New NYSE and NASDAQ Listing Standards Approved: Compensation Committee Independence, Compensation Adviser Engagement and Independence

On January 11, 2013, the U.S. Securities and Exchange Commission (the “SEC”) approved new listing standards submitted by the New York Stock Exchange (“NYSE”) and the NASDAQ Stock Market (“NASDAQ”) concerning the independence of compensation committee members and the engagement and independence of compensation advisers. The new listing standards were required by the Dodd-Frank Act and the SEC rules adopted under the Dodd-Frank Act on June 20, 2012 (the “SEC Rules”).

As approved, the new listing standards of the NYSE (the “NYSE Rules”) and NASDAQ (the “NASDAQ Rules”) are nearly identical to the new listing standards initially proposed by the NYSE and NASDAQ on September 25, 2012.

Effective Date

The NYSE Rules will be effective on July 1, 2013, although companies are not required to comply with the NYSE Rules concerning the independence of compensation committee members until the earlier of (i) the first annual meeting held after January 15, 2014 or (ii) October 31, 2014.

The NASDAQ Rules also will be effective on July 1, 2013, although companies are not required to comply with the NASDAQ Rules concerning the independence of compensation committee members, and the requirement that companies have a formal compensation committee and written compensation committee charter, until the earlier of (i) the first annual meeting held after January 15, 2014 or (ii) October 31, 2014. In connection with these changes, NASDAQ-listed companies are required to certify to NASDAQ, no later than 30 days after the final applicable implementation deadline, that they have complied with the new compensation committee composition and charter requirements.

Compensation Committee Independence

Both the NYSE Rules and the NASDAQ Rules require listed companies to specifically consider additional information when making independence determinations for compensation committee members. In addition, the NASDAQ Rules impose a new objective independence requirement that must be met by compensation committee members.

NYSE Rules

The NYSE Rules do not make any changes in the objective independence requirements for compensation committee members, but they do specifically require the board of directors to consider certain information when making independence determinations for compensation committee members. The NYSE Rules require boards of directors, when making these determinations, to consider all factors specifically relevant to determining whether a director has a relationship to the listed company that is material to that director’s ability to be independent from management in connection with the duties of a compensation committee member, including, but not limited to:

• the source of compensation of such director, including any consulting, advisory or other compensatory fee paid by the listed company to such director; and

• whether such director is affiliated with the listed company, a subsidiary of the listed company or an affiliate of a subsidiary of the listed company.

With respect to a director’s affiliation with the listed company, the NYSE clearly stated that it believed share ownership served to align directors’ interests with those of unaffiliated shareholders and would not adversely affect a director’s ability to be independent from management as a compensation committee member. Additionally, the commentary to the NYSE Rules indicates that the board should consider whether an affiliate relationship places a compensation committee member under the direct or indirect control of the listed company or its senior management, or creates a direct relationship between the director and members of senior management, in each case of a nature that would impair his or her ability to make independent judgments about the listed company’s executive compensation. As a result, it is clear that having a director who was also a large shareholder or was affiliated with a large shareholder serve as a compensation committee member would not be viewed as inappropriate by the NYSE.

Because the NYSE Rules do not include any new objective independence standards, companies will not necessarily be required to make changes to their compensation committee composition. However, because of the requirement to consider information that may not have been specifically considered in the past, some companies may need to include additional disclosure in their proxy statements to address Item 407(a)(3) of Regulation S-K, which requires companies to describe, by specific category or type, transactions, relationships or arrangements not otherwise disclosed that were considered by the board of directors in making its independence determination.

The NYSE Rules also provide listed companies with an opportunity to cure noncompliance with the compensation committee independence requirement in certain circumstances. If a compensation committee member ceases to be independent for reasons outside the member’s reasonable control, that person, with notice by the company to the NYSE, may remain a compensation committee member until the earlier of the next annual shareholders’ meeting or one year from the occurrence of the event that caused the member to be no longer independent, provided that a majority of the members of the compensation committee continue to be independent.

NASDAQ Rules

The NASDAQ Rules make two principal changes to the existing listing standards relating to the independence of compensation committee members.

