Compensation Committee

Transcription

1 Chapter 5 Compensation Committee [Chapter 5 is current as of September 1, 2010.] SUMM 5:1 SUMM 5:2 SUMM 5:3 SUMM 5:4 SUMM 5:5 SUMM 5:6 SUMM 5:7 Overview Dodd-Frank Act Compensation Committee Requirements NYSE Compensation Committee Requirements Nasdaq Rules Relating to Executive Compensation SEC Corporate Governance Disclosure Relating to Compensation Committees Additional Compensation Committee Independence Considerations Proposed Legislation to Heighten Independence Standards 5:1 Dodd-Frank Act Compensation Committee Requirements 5:1.1 Overview 5:1.2 Relevant Text of the Dodd-Frank Act 5:1.3 Discussion of the Requirements [A] Compensation Committee Independence [B] Additional Disclosure Under the Dodd-Frank Act [B][1] Background [B][2] Discussion of the Additional Disclosure Under the Dodd-Frank Act 5:2 NYSE Compensation Committee Requirements 5:2.1 Overview 5:2.2 Text of Section 303A.05 (Including NYSE Commentary) 5:2.3 Discussion of the Rule 5:2.4 Sample Compensation Committee Charter for NYSE-Listed U.S. Companies 5:3 Nasdaq Rules Relating to Executive Compensation 5:3.1 Overview 5:3.2 Text of Rule 5605(d) (Including Interpretations) 5:3.3 Discussion of the Rule 5:3.4 Sample Compensation Committee Charter for Nasdaq-Listed U.S. Companies (Public Co., Rel. #2, 11/10) 5 1

2 SUMM 5:1 PUBLIC COMPANY DESKBOOK 5:4 SEC Corporate Governance Disclosure Relating to Compensation Committees 5:4.1 Background 5:4.2 Text of SEC Rules Relating to Compensation Committees [A] Item 407(e) of Regulation S-K [B] Items 7 and 8 of Schedule 14A 5:4.3 Compensation Committee Process [A] Requirements Under 2006 Rule [B] Compensation Consultant Disclosure Under 2009 Revisions [B][1] Background [B][2] Discussion of 2009 Revisions 5:5 Additional Compensation Committee Independence Considerations 5:5.1 Background 5:5.2 Standards for Outside Director Under Section 162(m) of the Code [A] Text of Requirements [A][1] Section 162(m) of the Internal Revenue Code [A][2] Treasury Regulation (e)(3) [B] Discussion of the Rule [B][1] Requirements to Be an Outside Director [B][2] Former Officer [B][3] Remuneration Received from the Company 5:5.3 Standards for Non-Employee Director Under Section 16 of the Exchange Act [A] Text of Requirements [A][1] Text of Section 16(b) of the Exchange Act [A][2] Text of Rule 16b-3 [B] Discussion of the Rule 5:6 Proposed Legislation to Heighten Independence Standards SUMM 5:1 Overview In 2003, the NYSE and Nasdaq Stock Market, as part of their adoption of heightened corporate governance standards, adopted rules that required boards of directors to establish compensation committees composed entirely of independent directors that have broad responsibility for executive and director compensation. In 2006, the SEC issued comprehensive changes to its executive compensation rules, which included a consolidation and expansion of the required disclosure relating to corporate governance practices. In addition, public company directors serving on the compensation committee have long been subject to the independence standards effectively imposed by section 16 of the Exchange Act and section 162(m) of the Internal Revenue Code. 5 2

3 Compensation Committee SUMM 5:4 SUMM 5:2 Dodd-Frank Act Compensation Committee Requirements On July 21, 2010, President Obama signed into law the Dodd- Frank Wall Street Reform and Consumer Protection Act (the Dodd- Frank Act ), 1 which included revisions to the independence requirements for compensation committees. In particular, section 952 adds a new section 10C to the Exchange Act, which requires the SEC to promulgate rules requiring national securities exchanges to prohibit the listing of an issuer s equity securities if its board does not have an independent compensation committee. SUMM 5:3 NYSE Compensation Committee Requirements Under the NYSE listing standards, each U.S. listed company must have a compensation committee composed of independent directors. The compensation committee must have a written charter, which must be posted on the company s website, addressing (at a minimum) the committee s purpose and responsibilities, including determining (either as a committee or together with the other independent directors) the compensation of the CEO, exercising authority or making recommendations to the board with respect to non- CEO executive officer compensation, and producing the annual report on executive compensation. The rules expressly permit the responsibilities of the compensation committee to be allocated to one or more other committees composed entirely of independent directors. SUMM 5:4 Nasdaq Rules Relating to Executive Compensation Under the Nasdaq listing standards, the compensation of the CEO and officers of each listed company (other than controlled companies) must be determined, or recommended to the board for determination, by either a majority of the independent directors or a compensation committee composed solely of independent directors. In addition, the CEO may not be present during voting or deliberations concerning the determination of the CEO s compensation. As with the Nasdaq corporate governance requirements generally, non-u.s. companies may obtain an exemption from this requirement. 1. Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No , 124 Stat (2010). (Public Co., Rel. #2, 11/10) 5 3

