April 27, 2011Client Alert

Developments in Securities Law - April 2011


Listing Standards for Compensation Committees and Compensation Consultants


On March 30, 2011, the Securities and Exchange Commission (“SEC”) adopted proposed rules that would require the national securities exchanges to adopt new listing standards regarding compensation committees and compensation consultants. The new rules are in response to a provision in the Dodd-Frank Act that added a new Section 10C to the Securities Exchange Act of 1934.  Section 10C requires the SEC to adopt rules directing the exchanges to prohibit the listing of equity securities of an issuer not in compliance with the compensation committee and compensation adviser requirements of such statute. The proposed rules largely repeat the requirements of Section 10C, leaving the development of the listing standards to the exchanges.  The SEC, however, is expected to work with the exchanges in crafting the new standards, and any standards proposed by the exchanges will be subject to SEC approval.


The proposed rules should not have any effect on the current proxy season. The SEC is seeking comments on the proposed rules by April 29, 2011, and the SEC is required to adopt final rules by July 16, 2011. 


In the proposed rules, the SEC directs the exchanges to adopt listing standards that require each compensation committee member to be (i) a member of the board of directors and (ii) independent. While the proposed rules do not define “independence,” they list certain relevant factors from Section 10C(a)(1) for the exchanges to consider in their determination of a definition, in particular:


  • the source of compensation of an issuer’s board member, including any consulting, advisory or other compensatory fee paid by the issuer to such board member; and
  • whether an issuer’s board member is affiliated with the issuer, a subsidiary of the issuer or an affiliate of a subsidiary of the issuer.


As provided in the Dodd-Frank Act, certain categories of companies are exempt from these compensation committee member independence requirements:


  • controlled companies (i.e., companies in which more than 50 percent of the voting power in the election of directors is held by an individual, a group or another issuer);
  • 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 why it does not have an independent compensation committee.


The proposed rules would direct the exchanges to prohibit the listing of any equity security of an issuer not in compliance with these independence requirements, as required by the statute. Nevertheless, as required by Section 10C, issuers must have a reasonable opportunity to cure any defects that would result in the delisting or prohibition of the listing of such issuer’s securities because of the failure to meet the new requirements. Therefore, an exchange may allow a compensation committee member who ceases to be independent for reasons outside such member’s reasonable control to remain a member until the earlier of the next annual meeting or one year from the occurrence of the event that caused the member to be no longer independent, with notice to the applicable exchange by the issuer.  


In the proposed rules, the SEC also directs the exchanges to adopt listing standards regarding the authority of compensation committees to retain compensation advisors, as well as such compensation committees’ responsibilities regarding such compensation advisors. Specifically, the exchanges must adopt listing standards requiring issuers to comply with the following requirements regarding compensation committees:


  • The committee must have the authority, in its sole discretion, to retain or obtain the advice of compensation consultants, independent legal counsel and other advisors (collectively, “compensation advisers”).
  • Before selecting any compensation adviser, the committee must take into consideration specific factors identified by the SEC that affect the independence of compensation advisers.
  • The committee must be directly responsible for the appointment, compensation and oversight of the work of any compensation adviser.
  • Each listed issuer must provide appropriate funding for the payment of reasonable compensation, as determined by the committee, to compensation advisers.


Finally, pursuant to the proposed rules, issuers will have to expand their disclosure in any proxy or information statements for shareholder annual meetings (or a special meeting in lieu of an annual meeting) at which directors are to be elected. Currently, Item 407(e)(3) of Regulation S-K requires registrants that are subject to the proxy rules to provide certain disclosure regarding their compensation committees and the use of compensation consultants, including details about the fees paid to compensation consultants. The additional disclosure requirements, which will be integrated with these existing provisions, would require disclosure of whether (i) the compensation committee retained or obtained the advice of a compensation consultant and (ii) the work of the compensation consultant has raised any conflict of interest and, if so, the nature of the conflict and how it is being addressed. The phrase “obtained the advice” refers to whether a compensation committee has requested or received advice from a compensation consultant, regardless of whether there was a formal engagement, a relationship with such committee or management, or payment of any fees.


Incentive-Based Compensation

On March 2, 2011, the SEC adopted proposed rules on incentive-based compensation applicable to broker-dealers and investment advisors that have more than one billion dollars in assets. The rules require the structure of incentive-based compensation practices to be disclosed to the SEC and prohibit these entities from maintaining compensation arrangements that encourage inappropriate risks.  



SEC Considers Significant Changes for Privately-Held Companies

The SEC is reviewing two long-standing rules that restrict the process by which startup companies raise capital, specifically that a privately-held company (1) be subjected to the disclosure requirements of public companies once the company has 500 or more shareholders, and (2) must specifically target potential investors with whom an established relationship exists, rather than widely publicize an investment opportunity for all who may be interested (referred to as “general solicitation”).


The 500 shareholder rule has drawn attention in the past as the impetus to push private companies to reluctantly go public (e.g., Microsoft, Google and recent discussions around Facebook). The general solicitation prohibition also made headlines last December when Goldman Sachs restricted a private offering to non-U.S. citizens due to concerns that media attention surrounding its offering inadvertently violated the rule.


At this point, these SEC action items have little practical impact. They were revealed in a letter from SEC Chairman Mary Schapiro to the Chairman of the House Committee on Oversight and Government Reform that emphasized the review was in “very early stages.” If the review ultimately leads to relaxing the rules, privately-held companies could benefit through greater access to capital and being able to avoid prematurely devoting significant resources to public reporting requirements. 



No relevant Final Rules.



No relevant C&DI.



No relevant Releases or Policy Statements.





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