First, the NASDAQ Rules prohibit compensation committee members from accepting, directly or indirectly, any consulting, advisory or other compensatory fee from the company or any subsidiary, subject to limited exceptions for director and committee member fees and fixed compensation under a retirement plan (including deferred compensation) for prior service with the company (provided that such compensation is not contingent on continued service).

This prohibition is identical to current prohibitions relating to compensatory fees for audit committee members and, accordingly, there is no “look back” period for the prohibition on receiving compensatory fees. As a result, compensatory fees received by a director prior to the time the director starts serving as a member of the compensation committee would not disqualify that director from serving as a member of the compensation committee.

Although the NASDAQ Rules do not specifically define what constitutes “indirect” acceptance of a compensatory fee, we expect NASDAQ to interpret this phrase in the same manner as it does for audit committee members, which includes acceptance of such a fee by a spouse, a minor child or stepchild or a child or stepchild sharing a home with the member or by an entity in which such member is a partner, member, an officer such as a managing director occupying a comparable position or executive officer, or occupies a similar position (except limited partners, non-managing members and those occupying similar positions who, in each case, have no active role in providing services to the entity) and which provides accounting, consulting, legal, investment banking or financial advisory services to the listed company or any subsidiary of the listed company.

Second, in addition to the prohibition on receiving compensatory fees, the NASDAQ Rules also require the board of a listed company to consider whether the director is affiliated with the listed company, a subsidiary of the listed company, or an affiliate of a subsidiary, to determine whether any affiliation would impair the director’s judgment as a member of the compensation committee. In the commentary to the NASDAQ Rules, NASDAQ noted 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.” In other words, a director who is a large shareholder or is affiliated with a large shareholder should not be automatically precluded from serving on the compensation committee solely as a result of that affiliation.

The NASDAQ Rules also provide an opportunity to cure noncompliance with the compensation committee composition requirements in certain circumstances. If a listed company fails to comply with the compensation committee composition requirements due to one vacancy, or one compensation committee member ceases to be independent due to circumstances beyond the member’s reasonable control, the listed company will have until the earlier of the next annual shareholders’ meeting or one year from the occurrence of the event to regain compliance, provided that if the annual shareholders’ meeting occurs no later than 180 days following the event that resulted in the failure, the listed company will have 180 days from the date of the event to regain compliance. A listed company relying on this cure period is required to provide notice to NASDAQ immediately upon learning of the noncompliance. This cure period is the same as the cure period provided by current NASDAQ listing standards with respect to the majority independent board requirement.

The NASDAQ Rules also continue to allow a listed company to have a non-independent director serve on the compensation committee under exceptional and limited circumstances.

Compensation Adviser Engagement and Independence

NYSE Rules and NASDAQ Rules

With respect to the retention of compensation consultants, legal counsel or other advisers (“compensation advisers”) by a compensation committee and the requirement that the compensation committee consider specific independence factors prior to selecting a compensation adviser, both the NYSE Rules and the NASDAQ Rules generally mirror the corresponding requirements of the SEC Rules in mandating the following:

• The compensation committee may, in its sole discretion, retain or obtain the advice of compensation advisers.

• The compensation committee shall be directly responsible for the appointment, compensation and oversight of the work of a compensation adviser retained by the compensation committee.

• The company must provide for appropriate funding, as determined by the compensation committee, for the payment of reasonable compensation to any compensation advisers retained by the compensation committee.

• Before selecting any compensation adviser, the compensation committee must take into consideration the following six independence criteria and, in the case of NYSE-listed companies, all other factors relevant to that person’s independence from management:

In addition, both the NYSE Rules and the NASDAQ Rules require companies’ compensation committee charters to include these specific rights and responsibilities. Although NASDAQ-listed companies have until the earlier of (i) the first annual meeting held after January 15, 2014 or (ii) October 31, 2014 to put in place a written compensation committee charter, the compensation committee is required to have the specific rights and responsibilities described above by July 1, 2013. Whether those rights and responsibilities are granted through the charter or a board resolution or other action is left to the company’s discretion, per the NASDAQ Rules.