4 SUMM 5:5 PUBLIC COMPANY DESKBOOK Unlike the NYSE listing standards, a formal written compensation committee charter is not required and the rules do not expressly contemplate delegation (although the wording of the rule would permit delegation). SUMM 5:5 SEC Corporate Governance Disclosure Relating to Compensation Committees Under SEC rules, a U.S. company is required to include in its proxy statement the following disclosure regarding its compensation committee and compensation process: A description of the processes and procedures it employs for the consideration of both executive officer and director compensation, including the scope of the authority of the compensation committee. Any role executive officers play in determining the amount and form of executive and director compensation. The name of any compensation consultant involved in determining or recommending the amount or form of executive or director compensation, together with the nature and scope of the assignment and the material elements of the instructions or directions given. The existence and details of any compensation committee interlocks. A Compensation Committee Report. SUMM 5:6 Additional Compensation Committee Independence Considerations In light of the actions generally within the purview of compensation committees, the independence standards of Rule 16b-3 under the Exchange Act and section 162(m) of the Internal Revenue Code are often relevant to compensation committee members. The standards under these provisions effectively impose two additional layers of independence requirements for compensation committee members. SUMM 5:7 Proposed Legislation to Heighten Independence Standards There have been a number of recent initiatives to increase the independence and accountability of compensation committee members. On July 31, 2009, the House of Representatives passed the Corporate and Financial Institution Compensation Fairness Act of 5 4

5 Compensation Committee 5: , which among other things would require additional independence standards for public company compensation committees. 5:1 Dodd-Frank Act Compensation Committee Requirements 5:1.1 Overview On July 21, 2010, President Obama signed into law the Dodd- Frank Act, which included revisions to the independence requirements for compensation committees. In particular, section 952 adds a new section 10C to the Exchange Act, which requires the SEC to promulgate rules requiring national securities exchanges to prohibit the listing of an issuer s equity securities if its board does not have an independent compensation committee. 5:1.2 Relevant Text of the Dodd-Frank Act SEC COMPENSATION COMMITTEE INDEPENDENCE. (a) IN GENERAL. The Securities Exchange Act of 1934 (15 U.S.C. 78 et seq.) is amended by inserting after section 10B, as added by section 753, the following: SEC. 10C. COMPENSATION COMMITTEES. (a) INDEPENDENCE OF COMPENSATION COMMITTEES. (1) LISTING STANDARDS. The Commission shall, by rule, direct the national securities exchanges and national securities associations to prohibit the listing of any equity security of an issuer, other than an issuer that is a controlled company, limited partnership, company in bankruptcy proceedings, openended management investment company that is registered under the Investment Company Act of 1940, or a foreign private issuer that provides annual disclosures to shareholders of the reasons that the foreign private issuer does not have an independent compensation committee, that does not comply with the requirements of this subsection. (2) INDEPENDENCE OF COMPENSATION COMMIT- TEES. The rules of the Commission under paragraph (1) shall require that each member of the compensation committee of the board of directors of an issuer be (Public Co., Rel. #2, 11/10) 5 5

6 5:1.2 PUBLIC COMPANY DESKBOOK (A) a member of the board of directors of the issuer; and (B) independent. (3) INDEPENDENCE. The rules of the Commission under paragraph (1) shall require that, in determining the definition of the term independence for purposes of paragraph (2), the national securities exchanges and the national securities associations shall consider relevant factors, including (A) the source of compensation of a member of the board of directors of an issuer, including any consulting, advisory, or other compensatory fee paid by the issuer to such member of the board of directors; and (B) whether a member of the board of directors of an issuer is affiliated with the issuer, a subsidiary of the issuer, or an affiliate of a subsidiary of the issuer. (4) EXEMPTION AUTHORITY. The rules of the Commission under paragraph (1) shall permit a national securities exchange or a national securities association to exempt a particular relationship from the requirements of paragraph (2), with respect to the members of a compensation committee, as the national securities exchange or national securities association determines is appropriate, taking into consideration the size of an issuer and any other relevant factors. (b) INDEPENDENCE OF COMPENSATION CONSULTANTS AND OTHER COMPENSATION COMMITTEE ADVISERS. (1) IN GENERAL. The compensation committee of an issuer may only select a compensation consultant, legal counsel, or other adviser to the compensation committee after taking into consideration the factors identified by the Commission under paragraph (2). (2) RULES. The Commission shall identify factors that affect the independence of a compensation consultant, legal counsel, or other adviser to a compensation committee of an issuer. Such factors shall be competitively neutral among categories of consultants, legal counsel, or other advisers and preserve the ability of compensation commit- 5 6

7 Compensation Committee 5:1.2 tees to retain the services of members of any such category, and shall include (A) the provision of other services to the issuer by the person that employs the compensation consultant, legal counsel, or other adviser; (B) the amount of fees received from the issuer by the person that employs the compensation consultant, legal counsel, or other adviser, as a percentage of the total revenue of the person that employs the compensation consultant, legal counsel, or other adviser; (C) the policies and procedures of the person that employs the compensation consultant, legal counsel, or other adviser that are designed to prevent conflicts of interest; (D) any business or personal relationship of the compensation consultant, legal counsel, or other adviser with a member of the compensation committee; and (E) any stock of the issuer owned by the compensation consultant, legal counsel, or other adviser. (c) COMPENSATION COMMITTEE AUTHORITY RELATING TO COMPENSATION CONSULTANTS. (1) AUTHORITY TO RETAIN COMPENSATION CONSUL- TANT. (A) IN GENERAL. The compensation committee of an issuer, in its capacity as a committee of the board of directors, may, in its sole discretion, retain or obtain the advice of a compensation consultant. (B) DIRECT RESPONSIBILITY OF COMPENSATION COMMITTEE. The compensation committee of an issuer shall be directly responsible for the appointment, compensation, and oversight of the work of a compensation consultant. (C) RULE OF CONSTRUCTION. This paragraph may not be construed (Public Co., Rel. #2, 11/10) 5 7

