Section 952 of the Dodd-Frank Act added Section 10C to the Securities Exchange Act of 1934.  Section 10C required the SEC to adopt rules directing the securities exchanges to issue listing standards requiring listed companies to comply with Section 10C's compensation committee and compensation adviser independence requirements.  On June 20, 2012, the SEC adopted final rules (the “Final Rules”) directing the securities exchanges to prohibit the listing of any equity security of an issuer that is not in compliance with Section 10C's compensation committee and compensation adviser requirements (see our Client Alert on the Final Rules here).  In the past few months, several securities exchanges (most notably, the New York Stock Exchange (NYSE) and the NASDAQ Stock Market (NASDAQ)) proposed amendments to their corporate governance listing standards relating to compensation committee and adviser independence requirements as required by the Final Rules.

The Proposed Listing Standards

Compensation Committees

NYSE Proposed Standards.  Under the proposed NYSE standards, the board must consider all factors "specifically relevant" to determining whether a director has a relationship with the company that is material to that director's ability to be independent from management.  In terms of specific factors to be considered, the NYSE did not include any additional independence factors beyond the following factors referenced in Exchange Act Rule 10C-1(b)(1)(ii): (a) any compensation received by the director from any person or entity (including any consulting, advisory, or other compensatory fee paid by the company to such director); and (b) the director's affiliate relationship with the company, its subsidiary, or an affiliate of a subsidiary of the company.  When considering compensation, the NYSE proposal noted that the board should examine whether the receipt of such compensation would impair the director's ability to make independent judgments about the company's executive compensation.  When considering affiliate relationships, the NYSE proposal noted that the board should consider whether the relationship places the director under the direct or indirect control of the company or its senior management or creates a direct relationship between the director and members of senior management.  The NYSE also proposed a cure period, during which, as long as the compensation committee continues to have a majority of independent directors, a compensation committee member who ceases to be independent for reasons outside of the director’s reasonable control may continue to serve until the earlier of the next annual meeting or one year from the noncompliance event.

NASDAQ Proposed Standards.  The most significant aspect of the NASDAQ proposal is the new requirement that listed companies have a standing compensation committee consisting of at least two directors, each of whom must satisfy the new proposed independence standards.  Under current NASDAQ listing standards, executive compensation may be determined either by a compensation committee consisting solely of independent directors or by a vote of a majority of independent directors of the board.  The NASDAQ proposed standards also require adoption of a formal written compensation committee charter addressing certain matters (including the scope of the committee's responsibilities, how it carries out its responsibilities, the committee's responsibilities for determining executive compensation, and specific responsibilities relating to the retention and compensation of compensation advisers and the assessment of their independence).  The charter must be reviewed and assessed on an annual basis.

In contrast to the NYSE proposal concerning the compensation factor of Exchange Act Rule 10C-1(b)(1)(ii), NASDAQ proposes a mandatory prohibition against service on the compensation committee if the director receives, directly or indirectly, any consulting, advisory, or other compensatory fee from the company or its subsidiaries (other than directors' fees).  With respect to affiliate relationships, NASDAQ would also require the board to consider the affiliate status of the director and whether such affiliation would impair the director's judgment as a member of the compensation committee.  The NASDAQ proposed rules also include a cure period similar to the NYSE’s proposal for non-compliance beyond the reasonable control of a director, except that the cure period may not exceed 180 days from the non-compliance event. 

Compensation Adviser Requirements

NYSE Proposed Standards.  The proposed NYSE standards concerning compensation adviser requirements largely track the related provisions in Section 10C, particularly those relating to the powers of compensation committees to retain and obtain the advice of compensation consultants, independent legal counsel, and other advisers (collectively, “Compensation Advisers”).  In fact, the proposed NYSE standards adopted Exchange Act Rule 10C-1(b)(4)’s provisions virtually verbatim, requiring the compensation committee to (a) have the sole power to retain or obtain the advice of Compensation Advisers and (b) be responsible for the appointment, compensation, and oversight of such Compensation Advisers.  In addition, NYSE-listed companies must provide appropriate funding for payment of reasonable compensation to such Compensation Advisers retained by the compensation committee.  The NYSE proposed standards similarly follow the Final Rules and incorporate by reference the six factors set forth in Rule 10C-1(b)(4) that must be considered by the compensation committee in determining the independence of Compensation Advisers selected by the compensation committee.

