On June 20, 2012, the SEC issued (1) a final rule¹ that requires national securities exchanges and associations to establish listing standards for listed entities that have compensation committees or that engage compensation consultants or advisers and (2) rule amendments to existing proxy disclosures. The rule was developed to address the requirements of Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which added Section 10C to the Securities Exchange Act of 1934. Entities that do not comply with the new requirements will be prohibited from listing their equity securities on national exchanges.

Requirements

Compensation committee members must be members of the board of directors and must be independent. The final rule does not define “independence,” instead requiring exchanges to define the term on the basis of “relevant factors.” At a minimum, such factors include (1) a board director’s source of compensation, such as “any consulting, advisory or other compensatory fee paid by the issuer” to a board member, and (2) any affiliation that the board member has “with the issuer, a subsidiary of the issuer, or an affiliate of a subsidiary of the issuer.”

A compensation committee may obtain or retain compensation advisers but is “directly responsible for the appointment, compensation and oversight” of these advisers. A listed company must also “appropriately fund” its compensation committee. In addition, exchange listing standards would stipulate that a “compensation committee . . . may select a compensation consultant, legal counsel or other adviser [other than in-house counsel only] after considering the six independence factors.”

The final rule also requires that, in the absence of a compensation committee, the listing standards will apply to members of a company’s board of directors who help oversee executive compensation matters on behalf of the board of directors.

Exemptions

The final rule allows exchanges to exempt certain relationships from the independence requirements (subject to SEC approval) and explicitly excludes four categories of companies from these requirements: “(1) [l]imited partnerships; (2) [c]ompanies in bankruptcy proceedings; (3) [o]pen-end management investment companies registered under the Investment Company Act of 1940; and (4) [a]ny foreign private issuer that discloses in its annual report the reasons that the foreign private issuer does not have an independent compensation committee.” In addition, controlled companies and smaller reporting companies are exempt from all of the new compensation committee listing standards.

Disclosure

Amendments to the existing proxy disclosure rules in Regulation S-K, Item 407,² require registrants to disclose their use of compensation consultants as well as the nature of any conflicts of interest and how these are addressed.

Effective Date

The final rule and amendments will be effective within 30 days after their publication in the Federal Register. Each exchange must propose listing standards that comply with the new rule no later than 90 days after the final rule and rule amendments become effective, and the Commission must approve the new listing standards within one year after the new rule’s effective date. Further, issuers must comply with the disclosure amendments in any proxy or information statement for an annual meeting of shareholders at which a directors’ election will be held on or after January 1, 2013.

[1] SEC Final Rule Release No. 33-9330, Listing Standards for Compensation Committees.

[2] SEC Regulation S-K, Item 407, “Corporate Governance.”

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