8 5:1.2 PUBLIC COMPANY DESKBOOK (i) to require the compensation committee to implement or act consistently with the advice or recommendations of the compensation consultant; or (ii) to affect the ability or obligation of a compensation committee to exercise its own judgment in fulfillment of the duties of the compensation committee. (2) DISCLOSURE. In any proxy or consent solicitation material for an annual meeting of the shareholders (or a special meeting in lieu of the annual meeting) occurring on or after the date that is 1 year after the date of enactment of this section, each issuer shall disclose in the proxy or consent material, in accordance with regulations of the Commission, whether (A) the compensation committee of the issuer retained or obtained the advice of a compensation consultant; and (B) 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. (d) AUTHORITY TO ENGAGE INDEPENDENT LEGAL COUN- SEL AND OTHER ADVISERS. (1) IN GENERAL. The compensation committee of an issuer, in its capacity as a committee of the board of directors, may, in its sole discretion, retain and obtain the advice of independent legal counsel and other advisers. (2) DIRECT RESPONSIBILITY OF COMPENSATION COM- MITTEE. The compensation committee of an issuer shall be directly responsible for the appointment, compensation, and oversight of the work of independent legal counsel and other advisers. (3) RULE OF CONSTRUCTION. This subsection may not be construed (A) to require a compensation committee to implement or act consistently with the advice or recommendations of independent legal counsel or other advisers under this subsection; or 5 8

9 Compensation Committee 5:1.2 (B) to affect the ability or obligation of a compensation committee to exercise its own judgment in fulfillment of the duties of the compensation committee. (e) COMPENSATION OF COMPENSATION CONSULTANTS, INDEPENDENT LEGAL COUNSEL, AND OTHER ADVISERS. Each issuer shall provide for appropriate funding, as determined by the compensation committee in its capacity as a committee of the board of directors, for payment of reasonable compensation (1) to a compensation consultant; and (2) to independent legal counsel or any other adviser to the compensation committee. (f) COMMISSION RULES. (1) IN GENERAL. Not later than 360 days after the date of enactment of this section, the Commission shall, by rule, direct the national securities exchanges and national securities associations to prohibit the listing of any security of an issuer that is not in compliance with the requirements of this section. (2) OPPORTUNITY TO CURE DEFECTS. The rules of the Commission under paragraph (1) shall provide for appropriate procedures for an issuer to have a reasonable opportunity to cure any defects that would be the basis for the prohibition under paragraph (1), before the imposition of such prohibition. (3) EXEMPTION AUTHORITY. (A) IN GENERAL. The rules of the Commission under paragraph (1) shall permit a national securities exchange or a national securities association to exempt a category of issuers from the requirements under this section, as the national securities exchange or the national securities association determines is appropriate. (B) CONSIDERATIONS. In determining appropriate exemptions under subparagraph (A), the national securities exchange or the national securities association shall take into account the potential impact of the requirements of this section on smaller reporting issuers. (Public Co., Rel. #2, 11/10) 5 9

10 5:1.3 PUBLIC COMPANY DESKBOOK (g) CONTROLLED COMPANY EXEMPTION. (1) IN GENERAL. This section shall not apply to any controlled company. (2) DEFINITION. For purposes of this section, the term controlled company means an issuer (A) that is listed on a national securities exchange or by a national securities association; and (B) that holds an election for the board of directors of the issuer in which more than 50 percent of the voting power is held by an individual, a group, or another issuer. (b) STUDY AND REPORT. (1) STUDY. The Securities and Exchange Commission shall conduct a study and review of the use of compensation consultants and the effects of such use. (2) REPORT. Not later than 2 years after the date of the enactment of this Act, the Commission shall submit a report to Congress on the results of the study and review required by this subsection. 5:1.3 Discussion of the Requirements [A] Compensation Committee Independence In determining the definition of independence, the Dodd-Frank Act mandates that the SEC rules must require the national securities exchanges to consider (1) the source of director compensation, including any consulting, advisory or other compensatory fee paid to the director by the issuer and (2) whether the director is affiliated with the issuer, a subsidiary of the issuer or an affiliate of a subsidiary of the issuer. 2 While these two independence factors are similar to the factors identified in section 10A(m) of the Exchange Act with 2. The SEC may, but is not required to, include additional factors to be considered in determining a director s independence. In addition, the SEC rules may permit national securities exchanges to provide exemptions from the independence requirements for a category of issuers, taking into account especially the potential impact on smaller issuers. 5 10

