SEC issues new rules regarding independence for Compensation Committees

The role of compensation committees for publicly-traded companies has continued to be refined as shareholders and shareholder advisory service companies continue to place more focus on the executive compensation programs implemented and administered by such committees. This intensified focus comes from perceived executive compensation abuses and other changes implemented over the past several years, including new expanded proxy disclosure obligations on executive pay and benefits, and “say on pay” voting rules.

On June 20, 2012, the SEC approved a new final rule requiring securities exchanges to adopt standards for ensuring the independence of board members serving on compensation committees of publicly-traded companies (or in the absence of such a committee, the board members that oversee executive compensation matters on behalf of the board) and their engagement of compensation advisers and legal counsel.

SEC Chairman Mary L. Schapiro states that the new rule will “enhance the board's decision-making process on executive compensation matters, particularly the selection, engagement and oversight of compensation advisers, and will provide more transparency with respect to conflicts of interest of consultants engaged by boards.”

The new rule, implemented as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act, requires national stock exchanges to issue listing standards on each of the following:

• A requirement that each member of a company’s compensation committee be a member of the board of directors and “independent.” For purposes of determining independence, the rules implemented by an exchange will need to consider relevant factors, including whether the member directly or indirectly is affiliated with the company or a subsidiary of the company, or receives compensation, fees or other remuneration from the company. An exchange may also require the consideration of other factors in determining a committee members’ independence.
• The compensation committee will have the right, exercised in its sole discretion, to engage its own compensation consultant, legal counsel or other advisers and will be directly responsible for the appointment, compensation and oversight of such advisers. Nonetheless, the listed company will be required to pay for the costs of the adviser(s) engaged by the compensation committee.
• The compensation committee will be required to consider the following six independence factors (plus any additional factors determined by the exchange) in selecting a compensation consultant, legal counsel or other adviser, other than in-house legal counsel:
  • Whether the compensation consulting company employing the compensation adviser is providing other services to the company;
  • The amount of fees the compensation adviser and the company that employs him or her has received in fees from the company, as a percentage of their total revenue;
  • The policies and procedures adopted by the compensation adviser and his or her employer to prevent conflicts of interest;
  •  Whether the compensation adviser has business or personal relationships with a member of the compensation committee;
  • The amount of company stock owned by the compensation adviser, and 
  • Whether the compensation adviser or the person employing the adviser has any business or personal relationship with an executive officer of the company. 
• Certain entities will be exempted from the new rules. These include: 
  • Limited partnerships;
  • Companies that are in bankruptcy;
  • Open-end management investment companies registered under the Investment Company Act of 1940; and
  • Foreign private issuers that disclose in their annual reports the reasons they do not have an independent compensation committee.

In addition, the rules permit an exchange to provide for the exemption of other entities such as "controlled companies" (more than 50 percent of the voting power is held by an individual, group or company) and smaller reporting companies.

The SEC has also expanded the proxy disclosure rules for publicly-traded companies regarding the use or compensation advisers to include additional disclosures regarding potential conflicts of interests that may exist with such advisers and how such conflicts are being addressed.

The new rules take effect 30 days following publication in the Federal Register. Exchanges will have 90 days following publication to propose their particular listing standard rules.

For more information, please contact:

John M. Wirtshafter

216.348.5833

jwirtshafter@mcdonaldhopkins.com

Michael G. Riley

216.348.5454

mriley@mcdonaldhopkins.com

Antoinette M. Pilzner

248.646.5075

apilzner@mcdonaldhopkins.com

David G. Johnson

216.348.5456

djohnson@mcdonaldhopkins.com

Executive Compensation

Large and small employers need to attract, motivate and retain executive talent. We help clients deal with their most valuable assets: their key executives. This may involve advising entrepreneurs and start-up companies about structuring business entities to create equity incentives, or advising compensation committees of public companies regarding best practices and compliance in the rapidly developing area of non-qualified deferred compensation or executive compensation proxy reporting.