NASDAQ Proposed Standards.  NASDAQ's proposed standards also track the Final Rules without significant change with respect to Compensation Advisers.  NASDAQ also did not propose any additional factors for consideration in determining the independence of Compensation Advisers beyond the six factors set forth in Rule 10C-1. 

Exemptions

NYSE Proposed Standards.  The NYSE proposals would exempt from all new requirements specified categories of companies, including controlled companies, limited partnerships, companies in bankruptcy, and companies with only preferred stock.  The NYSE standards would exempt smaller reporting companies from the compensation committee independence requirements and the requirement to test the independence of Compensation Advisers.  Foreign private issuers are also exempt from the new requirements if they follow home country practices. 

NASDAQ Proposed Standards.  The NASDAQ proposals rules would exempt specified categories of companies, including controlled companies, limited partnerships, asset-backed companies, management investment companies, and cooperatives.  The NASDAQ proposed standards would require smaller reporting companies to have a standing compensation committee consisting of at least two independent directors who must satisfy NASDAQ’s existing standard of independence.  Smaller reporting companies would also be required to have a written compensation committee charter or board resolution that specifies the committee's responsibilities and authority, except those responsibilities and authority relating to Compensation Advisers under the proposed rules.  The NASDAQ standards would otherwise exempt smaller reporting companies from the enhanced compensation committee independence requirements, as well as the requirements relating to Compensation Advisers.  Foreign private issuers are also exempt from these requirements if they follow home country practices and disclose in their annual reports each NASDAQ requirement that is not followed and the home country practice that is followed in lieu of the NASDAQ requirement.

Implementation

NYSE Proposed Standards.  If approved by the SEC, the NYSE's proposed rules relating to the independence of compensation committee members will not become effective until the earlier of (i) the first annual meeting after January 15, 2014, or (ii) October 31, 2014.  The remaining rules, including those related to Compensation Advisers, will become effective on July 1, 2013. 

NASDAQ Proposed Standards.  Upon approval by the SEC, NASDAQ proposes to immediately make effective those provisions relating to the responsibility and authority of compensation committees and the selection of compensation committee advisers.  The remaining provisions will become effective at the earlier of (i) the second annual meeting held after SEC approval of the proposed rules or (ii) December 31, 2014.

Practical Considerations

In light of the imminent adoption of the new listing standards, either as proposed or with minor adjustments, it is advisable for companies and their legal counsel to consider the potential impact of the new listing standards and what actions may be necessary to bring boards into compliance.  In particular, consider the following actions:

• Undertake an analysis of the independence of each member of your compensation committee under the new listing standards to determine if you already comply.  If not, what actions will be necessary to bring your company into compliance?
• Educate your board and the current compensation committee as to the expected new standards.
• Review your directors and officers (D&O) questionnaires to determine if alterations are necessary to obtain the necessary information for compliance with the new listing standards.  Also consider if your current committee charter or other governance guidelines will need amendment.
• If you are a NASDAQ-listed company that does not have a compensation committee, begin the planning process for formation of a compensation committee and the adoption of a formal charter. 
• Establish or update procedures or screening questionnaires utilized to test the independence of Compensation Advisers and root out conflicts of interest.  Note that, apart from exchange listing standards, the Final Rules require companies to comply with enhanced conflict of interest disclosures under Item 407(e)(3)(iv) of Regulation S-K in proxy statements for any annual or special stockholder meeting occurring on or after January 1, 2013 and steps must be taken to comply with these enhanced disclosure requirements.