[Federal Register Volume 77, Number 124 (Wednesday, June 27, 2012)]
[Rules and Regulations]
[Pages 38422-38455]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-15408]
[[Page 38421]]
Vol. 77
Wednesday,
No. 124
June 27, 2012
Part III
Securities and Exchange Commission
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17 CFR Parts 229 and 240
Listing Standards for Compensation Committees; Final Rule
Federal Register / Vol. 77 , No. 124 / Wednesday, June 27, 2012 /
Rules and Regulations
[[Page 38422]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 229 and 240
[Release Nos. 33-9330; 34-67220; File No. S7-13-11]
RIN 3235-AK95
Listing Standards for Compensation Committees
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: We are adopting a new rule and amendments to our proxy
disclosure rules to implement Section 952 of the Dodd-Frank Wall Street
Reform and Consumer Protection Act of 2010, which added Section 10C to
the Securities Exchange Act of 1934. Section 10C requires the
Commission to adopt rules directing the national securities exchanges
and national securities associations to prohibit the listing of any
equity security of an issuer that is not in compliance with Section
10C's compensation committee and compensation adviser requirements. In
accordance with the statute, new Rule 10C-1 directs the national
securities exchanges to establish listing standards that, among other
things, require each member of a listed issuer's compensation committee
to be a member of the board of directors and to be ``independent,'' as
defined in the listing standards of the national securities exchanges
adopted in accordance with the final rule. In addition, pursuant to
Section 10C(c)(2), we are adopting amendments to our proxy disclosure
rules concerning issuers' use of compensation consultants and related
conflicts of interest.
DATES: Effective Date: July 27, 2012.
Compliance Dates: Each national securities exchange and national
securities association must provide to the Commission, no later than
September 25, 2012, proposed rule change submissions that comply with
the requirements of Exchange Act Rule 10C-1. Further, each national
securities exchange and national securities association must have final
rules or rule amendments that comply with Rule 10C-1 approved by the
Commission no later than June 27, 2012. Issuers must comply with the
disclosure changes in Item 407 of Regulation S-K in any proxy or
information statement for an annual meeting of shareholders (or a
special meeting in lieu of the annual meeting) at which directors will
be elected occurring on or after January 1, 2013.
FOR FURTHER INFORMATION CONTACT: N. Sean Harrison, Special Counsel,
Office of Rulemaking, at (202) 551-3430, or Heather Maples, Senior
Special Counsel, Office of Chief Counsel, at (202) 551-3520, in the
Division of Corporation Finance, U.S. Securities and Exchange
Commission, 100 F Street NE., Washington, DC 20549-3628.
SUPPLEMENTARY INFORMATION: We are adopting new Rule 10C-1 under the
Securities Exchange Act of 1934 \1\ and amendments to Item 407 \2\ of
Regulation S-K.\3\
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\1\ 15 U.S.C. 78a et seq.
\2\ 17 CFR 229.407.
\3\ 17 CFR 229.10 through 229.1208.
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Table of Contents
I. Background and Summary
II. Discussion of the Final Rules
A. Exchange Listing Standards
1. Applicability of Listing Standards
a. Proposed Rule
b. Comments on the Proposed Rule
c. Final Rule
2. Independence Requirements
a. Proposed Rule
b. Comments on the Proposed Rule
c. Final Rule
3. Authority To Retain Compensation Advisers; Responsibilities;
and Funding
a. Proposed Rule
b. Comments on the Proposed Rule
c. Final Rule
4. Compensation Adviser Independence Factors
a. Proposed Rule
b. Comments on the Proposed Rule
c. Final Rule
5. Opportunity To Cure Defects
a. Proposed Rule
b. Comments on the Proposed Rule
c. Final Rule
B. Implementation of Listing Requirements
1. Exchanges and Securities Affected
a. Proposed Rule
b. Comments on the Proposed Rule
c. Final Rule
2. Exemptions
a. Proposed Rule
i. Issuers Not Subject to Compensation Committee Independence
Requirements
ii. Exemption of Relationships and Other Categories of Issuers
b. Comments on the Proposed Rule
c. Final Rule
C. Compensation Consultant Disclosure and Conflicts of Interest
1. Proposed Rule
2. Comments on the Proposed Rule
3. Final Rule
a. Disclosure Requirements
b. Disclosure Exemptions
c. Disclosure Regarding Director Compensation
D. Transition and Timing
III. Paperwork Reduction Act
A. Background
B. Summary of the Final Rules
C. Summary of Comment Letters and Revisions to Proposals
D. Revisions to PRA Reporting and Cost Burden Estimates
IV. Economic Analysis
A. Background and Summary of the Rule Amendments
B. Benefits and Costs, and Impact on Efficiency, Competition and
Capital Formation
1. Section 10C of the Exchange Act, as Added by Section 952 of
the Act
2. Discretionary Amendments
V. Final Regulatory Flexibility Act Analysis
A. Need for the Amendments
B. Significant Issues Raised by Public Comments
C. Small Entities Subject to the Final Rules
D. Reporting, Recordkeeping and Other Compliance Requirements
E. Agency Action To Minimize Effect on Small Entities
VI. Statutory Authority and Text of the Amendments
I. Background And Summary
On March 30, 2011, we proposed a new rule and rule amendments \4\
to implement Section 10C of the Securities Exchange Act of 1934 (the
``Exchange Act''),\5\ as added by Section 952 of the Dodd-Frank Wall
Street Reform and Consumer Protection Act of 2010 (the ``Act'').\6\
Section 10C requires the Commission to direct the national securities
exchanges \7\ (the ``exchanges'') and national securities associations
\8\ to prohibit the listing of any equity
[[Page 38423]]
security of an issuer, with certain exceptions, that does not comply
with Section 10C's compensation committee and compensation adviser
requirements.\9\
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\4\ See Release No. 33-9199 (Mar. 30, 2011) [76 FR 18966] (the
``Proposing Release'').
