Thursday, March 31, 2011

SEC Proposals Would Implement Dodd-Frank Mandates on Independent Compensation Committees and Compensation Consultants

Pursuant to Dodd-Frank mandates, the SEC has proposed rules directing exchanges to adopt listing standards requiring issuers to have independent compensation committees. 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 the director and whether a director 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.

While the proposed independence rules for compensation committees are similar to the independence rules for audit committees adopted under the Sarbanes-Oxley Act, with one significant difference. Dodd-Frank requires only that the exchanges consider the relevant factors of the source of compensation and any affiliate relationship in developing independence standards for compensation committee members, while Sarbanes-Oxley expressly states that certain relationships preclude independence of an audit committee member. Thus, the exchanges will have the flexibility to establish their own minimum independence criteria for compensation committee members after considering the relevant factors.

In doing so, the SEC believes that the exchanges would likely consider whether the prohibitions imposed on audit committee members should also be applicable to compensation committee members. But, again, there is discretion, and the Commission recognizes that the exchanges may determine that, even though affiliated directors are not allowed to serve on audit committees, such a blanket prohibition would be inappropriate for compensation committees, and certain affiliates, such as representatives of significant shareholders, should be permitted to serve.

The listing standards would also have to provide that the compensation committee must be fully funded and have the sole discretion to retain the advice of a compensation consultants and be directly responsible for the appointment, payment and oversight of the such consultants.

As directed by Dodd-Frank, the SEC would require the exchanges to exempt the following five categories of entities from the compensation committee independence requirements: controlled companies, limited partnerships. companies in bankruptcy proceedings, mutual funds, and foreign private issuers that disclose in their annual report the reasons that they do not have an independent compensation committee.

In addition, the SEC proposes that, in selecting a compensation consultant, legal counsel or other adviser, the compensation committee must follow a number of independence factors, including whether the compensation consultant’s employer is providing any other services to the company and what percentage of the employer’s total revenue comes from fees charged the company for the consultant. The compensation committee must also consider what conflict of interest policies have been adopted by the employer of the compensation consultant and whether the consultant has any business or personal relationship with a member of the compensation committee or owns any stock in the company. The proposals would allow the exchanges themselves to impose additional considerations.

SEC proxy rules currently require disclosure of information about the use of compensation consultants, including specific information about fees paid to consultants. The proposal would modify existing rules to require disclosure about whether the compensation committee has obtained the advice of a compensation consultant and 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.

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.
The Act requires the issuance of the Section 952 rules by July 16, 2011. But the Act did not establish a specific deadline by which the listing standards promulgated by the exchanges must be in effect. To facilitate timely implementation of the proposals, the SEC proposes that each exchange must provide to the Commission, no later than 90 days after publication of the final rules in the Federal Register, proposed rules or rule amendments that comply with the SEC final rules. Further, each exchange would need to have final rule or rule amendments compliant with the SEC final rule approved by the Commission no later than one year after publication of the final rule.

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