When Do You Need to Start Complying With New NASDAQ and NYSE Compensation Committee Rules?

On January 11, 2013, the SEC approved proposed changes to the listing standards of the New York Stock Exchange LLC and NASDAQ Stock Market LLC related to compensation committees. Both exchanges created transition periods to comply with the new rules.

As of July 1, 2013, NASDAQ and NYSE listed companies will be required to comply with the new rules relating to the authority of a compensation committee to retain compensation consultants, legal counsel, and other compensation advisers; the authority to fund such advisers; and the responsibility of the committee to consider independence factors before selecting such advisers. The requirement that such authority and responsibilities of the compensation committee be included in the compensation committee’s written charter does not apply until a later date (see below) for NASDAQ listed companies and such companies should consider under state corporate law whether to grant such specific responsibilities and authority through a charter, resolution or other board action. In contrast, NYSE listed companies will have to amend their existing charters as of July 1, 2013 to address these additional rights and responsibilities of the compensation committee related to compensation consultants, legal counsel, and other compensation advisers. To the extent a NASDAQ listed company does not have a compensation committee by July 1, 2013, these requirements will apply to the independent directors who determine, or recommend for the board’s determination, the compensation of the CEO and other executive officers of the company.

The remaining new rules, for example, compensation committee charter and independence standards for compensation committee members, will not have to be complied with by NASDAQ listed companies until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014.

NYSE listed companies will have until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014, to comply with the new standards for compensation committee director independence.

Indemnify Me, Maybe

A recent Delaware Chancery Court letter opinion is a reminder that directors, officers and their counsel should carefully review the mandatory indemnification and advancement of expenses language in their bylaws and indemnification agreements to ensure that they mean what they think the mean.
In Miller v. Palladium Industries, Inc. (Del. Ch. December 31, 2012, available at http://courts.delaware.gov/opinions/download.aspx?ID=182530), the Court dismissed an action for mandatory advancement of legal defense costs brought by a former director who was being sued by the corporation. The relevant provisions of the bylaws provided for mandatory indemnification and advancement of expenses; however, another section of the bylaws provided that expenses incurred in defending a proceeding “shall be paid by the corporation in advance of such proceeding’s final disposition unless otherwise determined by the Board of Directors in the specific case . . ..” Here, the Board had determined that the advancement of expenses was not in the best interests of the corporation for various reasons and denied the request.
The Court did not consider the two bylaw provisions ambiguous and construed them together: “Palladium must advance legal fees and expenses if the board does not adopt a contrary directive. . . . Failure of the board to act in a specified time after receipt of a request for advancement will leave the request as a mandatory one. Here, the board acted in a timely fashion – within roughly thirty days from the date of Miller’s demand.” As a result, the Court dismissed the former director’s claim for advancement of expenses.
So blow the dust off your bylaws and indemnification agreements, read the applicable language and make sure it says what you think it says.

The SEC Approved PCAOB Rules on Communications with Audit Committees

On December 17, 2012, the SEC approved PCAOB proposed rules on Auditing Standard No. 16, Communications with Audit Committees.  Auditing Standard No. 16 supersedes PCAOB’s interim standards AU section 380, Communication with Audit Committees, and AU section 310, Appointment of the Independent Auditor.  Auditing Standard No. 16 is effective for audits of financial statements for fiscal years beginning on or after December 15, 2012 and applies to the audits of all issuers, including emerging growth companies established under the JOBS Act and foreign private issuers.

It is interesting to note that, among other matters, Auditing Standard No. 16 expands the inquiries of the audit committee required by Auditing Standard No. 12, Identifying and Assessing Risks of Material Misstatement, which requires the auditor to inquire of the audit committee regarding its knowledge of the risks of material misstatements, including fraud risks.  The inquiry required by Auditing Standard No. 16 goes beyond material misstatements and fraud risks and provides that the auditor “should inquire of the audit committee about whether it is aware of matters relevant to the audit, including, but not limited to, violations or possible violations of laws or regulations.” 

 In light of this inquiry, audit committees will need to discuss procedures for evaluating violations, including possible violations, of laws and regulations, especially considering the fact that this requirement does not include any materiality threshold.

