(The following post originally appeared on ONSecurities, a top Minnesota legal blog founded by Martin Rosenbaum to address securities, governance and compensation issues facing public companies.)
On March 30, 2011, the SEC issued proposed rules (PDF) under Section 952 of the Dodd-Frank Act, which added Section 10C under the Securities Exchange Act of 1934. The proposed rules will direct the national securities exchanges to adopt independence and other listing standards relating to compensation committees and compensation advisors. The proposed rules don’t contain any big surprises and probably won’t have a big impact on most companies’ practices, but there are still some provisions of interest.
Independence of Committee Members. Under new Rule 10C-1, the exchanges must adopt independence standards for members of compensation committees, considering factors such as the sources of compensation of the individual by the company, and the individual’s affiliations with the company. Note that exchanges such as the New York Stock Exchange and Nasdaq already require committee members to meet the exchanges’ general independence standards, and that at most companies the committee members also must meet additional independence standards such as the requirements for “non-employee directors” under Rule 16b-3.
Comment: Interestingly, the SEC did not specify the parameters of the independence standards. This is very different from Rule 10A-3, adopted under the Sarbanes-Oxley Act (SOX) to apply to audit committees. Rule 10A-3 specified the heightened independence standards for audit committees, rather than leaving the details up to the exchanges. In its new proposing release for Rule 10C-1, the SEC pointed out that the authorizing statutes had different language. Unlike the SOX provision, Section 952 of the Dodd-Frank Act did not require the SEC to establish the standards. However, there was speculation that the new rule would define standards for compensation committee members similar to the provisions of Rule 10A-3 for audit committee members. Instead, it’s possible that the exchanges will each adopt differing sets of standards under the rule. Once the SEC adopts its final rules, the exchanges will have up to a year to adopt their final standards.
Standards for Selection of Advisors. Under proposed Rule 10C-1, listed companies’ compensation committees will also be required to consider five independence factors when selecting advisors such as consultants or counsel. Note that these advisors will not be required to be independent, but the committee will have to consider the factors, which include whether the advisor provides other services to the company, whether the advisor has business or personal relationships with members of the committee, and whether the advisor’s firm has adopted policies to prevent conflicts of interest.
Comment: Some commentators have speculated that, in practice, these standards will lead lots of compensation committees to engage independent counsel, because they won’t want to document that they chose non-independent counsel. We’ll see – I’m not convinced that this will happen in practice. After the adoption of SOX in 2002, there was widespread speculation that many audit committees would hire independent counsel. After the storm blew over, very few committees adopted this practice.
New Disclosure Standard. Under the proposed rules, Item 407(e)(iii) of Regulation S-K would be modified to add some additional disclosures in the proxy statement about the role of compensation consultants to the committee and payments to the consultants for other services to the issuer.
Comment: The proposed revised disclosures will not be dramatically different from the Item 407(e)(iii) disclosures added by the SEC for the 2010 proxy season.