SEC Votes to Propose A New Rule and Rule Amendments Regarding Compensation Committee Structure and Disclosure

March 31, 2011

On March 30, 2011, the Securities and Exchange Commission proposed a new rule and amendments to existing rules to implement new requirements applying to compensation committee membership and disclosure regarding compensation consultants. The Commission’s proposals, if adopted, would implement Section 10C of the Securities Exchange Act of 1934, enacted by Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Proposing Release is available here.

Proposed Listing Standards. The Commission proposed new Rule 10C-1, which would instruct any national securities exchanges and national securities associations that list equity securities (the “exchanges”) to modify their listing standards (“listing standards”) to include the following requirements for issuers listing a class of equity securities (a “listed issuer”):

  • Independence. Each member of any committee of a listed issuer that oversees executive compensation -- regardless of whether the committee is designated as the “compensation committee” or simply a functional equivalent -- must be both a member of the issuer’s board of directors and independent. As proposed, Rule 10C-1 would not require listing standards to apply to a listed issuer who does not have a committee to oversee executive compensation. For purposes of Rule 10C-1(b)(1), the definition of independence applicable to compensation committee members adopted by each exchange must consider relevant factors, including, but not limited to, the source of compensation of a director, including any consulting, advisory or other compensatory fee paid by the listed issuer to such director, and whether the director is affiliated with the listed issuer, a subsidiary of the listed issuer, or an affiliate of a subsidiary of the listed issuer.


  • Advisers. Under proposed Rule 10C-1(b)(2), listing standards will require that a compensation committee of a listed issuer have the authority to retain a compensation adviser (e.g., compensation consultant, legal counsel, or other adviser) and direct responsibility for the appointment, compensation and oversight of the work of any compensation adviser. Further, each listed issuer would be required to provide appropriate funding to pay the compensation committee’s advisers. Before retaining a consultant, under proposed Rule 10C-1(b)(4), a compensation committee must consider competitively neutral factors affecting independence (i.e., the factors must preserve the ability of the compensation committee to retain the services of any member of the categories noted above), including the following factors:

    • The provision of other services to the listed issuer by the person that employs the compensation adviser;
    • The amount of fees received from the listed issuer by the person that employs the compensation adviser, as a percentage of the employer’s total revenue;
    • The policies and procedures of the person that employs the compensation adviser that are designed to prevent conflicts of interest;
    • Any business or personal relationship of the compensation adviser with a member of the compensation committee; and
    • Any stock of the listed issuer owned by the compensation adviser.

As proposed, Rule 10C-1(b) provides for an exemption from listing standards for the following six categories of listed issuers: 

  • Controlled companies;
  • Limited partnerships;
  • Companies in bankruptcy proceedings;
  • Open-end management investment companies registered under the Investment Company Act of 1940;
  • Any foreign private issuer that provides annual disclosures to shareholders of the reasons that it does not have an independent compensation committee; and
  • Any other category of issuer determined by the exchanges after consideration of issuer size or other relevant factors and the impact of Rule 10C-1.

Proposed Rule 10C-1(a)(3) would require the exchanges to establish appropriate procedures for a listed issuer to have a reasonable opportunity to cure any defects that would be the basis for a prohibition of the listing of a listed issuer’s securities as a result of its failure to meet the requirements set forth in Section 10C.

Proposed Disclosure Requirements. The Commission also proposed amendments to implement the requirements of Exchange Act Section 10C(c)(2) regarding disclosure in any proxy or consent solicitation material for an annual meeting (or a special meeting in lieu of the annual meeting) concerning compensation consultants. These proposed amendments would apply to all Exchange Act registrants that are subject to the federal proxy rules, including controlled companies. Specifically, the Commission proposed amendments to Item 407(e)(3) of Regulation S-K that would require disclosure regarding whether a compensation committee has retained or obtained the advice of a compensation consultant, whether the work of the compensation consultant has raised any conflicts of interest between the issuer and the compensation consultant, and, if so, the nature of the conflict and how it is being addressed. As proposed, an instruction would be added to Item 407(e)(3) to provide guidance to issuers as to whether the compensation committee or management has “obtained the advice” of a compensation consultant; specifically, the instruction will clarify that the phrase “obtained the advice” relates to whether a compensation committee or management has requested or received advice from a compensation consultant, regardless of whether there is a formal engagement of the consultant or a client relationship between the compensation consultant and the compensation committee or management or any payment of fees to the consultant for its advice. The Commission proposed an additional instruction to Item 407(e)(3) to assist issuers in determining whether there is a conflict of interest that needs to be disclosed, noting that, at a minimum, the compensation committee should consider the five factors specified in proposed Rule 10C-1(b)(4) (listed above). Additionally, the Commission proposed the following amendments to make the requirements of Item 407(e)(3) internally consistent:

  • Item 407(e)(3) currently requires disclosure of “[a]ny role of compensation consultants in determining or recommending the amount or form of executive and director compensation” (emphasis added). The proposed amendment would replace the “any role” standard with a “retained or obtained the advice” standard and an instruction would be added to clarify the meaning of “retained or obtained.”

  • Item 407(e)(3) currently exempts services by compensation consultants involving only broad-based non-discriminatory plans and the provision of non-customized survey data from the disclosure requirements. The proposed amendment would remove this exemption.

Areas for Comment. The proposed new rule and amendments would impose significant new corporate governance and disclosure requirements. In the Proposing Release, the Commission requested comments that will help determine the manner in which the adopted form of these rules will apply to companies. Below are some of the more pressing issues that you may wish to consider in determining your comments to the proposed new rule and amendments:

  • As proposed, Rule 10C-1 would not apply to listed issuers who do not have a specific committee to oversee executive compensation.

  • As proposed, Rule 10C-1 and the amendment to Item 407(e)(3) would implement requirements that apply to smaller reporting companies, with the exchanges given discretion to consider whether smaller reporting companies should be exempted.

  • As proposed, the amendment to Item 407(e)(3) would apply to all Exchange Act registrants that are subject to the federal proxy rules, including non-listed issuers and listed issuers that are exempted under the listing standards; however, the proposed instruction regarding the manner in which to determine when a conflict arises between a company and its compensation consultant references the proposed Rule 10C-1(b)(4) standard that is only applicable to listed issuers.

Comments on the proposed new Rule 10C-1 and amendments to Item 405(e)(3) of Regulation S-K should be submitted to the Commission on or before April 29, 2011.

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If you have any questions regarding the proposed rules or the submission of comments to the Commission, please contact the authors of this Client Alert, any of O’Melveny’s Corporate Finance partners or, as to aspects of the rules related to executive compensation matters, any of O’Melveny’s Executive Compensation and Employee Benefits partners.