The NASDAQ Stock Market, LLC (Nasdaq) has proposed rules to adopt new listing standards for compensation committees and for the selection of compensation advisers in a filing with the Securities and Exchange Commission (SEC) on September 25, 2012. The Nasdaq proposed rules are subject to public comment and SEC approval. Once finalized, these listing standards will implement SEC Rule 10C-1, adopted pursuant to Section 10C(a) of the Securities Exchange Act of 1934 and Section 952 of the Dodd-Frank Act, which directs the national securities exchanges to establish listing standards for compensation committees and the selection of compensation advisers.
Standing Compensation Committee
For the first time, Nasdaq will require a listed company to have a standing compensation committee comprised of at least two members. Recognizing that responsibility for executive compensation decisions is one of the most important responsibilities entrusted to a board of directors, Nasdaq is proposing to eliminate the current alternative of allowing compensation decisions to be made by a majority of independent directors in favor of such decisions being made by a standing committee dedicated solely to oversight of executive compensation. The proposed rules also establish a requirement to adopt a compensation committee charter and to review and assess the adequacy of such charter on an annual basis.
Compensation Committee Composition
As proposed by Nasdaq, compensation committees must be comprised of at least two members. Each member of the compensation committee must:
- be an “Independent Director”, as defined in Nasdaq Listing Rule 5605(a)(2);
- not receive, directly or indirectly, any consulting, advisory or other compensatory fee from the listed company or its subsidiaries during the member’s term of service on the compensation committee; and
- not be affiliated with the listed company, a subsidiary of the listed company or an affiliate of a subsidiary of the listed company under circumstances where the affiliation would impair the director’s judgment as a member of the compensation committee.
General Independence. Currently, Nasdaq has a two-part test for independence under Rule 5605(a)(2). In addition to certain categories of directors who cannot be considered independent, the board must make an affirmative determination that the director has no relationship that, in the opinion of the board, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. Nasdaq has proposed to leave unchanged its two-part test for independence under Rule 5605(a)(2).
Prohibition on Compensatory Fees. Nasdaq has proposed a bright-line test that would prohibit a compensation committee member from receiving, directly or indirectly, any consulting, advisory, or other compensatory fees while serving on the compensation committee, other than compensation for board service or the receipt of fixed amounts of compensation under a retirement plan for prior service with the listed company. This approach is consistent with eligibility standards for service on audit committees.
Company Affiliations. Nasdaq also considered to what extent a director’s affiliations should be considered in determining the director’s eligibility for service on the compensation committee. Distinguishing compensation committees from audit committees, Nasdaq concluded that “a blanket prohibition would be inappropriate for compensation committees,” acknowledging that “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.” While the proposed Nasdaq rules require that boards of directors consider whether any affiliations would impair a director’s judgment as a member of the compensation committee, Nasdaq does not propose any bright-line rules. Also, there is no “look-back” period; consequently, the board need only consider affiliation with respect to relationships that occur during the director’s service on the committee.
Exemptions
Nasdaq proposes to retain its existing exception that allows a non-independent director to serve on the compensation committee under “exceptional and limited circumstances.” If a compensation committee consists of at least three members, one director who is not independent and meets certain other tests may serve on the compensation committee for up to two years if the board, under exceptional and limited circumstances, determines that the director’s service on the committee is required by the best interests of the company and its stockholders.
Smaller Reporting Companies
Nasdaq proposes to require smaller reporting companies to have a compensation committee comprised of at least two Independent Directors. Smaller reporting companies would not need to adhere to the new requirements relating to compensatory fees and affiliation. Smaller reporting companies also would be required to adopt a formal written compensation committee charter or board resolution that includes the same content as other companies; however, they would not need to incorporate into their charters or board resolutions the language in Rule 10C-1 regarding authority to retain and fund compensation consultants and counsel and responsibility to consider the independence of advisers and counsel, nor would they be required to review and reassess the adequacy of the charter or board resolutions annually.
Cure Period
SEC Rule 10C-1(a)(3) requires national exchanges to provide appropriate procedures for listed companies to have a reasonable opportunity to cure any noncompliance with the compensation committee standards that could result in the delisting of the company’s securities. The listing standards may also provide that if a member of the compensation committee ceases to be independent for reasons outside of the member’s reasonable control, that person, with notice by the company to the applicable exchange, may remain on the compensation committee until the earlier of the next annual meeting of stockholders or one year from the occurrence of the event. Nasdaq adopted the SEC’s cure period, modified to provide that if the company’s annual stockholders’ meeting occurs within 180 days following the event that caused the noncompliance, the company will instead have 180 days from the date of the event to cure the noncompliance.
Independence of Consultants and Counsel
SEC Rule 10C-1 provides that compensation committees are not required to select consultants, counsel or other advisers that are “independent,” but instead, in making their selections, compensation committees must take into account the following six factors, which bear upon independence:
- the provision of other services to the company by the employer of the compensation consultant, counsel or other adviser (referred to as the “advisory firm,” as distinguished from the individual adviser);
- the amount of fees received from the company by the advisory firm, as a percentage of the advisory firm’s total revenue;
- the advisory firm’s policies and procedures that are designed to prevent conflicts of interest;
- any business or personal relationship of the compensation consultant, counsel or other adviser with a member of the compensation committee;
- any stock of the company owned by the compensation consultant, counsel or other adviser; and
- any business or personal relationship between an executive officer of the company and the compensation consultant, counsel, other adviser or the advisory firm.
Nasdaq concluded that these six independence factors were adequate and did not propose any additional factors in its listing standards.
Anticipated Effective Dates and Transition Period
Nasdaq’s proposed rule relating to the compensation committee’s responsibilities and authority, including the responsibility to consider the independence of compensation advisers, would be effective immediately following SEC approval. The remaining provisions, including compensation committee independence requirements, would become effective on the earlier of the company’s second annual meeting held after the date of approval of the proposed rules, or December 31, 2014.
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John McIlvery, Partner and Chair of the Public Securities Practice Group at Stubbs Alderton & Markiles, LLP discusses the rules proposed by Nasdaq governing the listing standards for compensation committees and for the selection of compensation advisors.
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For more information about the Public Securities Practice at Stubbs Alderton & Markiles, LLP, contact John McIlvery at or (818) 444-4502.
