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FEBRUARY 12, 2013

NYSE and NASDAQ amend compensation committee rules By Lloyd H. Spencer, Courtney L. Lindsay, II, and Pierce Han In late September 2012, both the New York Stock Exchange (“NYSE”) and The NASDAQ Stock Market (“Nasdaq”) proposed new compensation committee independence requirements for listed companies. The proposals, which came in response to the Securities and Exchange Commission (“SEC”) adopting Rule 10C-1, available here, implementing Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), were approved by the SEC on January 11, 2013. Rule 10C-1 directs the NYSE and Nasdaq to prohibit the listing of any equity security of any issuer that is not in compliance with the rule’s requirements regarding compensation committees of listed issuers and related requirements regarding compensation advisers and consultants.

Overview of Rule 10C-1 Independence standards for compensation committee members SEC Rule 10C-1 requires that each member of an issuer’s compensation committee be “independent” in order for that issuer to be listed on a national securities exchange. Unlike the rules pertaining to audit committee members, the SEC did not define the term “independent” in its rules. Instead, the SEC instructed the NYSE and Nasdaq to determine the independence standards for compensation committee members and required them to consider the following factors: 

the source of compensation of a director, including any consulting, advisory, or other compensatory fee paid by the issuer to the director; and

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whether such director is an affiliate of the issuer.

These independence requirements do not apply to limited partnerships, companies in bankruptcy proceedings, open-end management investment companies registered under the Investment Company Act of 1940, and any foreign private issuer that discloses in its annual report the reasons why it does not have an independent compensation committee. Besides these exemptions, after considering the size of the issuer or other relevant factors, the NYSE and Nasdaq are permitted to exempt certain relationships with respect to members of the compensation committee. Retaining compensation advisers Rule 10C-1 requires the NYSE and Nasdaq to mandate that listed issuers provide their compensation committees with the authority and funding necessary to retain or obtain the advice of a compensation consultant, legal counsel, or other adviser (“compensation adviser”). The

compensation committee must also be directly responsible for the appointment, compensation, and oversight of any compensation advisers they retain. Rule 10C-1 also requires the NYSE and Nasdaq to provide in its rules that the compensation committee may select a compensation adviser only after taking into consideration the following six factors (the “independence factors”), in addition to any other factors identified by the relevant exchange in its listing standards: 

any other services the entity that employs the adviser provides to the issuer;

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how much, as a percentage, the fees paid by the issuer to the entity that employs the adviser represents of that entity’s total revenue;

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the policies and procedures the entity that employs the adviser has in place to prevent conflicts of interest;

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any business or personal relationship the adviser may have with a member of the compensation committee;

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any stock of the issuer that the adviser owns; and

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any business or personal relationship the adviser or the entity that employs the adviser has with any executive officer of the issuer.

The SEC was sure to note in this rule that the funding and authority provisions in this section did not mean that compensation committees are required to implement the recommendations of an adviser. Even after hiring a compensation adviser, a compensation committee must continue to exercise its sole reasonable discretion when performing its duties. Exemptions from new listing requirements In addition to the exemptions previously discussed, the new listing requirements do not apply to any controlled company or any smaller reporting company. Rule 10C-1 also permits the NYSE and Nasdaq to exempt certain additional issuers from the requirements of Section 10C and its corresponding regulations taking into consideration, among other relevant factors, the potential impact of such requirements on smaller reporting issuers. New disclosure requirements Section 10C(c)(2) of the Exchange Act requires issuers to disclose in their annual proxy statements whether its compensation committee retained or obtained advice from a compensation consultant and whether the compensation consultant’s work raised any conflicts of interest. If such circumstances do exist, the issuer must also disclose the nature of the conflict and how it is being addressed. The SEC revised Item 407(e)(3) of Regulation S-K to require disclosure whether the compensation consultant’s work raised any conflicts of interest, and if so, the nature of the conflict and how it is being addressed. The SEC added an instruction that issuers should, at a minimum, use the six independence factors identified above for determining whether there is a conflict of interest. The new disclosure requirements apply to all issuers including controlled companies, smaller reporting companies, and non-listed issuers. Issuers are required to comply with the new disclosure rules at any annual meeting (or special meeting in lieu thereof) at which directors will be elected occurring on or after January 1, 2013.