11 Compensation Committee 5:1.3 respect to the independence of audit committee members, the audit committee statute provides flatly that these relationships are a bar to the independence of an audit committee member. Thus, though the language of section 952 seems to provide greater flexibility, it remains possible that the rules will ultimately define independence in a manner that is more restrictive than the NYSE and Nasdaq independence requirements currently applicable to compensation committee members of U.S. listed companies. In particular, the reference to affiliate status raises the question of whether significant share ownership, which would not necessarily be a bar to independence under the current stock exchange rules, could present an independence issue under the rules implementing section [B] Additional Disclosure Under the Dodd-Frank Act [B][1] Background Section 952 of the Dodd-Frank Act added a new section 10C to the Exchange Act, which requires the SEC and stock exchanges to impose additional procedural and disclosure requirements with respect to the use of compensation consultants, counsel and other advisors by listed companies (other than controlled companies). The rules required under this section must be issued within 360 days after the enactment of the Dodd-Frank Act. [B][2] Discussion of the Additional Disclosure Under the Dodd-Frank Act New section 10C requires an issuer s proxy or consent solicitation materials for any meeting occurring one year after the enactment of the Dodd-Frank Act to disclose whether the compensation committee has retained, or obtained the advice of, a compensation consultant, whether the work of the compensation consultant has 3. These independence requirements will not apply to the following: a controlled company, which is a listed company that has more than 50 percent of its voting power held by an individual, a group or another issuer; foreign private issuers that provide annual disclosure to shareholders of reasons that they do not have an independent compensation committee; limited partnerships; companies in bankruptcy proceedings; open-end management investment companies registered under the Investment Company Act; or companies that list only debt securities, not equity securities. (Public Co., Rel. #2, 11/10) 5 11

12 5:2 PUBLIC COMPANY DESKBOOK raised any conflict of interest and, if so, the nature of the conflict and the manner in which the conflict is being addressed. 4 5:2 NYSE Compensation Committee Requirements 5:2.1 Overview The NYSE rules adopted in 2003 as part of the NYSE s enhanced corporate governance listing standards 5 require each listed company to establish a compensation committee composed entirely of independent directors. See section 3:1.2 for a discussion of the background and adoption of the enhanced stock exchange listing standards in In addition, the compensation committee must have authority to engage, and the funds to pay, consultants, counsel and advisors. Consultants, counsel and advisors are not required to be independent, but the compensation committee must consider factors affecting independence before making a selection. The relevant factors are to be identified by the SEC and must include the business and personal relationships between the consultant, counsel or advisor and a member of the compensation committee, and the relationships between the employer of such consultant, counsel or advisor and the issuer. Section 952 specifies that such factors must be competitively neutral among categories of consultants, legal counsel, or other advisers and preserve the ability of compensation committees to retain the services of members of any such category. The compensation committee must have direct responsibility for the appointment, compensation and oversight of the work of the compensation consultant, counsel or advisor. 5. See Self-Regulatory Organizations; New York Stock Exchange, Inc. and National Association of Securities Dealers, Inc.; Order Approving Proposed Rule Changes (SR-NYSE and SR-NASD ) and Amendments No. 1 thereto; Order Approving Proposed Rule Changes (SR-NASD , SR-NASD , SR-NASD and SR- NASD ) and Amendments No. 1 to SR-NASD and SR-NASD ; and Notice of Filing and Order Granting Accelerated Approval of Amendment Nos. 2 and 3 to SR-NYSE , Amendment Nos. 2, 3, 4, and 5 to SR-NASD , Amendment Nos. 2 and 3 to SR-NASD , Amendment Nos. 1, 2, and 3 to SR-NASD , and Amendment No. 2 to SR-NASD , Relating to Corporate Governance, Rel. No (Nov. 4, 2003), 68 Fed. Reg. 64,154 (Nov. 12, 2003), available at htm. The NYSE has issued interpretations of its corporate governance rules in the form of Frequently Asked Questions. See NYSE Listed Company Manual Section 303A Corporate Governance Listing Standards Frequently Asked Questions (Jan. 29, 2004; updated as of Feb. 13, 2004) ( Corporate Governance FAQs ), available at

13 Compensation Committee 5:2.2 5:2.2 Text of Section 303A.05 (Including NYSE Commentary) [The NYSE rules were issued with an accompanying official commentary that should be considered part of the rules. The following reflects the rules and commentary as of March 1, 2010, including minor changes to the rule text that became effective January 1, ] 303A.05 Compensation Committee (a) Listed companies must have a compensation committee composed entirely of independent directors. (b) The compensation committee must have a written charter that addresses: (i) the committee s purpose and responsibilities which, at minimum, must be to have direct responsibility to: (A) review and approve corporate goals and objectives relevant to CEO compensation, evaluate the CEO s performance in light of those goals and objectives, and, either as a committee or together with the other independent directors (as directed by the board), determine and approve the CEO s compensation level based on this evaluation; (B) make recommendations to the board with respect to non-ceo executive officer compensation, and incentive-compensation and equity-based plans that are subject to board approval; and (C) prepare the disclosure required by Item 407(e)(5) of Regulation S-K; (ii) an annual performance evaluation of the compensation committee. 6. See Self-Regulatory Organizations; New York Stock Exchange LLC; Order Approving a Proposed Rule Change as Modified by Amendment No. 1 to Amend Certain Corporate Governance Requirements, Rel. No , File No. SR-NYSE (Nov. 25, 2009), available at (Public Co., Rel. #2, 11/10) 5 13

