On January 11, 2013, the SEC approved new listing standards regarding independence requirements for compensation committees and compensation advisers of New York Stock Exchange (NYSE) listed companies.1 The NYSE initially proposed the new listing standards on September 25, 2012,2 based on the final rules that the SEC adopted June 20, 2012 (SEC Rules),3 and amended the initial proposal on October 1, 2012 and January 8, 2013.
Noteworthy Developments Relative to Initial Proposal
The following are matters of note relative to the initial proposal as a result of the SEC’s action:
By no later than July 1, 2013, an NYSE-listed company (NYSE Company) must ensure that its compensation committee charter includes expanded authority and responsibilities of the committee with respect to the oversight of compensation consultants, outside legal counsel, and other advisers.
As of the same date, an NYSE compensation committee may no longer select, or receive advice from, an adviser unless it has conducted the six-factor independence assessment as the new NYSE listing standards require.
New requirements regarding the independence of NYSE compensation committee members will not take effect until the earlier of an NYSE company’s first annual meeting after January 15, 2014 or October 31, 2014.
The new NYSE listing standards do not break significant new ground. As discussed below, the new NYSE listing standards do not add any new specific test that an NYSE compensation committee member must meet to qualify as independent for NYSE compensation committee purposes. It is important to note that, 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. The new NYSE listing standards regarding the independence of compensation committee members take effect upon the earlier of an NYSE company’s first annual meeting after January 15, 2014 or October 31, 2014.
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. For the sake of clarity, however, the new NYSE listing standards adopt verbatim the related SEC Rules and take effect on July 1, 2013. By no later than July 1, 2013, an NYSE Company must ensure that its compensation committee charter includes the required authority and responsibilities of the committee with respect to the oversight of compensation consultants, outside legal counsel, and other advisers.
As the SEC Rules require, the new NYSE listing standards add a new requirement for an NYSE compensation committee to consider specified factors as they relate to compensation advisers. The new NYSE listing standards mirror the six factors in the SEC Rules, but also provide that the NYSE compensation committee must consider “all factors relevant to that person’s independence from management.” As of July 1, 2013, an NYSE compensation committee may no longer select, or receive advice from, an adviser unless it has conducted an independence assessment as the new NYSE listing standards require.
Highlights of the New NYSE 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 new NYSE listing standards do not make any significant changes to the NYSE’s existing independence standards applicable to compensation committee members. The new NYSE listing standards add certain consideration requirements applicable to a board of directors (Board) of an NYSE Company, but the NYSE did not impose a more stringent independence test like the one that applies to members of audit committees.
The NYSE’s 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 Company. This subsection sets forth five “bright-line” tests to be used in making this determination, and the new NYSE listing standards do not change any of these tests.
The new NYSE listing standards add subsection 303A.02(a)(ii), which requires that, in affirmatively determining the independence of any compensation committee member for NYSE compensation committee purposes, the Board must consider “all factors specifically relevant” to determining whether such member has a relationship to the NYSE 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 following two factors that appear in the SEC Rules:
The new NYSE listing standards also 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) holds in excess of a specific percentage of the NYSE Company’s outstanding shares. The NYSE reaffirmed its position that share ownership in an NYSE Company aligns the compensation committee member’s interests with those of its shareholders. Furthermore, the NYSE believes that the NYSE’s existing bright-line independence listing standards are sufficiently broad to encompass all forms of relationships that would negate a compensation committee member’s independence regarding the member’s committee duties.
However, 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 Company, that would impair the member’s ability to make independent judgments about the NYSE Company’s compensation. 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 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 Company’s compensation.
A Board must consider these factors in determining the independence of compensation committee members beginning the earlier of an NYSE Company’s first annual meeting after January 15, 2014 or October 31, 2014.
Compensation Committee Authority to Retain Advisers
The new NYSE listing standards require that (i) a compensation committee has the authority to retain its own compensation advisers, (ii) a compensation committee is directly responsible for the appointment, compensation, and oversight of each adviser that it retains, and (iii) an NYSE Company provide appropriate funding to its compensation committee to allow the committee to pay reasonable compensation to advisers. The new NYSE listing standards do not, however, require a compensation committee to retain its own advisers.
Existing NYSE listing standards 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. compensation committee charters of NYSE Companies must be revised accordingly by July 1, 2013.
NYSE Compensation Committee Review of Factors Impacting Compensation Adviser Independence
Pursuant to the SEC Rules, the new NYSE listing standards require a compensation committee to take into consideration specified factors that could bear on the independence of any compensation consultant, legal counsel, or other advisers (Compensation Advisers) to the committee, including Compensation Advisers that the NYSE compensation committee retains or that management retains. As of July 1, 2013, an NYSE compensation committee may no longer select, or receive advice from, an adviser unless it has conducted an independence assessment as required by the new NYSE listing standards.
More specifically, the NYSE adopted essentially verbatim the list of 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. Specifically, the NYSE compensation committee must consider the following six factors when making this selection:
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. 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. 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. Similarly, no such independence analysis is required with respect to a 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.4
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 advisers and that 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.
In response to comments, the NYSE expressly considered, but did not impose, a disclosure requirement relating to Compensation Advisers. The relevant commenter also had proposed requiring, with respect to outside counsel that the compensation committee hired, the same disclosure that SEC rules require with respect to the nature of any conflict that arises from the engagement of a compensation consultant. 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 hired, the NYSE stated its belief that the rigorous conflict of interest requirements applicable to attorneys adequately address the commenter’s concerns.
The new NYSE listing standards include procedures for NYSE Companies to have a reasonable opportunity to cure any non-compliance with the new NYSE listing standards. Specifically, 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 Company to the NYSE, may remain a member until the earlier of the next annual meeting or one year from the occurrence of the event that caused the member to be no longer independent. 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 (excluding the compensation committee member who is determined to be no longer independent).
The new NYSE listing standards provide an exemption for all categories of issuers 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 1940 Act, passive business organizations in the form of trusts (such as royalty trusts), derivatives, and special purpose securities (as described in Sections 703.19 and 703.20 of the NYSE Listed Company Manual), and issuers whose only listed equity security is a preferred stock.
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. Pursuant to an amendment to the initial NYSE proposal, the start date of the six-month 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.
Actions NYSE Companies Should Take Now
NYSE Companies should act now to ensure timely compliance with the new NYSE listing standards, including taking the following steps:
Such factors must be addressed no later than the earlier of an NYSE Company’s first annual meeting of shareholders after January 15, 2014 or October 31, 2014. As a practical matter, an NYSE Company will presumably need to address those factors prior to sending its proxy statement for that annual meeting.
1 The final NYSE listing standards are available on the SEC Web site.
2 The NYSE listing standards proposed on September 25, 2012 are discussed in Foley’s Legal News Alert on this topic, dated October 3, 2012.
3 The SEC Rules regarding compensation committees are discussed in more detail in Foley’s Legal News Alert on this topic, dated June 25, 2012. The SEC Rules were adopted in response to the mandate of Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
4 These two limited exceptions for certain Compensation Advisers basically 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.
Legal News Alert is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and colleagues. If you have any questions about this update or would like to discuss the topic further, please contact your Foley attorney or:
Patrick G. Quick
Todd B. Pfister
Mark T. Plichta
Aubrey V. Refuerzo