Time Period for SEC Action on Exchanges’ Proposed Compensation Committee Rules Was Extended until January 13, 2013

On September 25, 2012, each of The NASDAQ Stock Market LLC and New York Stock Exchange filed with the SEC proposed rules amending their listing standards for compensation committees.  Generally, under the Securities Exchange Act of 1934, the SEC should decide whether to approve or disapprove proposed rule changes within 45 days of the publication of notice of the filing of a proposed rule change or within such longer period (up to 90 days) as the SEC may designate.  The 45th day from the publication of notice of filing of the compensation committee proposed rule changes by the exchanges was November 29, 2012. The SEC extended the 45-day time period for SEC action on these proposed rule changes and designated January 13, 2013, as the date by which the SEC should either approve or disapprove these changes.

ISS Releases 2013 Updates to Proxy Voting Guidelines

On November 16, 2012, the ISS released its final 2013 Updates to its U.S. Corporate Governance Policy. ISS also will release a FAQ document in December 2012 for further guidance. The Updates will be effective for meetings on or after February 1, 2013.

Highlights of the 2013 Updates include:

• Stock Pledges/Hedges: In response to comments, ISS will be taking a case-by-case approach in determining whether pledging of company shares rises to a level of serious concern for shareholders. Also in response to comments, ISS is including significant pledging of company stock as a failure of risk oversight and thus considered a governance failure for which directors should be held accountable (rather than communicating concern through a say-on-pay recommendation as originally proposed). However, hedging of company stock, through covered call, collar or other derivative transactions, will be considered a problematic practice warranting a negative voting recommendation on the election of directors.

• Failure to Act on Shareholder Proposals: ISS will keep its current policy in effect for 2013, with some modifications: ISS will recommend a negative vote for individual directors, committee members or the entire board, if the board failed to act on a shareholder proposal that received the support of either (i) a majority of the outstanding shares or (ii) a majority of the votes cast in the last year and one of the two previous years. Beginning in 2014, ISS will recommend a vote negative vote if the board failed to act on a shareholder proposal that received the support of a majority of shares cast in the previous year. Under the Update, the ISS now has the flexibility to recommend a negative vote on members of the board as deemed appropriate, not necessarily the full board. The ISS also has included more guidance on the case-by-case examination of the sufficiency of a company’s action in response to a majority-supported shareholder proposal.

• Peer Groups: The new methodology incorporates information from companies’ self-selected pay benchmarking peer groups in order to identify and prioritize Global Industry Classification Standard (GICS) industry groups beyond the subject company’s own GICS classification. The methodology draws peers from the subject company’s GICS group as well as from GICS groups represented in the company’s peer group, while maintaining the approximate proportions of these industries in the final peer group where possible. The methodology additionally focuses initially at an 8-digit GICS resolution to identify peers that are more closely related in terms of industry. Finally, when selecting peers, the methodology prioritizes peers that maintain the company near the median of the peer group, are in the subject company’s peer group, and that have chosen the subject company as a peer. The peer group methodology maintains its focus on identifying companies that are reasonably similar to the subject company in terms of industry profile, size, and market capitalization. Other changes to the peer group methodology include using slightly relaxed size requirements, especially at very small and very large companies, and using revenue instead of assets for certain financial companies.

• Realizable Pay: Realizable pay is being added to the research report for large capitalization companies. Realizable pay will consist of the sum of relevant cash and equity-based grants and awards made during a specified performance period being measured, based on equity award values for actual earned awards, or target values for ongoing awards, calculated using the stock price at the end of the performance measurement period. Stock options or stock appreciation rights will be revalued using the remaining term and updated assumptions, as of the performance period, using the Black-Scholes Option Pricing model. The realizable pay consideration may mitigate or exacerbate the CEO’s pay for performance concerns.

• Voting on “Say on Golden Parachute” Proposals: The Update will (i) include existing change-in-control arrangements maintained with named executive officers rather than focusing only on new or extended arrangements and (ii) place further scrutiny on multiple legacy problematic features (e.g. single trigger equity, tax gross –ups, etc.) in change in control agreements.

SEC and DOJ Issue Joint Guidance on FCPA Interpretation

On November 14, 2012, the Enforcement Division of the United States Securities and Exchange Commission and the Criminal Division of the United States Department of Justice announced the issuance of A Resource Guide to the U.S. Foreign Corrupt Practices Act.  The 130 page guide addresses various topics that will be of interest to any company with activities outside the United States, including who and what is covered by the FCPA’s anti-bribery provisions; the definition of  a “foreign official”; what constitute proper and improper gifts, travel and entertainment expenses; facilitating payments and a host of other topics as well.  The SEC, in its press release, said that “the guide takes a multi-faceted approach toward setting forth the statute’s requirements and providing insights into SEC and DOJ enforcement practices.” 

