SEC Issues Rule for Compensation Committees

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By Anne Rosivach

The US Securities and Exchange Commission (SEC) has approved a new rule directing national securities exchanges to adopt specific listing standards governing the independence of public company compensation committees and compensation advisers. The rule, 10C-1, is mandated under Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The SEC regulates securities exchanges, which in turn have detailed rules for companies that list their securities for trade on the exchanges. 

Companies listing securities must be in compliance with the standards in order for shares to continue trading. Exchanges were required to submit proposed standards for compliance with Rule 10C-1 on September 25. 

Rule 10C-1 does not require a uniform definition of independence, but, according to Michael Cohen, principal, SEC Services Group at Friedman LLP in New York City",it does require that the definition of independent include consideration of a director's source of compensation, including any consulting fees paid by the issuer, and whether the director is affiliated with the issuer, a subsidiary, or an affiliate of a subsidiary." 

Currently, listing companies must disclose the involvement of a compensation consultant in the annual report or proxy statements. What is new, Cohen says, is that "the exchanges must require listing companies to state that members of the compensation committee, who should be members of the board of directors of the company, are independent under the standards of the exchange. The compensation committee must also disclose that they have considered certain factors related to compensation consultants. They do not have to be independent, but compensation committees must consider a set of independence factors prior to selecting them.

"Compensation committees of the board of directors need to be able to get the advice of compensation advisers. Rule 10C-1 gives the compensation committee the authority to obtain that advice. The compensation committee is responsible for the hiring of compensation advisers if they choose, and the company must provide funding to pay those advisers.

"Compliance with the rule should not be very difficult and should not involve a significant cost, even for smaller reporting companies that list on the NASDAQ. The NASDAQ already has rules in place relating to the independence of directors and the independence of the audit committee.

"Companies have at least a year or a year and a half before they must be in compliance. Most of my clients list on the NASDAQ. I have suggested they should do two things in the coming months. They should

  • Appoint a two-person independent compensation committee, and
  • Adopt a written charter with guidelines relating to compensation advisers."

In an article in Friedman LLP's SEC Impact newsletter, Cohen wrote",The New York Stock Exchange rule requires public company boards to evaluate each director's independence by considering the directors' sources of compensation and ties with the company. The NASDAQ listing standards say compensation committees will have to have at least two members, both of whom will have to be independent. NASDAQ says that in order to be independent, a director cannot have been an executive or employee of the company within the past three years, have a family member employed by the company, or have ties to a company that does business with the company. Directors also cannot have financial ties to the company's auditor."

The SEC gives the exchanges the right to give exemptions to the rule. Excluded entities include smaller reporting companies, controlled companies (those in which more than 50 percent of the voting power is held by a single block), limited partnerships, registered open-end management investment companies, certain foreign issuers, and companies in bankruptcy.

Exchanges were required to submit draft standards by September 25. Final rules or rule amendments that comply with Rule 10C-1 approved by the Commission must be submitted no later than June 27, 2013. Issuers must comply with the disclosure changes in Item 407 of Regulation S-K in any proxy or information statement on or after January 1, 2013, the SEC Statement on Listing Standards states.

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