September 2012 Securities Update IN THIS ISSUE 1 NYSE and NASDAQ Propose New Compensation Committee Listing Standards NYSE and NASDAQ Propose New Compensation Committee Listing Standards By Troy M. Calkins and Kimberly K. Rubel The Securities and Exchange Commission in June 2012 adopted Rule 10C-1 of the Securities Exchange Act of 1934 pursuant to Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Rule 10C-1 in part requires national securities exchanges to adopt listing standards for public companies addressing the independence of compensation committee members and the use by compensation committees of compensation advisers. Our prior article discussing Rule 10C-1 in detail can be found at http://www.drinkerbiddle. com/resources/publications/2012/securities-update- June-2012. 5 Tougher Iran Sanctions Approved by Congress May Affect U.S. Parent Companies 6 Why Your Board Needs to Think about Swaps The NYSE and NASDAQ have now proposed amendments to their respective listing standards relating to compensation committees of listed companies pursuant to Rule 10C-1. The full text of the proposed rule changes can be found for the NYSE at http://www.nyse.com/nysenotices/nyse/rule-filings/ pdf?file_no=sr-nyse-2012-49&seqnum=2 and for NASDAQ at http://nasdaq.cchwallstreet.com/nasdaq/pdf/nasdaqfilings/2012/sr-nasdaq-2012-109.pdf. Timing The SEC will accept comments for a 21-day period, after which the SEC will decide whether to approve the listing standards as proposed or require the exchanges to make changes. There are differences between the two proposals, so the SEC also may ask the exchanges to sync up their approaches in some respects. Rule 10C-1 requires the SEC to declare the listing standards effective by July 27, 2013. NYSE companies would have to comply with the new standards by the earlier of the first annual shareholder meeting after January 15, 2014 and October 31, 2014. NASDAQ companies would have to comply by the earlier of the second annual shareholder meeting after the final rules are issued and December 31, 2014, except that standards relating to the compensation committee s authority to retain independent advisers and responsibility to consider adviser independence would be effective upon final rule approval. Heightened Compensation Committee Independence Standards Rule 10C-1 requires boards to consider both the sources of compensation of a compensation committee member and the member s affiliations with the company.
While the Rule permits the exchanges to specify additional factors, neither the NYSE or NASDAQ did so. As required by Rule 10C-1, both exchanges proposed listing standards contain cure periods that allow companies to correct deficiencies under specified limited circumstances. NYSE In addition to general director independence standards, the proposed NYSE listing standards would require the board to affirmatively determine the independence of each compensation committee member considering all factors relevant to determining whether he or she has a relationship with the company that is material to his or her ability to be independent from management in connection with his or her duties as a committee member. The board s consideration must include, but need not be limited to: > Sources of compensation, including any consulting, advisory or other compensatory fees paid by the company to the director. In commentary, the NYSE states that the board should consider whether the committee member receives compensation from any person or entity that would impair his or her ability to make independent judgments about the company s executive compensation. > Affiliations with the company, a subsidiary of the company or an affiliate of a subsidiary of the company. As explained by the NYSE in commentary, the board should consider whether an affiliate relationship places the committee member under the direct or indirect control of the company or its senior management, or creates a direct relationship between the director and senior management members, in each case of a nature that would impair his or her ability to make independent judgments about the company s executive compensation. The NYSE retained commentary to director independence standards noting that ownership of even a significant amount of company stock would not, by itself, preclude finding that a director is independent. While the board must consider these factors, this is not a bright-line test, and the board may find a director independent even though he or she receives a compensatory fee from or has an affiliation with the company, so long as his or her ability to make independent judgments about the company s executive compensation is not impaired. NASDAQ The NASDAQ proposal would require compensation committee members to meet general independence standards and prohibit them from accepting, directly or indirectly, any consulting, advisory or other compensatory fees from the company or any of its subsidiaries, other than board and committee fees and fixed amounts under retirement plans for prior service. Unlike the NYSE, NASDAQ proposes a bright-line test, such that the receipt of any consulting, advisory or other compensatory fees by a director would preclude serving on the compensation committee, the same standard NASDAQ applies to audit committee members. Though not a bright-line test, NASDAQ company boards would also have to consider whether compensation committee members are affiliated with the company, a subsidiary of the company or an affiliate of a subsidiary of the company and whether any affiliation would impair his or her judgment as a member of the compensation committee. In commentary, NASDAQ states that it does not view ownership of company stock in and of itself as a bar to compensation committee service, even if that ownership constitutes control. 2
