SEC Releases Final Rules On Compensation Committee Independence And Compensation Advisers

July 5, 2012 | Comments Off on SEC Releases Final Rules On Compensation Committee Independence And Compensation Advisers
Posted by John L. Sikora

On June 27, 2012, the Securities and Exchange Commission published new Rule 10C-1 under the Securities Exchange Act of 1934 to implement Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.  Section 952 added Section 10C to the Exchange Act, which requires the SEC to adopt rules to direct the national securities exchanges (for example, the NYSE and the NASDAQ) to prohibit the listing of the equity securities of an issuer that does not comply with Section 10C’s requirements relating to compensation committees and compensation advisers.

Summary of Rule 10C-1

Rule 10C-1 requires issuers whose equity securities are listed on a national securities exchange to comply with the following requirements:

Requirements Relating to Compensation Committee Independence:

  • Each member of the issuer’s compensation committee must be an independent member of the board of directors.  The national securities exchanges currently have their own definitions of independence, and generally require an issuer to either have a compensation committee comprised of independent directors or the independent members of the board determine executive compensation.  Rule 10C-1 does not require the exchanges to adopt a specific definition of independence, but provides that the exchanges will consider the source of a director’s compensation, including any consulting or advisory fees the director receives from the issuer, whether the director is affiliated with the issuer or any subsidiary of the issuer, and any other relevant factors to determine their own independence requirements.
  • The independence rule applies to the compensation committee of the board of directors, but Rule 10C-1 does not require an issuer to have a separately designated compensation committee (although certain national securities exchanges, such as the NYSE, may require a separate compensation committee).  If an issuer does not have a committee designated as a “compensation committee,” and a different committee oversees executive compensation matters (such as a “human resources committee” or a “corporate governance committee”), the independence rule applies to that committee.  Further, if an issuer does not have a separate committee to oversee executive compensation, the independence rule applies to the members of the board who oversee executive compensation.
  • The rules adopted by the national securities exchanges must provide issuers a reasonable opportunity to cure defects that would be a basis for prohibition (for example, if a compensation committee member ceased to be independent for reasons outside of the member’s reasonable control).
  • Limited partnerships, companies in bankruptcy proceedings, open-end management investment companies registered under the Investment Company Act of 1940, and certain foreign private issuers are exempt from the compensation committee independence requirement.

Requirements Relating to Compensation Advisers:

  • The compensation committee must have the authority to retain or obtain the advice of a compensation consultant, independent legal counsel or other adviser (referred to collectively as a “compensation adviser” herein), in the compensation committee’s discretion.  The issuer must provide the compensation committee with appropriate funding to retain any such compensation adviser.
  • The compensation committee must conduct an assessment of a potential compensation adviser’s independence from the issuer based on several factors listed in Rule 10C-1, which include, among others, any other services performed by the adviser’s employer to the issuer, the fees received by the adviser’s employer from the issuer, and whether the adviser (but not the adviser’s employer) owns any stock of the issuer.  The compensation committee does not need to conduct this assessment with respect to in-house counsel, but must conduct the assessment with respect to outside legal counsel.  However, Rule 10-C-1 only requires the compensation committee to consider the enumerated independence factors before selecting a compensation adviser; the rule does not require a compensation adviser to be independent.
  • The compensation committee must have direct responsibility for the appointment, compensation and oversight of any such compensation adviser.
  • The compensation committee is not required to act upon the advice or recommendations of any such compensation adviser, and the retention of a compensation adviser does not change the compensation committee’s ability or obligation to exercise its own judgment in the fulfillment of its duties.
  • Notwithstanding the foregoing, Rule 10C-1 does not limit or impair the compensation committee’s ability to obtain advice from non-independent advisers, such as in-house counsel or outside counsel and non-independent compensation advisers engaged by management.

Exemptions from Rule 10C-1

Smaller reporting companies and “controlled companies” are exempt from Rule 10C-1’s requirements relating to compensation committee independence and compensation committee advisers described above.  A “controlled company” is defined in Rule 10C-1 as a listed issuer of which more than 50% of the voting power is held by one individual, company or group.  The national securities exchanges are also permitted to provide for additional exemptions.

Effective Date

The national securities exchanges are required to have rules in place that comply with the requirements of Rule 10C-1 and that have been approved by the SEC by June 27, 2013.

Compliance Matters

Rule 10C-1 adds a number of corporate governance housekeeping items for larger issuers to which the requirements will apply.  The board will need to regularly monitor the qualification of each compensation committee member with the independence requirements of the exchange on which the issuer is listed.  It will be vital for the board to identify a defect as soon as possible after it occurs so that the issuer can avail itself of the opportunity to cure the defect under Rule 10C-1, which will likely include prompt notification to the national securities exchange of the defect.  The board should review and, if necessary, amend, the compensation committee’s charter to ensure that the committee is vested with the discretion and authority prescribed by Rule 10C-1 to retain, oversee and compensate compensation advisers.  In addition, the compensation committee will have to properly document the independence assessments for compensation advisers, and that the committee considered each of the factors enumerated in Rule 10C-1.


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