Last Wednesday, the SEC proposed new rules required by Section 952 of Dodd-Frank Act.  Under the proposal, each national securities exchange will be required to adopt new listing standards to prohibit the listing of any issuer that is not in compliance with the exchange’s independence requirements for compensation committees.  While compensation committees will need to be comprised entirely of independent directors, each national securities exchange will need to define independence for itself taking into consideration two factors: (1) the source of compensation of a Board member, including any consulting, advisory, or other compensatory fee paid by the issuer to the Board member, and (2) whether a Board member is affiliated with the issuer.  It is important to note that, in passing the Dodd-Frank Act, Congress did not infringe on the traditional role of states in defining corporate law.  There is neither a requirement to actually have a compensation committee nor a requirement for a compensation committee to approve executive compensation.  Any such requirements would be set forth by the national securities exchanges, such as the New York Stock Exchange currently requires.

The independence requirements, as proposed, would be applicable to any committee of the Board that oversees executive compensation, whether or not the committee is formally designated as a “compensation committee.”  While this particular requirement of the proposed rules is an attempt to prevent issuers from evading the independence requirements by renaming the compensation committee as a “human resource committee”, we could see an unexpected result of having these independence requirements potentially applying to more than one Board committee depending on how the issuer’s Board has allocated responsibility to its committees.  We recommend issuers review their current Board charters to ensure that all responsibility for reviewing executive compensation is allocated to only one committee.

The SEC emphasized that there is a significant difference between Section 301 of Sarbanes-Oxley Act of 2002 (“SOX”), which required the SEC to direct the national securities exchanges to adopt independence standards for audit committees, and Section 952 of Dodd-Frank, despite Congress’ use of the same two independence factors (discussed above).  SOX prohibits the national securities exchanges from having independence standards that would violate the independence factors listed above, whereas Section 952 of Dodd-Frank merely requires the national securities exchanges to consider the factors.  Thus, there is significant leeway for the national securities exchanges in adopting final listing standards.  We expect that this leeway will lessen the concern that a significant shareholder would be precluded from serving on the compensation committee merely because of the size of the shareholder’s interest in the issuer (as is currently the case with the audit committee).  We would further expect that the national securities exchanges would use other indicia to preclude independence, such as whether the committee member has personal or business relationships with the executive officers.  While the final SEC rules must be adopted by July, the final listing standards may not be in place before the 2012 proxy season, although the proposed listing standards will need to be submitted to the SEC by October.  Thus, as this point, the impact and the timing of the new proposal are unclear.

Finally, compensation committees must be given the authority to appoint and oversee the work of any compensation consultant, independent legal counsel, or any other advisor to the compensation committee.  In addition, national securities exchanges will be required to adopt new listing standards to prohibit the listing of any issuer that does not provide appropriate funding, as determined by the compensation committee, for payment of reasonable compensation to their advisors.  When engaging advisors, compensation committees would be required to consider certain independence factors that focus on the relationship between the advisor and the issuer.

To review the proposed rules, click here.