New U.S. Requirements for Compensation Committees Under Dodd-Frank

The U.S. stock exchanges will be imposing new requirements on listed issuers’ compensation committees. These requirements are similar to those currently applicable to audit committees. The requirements pertain to the independence of compensation committee members and their responsibilities when retaining advisers.

As mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Securities and Exchange Commission has directed the U.S. stock exchanges to formulate new listing standards, which we expect to become effective in 2013. The changes will affect all issuers with equity securities listed on a U.S. stock exchange; other SEC-reporting companies will not be affected. The SEC has provided exemptions from some of the requirements for controlled companies and foreign private issuers, including Canadian MJDS (Multijurisdictional Disclosure System) issuers, and the stock exchanges have discretion to create additional exemptions.

Independence of Compensation Committee Members

All the members of a compensation committee of a listed issuer will be required to be independent. If an issuer does not have a formal compensation committee, the independence requirement will apply to the members of the board of directors who oversee executive compensation matters on the board’s behalf. The meaning of independence in this context will be determined by the U.S. stock exchanges, subject to SEC approval.

Existing governance standards in both the United States and Canada already prescribe certain bright-line independence tests. In developing specific independence standards for compensation committee members, the U.S. stock exchanges may impose additional requirements relating to

  • a director’s source of compensation from the issuer, including any consulting, advisory or compensatory fees; and
  • whether a director is affiliated with the issuer or its subsidiaries – that is, whether a director has the ability to direct, or cause the direction of, the issuer’s management and policies, either through the ownership of voting securities or otherwise.

These criteria are the same as currently apply to audit committee members, and we expect the new independence standards for compensation committees to closely track the audit committee requirements.

Controlled companies will be exempt from the compensation committee independence requirements. Foreign private issuers will also be exempt, provided that they disclose their reasons for not having an entirely independent compensation committee. Although most Canadian cross-border issuers have independent compensation committees in conformity with Canadian best practice guidelines, if the U.S. stock exchanges adopt stricter criteria, Canadian issuers will have to constitute their compensation committees accordingly or disclose that some or all of the members are not independent under U.S. standards. The U.S. stock exchanges also have discretion to create other exemptions, such as for emerging growth companies or newly listed issuers.

Compensation Committee Advisers

The U.S. stock exchanges will also be implementing new listing standards governing the relationship between compensation committees and their advisers, similar to existing U.S. and Canadian requirements applicable to audit committees. Compensation committees will need to have the authority to obtain advice from compensation consultants, legal counsel and other advisers. They will also have to be directly responsible for the appointment, compensation and oversight of any advisers that they retain, and issuers will have to provide appropriate funding to pay reasonable compensation to these advisers.

Advisers will not have to be independent, but before obtaining advice from them, compensation committees will have to consider the following six factors bearing upon advisers’ independence:

  • whether the adviser provides other services to the issuer;
  •  the fees paid to the adviser in relation to the adviser’s total revenue;
  •  the adviser’s policies and procedures in respect of conflicts of interest;
  • the adviser’s business or personal relationships with the issuer’s executive officers and compensation committee members; and
  • the adviser’s stock ownership in the issuer.

Accordingly, the SEC expects that compensation committees will need to create procedures for collecting and analyzing information about potential compensation advisers before they can obtain advice from them.

Controlled companies will be exempt from these requirements. The U.S. stock exchanges have discretion to create additional exemptions, such as for foreign private issuers, including Canadian MJDS issuers. However, Canadian issuers are already subject to a similar regime regarding compensation governance and advisers’ potential conflicts of interest, and this regime was recently enhanced by Canadian securities regulators implementing new disclosure requirements in 2012. 

In addition to the new listing standards, the SEC is supplementing its existing proxy disclosure requirements. Issuers will be required to disclose in their proxy materials whether a compensation consultant’s work raised any conflict of interest and, if so, the nature of the conflict and how it is being addressed. The new disclosure requirements will apply to annual meetings beginning in 2013, but only if the issuer is subject to the SEC’s proxy rules. Since foreign private issuers, including Canadian MJDS issuers, are exempt from the SEC’s proxy rules, they are not subject to these new disclosure requirements.

To discuss these issues, please contact the author(s).

This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.

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