As previously noted by my colleagues Shawn M. Wright and James R. Billings-Kang in an article appearing in The National Law Journal, the DOJ and the SEC continue to be very active in enforcing the FCPA and as previously discussed in this blog, companies with operations outside the United States should consider their SEC disclosure obligations relating to the FCPA.  As such, the guide is sure to be a great resource to both companies with international operations and the legal community advising them with respect to the FCPA.  For additional resources relating to the FCPA, please visit our website.

New Staff Legal Bulletin 14G Addresses Rule 14a-8 Shareholder Proposal Issues

The Division of Corporation Finance released Staff Legal Bulletin 14G on October 16, 2012 providing additional guidance for excluding shareholder proposals under Rule 14a-8 based on proof of ownership and references to websites:
• The SEC clarified that for purposes of verifying whether a beneficial owner is eligible to submit a proposal under Rule 14a-8, a proof of ownership letter from an affiliate of a DTC participant satisfies the requirement to provide a proof of ownership letter from a DTC participant.
• A shareholder who holds securities through a securities intermediary that is not a broker or bank can satisfy Rule 14a-8’s documentation requirement by submitting a proof of ownership letter from that securities intermediary. If the securities intermediary is not a DTC participant or an affiliate of a DTC participant, then the shareholder will also need to obtain a proof of ownership letter from the DTC participant or an affiliate of a DTC participant that can verify the holdings of the securities intermediary.
• The SEC said that it will not concur in the exclusion of a proposal under Rules 14a-8(b) and 14a-8(f) on the basis that a proponent’s proof of ownership does not cover the one-year period preceding and including the date the proposal is submitted unless the company provides a notice of defect that identifies the specific date on which the proposal was submitted and explains that the proponent must obtain a new proof of ownership letter verifying continuous ownership of the requisite amount of securities for the one-year period preceding and including such date to cure the defect. The SEC views the proposal’s date of submission as the date the proposal is postmarked or transmitted electronically. In addition, companies should include copies of the postmark or evidence of electronic transmission with their no-action requests.
• If a shareholder proposal or supporting statement refers to a website that provides information necessary for shareholders and the company to understand with reasonable certainty exactly what actions or measures the proposal requires, and such information is not also contained in the proposal or in the supporting statement, the SEC believes the proposal would raise concerns under Rule 14a-9 and would be subject to exclusion under Rule 14a-8(i)(3) as vague and indefinite. However, if shareholders and the company can understand with reasonable certainty exactly what actions or measures the proposal requires without reviewing the information provided on the website, then the SEC believes that the proposal would not be subject to exclusion under Rule 14a-8(i)(3) on the basis of the reference to the website address.
• The SEC will not concur that a reference to a website may be excluded as irrelevant under Rule 14a-8(i)(3) on the basis that it is not yet operational if the proponent, at the time the proposal is submitted, provides the company with the materials that are intended for publication on the website and a representation that the website will become operational at, or prior to, the time the company files its definitive proxy materials.
• If information on a website changes after submission of a proposal and the company believes the revised information renders the website reference excludable under Rule 14a-8, the SEC may concur that the changes to the referenced website constitute “good cause” for the company to file its reasons for excluding the website reference after the 80-day deadline under Rule 14a-8(j) and grant the company’s request that the 80-day requirement be waived.

The Bulletin is available at http://www.sec.gov/interps/legal/cfslb14g.htm.

ISS Releases Proposed Updates to Proxy Voting Guidelines for Comment

The ISS recently released its 2013 proposed updates to their proxy voting guidelines. Five proposals would affect US based companies, of which one was directed at shareholder proposals and four focused on executive compensation, as follows:
• ISS would recommend a vote AGAINST or WITHHOLD from the entire board if the board failed to act on a shareholder proposal that received the support of a majority of shares cast in the previous year. Currently, ISS would make such a recommendation only if the proposal received the support of either (i) a majority of the outstanding shares or (ii) a majority of the votes cast in the last year and one of the two previous years.
• A revision in the methodology for selecting peer groups for executive compensation comparisons in say-on-pay proposals.
• The use of a comparison of realizable pay to grant date pay as part of the evaluation of pay-for-performance alignment.
• Adding the pledging of company shares by directors and officers as a factor that may lead to negative recommendations under the existing problematic pay practices evaluation.
• A change on say-on-golden parachute proposals to (i) include existing change-in-control arrangements maintained with named executive officers rather than focusing only on new or extended arrangements and (ii) to place further scrutiny on multiple legacy problematic features (e.g. single trigger equity, tax gross –ups, etc.) in change in control agreements.
The full proposals are available at http://www.issgovernance.com/policycomment2013. The comment period expires on October 31, 2012.