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Nasdaq compensation committee rules In late September 2012, Nasdaq filed its initial compensation committee proposal with the SEC, which was amended in December 2012 and January 2013. In short, the Nasdaq rules now require listed companies to have a compensation committee and that the compensation committee must consist of at least two members, each of whom must be an independent director as defined in Nasdaq’s rules. Compensation committees of listed companies must also have a formal written charter and be given certain responsibilities and authority. Independence requirements All compensation committee members must be independent within the meaning of such term as defined in Nasdaq’s Rule 5605(a)(2). In addition to meeting the general independence standards set forth in Rule 5605(a)(2), no compensation committee member may accept directly or indirectly any consulting, advisory, or other compensatory fees from the issuer or any of its subsidiaries. This prohibition, however, does not apply to fees received for serving on the compensation committee itself, from serving on the board of directors, or from any fixed amounts under a retirement plan for past service with the issuer (so long as the compensation is not contingent on continued service). The Nasdaq rules also require the issuer to consider whether a director is affiliated with the issuer or a subsidiary of the issuer in such a manner that would impair the director’s judgment as a member of the committee when considering whether such director is eligible to serve on the compensation committee. Nasdaq opted to not include a blanket prohibition of directors who are affiliates from serving on the compensation committee. Certain exceptions apply to the independence requirements when the compensation committee includes three or more members. If the issuer meets this numerical requirement, then under limited and exceptional circumstances it may appoint an individual who is not independent provided the director is not currently an executive officer, an employee, or the family member of an executive officer. These limited and exceptional circumstances include those instances when it is in the best interests of the issuer and its shareholders. A compensation committee member may not serve more than two years under this exception. If an issuer makes such an appointment, it must disclose on its website, a proxy statement or in a Form 10-K or 20-F the nature of the member’s relationship and the reason(s) why the member should be appointed. Any issuer that falls out of compliance due to one vacancy or if one compensation committee member ceases to be independent due to circumstances beyond the member’s reasonable control, the issuer will have until the earlier of (i) the next annual shareholders’ meeting or (ii) one year from the event that caused non-compliance to regain compliance. However, if the annual shareholders’ meeting is no later than 180 days following the event that caused non-compliance, the issuer will then have 180 days to regain compliance. Compensation committee charter Listed companies are required to certify that they have adopted a formal written charter for its compensation committee and that its compensation committee will review and reassess the adequacy of that charter on an annual basis. The compensation committee charter must specify:

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the scope of the compensation committee’s responsibilities and how it carries out those responsibilities, including structure, processes, and membership requirements;

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the compensation committee’s responsibility for determining, or recommending to the board for determination, the compensation of the chief executive officer and all other executive officers of the issuer;

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that the chief executive officer may not be present during voting or deliberations on his or her compensation; and

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the specific compensation committee responsibilities and authority regarding the engagement of compensation advisers.

Compensation committee responsibilities and authority Nasdaq rules require that the compensation committee must have the authority, in its sole discretion, to retain or obtain the advice of a compensation adviser. The compensation committee must be directly responsible for the appointment, compensation, and oversight of the work of a compensation adviser retained by the committee. The issuer is required to provide appropriate funding, as determined by the compensation committee, for the payment of reasonable compensation to a compensation adviser. The compensation committee may select a compensation adviser only after taking into consideration the six independence factors set forth in Rule 10C-1. This independence consideration requirement for advisers does not apply to in-house counsel. However, nothing in the Nasdaq rules requires a compensation adviser to be independent, only that the compensation committee consider the enumerated independence factors before selecting, or receiving advice from, a compensation adviser. Compensation committees may select, or receive advice from, any compensation adviser they prefer, including ones that are not independent, after considering the six independence factors. Also, the compensation committee is not required to conduct an independence assessment for a compensation adviser that acts in a role limited to the following activities: 

consulting on any broad-based plan that does not discriminate in scope, terms, or operation, in favor of executive officers or directors of the issuer, and that is available generally to all salaried employees; and/or

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providing information that either is not customized for a particular issuer or that is customized based on parameters that are not developed by the adviser, and about which the adviser does not provide advice.

Application to smaller reporting companies Smaller reporting companies are exempt from the new compensation committee rules, except that they must: 

have, and certify that it has and will continue to have, a compensation committee of at least two members, both of whom must be independent directors; and

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have, and certify that it has, a written compensation committee charter or board resolution, except that the charter does not have to include the specific responsibilities and authorities of the committee.

Application to foreign private issuers Nasdaq’s current rules permit foreign private issuers to follow their home country practice in lieu of many of Nasdaq’s corporate governance listing standards. However, the foreign private issuer must disclose in its annual report filed with the SEC each requirement that it does not follow and describe the home country practice followed in lieu of such requirement. The Nasdaq rule applies this allowance to the compensation committee rules provided the foreign private issuer complies with the same disclosure condition. In addition, the foreign private issuer must disclose in its annual report filed with the SEC the reasons why it does not have an independent compensation committee meeting the enhanced standards of independence. Effective dates Listed companies must give compensation committees the responsibilities and authority described above by July 1, 2013. If listed companies do not yet have a compensation committee, these responsibilities and authority must be given to the independent directors responsible for compensation. Listed companies must implement the remaining aspects of the rules by the earlier of (i) their first annual meeting after January 15, 2014, or (ii) October 31, 2014. Companies must certify to Nasdaq within 30 days of the deadline applicable to it that it has complied with the compensation committee rules.

