independence determination. See Nasdaq Rule 5605(a)(2) and Section 303A.02(a)-(b) of the NYSE Listed Company Manual. Compensatory fees do not include fees received as a director or committee member or fixed amounts of compensation under a retirement plan, including deferred compensation, for prior service with the company, provided that such compensation is not contingent on continued service. -4-

stock position in the company and the exchanges filings suggest that, in certain circumstances, it may be appropriate for affiliates such as representatives of significant stockholders to serve on the committee. Compensation Committee Advisers. Under the NYSE and Nasdaq rules, compensation committees will be required to have broad authority to engage Advisers and must have appropriate funding, as determined by the compensation committee, for the payment of reasonable compensation to any Adviser. Before selecting or receiving advice from an Adviser, the compensation committee is required to consider the following independence factors, which must be set forth in the committee s charter: the provision of other services to the listed company by the person that employs the Adviser; the amount of fees received from the listed company by the person that employs the Adviser, as a percentage of the total revenue of such employer; the policies and procedures of the person that employs the Adviser that are designed to prevent conflicts of interest; any business or personal relationship of the Adviser with a member of the compensation committee; any stock of the listed company owned by the Adviser; and any business or personal relationship of the Adviser or the person employing the Adviser with an executive officer of the listed company. 6 The compensation committee is not required to obtain the advice of an Adviser and is not prohibited from receiving advice from an Adviser that is not independent; the rules only require that, if the committee chooses to obtain the advice of an Adviser, the independence factors be considered before the committee retains or receives advice from any Adviser. The rules confirm that compensation committees are not required to implement or act consistently with the advice or recommendations of an Adviser and the committee may exercise its own judgment in fulfilling its duties. The final NYSE and Nasdaq rules add that a compensation committee is not required to assess the independence of an Adviser whose services are limited to (i) consulting on any broad-based, nondiscriminatory plan that is generally available to all salaried employees or (ii) providing information that either is not customized for the issuer or is customized based on parameters that are not developed by the Adviser, and about which the Adviser does not provide advice. 7 In addition, the requirement to assess the independence of Advisers applies to outside legal counsel that provides advice to the compensation committee, but not in-house counsel. Cure Periods. Rule 10C-1(a)(3) requires that national securities exchanges give listed issuers a reasonable opportunity to cure a failure to meet the enhanced independence standards. The NYSE and 6 7 These factors are consistent with those enumerated in Rule 10C-1(b)(4). This exception is based on the limited exception to the disclosure requirements related to the role of compensation consultants in determining executive compensation contained in Item 407(e)(3)(iii) of Regulation S-K. -5-

Nasdaq rules provide that, if a member of a compensation committee ceases to be independent for reasons outside the director s reasonable control, that person may remain a member of the compensation committee until the earlier of the next annual meeting or one year from the occurrence of the event resulting in a lack of independence. Nasdaq further provides for a minimum cure period of 180 days, and the NYSE rules provide that the cure period applies only if the compensation committee continues to have a majority of independent directors. Exceptional and Limited Circumstances under Nasdaq Rules. The Nasdaq rules retain the current exception to the Nasdaq independence listing standards that permits a non-independent director to serve on the compensation committee under exceptional and limited circumstances, even if the director fails to meet the Nasdaq independence requirements. A director who is not independent and is not an executive officer, employee or family member of an executive officer may serve on the compensation committee under exceptional and limited circumstances for a maximum of two years if: the compensation committee consists of at least three members; the board determines that such director s membership on the compensation committee is required by the best interests of the company and its shareholders; the company discloses, either on the company s website or in the proxy statement for the next annual meeting of shareholders, the nature of the relationship and the reasons for the board s determination; and the company discloses its reliance on the exemption in its proxy statement as required by Instruction 1 to Item 407(a) of Regulation S-K. TIMING AND IMPLEMENTATION The NYSE and Nasdaq rule changes relating to the authority of the compensation committee to retain and fund Advisers and the committee s responsibility to consider the independence factors before selecting or receiving advice from Advisers take effect on July 1, 2013. Issuers must comply with the remaining rule changes, including, in the case of Nasdaq-listed companies, the requirement to have a standing compensation committee and written formal charter, by the earlier of (a) the first annual meeting after January 15, 2014 or (b) October 31, 2014. If a Nasdaq-listed company does not have a compensation committee on July 1, 2013, the applicable rules will apply to the independent directors who determine, or recommend to the board for determination, executive compensation. The compensation committee independence requirements will be subject to the existing transition periods applicable in the case of initial public offerings, companies listing in connection with a spin-off or carveout, companies emerging from bankruptcy, and companies that cease to qualify as controlled companies or foreign private issuers. -6-

IMPLICATIONS AND NEXT STEPS Issuers that have adopted a compensation committee charter should consider the manner in which the charter will need to be updated by July 1, 2013 to reflect the committee s expanded authority, and should take steps to ensure that the compensation committee makes the appropriate independence assessments before selecting a new Adviser or receiving advice from a current Adviser after July 1, 2013. As discussed in our previous publication regarding the NYSE and Nasdaq proposals, issuers should consider soliciting information from compensation committee members, executive officers and Advisers to the compensation committee to provide a basis for these independence assessments. Moreover, any Nasdaq-listed company that has not yet adopted a compensation committee charter should begin the process of preparing a charter and moving through the approval process. We would be pleased to assist clients in revising their Director and Officer Questionnaires, preparing a compensation adviser questionnaire or preparing a new or revised compensation committee charter. * * * Copyright Sullivan & Cromwell LLP 2012-7-

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