Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act amends the Securities Exchange Act of 1934 by adding new Section 10C, requiring the Securities and Exchange Commission to adopt rules directing the national securities exchanges* to prohibit the listing of the equity securities of a company that does not comply with certain compensation committee and compensation advisor requirements. Yesterday the Commission released a set of proposed rules and amendments that are designed to implement Section 952.
As per usual, the Commission is soliciting public comments on the proposed rules and amendments, which are due on or before April 29, 2011.
Updated April 29, 2011:
Who do the proposed rules and amendments apply to?
Proposed Rule 10C-1
Proposed Exchange Act Rule 10C-1 requires that the rules of the national securities exchanges prohibit the initial or continued listing of any equity security of a company that does not comply with certain compensation committee and compensation advisor requirements.
As proposed Rule 10C-1 only applies to companies with exchange-listed equity securities, excluding security future products and standardized options. The Commission estimates that there are approximately 76 companies that fall outside of the scope of Rule 10C-1 by virtue of having only exchange-listed debt securities, and is specifically seeking comment on whether these companies should be made to comply with the final rule.
Additionally, by definition, companies with securities quoted through inter-dealer quotation systems in an over the counter market, such as the OTC Bulletin Board or the OTC Markets Group (formerly the Pink Sheets), are excluded from Rule 10C-1, unless, of course, they also have a class of equity securities listed on a national securities exchange.
Proposed Amendments to Item 407 of Regulation S-K
The proposed amendments to Item 407 of Regulation S-K broaden the scope of existing disclosure requirements with respect to compensation advisor and conflict of interest disclosures.
As proposed the amendments apply to all Exchange Act reporting companies that are subject to the proxy rules, this includes companies with securities quoted in an over the counter market, such as the OTC Bulletin Board or the OTC Markets Group, and controlled companies, but excludes foreign private issuers, which are not subject to the proxy rules, and registered investment companies, but only because they are not subject to the disclosure requirements of Item 407 of Regulation S-K.
What does proposed Rule 10C-1 require regarding compensation committees?
Proposed Rule 10C-1 requires that if a company has a compensation committee, or a committee performing the function of a compensation committee (i.e., one that oversees executive compensation), each committee member must also be a member of the company’s board of directors and must be independent. The national securities exchanges are themselves tasked with defining independence in the context of compensation committee membership, but must take into consideration factors such as:
- sources of compensation paid to a board member, including consulting, advisory and other fees paid by the company; and
- whether a board member is affiliated with the company or a subsidiary of the company.
Notably, as proposed Rule 10C-1 does not direct the national securities exchanges to adopt listing standards that would require a company to have a compensation committee, or to apply the compensation committee independence standards to the independent members of a board of directors that oversee executive compensation when there is no committee. The Commission is also specifically seeking comment on whether the final rule should instead direct the national securities exchanges to adopt listing standards that simply require compensation committees.
What does proposed Rule 10C-1 require regarding compensation advisors?
Proposed Rule 10C-1 requires that a compensation committee have the discretion and reasonable funds available to retain compensation consultants, independent legal counsel and other advisors, and that the committee be responsible for appointing, compensating and overseeing the work of such advisors, but not be required to follow the their advice or recommendations.
When choosing advisors, proposed Rule 10C-1 does not require that they also be independent, only that the compensation committee, in its selection process, consider:
- whether the advisor provides other services to the company;
- the amount of fees the advisor receives from the company as a percentage of the advisor’s total revenues;
- what policies and procedures the advisor has in place to prevent conflicts of interest;
- whether the advisor has a business or personal relationship with any member of the compensation committee; and
- whether the advisor owns any company stock.
In addition to the foregoing, the national securities exchanges may adopt other relevant factors for consideration in their respective listing standards.
Are there any exemptions?
Exchange Act Section 10C exempts five categories of companies from the the compensation committee independence requirements:
- controlled companies;
- limited partnerships;
- companies in bankruptcy proceedings;
- open-ended management companies; and
- foreign private issuers that disclose in their annual report the reason they do not have an independent compensation committee.
Proposed Rule 10C-1 also authorizes the national securities exchanges to adopt listing standards that exempt:
- certain relationships from the compensation committee independence requirements; and
- entire categories of companies from all of the Section 10C requirements, taking into consideration the potential impact that the requirements may have on smaller reporting companies.
When will the new listing standards take effect?
Procedurally, following the public comment period, and once the final rules and amendments are adopted and published in the Federal Register, the national securities exchanges will have 90 days to propose conforming listing standards, which must then be approved by the Commission within one year of the date on which its final rules and amendments were published in the Federal Register.
To the extent that they do not already do so, the listing standards of the national securities exchanges will have to provide companies with a reasonable opportunity to cure any defects that would otherwise cause their securities to be delisted, or ineligible for listing, based on a failure to meet the new standards.
What new disclosures do the proposed amendments to Item 407 of Regulation S-K require?
As proposed, the amendments to Item 407 of Regulation S-K would require a company to make certain expanded disclosures in any proxy or information statement filed in connection with an annual or special meeting at which directors are elected, regarding whether:
- management or the company’s compensation committee retained or obtained the advice of a compensation advisor during the most recently completed fiscal year; and
- the work of the compensation advisor raised any conflicts of interest, and, if so, how the conflicts are being addressed.
When do the new disclosure requirements take effect?
The new disclosure requirements will not take effect until the effective date of the final rules and amendments adopted by the Commission.
* The proposed rules would also apply to a registered national securities association that lists equity securities in an automated inter-dealer quotation system. At present, the Financial Industry Regulatory Authority (FINRA) is the only registered national securities association, however, FINRA does not list equity securities and, as such, the new rules do not apply to it.