On June 20, 2012 the US Securities and Exchange Commission released a final rule (the "SEC's new rule"), under Section 10C of the Securities Exchange Act of 1934 (Section 10C") which was added by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 ("Dodd-Frank Act"). It was published in the Federal Register on June 27, 2012. The SEC's new rule requires national securities exchanges to adopt listing standards that mandate that compensation committees of public companies:
Be composed solely of independent board members. Have authority to hire and pay compensation advisers, including consultants and legal counsel (and to be provided funds to do so). Consider six enumerated independence factors before selecting a compensation adviser. This independence assessment is also required with respect to any adviser that provides advice to the committee (other than in-house counsel, as discussed below). In addition, the SEC's new rule requires proxy statement disclosure with respect to a compensation consultant (for whom proxy statement disclosure is already required) as to whether the consultant's work has raised any conflict of interest and, if so, the nature of the conflict and how it is being addressed.
Compensation committee member independence requirement. Most exchanges already require members of the company's compensation committee to be independent, using bright line standards that vary from exchange to exchange depending on the types of issuers typically listed on that exchange. See, for example, NYSE Listed Company Manual Section 303A.02(b); Nasdaq Rule 5605(a)(2). The existing listing standards preclude a director from being independent if he or she was recently employed by the company or if the a member of the director's immediate family is or was recently an executive officer of the company or received compensation in excess of specified limits.
In addition, both the NYSE and Nasdaq already provide that a director may be disqualified from being independent if the director has a material business relationship with the company, a family affiliations with the company's auditor or a family member employed by a business on whose compensation committee any of the executive officers of the listed company sit.
Further, Rule 16b-3 (exemption from short swing profit liability for certain equity transactions) Internal Revenue Code Section 162(m) (limitation on deduction for executive compensation) also require independence of the members of the committee approving the affected compensation (Rule 16b-3 uses the term "non-employee director").
Section 10C and the SEC's new rule do not define "independent." The statutory provision merely directs the SEC to require the exchanges to develop a definition of after taking into account the two relevant factors listed in Section 10C: a director's source of compensation from the company and whether the director is otherwise affiliated with the company or an affiliate of the company.
Unlike with audit committees (an audit committee member may not accept a fee from the company other than as a director), sources of compensation and affiliations need only be "considered" with respect to compensation committee members. Notably, the exchanges are not required (and indeed the Preamble to the SEC's new rule suggested it might not be appropriate to require) a limitation on stock ownership in order for a member of the compensation committee to be independent: "In establishing their independence requirements, the exchanges may determine that, even though affiliated directors are not allowed to serve on audit committees, such a blanket prohibition would be inappropriate for...