On June 20, 2012, the Securities and Exchange Commission (“SEC”) issued new guidance on a rule requiring national securities exchanges to adopt listing standards for public company compensation committees and compensation advisers such as independent legal counsel. The guidance implements Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which added Section 10C to the Securities Exchange Act of 1934 (the “Exchange Act”). Section 10C requires the SEC to adopt rules directing the national securities exchanges and national securities associations to prohibit the listing of any equity security of an issuer that is not in compliance with Section 10C’s requirements. For instance, one key requirement provides that the listed issuer must provide appropriate funding for payment of reasonable compensation to independent legal counsel and other compensation advisers. If an issuer does not provide such funding, the issuer’s equity security cannot be listed on the exchange. For the purposes of this article, the term “compensation advisers” encompasses legal counsel, compensation consultants, and other advisers.
Retention of Independent Legal Counsel
Section 10(C) of the Exchange Act provides that the compensation committee of a listed issuer may obtain the advice of a “compensation consultant,” and Section 10C(d) extends this authority to “independent legal counsel and other advisers.” While not required to do so, hiring independent outside legal counsel can aid an issuer’s board of directors’ compensation committee’s ability to obtain independent advice regarding compensation matters. To implement the statutory requirements contained in the Exchange Act, Rules 10C-1(b)(2) and (3) provide that:
- the compensation committee may, in its sole discretion, retain or obtain the advice of independent legal counsel;
- the compensation committee, which for this purpose includes those members of a listed issuer’s board of directors who oversee executive compensation matters on behalf of the board of directors in the absence of a board committee, shall be directly responsible for the appointment, compensation, and oversight of the work of any legal counsel retained by the compensation committee; and
- each listed issuer must provide for appropriate funding for payment of reasonable compensation, as determined by the compensation committee, to any legal counsel retained by the compensation committee
The SEC guidance clarifies that the foregoing requirements are limited only to legal counsel retained by the compensation committee. Further, the final rule does not require the compensation committee to act consistently with the advice of any legal counsel, and does not require the compensation committees to obtain advice only from independent counsel. Rather, the compensation committee can obtain advice from non-independent counsel, such as in-house counsel or outside counsel obtained by management. Notably, SEC Rule 10C-1(b)(3) provides that the issuer must provide appropriate funding for payment of reasonable compensation to independent legal counsel and other compensation advisers to ensure that the issuer’s compensation committee has the necessary funds to pay for such counsel.
Legal Counsel Independence Factors
As discussed above, the hiring of independent outside legal counsel can enhance the likelihood that the compensation committee is receiving independent advice. To ensure the independence of such advice, Exchange Act Section 10C(b) provides that the compensation committee must consider five independence factors specified in the statute as well as any other factors identified by the relevant exchange in selecting a compensation adviser. To implement this statutory requirement, Rule 10C-1(b)(4) includes the five factors included in the Exchange Act as well as an additional factor relating to any business or personal relationship between the executive officers of the issuer and the legal counsel. The SEC explained that this addition was necessary because such a relationship could create a significant conflict of interest when, for example, the chief executive officer and the legal counsel are business partners. The six factors that must be considered in selecting a compensation adviser include the following:
- The provision of other services to the issuer by the person that employs the legal counsel;
- The amount of fees received from the issuer (as a percentage of the total revenue) by the person who employs the legal counsel;
- The policies and procedures of the person employing the legal counsel that are designed to prevent conflicts of interest;
- Any business or personal relationship of the legal counsel with a member of the compensation committee;
- Any stock of the issuer owned by the legal counsel; and
- Any business or personal relationship between the executive officers of the issuer and the legal counsel or person employing the counsel.
In identifying these factors, the SEC stated that it did not believe it appropriate to establish bright-line or numerical thresholds for the given factors because the thresholds may not be competitively neutral. Further, the absence of such thresholds means that all facts and circumstances relevant to the six factors are to be considered. Throughout the guidance, the SEC reiterated that neither the Exchange Act nor the final rule requires legal counsel to be independent, only that the compensation committee consider the enumerated independence factors before selecting counsel.
Opportunity to Cure Defects, Exchanges Affected, Exemptions, and Disclosures
To comply with Exchange Rule 10A-3(a)(3), the SEC issued Rule 10C-1(a)(3) requiring the exchanges to provide appropriate procedures for listed issuers to have a reasonable opportunity to cure any noncompliance with the compensation committee listing requirements that could result in the delisting of an issuer’s securities. Further, the SEC specified that these listing requirements apply only to exchanges that list equity securities and within those exchanges, only to issuers with listed equity securities, not to companies that have only an issue of publicly-registered debt. Also, the listing requirements do not apply to securities futures products and standardized options.
Rule 10C-1(b)(1)(iii) also exempts the following entities from the listing standards: limited partnerships, companies in bankruptcy proceedings, controlled companies, smaller reporting companies, registered open-end management investment companies and foreign private issuers that provide annual disclosures to shareholders of the reasons why the foreign private issuer does not have an independent compensation committee. The final rule also authorizes the exchanges to exempt a particular relationship from the compensation committee member independence requirements, as the exchanges deem appropriate, taking into consideration the size of the issuer and any other relevant factors.
Finally, the SEC final rule complies with Section 10C(c)(2) of the Exchange Act by providing that issuers must disclose, in any proxy or other information statement relating to an annual meeting of shareholders, whether the work of any legal counsel played any role in determining or recommending the amount or form of executive compensation and whether such role has raised any conflict of interest. If so, the issuer must also disclose the nature of the conflict and how the conflict is being addressed.
Effective Date and Further Information
The final rule will take effect 30 days after publication in the Federal Register. Securities exchanges will be required to propose listing standards that comply with the rule within 90 days after it takes effect. The standards must be approved by the SEC within one year of the new rule’s effective date. Further guidance on the final rule can be found here.
Fraser Stryker is a leader in executive compensation, tax, and employee benefits law. Attorneys in the Firm’s Employee Benefits, Taxation, and Corporate Practice Groups advise individuals, businesses, and nonprofit/tax-exempt organizations on a wide variety of compensation, tax, and employee benefits matters. Fraser Stryker works with employers to implement and maintain executive and top management incentive, equity based, and deferred compensation programs and employee benefit plans that help attract and retain top talent. For more information on how Fraser Stryker can assist your organization’s Compensation Committee by providing independent legal counsel, please contact Nicole R. Konen.
This article is provided by Fraser Stryker for general informational purposes and is not intended to be and should not be construed as legal advice on any specific facts or circumstances.
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