14 5:2.2 PUBLIC COMPANY DESKBOOK Commentary: In determining the long-term incentive component of CEO compensation, the committee should consider the listed company s performance and relative shareholder return, the value of similar incentive awards to CEOs at comparable companies, and the awards given to the listed company s CEO in past years. To avoid confusion, note that the compensation committee is not precluded from approving awards (with or without ratification of the board) as may be required to comply with applicable tax laws (i.e., Rule 162(m)). Note also that nothing in Section 303A.05(b)(i)(B) is intended to preclude the board from delegating its authority over such matters to the compensation committee. The compensation committee charter should also address the following items: committee member qualifications; committee member appointment and removal; committee structure and operations (including authority to delegate to subcommittees); and committee reporting to the board. Additionally, if a compensation consultant is to assist in the evaluation of director, CEO or executive officer compensation, the compensation committee charter should give that committee sole authority to retain and terminate the consulting firm, including sole authority to approve the firm s fees and other retention terms. Boards may allocate the responsibilities of the compensation committee to committees of their own denomination, provided that the committees are composed entirely of independent directors. Any such committee must have a committee charter. Nothing in this provision should be construed as precluding discussion of CEO compensation with the board generally, as it is not the intent of this standard to impair communication among members of the board. Website Posting Requirement: A listed company must make its compensation committee charter available on or through its website. If any function of the compensation committee has been delegated to another committee, the charter of that committee must also be made available on or through the listed company s website. Disclosure Requirements: A listed company must disclose in its annual proxy statement or, if it does not file an annual proxy statement, in its annual report on Form 10-K filed with the SEC 5 14

15 Compensation Committee 5:2.3 that its compensation committee charter is available on or through its website and provide the website address. 5:2.3 Discussion of the Rule Under the NYSE listing standards, each U.S. listed company must have a compensation committee composed of independent directors. See section 3:1.3[B] for a discussion of the timing of effectiveness of the NYSE compensation committee requirements, including phase-in periods for IPO companies and other newly listed companies. See sections 3:1.3[C] and [D] for a discussion of the entities subject to the rule. As discussed in those sections, non-u.s. companies, controlled companies, limited partnerships and companies in bankruptcy proceedings are exempt from this requirement. The compensation committee must have a written charter, which must be posted on the company s website, addressing (at a minimum) the committee s purpose and responsibilities, which must be to have direct responsibility for: reviewing and approving the corporate goals and objectives relevant to CEO compensation, evaluating the CEO s performance in light of those goals and objectives and, either as a committee or together with the other independent directors (as directed by the board), determining and approving the compensation of the CEO based on this evaluation; making recommendations to the board (or discharging the board s responsibilities) with respect to non-ceo executive officer compensation, incentive-compensation and equitybased plans that are subject to board approval; producing the annual report on executive compensation; and performing an annual performance evaluation of the committee. 7 The rules recommend (but do not require) that the charter also address: committee member qualification, appointment and removal; committee structure and operations; committee reporting to the board; and the sole authority of the committee to retain, terminate and approve the fees and retention terms of any compensation consultant. 7. See section 8:1.3 for a discussion of a possible approach for conducting this self-evaluation. (Public Co., Rel. #2, 11/10) 5 15

16 5:2.4 PUBLIC COMPANY DESKBOOK The rules permit delegation to subcommittees. Companies should consider expressly allowing the compensation committee to delegate the approval of transactions to a subcommittee where necessary to satisfy the approval requirements of Rule 16b-3 under the Exchange Act and/or section 162(m) of the Internal Revenue Code. Each of Rule 16b-3 and section 162(m) provides for actions to be taken by non-employee or outside directors in connection with certain compensation matters. Rule 16b-3 provides an exemption from short-swing profit recovery under section 16 of the Exchange Act for, among other things, transactions between issuers and their directors and officers that are approved by a committee of the board that consists solely of two or more non-employee directors. Section 162(m) exempts certain performance-based compensation from the cap on deductibility if a compensation committee composed of two or more outside directors determines and certifies the relevant performance goals. Because the criteria set forth in Rule 16b-3 and section 162(m) vary somewhat from the NYSE independence requirements, it is possible for a compensation committee member who is independent for NYSE purposes to fail to be a non-employee director under Rule 16b-3 or an outside director under section 162(m). In that case, delegation to a subcommittee composed of directors meeting the relevant definition would be necessary to meet the requirements of these provisions. 8 Section 5:4 discusses the independence requirements of Rule 16b-3 and section 162(m) in more detail. The NYSE listing standards expressly permit the responsibilities of the compensation committee to be allocated to one or more other committees composed entirely of independent directors. These other committees would need to have written charters posted on the company s website, including the provisions required for the compensation committee s charter. 5:2.4 Sample Compensation Committee Charter for NYSE-Listed U.S. Companies The following is an annotated sample form of compensation committee charter that NYSE-listed U.S. companies can use as a starting point to create or modify their own. The annotations indicate the NYSE rule or other legal requirement upon which the relevant provision is based. The underlying form of compensation committee charter is for illustrative purposes only and should be tailored to fit the particular circumstances of each company. 8. See the section entitled Delegation to Subcommittee in the sample Compensation Committee Charter contained in section 5:2.4 for suggested language specifically permitting this delegation. 5 16

