Time to Plan for July 1 Deadlines: Stock Exchange Independence Rules for Compensation Committees and Their Advisers

By Jim Barrall, Partner, Latham & Watkins LLP

Now that most U.S. public companies have completed their 2013 proxy preparation work, it is time for them to prepare for two elements of the NYSE and Nasdaq rules on Compensation Committee and adviser independence , which become effective on July 1, 2013.

By way of quick recap:

• in July 2010, Congress enacted Section 952 of the Dodd-Frank Act, which imposed new independence requirements on Compensation Committees and their advisers and required the SEC to adopt rules directing the national stock exchanges and securities associations to adopt rules to implement the statute,
• in June 2012, the SEC adopted Rule 10C-1 of the Securities Exchange Act of 1934 implementing the statute,
• in September 2012, the NYSE and Nasdaq each filed proposed listing standards with the SEC to implement Rule 10C-1; and
• in January, the SEC approved the exchanges’ proposed rules in substantially the form in which they had been proposed.

While extensive in their scope, Section 952, Rule 10C-1, and the new exchange rules will require relatively few companies or Compensation Committees to make substantive changes in how they conduct their affairs. However, like most executive compensation rules adopted these days, they do impose paperwork and process requirements that affect every publicly traded company. Two of these rules take effect on July 1 and require company and Compensation Committee attention before then.

First, by July 1, Compensation Committees will need to be provided, in writing, with certain responsibilities and powers with respect to their independence and that of their advisers. While most Compensation Committees already believe that they have these responsibilities and powers, in most cases, the rules will require that committee charters be amended to expressly satisfy the rules. While Nasdaq companies can defer amending their charters until 2014, they are required by July 1 to have delegated these responsibilities and powers by Board action, so most will decide to amend their charters now.

Second, beginning July 1, before “selecting” any adviser, Compensation Committees are required to “take into consideration” six common-sense factors relating to the independence of the adviser, which are set forth in Rule 10C-1 and the exchange rules. These are the same six factors that most public companies and Compensation Committees have already studied and applied with respect the independence of committee compensation consultants, in order to disclose in their 2013 proxies whether the work of the consultant has raised any conflict of interest and, if so, the nature of the conflict and how it is being addressed, as also required by Section 952. (Not surprisingly, I have yet to see a proxy disclosing the existence of any such conflict.)

So most Compensation Committees have already evaluated the independence of their compensation consultant advisers to comply with the proxy disclosure rules. Now they need to apply the same independence analysis to any lawyers or other advisers who are selected on or after July 1 to advise the Compensation Committee. This will require a case-by-case evaluation as to whether a particular adviser is advising the committee with respect to a particular matter.

While many Compensation Committees do not separately engage lawyers to act as their independent legal advisers on an on-going basis, they sometimes engage their own lawyers in special situations, such as the termination of an officer’s employment, the hiring of a new officer, an investigation on behalf of the committee, or litigation against the committee. In such cases, the lawyers would be advisers to the committee and their independence would need to be reviewed under the listing standards’ factors before they are selected. However in most routine and on-going executive compensation matters, such as advising on plan and proxy drafting, tax consequences, and corporate, employment, or securities law consequences, lawyers generally advise a company’s legal, HR, or other departments and not their Compensation Committees. In such matters, outside counsel often have little or no contact with the Compensation Committee, which is likely receiving any legal advice it may require from the company’s legal department (which thankfully is exempted from an independence evaluation). If companies and their counsel conclude in such routine cases that the outside counsel selected by management in fact is not advising the Compensation Committee, the new rules would not require the committee to conduct an independence evaluation for such counsel. Finally, given general good governance practices at most public companies, the application of the six independence factors to a committee’s legal or other advisers before their next selection for advice by the Compensation Committee should not result in substantial surprises for most well-run Compensation Committees and companies. But rules are rules, and this work and analysis must be done.

Here is a link to Latham’s Corporate Governance Update being published today, which discusses these rules and deadlines in more detail July 1 Deadline for Implementing Compensation Committee and Adviser Independence Rules is Fast Approaching. The Update contains a link to Latham’s October Corporate Governance Commentary, which analyzes the new exchange rules in depth.

About the Guest Blogger:

James D. C. Barrall is a partner in the Los Angeles office of Latham & Watkins LLP and is the Global Co-Chair of the firm’s Benefits and Compensation Practice. Mr. Barrall specializes in executive compensation, corporate governance, employee benefits and compensation related disclosure and regulatory matters. He is regularly interviewed and quoted by such publications as the Wall Street Journal, Agenda, The Conference Board, BloombergLaw, Compliance Week and Corporate Secretary.

Mr. Barrall is a frequent author, contributing editor and lecturer on executive compensation, corporate governance, disclosure and other regulatory matters. He is a co-author of the chapter on extensions of credit to directors and officers in the American Bar Association’s Practitioner’s Guide to the Sarbanes-Oxley Act.

Mr. Barrall is a member of the Board of Advisors of the UCLA School of Law and the Lowell Milken Institute for Business Law and Policy. Mr. Barrall has lectured at the UCLA Law School, the UCLA Anderson School of Management and the Aresty Institute of Executive Education at the Wharton School, University of Pennsylvania.