ALM Properties, Inc.
Page printed from: Corporate Counsel
Select 'Print' in your browser menu to print this document.
Independence Day Ahead
Beginning in 2014, compensation committee members will face enhanced independence requirements under new governance listing standards for the New York Stock Exchange and Nasdaq (as well as other national exchanges). The new listing standards, recently approved by the Securities and Exchange Commission, will be in place as soon as January 15, 2014, or as late as October 31, 2014, depending on when a company holds its 2014 annual meeting of shareholders. While these implementation dates may seem far off today, companies and their counsel would be well advised to begin considering the impact the new standards may have on their committees and processes.
The new standards will differ substantially for NYSE companies and those listed on Nasdaq. For NYSElisted companies, the new standards will require that compensation committee members have no relationship with the company that is material to the member's ability to be independent of management in connection with his or her duties as a compensation committee member. In making this determination, the board of directors will need to consider all relevant factors, including:
Importantly, the determination required under the NYSE standards will require an assessment of all relevant factors, not just the two noted above.
By contrast, the new Nasdaq standard is based solely on the two factors noted above. The Nasdaq standard is nevertheless more stringent than the NYSE standard. Under Nasdaq's standard, the direct or indirect receipt of consulting, advisory, or other compensatory fees from the company by a director will automatically disqualify that director from eligibility for membership on the compensation committee. (An exception is made only for fees paid for services as a director and compensation under retirement plans that are not contingent on continued service.) And this applies regardless of whether the board considers the fees to be material to the director's independence.
Importantly, the Nasdaq rules do not apply a "look back" to the receipt of compensatory fees, meaning that only fees received while a member of the compensation committee will be relevant in analyzing a director's independence under the new standard. In applying the second factor noted above, the board of directors of a Nasdaq-listed company will be required to consider whether a compensation committee member is affiliated with the company, any subsidiary of the company, or any affiliate of a subsidiary of the company. If so, the board must determine whether that impairs the person's judgment as a compensation committee member.
For Nasdaq-listed companies, the new standards also impose a new requirement that the board maintain a standing compensation committee. Previously, Nasdaq-listed companies had flexibility to have compensation decisions for executives made by either the board's independent directors or by a compensation committee. NYSElisted companies, on the other hand, have long been required to have compensation committees.
The impact that the new independence standards for compensation committee members will have on many NYSE and Nasdaq-listed companies is uncertain. Both exchanges already generally require that compensation committees or directors that oversee executive compensation decisions be independent under the exchange's general standards for directors. It is also common for boards to require that their compensation committee members qualify as "nonemployee" directors under SEC rule 16b-3 and "outside directors" under section 162(m) of the Internal Revenue Code. As a result, most directors who oversee executive compensation matters are already free of the types of relationships that might render them ineligible to serve as a compensation committee member after the new standards take effect.
Nevertheless, it is important for all companies and their counsel to begin considering any needed changes in their approach to compliance well before the new independence standards go into effect. Companies should, at a minimum, brief the board and the compensation committee on the new standards and obtain from current and potential compensation committee members information sufficient to allow the board to determine their independence under the new requirements. Many companies already have added questions seeking this information to the annual questionnaire sent to directors and officers in connection with the annual report on Form 10-K and proxy statements.
Ensuring compliance with the new listing standards will also require building into the company's regular compliance processes a system for detecting transactions, relationships, or arrangements that could affect a director's independence under the new standards. This step should be similar to the existing processes used to monitor director independence under the standards imposed by various other rules and regulations. The company will also need to review and, if necessary, revise the compensation committee charter to reflect the new eligibility requirements if the charter sets forth in detail the independence standards for compensation committee members.
Establish your approach to compliance well in advance of the new standards taking effect to avoid unfortunate surprises. You don't want to discover, too late, that a director currently serving on the compensation committee has a direct or indirect relationship that would lead the board to conclude that the director is not independent under the new standards. Where, for example, a director is an executive officer of an entity that provides services to the listed company (such as accounting, consulting, legal, or financial services), the director might be deemed to receive a compensatory fee from the company, even if the director does not provide those services personally.
This conclusion would render the director ineligible to serve on a Nasdaq compensation committee and potentially ineligible to serve on a NYSE compensation committee. Similarly, a director might be deemed to receive an indirect compensatory fee where the director's spouse serves as an executive officer of an entity that provides consulting services to the company. This could also potentially affect the director's ability to serve on the compensation committee.
You want to leave plenty of time to make any changes in board committee assignments that might be deemed appropriate. Moreover, if a relationship is identified and the board is uncertain whether that should preclude service on the compensation committee, the company may be well advised to consult the relevant exchange for guidance. Doing so would require that additional time be built into the compliance process.
Because obtaining exchange guidance might require a dialogue over a period of time, we recommend that companies and their counsel begin considering what questions to ask of their directors, and then start asking them these hard questions. And you should do this well in advance of the new standards going into effect.
Alan Dye is a partner and Alex Bahn is counsel in the corporate practice of Hogan Lovells.