17 Committee Membership Compensation Committee 5:2.4 The Compensation Committee (the Committee ) of the Board of Directors (the Board ) of [Name of Corporation] (the Company ) shall consist solely of three or more members of the Board, each of whom the Board has determined has no material relationship with the Company and each of whom is otherwise independent under the rules of the New York Stock Exchange, Inc. [NYSE 303A.02 and.05(a)] Members shall be appointed by the Board [based on nominations recommended by the Company s Nominating Committee], Members shall serve at the pleasure of the Board and for such term or terms as the Board may determine. [Discuss qualifications for committee members.] [NYSE 303A.05 (commentary recommends, but does not require, that charter address committee member qualifications, appointment and removal)] Committee Purpose and Responsibilities The Committee shall have the purpose and direct responsibility to: 1. Review and approve corporate goals and objectives relevant to the compensation of the Company s Chief Executive Officer ( CEO ), evaluate the CEO s performance in light of those goals and objectives, and either as a committee or together with the other independent directors (as directed by the Board), determine and approve the CEO s compensation level based on this evaluation [NYSE 303A.05(b)(i)(A)]. In determining the longterm incentive component of CEO compensation, the Committee shall consider, among other factors, the Company s performance and relative shareholder return, the value of similar incentive awards to CEOs at comparable companies, the awards given to the CEO in past years, and [list other factors, if any]. [NYSE 303A.05 (commentary recommends, but does not require, that the committee consider these factors)] 2. [Make recommendations to] [Discharge the responsibilities of] the Board with respect to non-ceo executive officer compensation, incentive-compensation plans and equity-based plans that are subject to board approval [, including [list specific plans currently in existence], oversee the activities of the individuals and committees responsible for administering these plans, including [list specific committees to be overseen], and discharge any responsibilities imposed on the Committee by any of these plans]. [NYSE 303A.05(b)(i)(B)] (Public Co., Rel. #2, 11/10) 5 17

18 5:2.4 PUBLIC COMPANY DESKBOOK 3. Approve any new equity compensation plan or any material change to an existing plan where shareholder approval has not been obtained. [NYSE 303A.08 (commentary)] 4. In consultation with management, oversee regulatory compliance with respect to compensation matters, including overseeing the Company s policies on structuring compensation programs to preserve tax deductibility, and, as and when required, establishing performance goals and certifying that performance goals have been attained for purposes of Section 162(m) of the Internal Revenue Code. [NYSE 303A.05 (commentary notes committee may approve awards pursuant to 162(m))] [5. Make recommendations to the Board with respect to any severance or similar termination payments proposed to be made to any current or former [executive officer] [member of senior management] of the Company.] 6. Prepare an annual Compensation Committee Report for inclusion in the Company s annual proxy statement in accordance with applicable SEC rules and regulations. [NYSE 303A.05(b)(i)(C) and Item 407(e)(5) (Compensation Committee Report) of Regulation S-K] 7. Prepare and issue the evaluation required under Performance Evaluation below. [NYSE 303A.05(b)(i)(C) and (ii)] 8. Report to the Board on a regular basis, and not less than once per year. [NYSE 303A.05 (commentary recommends, but does not require, that charter address committee reporting to the Board)] 9. Perform any other duties or responsibilities expressly delegated to the Committee by the Board from time to time relating to the Company s compensation programs. Committee Structure and Operations The [Board] [Committee] shall designate one member of the Committee as its chairperson. [In the event of a tie vote on any issue, the chairperson s vote shall decide the issue.] The Committee shall meet at least [three times] a year at a time and place determined by the Committee chairperson, with further meetings to occur, or actions to be taken by unanimous written consent, when deemed necessary or desirable by the Committee or its chairperson. Members of the Committee may participate in a 5 18

19 Compensation Committee 5:2.4 meeting of the Committee by means of conference call or similar communications equipment by means of which all persons participating in the meeting can hear each other. [NYSE 303A.05 (commentary recommends, but does not require, that charter address committee structure and operations)] [The Committee may invite such members of management to its meetings as it deems appropriate, consistent with the maintenance of the confidentiality of compensation discussions. The CEO should not attend any meeting where the CEO s performance or compensation is discussed, unless specifically invited by the Committee]. [NYSE 303A.04 (commentary recommends, but does not require, that charter address committee structure and operations)] Delegation to Subcommittee The Committee may, in its discretion, delegate all or a portion of its duties and responsibilities to a subcommittee of the Committee. In particular, the Committee may delegate the approval of certain transactions to a subcommittee consisting solely of members of the Committee who are (i) Non-Employee Directors for the purposes of Rule 16b-3 under the Securities Exchange Act of 1934, as in effect from time to time, and (ii) outside directors for the purposes of Section 162(m) of the Internal Revenue Code, as in effect from time to time. [NYSE 303A.05 (commentary recommends, but does not require, that charter address delegation to subcommittees)] Performance Evaluation The Committee shall prepare and review with the Board an annual performance evaluation of the Committee, which evaluation shall compare the performance of the Committee with the requirements of this charter. The performance evaluation shall also recommend to the Board any improvements to the Committee s charter deemed necessary or desirable by the Committee. The performance evaluation by the Committee shall be conducted in such manner as the Committee deems appropriate. The report to the Board may take the form of an oral report by the chairperson of the Committee or any other member of the Committee designated by the Committee to make this report. [NYSE 303A.05(b)(ii)] (Public Co., Rel. #2, 11/10) 5 19

