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SEC's proposed rules on compensation committee independence
Practical Law Legal Update 8-505-9944 (Approx. 3 pages)
SEC's proposed rules on compensation committee independence
by Doreen E. Lilienfeld, Amy B. Gitlitz, David Kokell, and Mandee Lee, Shearman & Sterling LLP
| Published on 05 May 2011 • USA |
This article is part of the PLC Global Finance April 2011 e-mail update for the United States.
Speedread
On 30 March 2011, the Securities and Exchange Commission (SEC) issued proposed rules directing the national securities exchanges to adopt listing standards related to the independence of compensation committees and their selection of advisers. SEC rulemaking on these topics is required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Act), which prohibits national securities exchanges from listing any equity security of an issuer not in compliance with the exchange's compensation committee independence and adviser requirements. In the proposing release, the SEC also slightly revised its proxy disclosure rules related to the use of compensation consultants by compensation committees and an issuer's management.
On 30 March 2011, the Securities and Exchange Commission (SEC) issued proposed rules directing the national securities exchanges to adopt listing standards related to the independence of compensation committees and their selection of advisers. SEC rulemaking on these topics is required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Act), which prohibits national securities exchanges from listing any equity security of an issuer not in compliance with the exchange's compensation committee independence and adviser requirements. In the proposing release, the SEC also slightly revised its proxy disclosure rules related to the use of compensation consultants by compensation committees and an issuer's management.
Independence requirement
The proposed rules generally reiterate the requirements of the Act and apply to domestic and foreign private issuers. In particular, the proposed rules direct the national securities exchanges to both:
- Require that each member of an issuer's compensation committee be a member of the issuer's board of directors who is "independent" under the applicable exchange's independence standards.
- Develop independence requirements after considering certain factors, including the source of compensation from the issuer provided to a given director, the director's affiliation with the issuer, its subsidiaries or affiliates, as well as any other factors the exchange deems appropriate.
The proposed rules do not actually establish independence standards and do not provide any safe harbors, nor do they exempt any particular relationship between compensation committee members and issuers. These topics are left to the exchanges.
Exemptions from independence requirement
There are five categories of issuers that would not be subject to the compensation committee independence requirements: controlled companies, limited partnerships, companies in bankruptcy proceedings, open-end management investment companies registered under the Investment Company Act, and foreign private issuers that provide annual disclosures to shareholders of the reasons why they do not have an independent compensation committee. Exchanges may propose additional exempt issuer categories subject to SEC approval.
Compensation adviser disclosure
The Act dictates when an issuer must disclose (1) whether the compensation committee has retained or obtained the advice of a compensation consultant, (2) whether the work of the compensation consultant has raised any conflict of interest and, (3) if so, the nature of the conflict and how the conflict is being addressed. The current SEC Disclosure rules require registrants to disclose "any role of the compensation consultants in determining or recommending the amount or form of executive and director compensation." Given the similarities, the SEC elected to combine the current rules and the requirements under the Act into a single disclosure requirement that applies to all Exchange Act registrants subject to the proxy rules.
As proposed, a registrant will be required to disclose whether its compensation committee has "retained or obtained" the advice of a compensation consultant, rather than formally "engaged" one, during the registrant's last completed fiscal year. An instruction to the proposed rule clarifies that the phrase "obtained the advice" relates to whether a compensation committee has requested or received advice from a compensation consultant, regardless of whether there has been a formal engagement, a relationship with the compensation committee or management or any payment of fees.
Compensation adviser independence
The Act does not require that a compensation adviser actually be independent, but only that the compensation committee must consider certain independence factors when deciding to hire an adviser. These factors include:
- Whether the entity employing the compensation adviser provides other services to the issuer.
- The amount of fees received from the issuer by the entity employing the compensation adviser.
- The policies and procedures of the entity employing the compensation adviser designed to prevent conflicts of interest.
- Any business or personal relationship between the compensation adviser and a member of the compensation committee.
- Whether the compensation adviser owns any stock in the issuer.
The proposed rules include an instruction identifying the same independence factors (listed above) as a nonexclusive list of factors to be considered in determining whether there is a conflict of interest requiring disclosure. If the compensation committee determines that there is a conflict of interest, the issuer would be required to provide a clear and concise description of the specific conflict and how the issuer has addressed it; a general description of the issuer's policies and procedures on conflicts of interest would not suffice.
The SEC does not anticipate that exchange listing standards will impose any materiality or bright-line thresholds on the independence factors. In addition, the proposed rule does not require compensation committees to retain a compensation consultant or legal or other adviser, or preclude such adviser from providing other services to the issuer.
Opportunity to cure
The proposed rules would require the exchanges to establish definitive procedures and compliance periods, if they do not already have adequate procedures in place, to be followed prior to delisting an issuer's securities. The listing requirements will create a safe harbor for any member of a compensation committee who ceases to be independent for reasons outside the member's reasonable control and allow the member to remain on the compensation committee until the earlier of the issuer's next annual meeting or one year from the event that caused the member to no longer be independent, as contemplated in the Reform Act.
For more information on the proposed rule, see Shearman & Sterling's client publication.