The rule, once implemented by the exchanges, is intended to enhance a company’s decision-making process when setting compensation for company executives and to create a heightened awareness of the process and the potential for conflicts of interest. In its final rule, the SEC also revised the rules regarding annual disclosure by public companies in their proxy materials to include new information regarding the company’s use of compensation consultants and conflicts of interest that may affect the consultants’ services. 

Compensation Committees

The SEC’s rule will take effect on July 20, 2012, 30 days after the final rule’s publication in the Federal Register, and the exchanges must have proposed listing standards to comply with these directives no later than 90 days after that, i.e., by October 18, 2012. 

Specifically, the new exchange listing standards will include a requirement that the members of the compensation committee be independent, with heightened rules for determining whether a director is independent.  The standards will set out the factors that are to be evaluated for this purpose and will likely include a review of matters such as the source of compensation paid to any board or committee member and any affiliation the board or committee member may have with the company or related parties.  This is designed to enhance the standards for independence beyond what is currently required for a member of the board to be considered an “outside” or “nonemployee” director (under certain tax and SEC rules). 

The new listing standards will also require that the compensation committee be authorized and funded to carry out its obligations, meaning that the committee will be able to engage and pay its own advisers independent from the corporation’s in-house or outside counsel and will be responsible for determining and monitoring the independence of those advisers. 

Compensation Advisers

As noted above, the new rule issued by the SEC also mandates that the proxy materials provided annually to shareholders by publicly traded companies disclose information about the use of compensation consultants, including specific information about the fees paid to such consultants.  Under the revised rules, with respect to any compensation consultant who has played a role in determining or recommending the amount or form of executive and director compensation and whose work has raised any conflict of interest, companies will be required to disclose the nature of the conflict and how the conflict is being addressed.