Implementing Section 952 of the
Dodd-Frank Act, the SEC adopted regulations directing the exchanges to
establish listing standards requiring each member of a company’s compensation
committee to be an independent member of the board of directors. The regulations
do not require that exchanges establish a uniform definition of independence. Given the wide variety of issuers that are
listed on exchanges, said the SEC, exchanges were given the flexibility to develop
independence requirements appropriate for the issuers listed on each exchange.
Although this provides the exchanges with flexibility to develop the
appropriate independence requirements, the Commission reminded that the independence
requirements developed by the exchanges will be subject to review and final SEC
approval pursuant to Section 19(b) of the Exchange Act.
In addition, when developing
their own definitions of independence applicable to compensation committee
members, the exchanges must consider relevant factors, including a director’s
source of compensation, including any consulting, advisory or compensatory fee
paid by the issuer; and whether a director is affiliated with the issuer, a
subsidiary of the issuer, or an affiliate of a subsidiary of the issuer.
The regulations also direct the
exchanges to adopt listing standards providing that the compensation committee
may, in its sole discretion, retain or obtain the advice of a compensation adviser. The compensation
committee will be directly responsible for the appointment, compensation and
oversight of the work of any compensation adviser retained by the committee. Further,
each listed issuer must provide for appropriate funding for payment of
reasonable compensation, as determined by the compensation committee, to any
compensation adviser retained by the committee. According to the SEC, the regulations
may not be construed to require the compensation committee to implement or act
consistently with the advice or recommendations of any adviser to the
compensation committee or to affect the ability or obligation of a compensation
committee to exercise its own judgment in fulfillment of its duties.
Moreover, SEC regulations do not
require compensation committees to retain or obtain advice only from
independent advisers. The committee may
receive advice from non-independent counsel, such as in-house counsel or
outside counsel retained by management, or from a non-independent compensation
consultant or other adviser, including those engaged by management. Nor do the
regulations 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, such as compensation consultants or
legal counsel retained by management.
Section 10C(b) of the Exchange
Act, added by Dodd-Frank, provides that
the compensation committee of a listed issuer may select a compensation adviser
only after taking into consideration the five independence factors specified in
the statute as well as any other factors identified by the Commission. In accordance with Section 10C(b), these
factors would apply to the selection of compensation consultants, legal counsel
and other advisers to the committee. The
statute does not require a compensation adviser to be independent, only that
the compensation committee of a listed issuer consider the enumerated
independence factors before selecting a compensation adviser.
The SEC regulations require a
compensation committee to take into account the five factors enumerated in
Section 10C(b)(2), as well as one added by the Commission, which is any
business or personal relationships between the executive officers of the issuer
and the compensation adviser or the
person employing the adviser. This would
include, for example, situations where the chief executive officer of an issuer
and the compensation adviser have a familial relationship or where he chief
executive officer and the compensation adviser (or the adviser’s employer) are
business partners. The SEC agreed with
commentators who stated that business and personal relationships between an
executive officer and a compensation adviser or a person employing the compensation
adviser may potentially pose a significant conflict of interest that should be considered
by the compensation committee before selecting a compensation adviser.
The
five statutory factors are the provision of other services to the issuer by the
person that employs the compensation adviser; the amount of fees received from
the issuer by the person that employs the compensation adviser, as a percentage
of the total revenue
of that person; the policies of the person that employs the compensation adviser
that are designed to prevent conflicts of interest; any business or personal
relationship of the compensation adviser with a member of the compensation
committee; and any stock of the issuer owned by the compensation adviser.
The SEC believes that these six
factors, when taken together, are competitively neutral, as they will require
compensation committees to consider a variety of factors that may bear upon the
likelihood that a compensation adviser can provide independent advice to the
compensation committee, but will not prohibit committees from choosing any
particular adviser or type of adviser. The
factors should be considered in their totality, said the SEC, and no one factor
should be viewed as a determinative factor of independence
Neither Dodd-Frank nor the
implementing regulations require a compensation adviser to be independent, only
that the compensation committee consider the enumerated independence factors
before selecting a compensation adviser.
Compensation committees may select any compensation adviser they prefer,
including ones that are not independent, after considering the six independence
factors.
Changes to Item 407(e)(3) of
Regulation S-K will require issuers to disclose in their proxy statements whether
the work of any compensation consultant that has played any role in determining
or recommending the amount or form of executive and director compensation has
raised a conflict of interest, and if it had, disclose the nature of the
conflict and how it is being addressed.