NYSE compensation committee rules In late September 2012, the NYSE filed its initial compensation committee proposal with the SEC, which was amended in October 2012, December 2012 (subsequently withdrawn), and January 2013. In short, the NYSE rules require each compensation committee member to satisfy additional independence requirements and require the compensation committee charters to specify additional responsibilities and authority with respect to retaining compensation advisers and considering certain independence factors before selecting and receiving advice from compensation advisers. Independence requirements Current NYSE rules require the board of directors to affirmatively determine that a director has no material relationship with the issuer in order for that director to qualify as independent. The new compensation committee rules include an additional independence test that requires the board of directors to consider all factors specifically relevant to determine whether any director serving on the compensation committee has any material relationship with the issuer that is material to that director’s ability to be independent from management. The factors identified by the NYSE include the source of the director’s compensation, including any consulting, advisory, or other compensatory fee paid by the issuer, and whether the director is affiliated with the issuer, a subsidiary of the issuer, or an affiliate of a subsidiary of the issuer. The NYSE rules provide for a cure period that allows compensation committee members who are no longer independent for reasons outside of his or her control to continue serving on a compensation committee until the earlier of the next annual shareholders’ meeting or one year from

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the occurrence of the event that caused the member to no longer be independent provided they provide prompt notice to the NYSE and so long as a majority of the members of the compensation committee continue to be independent. Compensation committee charter Current NYSE rules require the compensation committee to have a written charter. The new compensation committee rules amended this provision to require that the charter address the rights and responsibilities of the compensation committee set forth in the NYSE rules, and described below. Compensation committee responsibilities and authority The NYSE rules were amended to provide the following specific responsibilities and authority of the compensation committee: 

the compensation committee may, in its sole discretion, retain or obtain the advice of a compensation adviser;

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the compensation committee shall be directly responsible for the appointment, compensation, and oversight of the work of any compensation adviser retained by the compensation committee;

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the issuer must provide for appropriate funding, as determined by the compensation committee, for payment of reasonable compensation to a compensation adviser retained by the compensation committee; and

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the compensation committee may select, or receive advice from, any compensation adviser only after considering all factors relevant to that person’s independence from management, including the six independence factors.

Compensation committees are not required to implement or act consistently with the advice or recommendations of a compensation adviser. Even after hiring a compensation adviser, a compensation committee must continue to exercise its own judgment in fulfillment of the duties of the compensation committee. Also, the compensation committee is not required to conduct an independence assessment for inhouse counsel or a compensation adviser that acts in a role limited to the following activities: 

consulting on any broad-based plan that does not discriminate in scope, terms, or operation, in favor of executive officers or directors of the issuer, and that is available generally to all salaried employees; and/or

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providing information that either is not customized for a particular issuer or that is customized based on parameters that are not developed by the adviser, and about which the adviser does not provide advice.

Nothing in the NYSE rules require a compensation adviser to be independent, only that the compensation committee consider the enumerated independence factors before selecting, or receiving advice from, a compensation adviser. Compensation committees may select, or receive

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advice from, any compensation adviser they prefer, including ones that are not independent, after considering the six independence factors. Application to smaller reporting companies The NYSE rules were amended to provide an exemption from compliance with certain corporate governance rules for “smaller reporting companies,” as defined in SEC regulations. As a result, smaller reporting companies will not be subject to the NYSE’s new independence standards that apply to directors who serve on a compensation committee or the requirement that compensation committees consider the independence factors prior to retaining compensation advisers. Application to foreign private issuers The current NYSE rules permit foreign private issuers to follow their home country practice in lieu of many of the NYSE’s corporate governance listing standards. However, the foreign private issuer must disclose in its annual report filed with the SEC each requirement that it does not follow and describe the home country practice followed in lieu of such requirement. The NYSE rule applies this allowance to the compensation committee rules provided the foreign private issuer complies with the same disclosure condition. Effective dates The new NYSE rules will become effective July 1, 2013. Listed issuers, however, must comply with the new compensation committee member independence rules by the earlier of (i) the first annual meeting after January 15, 2014, or (ii) October 31, 2014. For further information, please contact your Nixon Peabody attorney or: 

Lloyd H. Spencer, 202-585-8303 or [email protected]

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Courtney L. Lindsay, II, 202-585-8742 or [email protected]

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Pierce Han, 202-585-8139 or [email protected]

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