SEC Issues Proposed Rules Regarding Listing Standards for Compensation Committees and Incentive-Based Compensation Arrangements

The Securities and Exchange Commission (SEC) has recently issued proposed rules with other agencies to implement various sections of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010  dealing with incentive-based compensation arrangements for covered financial institutions and listing standards for compensation committees and advisers.

Incentive-Based Compensation Arrangements

The first proposal (pdf) would require brokers, dealers or investment advisers with assets of at least $1 billion to design their incentive compensation arrangements to take risk into account. Section 956 of the Dodd-Frank requires that federal regulators prohibit incentive-based payment arrangements, or any feature of any such arrangement, at a covered financial institution that the agencies determine encourages inappropriate risks by a financial institution by providing excessive compensation or that could lead to material financial loss. Generally, as discussed in a press release, the proposal would require that these incentive compensation arrangements “appropriately balance risk and financial rewards, be compatible with effective controls and risk management, and be supported by strong corporate governance.” Such measures imposed by the proposal include:

  • Requiring financial institutions with $1 billion or more in assets to annually report the structure of their incentive compensation arrangements to their federal regulator to determine whether the structure provides “excessive compensation, fees, or benefits” or “could lead to material financial loss” to the institution.. This report would include a narrative description of the components of the firm’s incentive-based compensation arrangements; a brief description of the firm’s policies and procedures governing the incentive-based arrangements, and an explanation as to why the entity believes the structure of its incentive-based compensation arrangement will help prevent it from suffering a material financial loss or does not provide certain executives with excessive compensation. Under the Proposed Rule, incentive-based compensation for a covered person would be considered excessive when amounts paid are unreasonable or disproportionate to, among other things, the amount, nature, quality, and scope of services performed by the covered person.
  • Providing additional requirements for financial institutions with $50 billion or more in assets, including deferral of incentive-based compensation of executive officers and approval of compensation for people whose job functions give them the ability to expose the firm to a substantial amount of risk. Among other requirements, these larger financial institutions would have to defer at least 50 percent of the incentive compensation of certain officers for at least three years. Moreover, the rule stipulates that any incentive-based compensation payments must be adjusted for losses incurred by the covered financial institution after the compensation was initially awarded.
  • Requiring covered institutions to develop policies and procedures that ensure and monitor compliance with requirements related to incentive-based compensation. In essence, a covered financial institution would be barred from establishing an incentive-based compensation arrangement unless the arrangement has been adopted under policies and procedures developed and maintained by the institution and approved by its board of directors.

A fact sheet on these requirements can be found here.

Comments on this proposed rule must be submitted within 45 days of the rule’s publication in the Federal Register, which is scheduled for April 14, 2011, and may be submitted electronically through the SEC’s webpage, through the federal eRulemaking portal, or via email to: rule-comments@sec.gov (include File Number S7-12-11 on the subject line). Alternatively, written copies may be sent in triplicate to: Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549 All submissions should refer to File Number S7-12-11.

Listing Standards for Compensation Committees and Advisers

The second proposed rule (pdf) would implement the section of the Dodd-Frank Act governing listing standards for a company’s compensation committees and advisers. Section 952 of the new law directs national securities exchanges/associations (e.g., NYSE, NASDAQ) to establish listing standards requiring publicly traded companies to have their compensation committee participants be members of the board of directors and meet a heightened standard of independence in order for their shares to continue trading on those exchanges. In addition, this section of the Act requires the SEC to adopt new disclosure rules for companies to report the use of compensation consultants and conflicts of interest.

With respect to the independence of compensation committee members, a fact sheet on the SEC’s proposal explains that in developing a definition of “independence,” exchanges would need to take into consideration such factors as:

  • 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.
  • 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 for the authority and funding of the compensation committees, the proposed rule would require the exchanges to develop listing standards permitting compensation committees to, in their discretion, retain or obtain the advice of a compensation adviser, and be directly responsible for their appointment, payment and oversight.

The listing standards to be developed by the exchanges would need to articulate that in choosing compensation consultants, legal counsels or other advisers, exchanges must take into account a number of considerations These factors include, but are not limited to:

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

The proposed rule also provides certain exemptions of companies from the independence requirements, such as controlled companies and limited partnerships.

The added disclosure requirements for publicly traded companies include proxy statement disclosures listing whether the company’s compensation committee has retained or obtained the advice of a compensation consultant, and if so, whether the work has triggered any conflict of interest. As noted in the fact sheet, the proposal “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.”

Comments on this proposal must be received on or before April 29, 2011, and may be submitted electronically through the SEC’s comment page, via email to: rule-comments@sec.gov; or through the federal eRulemaking portal. Alternatively, written comments may be submitted in triplicate to Elizabeth M. Murphy, Secretary, U.S. Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-1090. All submissions should refer to File Number S7-13-11.

For more information on the executive compensation provisions of the Dodd-Frank Act, see Littler’s ASAP: Executive Compensation and the Wall Street Reform and Consumer Protection Act by Nick Linn, Ilyse Schuman and Ellen Sueda.  

Photo credit: Ramy Majouji

Information contained in this publication is intended for informational purposes only and does not constitute legal advice or opinion, nor is it a substitute for the professional judgment of an attorney.