20 5:3 PUBLIC COMPANY DESKBOOK Resources and Authority of the Committee The Committee shall have the resources and authority appropriate to discharge its duties and responsibilities, including the authority to select, retain, terminate, and approve the fees and other retention terms of special counsel or other experts or consultants, as it deems appropriate, without seeking approval of the Board or management. With respect to compensation consultants retained to assist in the evaluation of director, CEO or senior executive compensation, this authority shall be vested solely in the Committee. [NYSE 303A.05 (commentary recommends, but does not require, that charter give the committee such authority)] 5:3 Nasdaq Rules Relating to Executive Compensation 5:3.1 Overview In 2003, as part of its adoption of enhanced corporate governance listing standards, 9 Nasdaq adopted rules requiring oversight by independent directors of executive officer compensation. See section 3:1.2 for a discussion of the background and adoption of the enhanced stock exchange listing standards in :3.2 Text of Rule 5605(d) (Including Interpretations) [The Nasdaq rules were issued with an accompanying official interpretation that should be considered part of the rules. In April 2009, new Nasdaq rules became effective that reorganized the rules relating to the qualification, listing, and delisting of companies, but no substantive changes were made to the rules. 10 ] Rule Board of Directors and Committees * * * * (d) Independent Director Oversight of Executive Officer Compensation 9. See Rel. No , supra note See Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Notice of Filing and Immediate Effectiveness of Proposed Rule Change Relating to Revisions and Restructuring of the NASDAQ Listing Rules, Rel. No (Mar. 31, 2009), 74 Fed. Reg. 15,552 (Apr. 6, 2009), available at

21 Compensation Committee 5:3.2 (1) Compensation of the chief executive officer of the Company must be determined, or recommended to the Board for determination, either by: (A) Independent Directors constituting a majority of the Board s Independent Directors in a vote in which only Independent Directors participate; or (B) a compensation committee comprised solely of Independent Directors. The chief executive officer may not be present during voting or deliberations. (2) Compensation of all other Executive Officers must be determined, or recommended to the Board for determination, either by: (A) Independent Directors constituting a majority of the Board s Independent Directors in a vote in which only Independent Directors participate; or (B) a compensation committee comprised solely of Independent Directors. (3) Non-Independent Committee Member under Exceptional and Limited Circumstances Notwithstanding paragraphs 5605(d)(1)(B) and 5605(d)(2)(B) above, if the compensation committee is comprised of at least three members, one director who is not independent as defined in Rule 5605(a)(2) 11 and is not a current officer or employee or a Family Member of an officer or employee, may be appointed to the compensation committee if the board, under exceptional and limited circumstances, determines that such individual s membership on the committee is required by the best interests of the Company and its shareholders, and the board discloses, in the proxy statement for the next annual meeting subsequent to such determination (or, if the Company does not file a proxy, in its Form 10-K or 20-F), the nature of the relationship and the reasons for the determination. A mem- 11. The Nasdaq definition of Independent Director is set forth in section 3:1.4[A] and discussed in section 3:1.4[G]. (Public Co., Rel. #2, 11/10) 5 21

22 5:3.3 PUBLIC COMPANY DESKBOOK ber appointed under this exception may not serve longer than two years. IM Independent Director Oversight of Executive Compensation Independent director oversight of executive officer compensation helps assure that appropriate incentives are in place, consistent with the board s responsibility to maximize shareholder value. The rule is intended to provide flexibility for a Company to choose an appropriate board structure and to reduce resource burdens, while ensuring Independent Director control of compensation decisions. 5:3.3 Discussion of the Rule See section 3:1.4[B] for a discussion of the timing of effectiveness of the Nasdaq requirements relating to executive compensation, including phase-in periods for IPO companies and other newly listed companies. See sections 3:1.4[C] and [D] for a discussion of the entities subject to the rule, including the availability of an exemption for non-u.s. issuers. The Nasdaq independence rules require that the compensation of the CEO and officers 12 of each listed company (other than controlled companies) 13 be determined, or recommended to the board for determination, by either (i) a majority of the independent directors, or (ii) a compensation committee composed solely of independent directors (subject to the exception described in the next paragraph). The CEO may not be present during voting or deliberations concerning the determination of the CEO s compensation. The rules provide that if the compensation committee is composed of at least three members, then one non-independent director can be appointed to the committee if the director is not a current officer or employee of the company or a family member thereof, 14 and the board of directors, under exceptional and limited circumstances, 12. Officer is defined by reference to Rule 16a-1 under the Exchange Act as an issuer s president, principal financial officer, principal accounting officer (or, if there is no such accounting officer, the controller), any vice-president of the issuer in charge of a principal business unit, division or function (such as sales, administration or finance), any other officer who performs a policy-making function, or any other person who performs similar policy-making functions for the issuer. 13. See section 3:1.4[E] for a definition of this term and a description of the disclosure required if this exception is used. 14. See chapter 3, note 65 for Nasdaq s definition of family member. 5 22

