Dodd-Frank Implementation Update: SEC Listing Standards Regarding Compensation Committee and Advisor Independence

The Dodd-Frank Act was a game-changing event in executive pay – and a new season is underway. The Dodd-Frank Wall Street Reform and Consumer Protections Act of 2010 (“Dodd-Frank”) was initially about financial institutions reform but was expanded to address the executive pay policies and practices at all publically held companies.

The SEC has proposed listing rules for comment in reaction to Dodd-Frank that would apply to proxy filings made after July 16, 2012 pending the resulting rules by each independent exchange. The reality, however, is that institutional investors and shareholder groups may react sooner than this timeframe in their say-on-pay votes.

This is just the first installment by the SEC to address the provisions of Dodd-Frank. The issues that remain on the 2011 regulatory docket include pay equity, pay for performance, incentive payment clawbacks and stock option award hedging prohibitions. 2011 is shaping up to be a very memorable year in the history books of executive pay legislation and regulation.

What Has the SEC Proposed?  

Section 952 of Dodd-Frank requires:

  • compensation committee independence,
  • compensation committee advisor independence,
  • funding that will allow the compensation committee to retain independent advisors, and
  • proxy statement disclosures on independence issues of compensation advisors to the compensation committee, conflicts of interest, and how those issues were resolved.

Who Does this Impact?  

The SEC listing rules would only apply to companies with equity securities that are listed on public exchanges. The independence standards apply only to directors on the board serving on a committee that oversees executive compensation issues. The SEC calls this a “compensation committee” but this could be any committee that addresses executive compensation issues and the committee could address other additional functions or issues. The SEC’s committee independence requirements have five categories of companies that can be exempt from these standards:

  • controlled companies (those owned 50% or more by another company or entity – this is a departure from the definition used for Audit Committee independence),
  • 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 that the foreign private issuer does not have an independent compensation committee.

In addition, the proposed rules could authorize the exchanges to exempt a particular relationship from the independence requirements that apply to compensation committee members.

Compensation Committee Independence  

The proposed SEC listing rules prohibit an exchange from listing an equity security for a company that does not meet certain independence standards. To consider the independence of a director, the exchanges must consider:

  • the sources of compensation of a director, including any consulting, advisory or compensatory fee paid by the company to such member of the board of directors and
  • whether a member of the board of directors of a company is affiliated with the company, a subsidiary of the company, or an affiliate of a subsidiary of the company.

As with all listing standards, the exchanges would seek the approval of the SEC before adopting them. The exchanges could add to or broaden how director independence will be determined beyond those listed in these guidelines. Similar to the rules for audit committees, a compensation committee would have one year to cure a defect should a committee member cease to be independent for reasons outside of their control.

These proposed listing rules are generally similar to the mandates of Dodd-Frank. Unfortunately, we all may have to wait for the modified listing rules established by the exchanges before we get a complete picture the rules that will be in effect for each exchange and registrant.

Compensation Committee Advisor Independence  

The proposed rules also would require the exchanges to adopt listing standards providing that a compensation committee may select a compensation consultant, legal counsel or other adviser only after considering the following five independence factors:

  1. Whether the compensation consulting company employing the compensation advisor is providing any other services to the company.
  2. How much the compensation consulting company who employs the compensation advisor has received in fees from the company, as a percentage of that person’s total revenue.
  3. What policies and procedures have been adopted by the compensation consulting company employing the compensation advisor to prevent conflicts of interest.
  4. Whether the compensation advisor has any business or personal relationship with a member of the compensation committee.
  5. Whether the compensation advisor owns any stock of the company.

Again, the SEC has essentially mirrored the requirements of Dodd-Frank, thus allowing the exchanges themselves the ability to impose additional considerations. If the compensation committee determined that a conflict of interest did exist with its advisor, the company would be required to describe the conflict clearly, concisely and in a manner that can be easily understood. They would also have to describe how the conflict was addressed on a case-by-case basis (a generic reiteration of corporate policies and procedures will not be viewed as satisfactorily addressing this requirement).

Note that while advisor independence is not mandatory, the optics of a perceived lack of independence would likely have a very negative impact on future mandatory say-on-pay shareholder votes.

Compensation Committee Funding  

The proposed SEC listing rules would require the exchanges to adopt listing standards providing that the compensation committee of a listed company:

  • may, in its sole discretion, retain or obtain the advice of a compensation advisor,
  • is directly responsible for the appointment, payment and oversight of compensation advisors, and
  • must be appropriately funded by the listed company.

This funding requirement essentially places the responsibility of advisory independence and the resolution of possible conflicts with the compensation committee.

Proxy Statement Disclosures  

Note that Exchange Act registrants subject to the federal proxy rules are already required to disclose information about their use of compensation consultants, including specific information about fees paid to consultants that the SEC added in late 2009. The proposed rules would modify existing rules to require disclosure about whether:

  • the compensation committee has retained or obtained the advice of a compensation consultant and/or.
  • the work of the compensation consultant has raised any conflict of interest and, if so, the nature of the conflict and how the conflict is being addressed.

The proposed rules also would eliminate the current disclosure exception for services that are limited to consulting on broad-based plans and the provision of non-customized benchmark data, but would retain the fee-disclosure requirements, including the exemptions from those requirements.


The rules of the game have changed: The best approach is to make sure you have a trusted advisor who understands and can relate the regulatory revolution that is approaching, is independent from other management advisors, and will offer advice that is grounded in business. An SEC registrant effectively has less than a year to coordinate advisors between management and the Board. The SEC’s proposed listing rules places the onus on the Board to find advisors they trust. The following is a list of questions a Board/Compensation Committee may find useful in this selection process:

  • Which business advisory service firms have existing or recent historic relationships with management that would impair or might give shareholders/regulators the perception that there are independence problems?
  • Do we need a second outside opinion to make sure the advice we are receiving makes sense and best fits our unique needs and circumstances?
  • Can we stay with our existing advisors or do we need to find another source of business advice and review for the Board/Compensation Committee?
    • Do the alternative providers under consideration have the horsepower to
      • Remain in business over the long-term or does their viability depend on the talents of less than a handful of specialists?
      • Track key accounting, tax and legal trends as they apply to executive pay issues?
      • Stand up to the demands of management and other dissenting directors?

Look for future updates as other major executive pay provisions of Dodd-Frank are enacted this year. Expect to hear more on pay equity, pay for performance, incentive payment clawbacks and stock option award hedging prohibitions as rules and requirements develop.

EisnerAmper LLP

This publication is intended to provide general information to our friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.



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