NYSE Proposes New Rules Related to Compensation Committee and Committee Adviser Independence

Earlier this week, the NYSE filed proposed rule changes with the SEC related to compensation committee independence and the hiring of compensation advisers.  The NYSE proposed such rules to comply with Exchange Act Rule 10C-1 adopted in June.  Rule 10C-1 requires national securities exchanges to adopt listing standards which effectuate the compensation committee and committee adviser independence requirements of Section 952 of the Dodd-Frank Act.   The NYSE’s proposed rules do not expand upon or vary much from the SEC rules.  The NYSE proposed to have its new listing standards effective on July 1, 2013; however, companies would have until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014, to comply with the such new standards.  Set forth below is a summary of the NYSE’s proposed rules:

 Compensation Committee Independence

The NYSE proposed rules do not establish any new bright line standards specific to compensation committee independence.  Instead, the NYSE proposed rules require that, in affirmatively determining the independence of any director who will serve on a compensation committee, a listed company’s board “consider all  factors specifically relevant to determining whether a director has a relationship to the listed company which is material to that director’s ability to be independent from management in connection with the duties of a compensation committee member, including, but not limited to, the two factors explicitly enumerated in Rule 10C-1(b)(ii)”:

  • the source of the director’s compensation, including any consulting, advisory or other compensatory fee paid by the listed company to such director; and
  • whether the director has an affiliate relationship with the listed company, a subsidiary of the listed company or an affiliate of a subsidiary of the listed company.

The proposing release specifically provides that the NYSE does not believe that board compensation should be considered as part of the independence determination.  Further, commentary to the proposed NYSE rules provides that “the board should consider whether the director receives compensation from any person or entity that would impair his ability to make independent judgments about the listed company’s executive compensation. Similarly, when considering any affiliate relationship a director has with the company, a subsidiary of the company, or an affiliate of a subsidiary of the company, in determining his independence for purposes of compensation committee service,. . . the board should consider whether the affiliate relationship places the director under the direct or indirect control of the listed company or its senior management, or creates a direct relationship between the director and members of senior management, in each case of a nature that would impair his ability to make independent judgments about the listed company’s executive compensation.”

 Compensation Committee Adviser Independence

The NYSE proposed rules related to compensation committee advisers provide that prior to hiring a compensation adviser, the compensation committee must consider the six factors set forth in Rule 10C-1(b)(4).  The NYSE proposed rules do not add any factors for a compensation committee to consider prior to hiring an adviser, as the “Exchange believes that the list included in Rule 10C-1(b)(4) is very comprehensive and the proposed listing standard would also require the compensation committee to consider any other factors that would be relevant to the adviser’s independence from management.”

The NYSE’s proposed new rules are subject to SEC review and comment.  We believe it is unlikely that the SEC will have many objections to the proposed rules, as they essentially mirror the SEC’s rules.  In light of the NYSE proposed rules, NYSE listed companies should be reviewing their compensation committee charters, the composition of the compensation committee and their relationships with the compensation advisers in order to identify whether any modifications or changes may be in order to comply with the coming NYSE standards.

New PCAOB Standard for Communications with Audit Committees

On August 15, 2012, the Public Company Accounting Oversight Board (PCAOB) adopted Auditing Standard No. 16, Communications with Audit Committees.  This standard sets forth matters that the auditor should discuss with audit committees prior to the issuance of the auditor’s report.  Standard No. 16 supersedes PCAOB’s interim standards AU sec. 380, Communication with Audit Committees, and AU sec. 310, Appointment of the Independent Auditor.  The PCAOB expects Standard No. 16, which is subject to the SEC approval, to be effective for audits of fiscal years beginning on or after December 15, 2012.  In addition, the PCAOB will request, subject to the SEC’s separate determination, that this standard apply to the audits of emerging growth companies established under the JOBS Act.

Standard No. 16 enhances certain existing auditor communication requirements and adds new communication requirements that provide the audit committee with additional information about the audit, including the following:

  • an overview of the overall audit strategy, including timing of the audit, significant risks the auditor identified, and significant changes to the planned audit strategy or identified risks;
  • information about the nature and extent of specialized skill or knowledge needed in the audit, the extent of the planned use of internal auditors, company personnel or other third parties, and other independent public accounting firms, or other persons not employed by the auditor that are involved in the audit;
  • the basis for the auditor’s determination that he or she can serve as principal auditor, if significant parts of the audit will be performed by other auditors;
  • situations in which the auditor identified a concern regarding management’s anticipated application of accounting pronouncements that have been issued but are not yet effective and might have a significant effect on future financial reporting;
  • difficult or contentious matters for which the auditor consulted outside the engagement team;
  • the auditor’s evaluation of going concern;
  • departure from the auditor’s standard report; and
  • other matters arising from the audit that are significant to the oversight of the company’s financial reporting process, including complaints or concerns regarding accounting or auditing matters that have come to the auditor’s attention during the audit.

PCAOB Issues Release About its Inspection Process to Assist Audit Committees

On August 1, 2012, the Public Company Accounting Oversight Board (PCAOB) issued Release No. 2012-003, Information for Audit Committees about the PCAOB Inspection Process.  This release was issued to assist audit committees in understanding the PCAOB’s inspection process of audit firms and gathering useful information about those inspections.  The release also includes certain questions an audit committee may want to ask their audit firm about the PCAOB inspection.  These questions include the following:

  • Was the company’s audit selected for PCAOB inspection?
  • Did the PCAOB identify deficiencies in other audits that involved auditing or accounting issues similar to issues presented in the company’s audit?
  • What were the audit firm’s responses to the PCAOB findings?
  • What is the audit firm changing to address any quality control issues?
  • What is the progress of the quality control remediation process?
  • What are the inspected years about which the PCAOB has made a final determination about the audit firm’s remediation efforts and what is the nature of that determination?
  • Has the PCAOB provided initial indications that the audit firm may not have sufficiently remediated any items?