There are several important practical considerations for listed companies to be aware of in considering the impact of these new listing standards:

• First, as was made clear in the release adopting the SEC Rules, these rules do not prohibit a compensation committee from receiving advice from, or otherwise utilizing a compensation adviser that is not specifically retained by the compensation committee (for example, a company’s regular outside counsel that is retained by management), nor do these rules require a compensation committee to be directly responsible for the appointment, compensation or oversight of compensation advisers that are not retained by the compensation committee.

• Second, the compensation committee must consider the compensation adviser independence criteria with respect to any compensation adviser that provides advice to the compensation committee, whether or not retained by the compensation committee, other than (i) in-house legal counsel or (ii) a compensation adviser that acts in a role limited to consulting on a broad-based plan that does not discriminate in scope, terms or operation in favor of executive officers or directors of the company and that is available generally to all salaried employees, or providing information that is not customized for the company or is customized based on parameters that are not developed by the adviser, and about which the adviser does not provide advice.

• Third, the compensation committee is not required to make a formal determination regarding independence, and the compensation committee is not prohibited from selecting or otherwise obtaining advice from a compensation adviser that is not considered to be independent.

NASDAQ Compensation Committee and Compensation Committee Charter Requirements

The NASDAQ Rules made two changes to NASDAQ’s existing listing standards that are not specifically related to items that were required to be addressed by the SEC Rules. The NASDAQ Rules require most domestic listed companies to have a formal compensation committee consisting of at least two independent directors and to have, and at least annually review and reassess the adequacy of, a written compensation committee charter that complies with the requirements of the NASDAQ Rules. Current NASDAQ listing standards require independent director oversight of executive officer compensation, but do not require listed companies to establish a formal compensation committee or to have a written compensation committee charter.

General Exemptions

Both the NYSE Rules and the NASDAQ Rules exempt (i) controlled companies, (ii) foreign private issuers (subject, in the case of the NYSE Rules, to certain additional disclosure requirements) and (iii) certain other listed companies from the new listing standards.

The NYSE Rules generally exempt smaller reporting companies from the new compensation committee independence requirements and the requirement for compensation committees to consider independence factors in connection with the selection of compensation advisers.

The NASDAQ Rules generally exempt smaller reporting companies from the new compensation committee independence requirements, the requirements relating to the retention of compensation advisers by the compensation committee, the requirement for compensation committees to consider independence factors in connection with the selection of compensation advisers and the requirement to have a written charter. The NASDAQ Rules do require that smaller reporting companies have a formal compensation committee of at least two members who satisfy current NASDAQ director independence requirements.

Summary of Actions to Take

Listed companies should prepare for the effectiveness of the NYSE Rules and the NASDAQ Rules by taking the following actions:

• Reviewing and revising the company’s compensation committee charter by July 1, 2013, as needed, in order to comply with the final rules.

• Establishing procedures by July 1, 2013 addressing the required consideration by the compensation committee of factors relating to compensation adviser independence. The procedures adopted should ensure that all required information relating to the independence of a compensation adviser is gathered and presented to the compensation committee before it receives advice from the compensation adviser.

• Reviewing engagements with current compensation advisers retained by the compensation committee to ensure that the compensation committee is directly responsible for their appointment, their compensation and oversight of their work. Note that engagements do not need to be in writing. Furthermore, as noted above, not every compensation adviser that provides advice to the compensation committee will have been, or needs to be, retained by the compensation committee (for example, a company’s regular outside counsel that is retained by management).

• Reviewing the company’s current compensation committee membership and structure in light of the final rules. If changes to a company’s compensation committee membership will be required, the company should begin planning early to ensure such changes will be in place on or before the applicable deadline, which will be the 2014 annual meeting for most companies.

• Modifying the company’s director eligibility and information gathering documents (such as director independence questionnaires) to gather the information necessary to evaluate the company’s current compensation committee membership and structure in light of the final rules. Some companies may desire to do this earlier than they usually would for the 2014 annual meeting in order to have time to address any changes to compensation committee composition that may be needed in advance of the 2014 annual meeting.