The board is not required to apply a look back in making these determinations, so the prohibition on fees and affiliations that must be considered are limited to those fees received or affiliations that existed during a director s committee service. Compensation Committee Authority and Responsibility The NYSE listing standards currently require compensation committees to have charters, but the charters will need to be amended to reflect the authority and responsibilities of committees as required under these new compensation committee and adviser independence rules, including that the committee has the sole discretion to retain compensation advisers and direct responsibility for the appointment, compensation and oversight of compensation advisers. As now required for NYSE companies, the proposed NASDAQ listing standards would require NASDAQ companies to have an independent compensation committee with at least two members. NASDAQ also proposes to require compensation committees to have a charter that addresses the committee s structure, authority and responsibilities and includes the currently applicable prohibition on the chief executive officer being present during voting or deliberations on his or her compensation. The committee would have to review and assess the adequacy of the charter annually. Compensation Committee Adviser Independence The NYSE and NASDAQ proposed standards would require compensation committee charters to state that the committee must consider conflicts of interest before selecting consultants, counsel or other advisers (other than in-house legal counsel). While compensation committees must consider these factors prior to selecting an adviser, it is important to note that the rules would not limit the committee to selecting only independent advisers. The exchanges propose requiring that compensation committees may select an adviser only after considering the six independence standards specified by the SEC in Rule 10C-1 and, in the case of NYSE companies, any other factors relevant to the adviser s independence. The standards specified in Rule 10C-1 include: > whether the company employing the compensation adviser is providing any other services to the listed company; > the amount of fees the company employing the compensation adviser has received from the listed company, as a percentage of the consulting company s total revenue; > what policies and procedures have been adopted by the 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 (which the SEC interprets to include stock owned by the adviser and his or her immediate family members); and > whether the compensation adviser or the company employing the adviser has any business or personal relationship with an executive officer of the listed company. 3
Neither exchange has proposed additional standards or elaborated on the Rule 10C-1 standards, and no doubt questions will arise. For example What constitutes providing advice to the committee? What types of information constitute advice that triggers the requirement? Since compensation committees are not prohibited from selecting non-independent advisers, a committee could continue to be advised by the company s outside legal counsel. As proposed, the NYSE standards would require a compensation committee to consider the six independence standards with respect to any outside legal counsel, but the NASDAQ standards would only require the committee to do so if it wanted to retain its own independent counsel. Exemptions As proposed, smaller reporting companies listed on NYSE or NASDAQ would not need to comply with the heightened compensation committee independence standards or the requirement to consider adviser independence; however, listed smaller reporting companies would have to have an independent compensation committee with a written charter. None of the new listing standards would apply to controlled companies, limited partnerships, companies in bankruptcy proceedings, open-end management investment companies registered under the Investment Company Act of 1940, and foreign private issuers that disclose in their annual report the reasons that they do not have an independent compensation committee. What Listed Companies Should Do Now Although the listing standards are subject to revision and will not be final for some time, there are several things that a listed company can do to prepare for the new requirements. > Review the applicable proposed standards and update the board and compensation committee regarding the new requirements and when they are expected to apply to the company. > Consider the independence of current compensation committee members under the proposed standards. > Determine how to assess compensation adviser independence, begin collecting conflicts information from advisers, and consider adviser independence under the proposed standards. > Consider updates to D&O questionnaire, compensation committee charter and policies, and proxy statement disclosure that will be necessary under new standards. > If you are a NASDAQ company without a separate independent compensation committee, prepare to comply with the requirement to have one. 4