NASDAQ Has Proposed Changes to Its Compensation Committee Rules. What Should We Do Now?

If you work for a Nasdaq-listed company, you should pay close attention to Nasdaq’s proposal related to compensation committees rules.  The proposal was issued last week in response to the SEC’s Rule 10C-1 and Section 952 of the Dodd-Frank Act that required the SEC to direct the national securities exchanges to prohibit the listing of any equity security of an issuer, subject to certain exemptions, that does not comply with the Act’s requirements relating to compensation committees and compensation advisers. 

 Summary of Nasdaq’s Proposal

 Generally, Nasdaq has proposed the following changes to its compensation committee rules:

  •  companies must have a compensation committee consisting of at least two members, each of whom must be an independent director as defined in Nasdaq’s current listing rules;
  • compensation committee members must not accept directly or indirectly any consulting, advisory or other compensatory fee, other than for board service, from a company or any subsidiary thereof;
  • in determining whether a director is eligible to serve on a compensation committee, a company’s board of directors must consider whether the director is affiliated with the company, a subsidiary of the company or an affiliate of a subsidiary of the company; and
  •  companies must adopt a formal, written compensation committee charter that must specify, among other matters, the compensation committee responsibilities and authority as set forth in Rule 10C-1 relating to the: (i) authority to retain compensation consultants, independent legal counsel and other compensation advisers; (ii) authority to fund such advisers; and (iii) responsibility to consider certain independence factors before selecting such advisers, other than in-house legal counsel.

 Effective Dates

 Proposed Nasdaq Listing Rule 5605(d)(3), which requires compensation committees to have the specific responsibilities and authority relating to compensation consultants, independent legal counsel and other compensation advisers, will be effective immediately upon the SEC’s approval of the Nasdaq’s proposal. 

 Nasdaq-listed companies must comply with the remaining amended listing rules described aboveby the earlier of: (1) their second annual meeting held after the date of approval of the proposed rules; or (2) December 31, 2014.  A company must certify to Nasdaq, no later than 30 days after the implementation deadline applicable to it, that it complied with the amended listing rules on compensation committees (Nasdaq will provide a form for this certification).

 What Should We Do Now?

 Please see below a list of suggested action items in connection with such proposals:

  1.  If you do not have a compensation committee and a majority of independent directors is making, or recommending to the board, compensation decisions related to executive officers of the company, start evaluating potential candidates for compensation committee membership.
  2. If you have a compensation committee consisting of one director, start evaluating potential candidates to expand the compensation committee to two members, as suggested by the SEC, or even to three members in order to avoid giving each director a veto power.
  3. Consider whether existing members of the compensation committee or potential members of the compensation committee are getting any compensatory fees from the company or any of its subsidiaries or are affiliated with the company or a subsidiary of the company or an affiliate of a subsidiary of the company.  Evaluate whether any changes to the current composition of the compensation committee are necessary.
  4. Implement new responsibilities and authority applicable to compensation committees, or independent directors involved in compensation decisions, relating to: (i) authority to retain compensation consultants, independent legal counsel and other compensation advisers; (ii) authority to fund such advisers; and (iii) responsibility to consider certain independence factors before selecting such advisers through a charter amendment or board resolution.
  5. Draft a new, or revise an existing, compensation committee charter.

 

NYSE Amends its Compensation Committee and Committee Adviser Independence Proposed Rules

Yesterday the NYSE filed an amendment to its proposed compensation committee and committee adviser independence rules.  According to the rule filing, the amendment corrects an error in the rule text under the heading “Transition Periods for Compensation Committee Requirements.”  According to the amended rule text, listed companies will have until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014, to comply with the new director independence standards with respect to compensation committees.  The other proposed rules, including those related to compensation committee advisers, will become effective on July 1, 2013.