\5\ 15 U.S.C. 78j-3.
\6\ Public Law 111-203, 124 Stat. 1900 (2010).
\7\ A ``national securities exchange'' is an exchange registered
as such under Section 6 of the Exchange Act [15 U.S.C. 78f]. There
are currently sixteen national securities exchanges registered under
Section 6(a) of the Exchange Act: NYSE Amex (formerly the American
Stock Exchange), BATS Exchange, BATS Y-Exchange, BOX Options
Exchange, C2 Options Exchange, Chicago Board Options Exchange,
Chicago Stock Exchange, EDGA Exchange, EDGX Exchange, International
Securities Exchange, NASDAQ OMX BX (formerly the Boston Stock
Exchange), The NASDAQ Stock Market, National Stock Exchange, New
York Stock Exchange, NYSE Arca and NASDAQ OMX PHLX (formerly
Philadelphia Stock Exchange). Certain exchanges are registered with
the Commission through a notice filing under Section 6(g) of the
Exchange Act for the purpose of trading security futures. See
Section II.B.1, below, for a discussion of these types of exchanges.
\8\ A ``national securities association'' is an association of
brokers and dealers registered as such under Section 15A of the
Exchange Act [15 U.S.C. 78o-3]. The Financial Industry Regulatory
Authority (``FINRA'') is the only national securities association
registered with the Commission under Section 15A of the Exchange
Act. FINRA does not list equity securities; therefore, we refer only
to national securities exchanges in this release. In addition,
Section 15A(k) of the Exchange Act [15 U.S.C. 78o-3(k)] provides
that a futures association registered under Section 17 of the
Commodity Exchange Act [7 U.S.C. 21] shall be registered as a
national securities association for the limited purpose of
regulating the activities of members who are registered as broker-
dealers in security futures products pursuant to Section 15(b)(11)
of the Exchange Act [15 U.S.C. 78o(b)(11)]. See Section II.B.1,
below, for a discussion regarding security futures products.
\9\ See Exchange Act Sections 10C(a) and (f).
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Specifically, Section 10C(a)(1) of the Exchange Act requires the
Commission to adopt rules directing the exchanges to establish listing
standards that require each member of a listed issuer's compensation
committee to be a member of the board of directors and to be
``independent.'' \10\ The term ``independent'' is not defined in
Section 10C. Instead, Section 10C(a)(3) provides that ``independence''
is to be defined by the exchanges after taking into consideration
``relevant factors,'' which are required to include (1) a director's
source of compensation, including any consulting, advisory or other
compensatory fee paid by the issuer to such director, and (2) whether a
director is affiliated with the issuer, a subsidiary of the issuer, or
an affiliate of a subsidiary of the issuer. Section 10C(a)(4) of the
Exchange Act requires our rules to permit the exchanges to exempt
particular relationships from the independence requirements, as each
exchange determines is appropriate, taking into consideration the size
of an issuer and any other relevant factors.
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\10\ Five categories of issuers are excluded from this
requirement: controlled companies, limited partnerships, companies
in bankruptcy proceedings, open-end management investment companies
registered under the Investment Company Act of 1940 (the
``Investment Company Act''), and foreign private issuers that
disclose in their annual reports the reasons why they do not have an
independent compensation committee.