The release can be obtained from the following link:

http://pcaobus.org/Inspections/Documents/Inspection_Information_for_Audit_Committees.pdf

How should companies evaluate whether there is a conflict of interest related to the compensation consultant’s work?

Tomorrow, on July 27, 2012, a new Regulation S-K, Item 407(e)(3)(iv), disclosure requirement focusing on the conflicts of interest of compensation consultants will become effective.  Item 407(e)(3)(iv) disclosure should be addressed in any proxy or information statement for a meeting of shareholders at which directors will be elected occurring on or after January 1, 2013.

Pursuant to the new requirement, public companies will have to disclose the nature of the conflict of interest, if any, related to the compensation consultant’s work on executive and director compensation and how the conflict of interest is being addressed.  To comply with this requirement, one of the threshold questions that a public company should ask is whether there is a conflict of interest.

In order to evaluate whether such conflict of interest exists, public companies should act now to establish controls and procedures for obtaining conflict of interest information. For example, the company should:

1. Establish internal procedures and processes to track:

(i)  all services provided to the company by the compensation consultant and the entity that employs the consultant starting from the last completed fiscal year; and

(ii) the amount of fees paid by the company to the entity that employs the compensation consultant.

2. Request from the compensation consultant, or from the entity that employs the consultant, the following information:

(i) the percentage that the amount of fees received from the company by the entity that employs the compensation consultant represents to the total revenue of such entit; and 

(ii) direct or indirect ownership of the company’s stock by the compensation consultant, and

(iii) policies and procedures of the entity that employs the compensation consultant that are designed to prevent conflicts of interest.

3. Add the following question to the company’s Directors’ and Officers’ Questionnaire:

Do you have a business or personal relationship with the compensation consultant or the entity employing the compensation consultant?   ___ Yes  ___ No         

If “yes,” please describe:

                                                                                                          

                                                                                                          

 

What has changed in compensation committee requirements and disclosures after the issuance of the new SEC release last week? What should we do now?

Due to the SEC’s adoption of a new Rule 10C-1, Listing Standards Relating to Compensation Committees, we are one step closer to having the mandate of Section 952 of the Dodd-Frank Act fully implemented and to securities exchanges adopting listing standards relating to the independence of the compensation committee members, the committee’s authority to retain compensation advisers, and the committee’s responsibility for the appointment, compensation and oversight of the work of a compensation adviser. Each national securities exchange must provide to the SEC proposed rules that comply with Rule 10C-1 no later than September 25, 2012 and must have final rules that comply with Rule 10C-1 no later than June 27, 2013.

Public companies will also have to comply with a new disclosure requirement related to the conflicts of interest of compensation consultants in any proxy statement for a meeting of shareholders at which directors will be elected occurring on or after January 1, 2013.  Pursuant to this new requirement under Item 407(e)(3)(iv) of Regulation S-K,  public companies will have to disclose the nature of the conflict of interest, if any, related to the compensation consultant’s work on executive and director compensation and how the conflict is being addressed. 

In addition to monitoring the rulemaking of national securities exchanges related to the implementation of Rule 10C-1 directives, public companies should consider taking the following actions in connection with the required analysis of the conflicts of interest related to the work of a compensation consultant:

  • establish procedures for obtaining information about (i) all services provided to the company by the compensation consultant and the entity that employs the consultant during the last completed fiscal year, (ii) the amount of fees received from the company by the entity that employs the compensation consultant as a percentage of the total revenue of such entity, and (iii) any stock of the company owned by the compensation consultant;
  • request and review the policies and procedures of the entity that employs the compensation consultant that are designed to prevent conflicts of interest; and
  • update directors’ and officers’ questionnaires to include questions related to the business or personal relationships of (i) the compensation consultant with a member of the compensation committee; and (ii) the compensation consultant, or the entity employing the compensation consultant, with an executive officer of the company.

Margin Call Sales May Violate Insider Trading Policies or Wake Up and Smell the Coffee (Burning)

            The chairman (and founder) and the lead independent director of Green Mountain Coffee Roaster (GMCR) both have been removed from their leadership positions as a result of margin call sales of company stock last Friday that were “inconsistent with” the company’s insider trading policy, GMCR announced yesterday.  According to the company’s press release, Mr. Robert P. Stiller no longer serves as Chairman of the Board and Mr. William D. Davis no longer serves as independent lead director because they had margin call-related stock sales totaling 5.548 million shares.  These forced sales were related to margin loans, which were secured by pledges of Mr. Stiller’s and Mr. Davis’ GMCR stock and triggered by recent GMCR stock price declines (the stock dropped almost 50% after the company released quarterly results and lowered its fiscal year forecast).  The sales occurred at a time when the trading window in GMCR stock was closed under the company’s internal trading policy.  Also, it was discovered that Mr. Davis pledged shares after the internal trading policy had been amended to prohibit pledges of company stock (other existing pledges were grandfathered).  

            These actions serve as a reminder that public companies should periodically review their insider trading policies to ensure that they are current and that management and others subject to the policies understand their operation.  We will address this topic further in the next issue of Up to Date.