If recent proposals by the New York Stock Exchange (NYSE) and the NASDAQ Stock Market (NASDAQ) are accepted by the Securities and Exchange Commission (SEC), most Canadian listed public companies whose shares trade in the U.S. will be exempted from the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act's (Dodd-Frank) compensation committee independence requirements and compensation consultant considerations, as discussed in this Client Advisory.
Dodd-Frank requires the SEC to ensure that U.S. stock exchanges include compensation committee member independence standards in their listing rules. In addition, Dodd-Frank requires compensation committees to consider potential conflicts of interest when using advisors.
The SEC released Exchange Act Rule 10C-1 in this connection on June 20, 2012. The NYSE and the NASDAQ responded to the SEC Rule with new listing proposals on September 25, 2012.
As noted in our September 27, 2012 Executive Pay Matters blog posting, both of the exchanges propose to provide relief from the committee independence rules to foreign private issuers (FPIs), i.e. to those companies whose shares are listed on a U.S. stock exchange as well as in their home country and who the SEC exempts from certain filing requirements (e.g. the U.S. proxy circular disclosure rules).
The NYSE and the NASDAQ proposals have been submitted to the SEC for final approval, which is expected to follow shortly. The committee member independence standards are to take effect in 2014 for most companies, while the compensation advisor requirements are to take effect on July 1, 2013 for NYSE companies and on the date of SEC approval for NASDAQ companies.
Committee Member Independence Requirements
Unless otherwise exempted, members of the compensation committee of a NYSE-listed company will need to satisfy the Exchange's general board independence standards and the board must affirmatively determine the independence of each committee member for service on the committee by considering "all factors specifically relevant to determining whether a director has a relationship to the listed company which is material to that director's ability to be independent from management in connection with the duties of a compensation committee member."
This consideration would include, but not be limited to, the two factors explicitly enumerated in Rule 10C-1(b):
- The source of compensation of the director, including any consulting, advisory or other compensatory fee paid by the listed company to such director.
- Whether the director is affiliated with the listed company, a subsidiary of the listed company or an affiliate of a subsidiary of the listed company.
Unless otherwise exempted, a member of the compensation committee of a NASDAQ-listed company must qualify as an independent director under the NASDAQ's general standards of director independence and must not accept, directly or indirectly, any consulting, advisory or other compensatory fees from the listed company or any subsidiary of the company. For this purpose, compensatory fees exclude fees for board and committee service and fixed amounts of compensation under a retirement plan for prior service.
In addition, the board must consider whether the compensation committee member is affiliated with the company and whether such affiliation would impair the director's judgment as a member of the committee.
Under Dodd-Frank itself, FPIs are required to adhere to the Act's compensation committee member independence requirements, unless they disclose in their annual report filed with the SEC, their reasons for not following those requirements (e.g. because they do not have a compensation committee).
While the SEC's Rule 10C-1 did not expand on this somewhat limited Dodd-Frank exemption, the NYSE and the NASDAQ have both proposed to allow FPIs to follow their home-country governance practices with respect to compensation committee membership.
It should be noted that FPIs for some time have been required to disclose to the exchanges any significant ways in which their corporate governance practices differ from those followed by domestic U.S. companies (generally by way of their annual Form 20-F filings with the SEC). If the exchanges' independence exemption proposals are accepted by the SEC, NASDAQ companies that take advantage of the FPI exemptions will need to disclose any resulting divergence in their annual filings. The NASDAQ will also require FPIs to explain why they chose not to follow the compensation committee requirements for U.S. domestic companies, but, interestingly, the NYSE will not require this.
Canadian Compensation Committee Requirements
In Canada, while the Canadian Securities Administrators (CSA) does not require members of a compensation committee to be independent, the CSA's corporate governance disclosure rules in National Instrument NI-58-101 require companies to:
- Describe the process by which the board determines the compensation for its officers and directors.
- Disclose whether the board has a compensation committee composed entirely of independent directors. If the company does not have a compensation committee composed entirely of independent directors, it must describe what steps the board takes to ensure an objective process for determining such compensation.
- Describe the responsibilities, powers and operation of the compensation committee.
The CSA also requires companies to disclose in their annual compensation discussion and analysis (CD&A) whether the board of directors has established a compensation committee, and if so, to:
- Disclose the name of each committee member and, in respect of each member, to state whether or not the member is independent (i.e. has no direct or indirect material relationship with the company).
- Disclose whether or not one of more of the committee members has any direct experience that is relevant to his or her responsibilities in executive compensation.
- Describe the skills and experience that enable the committee to make decisions on the suitability of the company's compensation policies and practices.
- Describe the responsibilities, powers and operation of the committee.
Compensation Committee Advisors
In implementing the Dodd-Frank compensation advisor requirements, SEC Rule 10C-1 directs compensation committees to consider the following factors in determining the independence of their compensation consultants, legal counsel and other advisors:
- Whether the advisor's firm provides other services to the company.
- The fees received from the company by the advisor's firm as a percentage of the firm's total income.
- The policies and procedures adopted by the advisor's firm to prevent conflicts of interest.
- Any business or personal relationship of the advisor with a compensation committee member.
- Stock of the company owned by the advisor.
- Any business or personal relationships between executive officers of the company and the advisor.
The requirements apply only to those advisors retained by the compensation committee, and not to advisors retained by management. While U.S. companies will be required to disclose in their future proxy circulars actual compensation consultant conflict of interest situations and how they were mitigated, this disclosure will not apply to FPIs.
While neither Dodd-Frank nor Rule 10C-1 specifically exempt FPIs from the having to consider potential advisor conflicts, the NYSE and the NASDAQ have both proposed to allow FPIs to follow their home-country governance practices with respect to compensation committee advisors.
Canadian Compensation Advisor Requirements
In Canada, the CSA to date has not issued rules with respect to the need for compensation committees to consider potential conflicts of interest on the part of compensation advisors, nor does the CSA require companies to disclose the existence of any such conflicts in proxy circulars.
The CSA does, however, require companies to:
- Disclose in their annual CD&As, the names of compensation consultants or advisors who have "been retained to assist the board of directors or the compensation committee in determining compensation for any of the company's directors and executive officers".
- Briefly describe the nature of any other services they provide to the company.
- Disclose whether the board or the committee must pre-approve other services provided to the company at the request of management.
In addition, the company must disclose the total annual fees paid to the compensation consultants for two years, separated between the executive compensation-related fees and all other fees. However, no minimum fee threshold applies for this purpose, in contrast to the SEC's US $120,000 fee disclosure threshold.
Canadian companies will want to consider the compensation committee independence issues raised by Dodd-Frank, notwithstanding the proposed exemptions for FPIs. It should be noted that the SEC still has not issued the rule needed to implement the compensation clawback requirements of Dodd-Frank.
This Advisory is not intended to constitute or serve as a substitute for legal, accounting, actuarial or other professional advice.