23 Compensation Committee 5:3.4 determines that the individual s membership on the committee is required by the best interests of the company and its shareholders. A member appointed under this exception may not serve longer than two years. If this exception is used, the board of directors must disclose the nature of the relationship and the reasons for the determination in the next annual meeting proxy statement after the determination. Unlike the NYSE rule, the Nasdaq rule does not specifically state that delegation to a subcommittee is permitted. The wording of the requirement would, however, permit delegation, since a subcommittee of an independent compensation committee would necessarily be a committee composed of independent directors. In particular, the rule would seem to permit a standing independent compensation committee to delegate responsibilities to a subcommittee composed of directors satisfying the standards of Rule 16b-3 under the Exchange Act and/or section 162(m) of the Internal Revenue Code. 15 5:3.4 Sample Compensation Committee Charter for Nasdaq-Listed U.S. Companies The following is an annotated sample form of compensation committee charter that Nasdaq-listed U.S. companies can use as a starting point to create or modify their own. The annotations indicate the Nasdaq rule or other legal requirement upon which the relevant provision is based. The underlying form of compensation committee charter is for illustrative purposes only and should be tailored to fit the particular circumstances of each company. Committee Membership Except as [provided below,] [permitted by Nasdaq Rule 5605(d),] the Compensation Committee (the Committee ) of the Board of Directors (the Board ) of [Name of Corporation] (the Company ) shall consist solely of independent directors, i.e., those directors who neither are officers or employees of the Company or its subsidiaries nor have a relationship which, in the opinion of the Board, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director, and who are otherwise independent under the rules of the Nasdaq Stock Market, Inc. [Nasdaq 5605(d)(1)] 15. See section 5:5 for a discussion of Rule 16b-3 and 162(m) and the reasons delegation may be necessary. See the section entitled Delegation to Subcommittee in the Sample Compensation Committee Charter contained in section 5:3.4 for suggested language specifically permitting this delegation. (Public Co., Rel. #2, 11/10) 5 23

24 5:3.4 PUBLIC COMPANY DESKBOOK Members shall be appointed by the Board [based on nominations by the Company s [Corporate Governance and] Nominations Committee] [Nasdaq 5605(e)(1)]. Members shall serve at the pleasure of the Board and for such term or terms as the Board may determine. [Discuss qualifications for committee members.] [If the Committee is comprised of at least three members, one director who is not independent and is not a current officer or employee, or a spouse, parent, child or sibling, whether by blood, marriage or adoption, of, or a person who has the same residence as, any current officer or employee, may be appointed to the Committee if the Board, under exceptional and limited circumstances, determines that such individual s membership on the Committee is required by the best interests of the Company and its stockholders, and the Board discloses, in the next annual meeting proxy statement [(or [Form 10-K] [Form 20-F] if no proxy statement is filed)] subsequent to such determination, the nature of the relationship between the director and the company, and the reasons for the determination. Any such member appointed to the Committee may only serve for up to two years. [Nasdaq 4350(d)(3)]] [May be included if applicable.] Committee Purpose and Responsibilities The Committee shall have the purpose and direct responsibility to: 1. Review and approve corporate goals and objectives relevant to the compensation of the Company s Chief Executive Officer ( CEO ), evaluate the CEO s performance in light of those goals and objectives, and either as a committee or together with the other independent directors (as directed by the Board), determine, or recommend to the Board for determination, the CEO s compensation level based on this evaluation [Nasdaq 5605(d)(1)]. In determining or recommending the long-term incentive component of CEO compensation, the Committee shall consider, among other factors, the Company s performance and relative shareholder return, the value of similar incentive awards to CEOs at comparable companies, the awards given to the CEO in past years, and [list other factors, if any]. 2. Either as a committee or together with the other independent directors (as directed by the Board), determine, or recommend to the Board for determination, the compensation of all other executive officers of the Company. [Nasdaq 5605(d)(2)] 5 24

25 Compensation Committee 5: [Make recommendations to] [Discharge the responsibilities of] the Board with respect to the Company s incentive compensation plans and equity-based plans[, including [list specific plans currently in existence], oversee the activities of the individuals and committees responsible for administering these plans, including [list specific committees to be overseen], and discharge any responsibilities imposed on the Committee by any of these plans]. 4. [Approve issuances under, or any material amendment of, any tax qualified, non-discriminatory employee benefit plan or parallel nonqualified plan pursuant to which a director, officer, employee or consultant will acquire stock or options.] [Nasdaq 5635(c)(3)] 5. [Approve issuances under, or any material amendment of, any stock option or other similar plan pursuant to which a person not previously an employee or director of the Company, as an inducement material to the individual s entering into employment with the Company, will acquire stock or options.] [Nasdaq 5635(c)(4)] 6. In consultation with management, oversee regulatory compliance with respect to compensation matters, including overseeing the Company s policies on structuring compensation programs to preserve tax deductibility, and, as and when required, establishing performance goals and certifying that performance goals have been attained for purposes of Section 162(m) of the Internal Revenue Code. 7. To review and approve any severance or similar termination payments proposed to be made to any current or former executive officer of the Company. 8. Prepare an annual Compensation Committee Report for inclusion in the Company s annual proxy statement in accordance with applicable SEC rules and regulations. [NYSE 5(b)(i)(C) and Item 407(e)(5) (Compensation Committee Report) of Regulation S-K] 9. [Prepare and issue the evaluation required under Performance Evaluation below.] 10. [Report to the Board on a regular basis, and not less than once per year.] (Public Co., Rel. #2, 11/10) 5 25