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SEC Proposed Rules on Compensation Committee and Consultant Independence
April 4th, 2011
The SEC recently issued proposed rules on consultant and compensation committee independence, as required under the Dodd-Frank legislation. Currently the SEC is seeking comments and the rules will be finalized thereafter. The fact sheet below below provides a summary of the findings and below that is a link to the full rules.

FACT SHEET

Listing Standards for Compensation Committees
SEC Open Meeting
March 30, 2011

Background

In 2010, Congress passed the Dodd-Frank Act that among other things sought to address issues regarding the compensation that companies pay their executives. Section 952 of the Act addresses the compensation committees formed by corporate boards as well as the compensation advisers that these committees retain.

In particular, this provision requires the SEC to direct the exchanges to adopt certain “listing standards” relating to the independence of the members on a compensation committee, the committee’s authority to retain compensation advisers, and the committee’s responsibility for the appointment, compensation and work of any compensation adviser. Once an exchange’s new listing standards are in effect, a listed company must meet these standards in order for its shares to continue trading on that exchange.

In addition, the provision requires each company to disclose in its proxy material for an annual meeting of shareholders whether its board’s compensation committee retained or obtained the advice of a compensation consultant. The provision also requires a company to disclose whether the work of the compensation consultant has raised any conflict of interest and, if so, the nature of the conflict and how the conflict is being addressed.

Requirements of the Proposed Rules

Independence of Compensation Committee Members

Under the SEC’s proposal, the exchanges would be required to adopt listing standards that require each member of a company’s compensation committee to be a member of the board of directors and to be independent. In developing a definition of independence, the exchanges would be required to consider such factors as:

  • The sources of compensation of a director, including any consulting, advisory or compensatory fee paid by the company to such member of the board of directors.
  • Whether a member of the board of directors of a company is affiliated with the company, a subsidiary of the company, or an affiliate of a subsidiary of the company.

As with all listing standards, exchanges would need to seek the approval of the SEC before adopting them.

Authority and Funding of the Compensation Committee

The proposed rules would require the exchanges to adopt listing standards providing that the compensation committee of a listed company:

  1. May, in its sole discretion, retain or obtain the advice of a compensation adviser.
  2. Is directly responsible for the appointment, payment and oversight of compensation advisers.
  3. Must be appropriately funded by the listed company.

Compensation Adviser Selection

The proposed rules also would require the exchanges to adopt listing standards providing that a compensation committee may select a compensation consultant, legal counsel or other adviser only after considering the following five independence factors:

  1. Whether the compensation consulting company employing the compensation adviser is providing any other services to the company.
  2. How much the compensation consulting company who employs the compensation adviser has received in fees from the company, as a percentage of that person’s total revenue.
  3. What policies and procedures have been adopted by the compensation consulting company employing the compensation adviser to prevent conflicts of interest.
  4. Whether the compensation adviser has any business or personal relationship with a member of the compensation committee.
  5. Whether the compensation adviser owns any stock of the company.

The exchanges themselves could impose additional considerations.

Exemptions

As directed by the statute, the proposed rules would require the exchanges to exempt the following five categories of companies from the compensation committee independence requirements:

  1. Controlled companies.
  2. Limited partnerships.
  3. Companies in bankruptcy proceedings.
  4. Open-end management investment companies registered under the Investment Company Act of 1940.
  5. Any foreign private issuer that discloses in its annual report the reasons that the foreign private issuer does not have an independent compensation committee.

In addition, the proposed rules would authorize the exchanges to exempt a particular relationship from the independence requirements applicable to compensation committee members.

The proposed rules also would authorize the exchanges to exempt any category of company from all of the requirements of the new compensation committee listing standards. The proposed rules would exempt controlled companies from all of the requirements of the new compensation committee listing standards.

As with all listing standards, the exchanges would need to seek the approval of the SEC before adopting any exemptions.

Compensation Consultant Conflicts of Interest Disclosure

Exchange Act registrants subject to the federal proxy rules are already required to disclose information about their use of compensation consultants, including specific information about fees paid to consultants that the SEC added in late 2009. The proposed rules would modify existing rules to require disclosure about whether:

  1. The compensation committee has retained or obtained the advice of a compensation consultant.
  2. The work of the compensation consultant has raised any conflict of interest and, if so, the nature of the conflict and how the conflict is being addressed.

The proposed rules also would eliminate the current disclosure exception for services that are limited to consulting on broad-based plans and the provision of non-customized benchmark data, but would retain the fee disclosure requirements, including the exemptions from those requirements.

What’s Next?

The SEC is seeking public comments on the proposed rules and data on matters relating to the proposed rules, including the costs and benefits associated with the proposals. Public comments on the proposed rules should be received by April 29, 2011. The SEC will review the comments it receives and consider those comments in determining whether to adopt the proposed rules.

To read the proposed rules in their entirety, click here.