Tougher Iran Sanctions Approved by Congress May Affect U.S. Parent Companies By Joan Koenig and George C. McKann The President signed the Iran Threat Reduction and Syria Human Rights Act of 2012 (H.R. 1905) into law on August 10, 2012. The legislation will significantly strengthen existing Iranian 1 sanctions and will mandate disclosure of activities that are sanctionable in public company annual and quarterly filings pursuant to the Securities Exchange Act of 1934, as amended (the Exchange Act ). Export Regulation Most notably, the statute prohibits transactions by foreign businesses that are owned or controlled by a U.S. parent company, making the Iranian sanctions more like those currently in place with respect to Cuba, where non-u.s. foreign entities are included in the definition of parties subject to U.S. jurisdiction. An important provision in the bill requires the imposition of civil penalties of up to twice the amount of the transaction on U.S. parent companies for the activities of their owned or controlled foreign entities that, if undertaken in the U.S. or by a U.S. person, would violate U.S. sanctions law. That is, if a foreign entity owned or controlled by a U.S. parent enters into an unauthorized transaction with an Iranian party, the penalty will be assessed against the U.S. parent company, not the foreign entity. This expansion of U.S. sanctions must be implemented within 60 days of the enactment of the bill, or October 9, 2012. Other than ensuring that owned/controlled foreign entities cease all transactions with Iran by October 9 (or obtain OFAC licenses for such activities, which could not possibly be completed in the time allotted), civil penalties can also be avoided if the U.S. parent divests itself of the foreign entity, or its interest therein, no later than 180 days after enactment of the bill. The extra-territorial application of sanctions is likely to be particularly problematic for several reasons. For example, under existing regulations, uncontrolled, or EAR99, medicines may be re-exported to Iran with no license required under the Export Administration Regulations, so long as they were not specifically destined for export to Iran when they left the U.S. (e.g., they are sold from inventory held outside the U.S.). After October 9, 2012, there is no indication that this regulation will change. After that date, however, non-u.s. companies owned or controlled by a U.S. parent will be largely unable to transact business with Iran at all. Therefore, a U.S. company that sells through an unrelated distributor will be in a better position to continue its status quo than a company that sells through an affiliate. In addition, although it is unlikely that other countries will be as hostile to U.S. sanctions against Iran as they are with respect to sanctions against Cuba, many countries, e.g., Canada and countries in the European Union, are currently subject to blocking legislation that prohibits them complying with a very similar extraterritorial restriction against that country. Given that implementing regulations may take years to be drafted and published, it is difficult to predict whether or how these issues may be resolved. Increased Public Company Disclosure Requirements The bill also requires Exchange Act reporting companies beginning with their first annual or quarterly periodic report filed after February 6, 2013 to disclose information 1 Although Syrian sanctions are also referenced, no substantive changes to the Syrian Sanctions Regulations are required as a result of the bill. 5
about their Iran-related activities. This required disclosure will force companies to determine whether they or any of their foreign or domestic owned/controlled entities have: > Engaged in any sanctionable activity described in the Iran Sanctions Act of 1996 which pertains to Iranian petroleum resources and products and development of Iranian weapons of mass destruction; > Engaged in any activities prohibited by the Comprehensive Iran Sanctions, Accountability and Devestment Act of 2010 relating to Iranian financial services transactions and transactions with the Iranian Revolutionary Guard Corps or any of its affiliates or representatives; > Transferred any goods, technologies or services to Iranian parties to commit human rights abuses against the people of Iran; or > Engaged in transactions with Specifically Designated Nationals, designated for involvement in terrorist activities, the proliferation of weapons of mass destruction, or being part of the Government of Iran (including owned/controlled entities), unless authorized by the Office of Foreign Asset Control of the U.S. Treasury. In each Exchange Act periodic report filed after February 6, 2013 the required disclosure must include, for any action taken during the period covered by the report: > The type and extent of the activity; > The gross revenues and net profits from the activity; and > Whether the company or any of its affiliates intends to continue the activity. In addition to the Exchange Act periodic report disclosure, the Exchange Act reporting company must also file a separate report with the Securities and Exchange Commission, which is then required to post the report on the SEC website and send the report to the President, as well as the House Committees on Foreign Affairs and Financial Services and the Senate Committees on Foreign Relations and Banking, Housing and Urban Affairs. The President is then charged with investigating whether sanctions should be imposed on the reporting company. Why Your Board Needs to Think about Swaps By Robin Sampson The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) included a mandate for new clearing requirements for swaps. While these requirements will have the biggest impact on financial institutions that act as counterparties to swaps, there are aspects of the new requirements that will impact all companies that enter into swaps. In particular, as described below, a public company will want to make sure that it obtains specific board approval prior to entering into any swaps under the new regime. The new regulatory structure will require swaps to be cleared through a derivatives clearing organization (DCO), reported to a swap data repository (SDR) or the Commodities Futures Trading Commission (CFTC), and executed on a designated 6
