Pay Ratio Rules to be Proposed this Week

On Wednesday, September 18, 2013 at 10:00 a.m. the SEC will hold an open meeting to consider whether to propose rules to require companies to disclose the median annual total compensation of all employees and the ratio of that median to the annual total compensation of the company’s chief executive officer as mandated by Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The July 1st Compliance Date for Certain of the New NASDAQ and NYSE Compensation Committee Rules is Around the Corner

On January 11, 2013, the SEC approved proposed changes to the listing standards of the New York Stock Exchange and NASDAQ Stock Market related to compensation committees. Both exchanges created transition periods to comply with the new rules. We want to remind companies that the following new requirements take effect on July 1, 2013[1]:

Compensation Committee Charter Amendments

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, or receiving advice from, such advisers[2].

NASDAQ.  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.  Accordingly, NASDAQ listed companies should consider whether to grant such specific responsibilities and authority by July 1, 2013 through the adoption of a charter, the amendment to an existing charter, or by resolution or other board action. The requirement to adopt a compensation committee charter 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 NYSE listed companies will have to amend their existing charters by July 1, 2013 to address these additional rights and responsibilities of the compensation committee related to compensation consultants, legal counsel, and other compensation advisers.

Assessing the Independence of Compensation Consultants

The new NASDAQ and NYSE rules provide that the compensation committee may only select, or receive advice from, a compensation consultant, legal counsel, or other compensation adviser after considering the following factors[3]:

  • the provision of other services to the company by the person that employs the adviser;
  • the amount of fees received from the company by the person or firm that employs the adviser, as a percentage of the total revenue of the person or firm that employs the adviser;
  • the policies and procedures of the person or firm that employs the adviser that are designed to prevent conflict of interests;
  • any business or personal relationship of the adviser with a member of the compensation committee;
  • any stock of the company owned by the adviser; and
  • any business or personal relationships between the executive officers of the company and the adviser or the person or firm employing the adviser.

Compensation committees must conduct an independence assessment for all of its advisers, with limited exceptions for in-house counsel and compensation advisers that act in a role limited to (i) consulting on broad-based plans that are generally applicable to all salaried employees, or (ii) providing information that is either not customized for the issuer or that is customized based on parameters that are not developed by the adviser, and about which the adviser does not provide advice.

We note that in evaluating compensation committee adviser independence, the NYSE requires consideration of all factors relevant to an adviser’s independence from management, in addition to the six enumerated factors listed above. NASDAQ does not have a similar catch-all requirement.

Both NASDAQ and NYSE listed companies should assess the independence of their current advisers prior to July 1, 2013.  Ordinarily, this assessment will be performed before a potential adviser is selected and will then be re-assessed on an annual basis.  We would suggest utilizing a compensation committee questionnaire to solict information from the compensation consultant in order to complete this assessment. 

 


[1] The new compensation committee independence requirements do not need to be complied with by NASDAQ or NYSE listed companies until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014. Nevertheless,  NASDAQ and NYSE listed companies should begin preparing to comply with such new independence requirements. 

 

[2] To the extent a NASDAQ listed company does not have a compensation committee by July 1, 2013, this requirement 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.

 

[3] To the extent a NASDAQ listed company does not have a compensation committee by July 1, 2013, this requirement 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.

 

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.

Say What? Smaller Reporting Companies Subject to Say-on-Pay in 2013.

Smaller reporting companies are subject to say-on-pay and say-on-frequency votes for the first time this year.  In January 2011, the SEC adopted final rules implementing the say-on-pay and say-on-frequency requirements of the Dodd-Frank Act. Under such rules, public companies are required to conduct shareholder advisory votes (i) to approve the compensation of executives, as disclosed pursuant to Item 402 of Regulation S-K, and (ii) to determine how often an issuer will conduct a shareholder advisory vote on executive compensation. Public companies, other than smaller reporting companies, were required to conduct such votes starting with the 2011 proxy season. Smaller reporting companies did not have to conduct such votes until their first annual or other meeting of shareholders occurring on or after January 21, 2013.

In drafting their proxy statements for this year’s annual meeting, smaller reporting companies should look to strategies utilized by other public companies during the past two proxy seasons to avoid a failed say-on-pay vote. For example, public companies have been using their proxy statements, especially their Compensation Discussion and Analysis section, as an opportunity to explain their executive compensation practices to shareholders. Although smaller reporting companies are not required to include a CD&A in their proxy statements, they may want to include disclosure similar to the CD&A or, at a minimum, a summary of executive compensation practices in their proxy statements this year to discuss the company’s compensation philosophy and how executive compensation is aligned with performance.

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.

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.

 

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.

NASDAQ Speaks – Potential Changes to Compensation Committee Rules and Roll-out of New and Improved Reference Library

At the “NASDAQ Speaks ’12: Latest Developments and Interpretations” webcast  held on June 7th, there were a couple of interesting items to note.  With respect to compensation committee rules, NASDAQ is considering the following changes, subject to the SEC adopting final rules under the Dodd-Frank Act and NASDAQ issuing proposed rules which become final:

  1. All companies will be required to have a compensation committee with at least 2 members.  This differs from the audit committee NASDAQ rule which requires at least 3 directors to serve on the audit committee.  Under the current NASDAQ rules, either  a compensation committee or  independent directors may approve or recommend executive compensation; and
  2. For a director to serve on the compensation committee, similar to the audit committee rules, such director will not be able to accept any consulting, advisory or other compensatory fee, directly or indirectly, other than for board services.  Additionally, the board must consider affiliation a director has with the company.   NASDAQ does not think significant ownership of the company’s securities should bar a director from serving on the compensation committee.

This summer NASDAQ is also going to roll-out its new and improved reference library which will permit a user to search reference sources by category, such as staff interpretations, listing council decisions and frequently asked questions.  The new reference liability will have an advanced search feature allowing users to search across different reference sources, by year, category and sub-category and keywords.  The search results will be expandable and color coded by source.