contract market (DCM) or swap execution facility (SEF), unless the swap has been exempted by CFTC rules. Meeting these new requirements will be burdensome to swap participants. The good news is that final rules published by the CFTC this summer clarify and give form to a relatively broad exemption that will provide a less burdensome alternative for most businesses that use swaps solely to hedge their business risks, as long as those businesses meet the criteria for the end user exception. The end-user exception may be elected if one of the counterparties to the swap (1) is not a financial entity, (2) is using the swap to hedge or mitigate commercial risks (such as interest rate changes or currency fluctuations), (3) notifies the CFTC how it meets its financial obligations associated with non-cleared swaps, and (4) elects not to clear the swap. Financial entity includes any entity that is a swap dealer, major swap participant, security-based swap dealer or participant, commodity pool, private fund, ERISA plan, as well as certain banks, but any bank, savings institution or credit union with total assets of less than $10 billion is not a financial entity for purposes of this rule. Certain foreign entities and certain financing affiliates of non-financial entities may also be eligible for the end user exemption. If at least one party is eligible for the end user exception, the parties may take advantage of the exception by reporting notice of election and the identity of the eligible counterparty to a swap data repository (SDR) or, if no SDR is available, to the CFTC. A reporting counterparty must provide the following information: > whether the electing counterparty is a financial entity but eligible for the exception as a small financial institution or as a financial entity acting as an affiliate of a non-financial entity; > whether the swap for which the end user exception is being elected is used to hedge or mitigate commercial risk; > information regarding how the electing counterparty generally meets its financial obligations with respect to non-cleared swaps; and > if the electing counterparty is a public company, whether its board of directors has approved the decision to enter into swaps that are exempt from the swap clearing requirements. Nothing in the rule prohibits a reporting party from providing the information above on a swap by swap basis, but as a practical matter most companies wishing to rely on the end user exception will prefer to provide this information on an annual basis (an improvement upon the initial proposal, which required notification of each and every swap transaction). The final rule went into effect on September 17, 2012, but reporting obligations will not begin until the swap clearing regimen is put into place. This will occur in stages beginning early in 2013 (with reports from end users not due until at least the third quarter of 2013), and for now, there is not much to do except plan ahead. Each public company that expects to take advantage of the end user exception should make sure that its board of directors (or an appropriate committee of the board) has explicitly approved the use of swaps for hedging or mitigating risk and the use of the end user exception for non-cleared swaps, and identified the means through which the issuer meets its financial obligations with respect to non-cleared swaps. This approval and identification should be scheduled at least annually. 7
For more information on matters discussed in this alert, please contact any of the Securities lawyers listed below or your regular Drinker Biddle Corporate & Securities Practice Group contact. James Biehl (609) 716-6567 James.Biehl@dbr.com Howard A. Blum (312) 569-1103 Howard.Blum@dbr.com Stephen T. Burdumy (215) 988-2880 Stephen.Burdumy@dbr.com Troy M. Calkins (312) 569-1150 Troy.Calkins@dbr.com William H. Clark, Jr. (215) 988-2804 William.Clark@dbr.com Scott B. Connolly (215) 988-2812 Scott.Connolly@dbr.com James M. Fischer (973) 549-7163 James.Fischer@dbr.com Michael B. Jordan (215) 988-2802 Michael.Jordan@dbr.com Gerald P. McCartin (202) 230-5113 Gerald.McCartin@dbr.com Matthew M. McDonald (215) 988-1192 Matthew.McDonald@dbr.com George C. McKann (312) 569-1127 George.McKann@dbr.com H. John Michel, Jr. (215) 988-2515 John.Michel@dbr.com Walter J. Mostek, Jr. (610) 993-2233 Walter.Mostek@dbr.com F. Douglas Raymond III (215) 988-2548 Doug.Raymond@dbr.com Kimberly K. Rubel (312) 569-1133 Kimberly.Rubel@dbr.com Joseph L. Seiler, III (212) 248-3145 Joseph.Seiler@dbr.com Robert C. Juelke (215) 988-2759 Robert.Juelke@dbr.com 2012 Drinker Biddle & Reath LLP. All rights reserved. A Delaware limited liability partnership Jonathan I. Epstein and Andrew B. Joseph, Partners in Charge of the Princeton and Florham Park, N.J., offices, respectively. This Drinker Biddle & Reath LLP communication is intended to inform our clients and friends of developments in the law and to provide information of general interest. It is not intended to constitute advice regarding any client s legal problems and should not be relied upon as such. CALIFORNIA DELAWARE ILLINOIS NEW JERSEY NEW YORK PENNSYLVANIA WASHINGTON DC WISCONSIN 8