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In addition to the independence requirements set forth in Section
10C(a), Section 10C(f) of the Exchange Act requires the Commission to
adopt rules directing the exchanges to establish listing standards that
provide for the following requirements relating to compensation
committees and compensation consultants, independent legal counsel and
other advisers (collectively, ``compensation advisers''), as set forth
in paragraphs (b)-(e) of Section 10C:
Each compensation committee must have the authority, in
its sole discretion, to retain or obtain the advice of compensation
advisers; \11\
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\11\ Exchange Act Sections 10C(c)(1)(A) and 10C(d)(1).
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Before selecting any compensation adviser, the
compensation committee must take into consideration specific factors
identified by the Commission that affect the independence of
compensation advisers; \12\
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\12\ Exchange Act Section 10C(b).
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The compensation committee must be directly responsible
for the appointment, compensation and oversight of the work of
compensation advisers; \13\ and
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\13\ Exchange Act Sections 10C(c)(1)(B) and 10C(d)(2).
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Each listed issuer must provide appropriate funding for
the payment of reasonable compensation, as determined by the
compensation committee, to compensation advisers.\14\
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\14\ Exchange Act Section 10C(e).
Finally, Section 10C(c)(2) requires each issuer to disclose in any
proxy or consent solicitation material for an annual meeting of
shareholders (or a special meeting in lieu of the annual meeting), in
accordance with Commission regulations, whether the issuer's
compensation committee retained or obtained the advice of a
compensation consultant; whether 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.
We proposed new Exchange Act Rule 10C-1 to implement the
compensation committee listing requirements of Sections 10C(a)-(g) \15\
of the Exchange Act. We proposed rule amendments to Item 407 of
Regulation S-K to require the disclosures mandated by Section
10C(c)(2), which are to be provided in any proxy or information
statement relating to an annual meeting of shareholders at which
directors are to be elected (or special meeting in lieu of the annual
meeting). In connection with these amendments, we also proposed to
revise the current disclosure requirements with respect to the
retention of compensation consultants.
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\15\ Section 10C(g) of the Exchange Act exempts controlled
companies from the requirements of Section 10C.
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The comment period for the Proposing Release closed on May 19,
2011.\16\ We received 58 comment letters from 56 different
commentators, including pension funds, corporations, compensation
consulting firms, professional associations, trade unions,
institutional investors, investment advisory firms, law firms,
academics, individual investors and other interested parties.
Commentators generally supported the proposed implementation of the new
requirements. Some commentators urged us to adopt additional
requirements not mandated by the Act. Other commentators opposed some
aspects of the proposed rule and rule amendments and suggested
modifications to the proposals.
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\16\ We extended the original comment period deadline from April
29, 2011 to May 19, 2011. See Listing Standards for Compensation
Committees, Release No. 33-9203 (Apr. 29, 2011) [76 FR 25273].
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We have reviewed and considered all of the comments that we
received on the proposals. The final rules reflect a number of changes
made in response to these comments. We discuss our revisions with
respect to the proposed rule and rule amendments in more detail
throughout this release.
II. Discussion of the Final Rules
A. Exchange Listing Standards
1. Applicability of Listing Standards
We proposed to direct the exchanges to adopt listing standards that
would apply Section 10C's independence requirements to members of a
listed issuer's compensation committee as well as any committee of the
board that performs functions typically performed by a compensation
committee. We are adopting this aspect of the rule substantially as
proposed, but with one change reflecting comments we received.
a. Proposed Rule
In enacting Section 10C of the Exchange Act, Congress intended to
require that ``board committees that set compensation policy will
consist only of directors who are independent.'' \17\ In addition,
Congress sought to provide ``shareholders in a public company'' with
``additional disclosures involving compensation practices.'' \18\
Although Section 10C includes numerous provisions applicable to the
``compensation committees'' of listed issuers, it does not require a
listed issuer to have a compensation committee or a committee that
performs functions typically assigned to a compensation committee.
Moreover, Section 10C does not provide that, in the absence of a
compensation committee, the entire board of directors will be
considered to be the compensation committee, nor does it include
provisions that have the effect of requiring a compensation committee
as a practical matter.
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\17\ See H.R. Rep. No. 111-517, Joint Explanatory Statement of
the Committee of Conference, Title IX, Subtitle E ``Accountability
and Executive Compensation,'' at 872-873 (Conf. Rep.) (June 29,
2010).
\18\ Id.
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Neither the Act nor the Exchange Act defines the term
``compensation committee.'' \19\ Our rules do not
[[Page 38424]]
currently require that a listed issuer establish a compensation
committee. Current exchange listing standards, however, generally
require listed issuers either to have a compensation committee or to
have independent directors determine, recommend or oversee specified
executive compensation matters.\20\ For example, the New York Stock
Exchange (``NYSE'') requires a listed issuer to have a compensation
committee composed solely of independent directors and to assign
various executive compensation-related tasks to that committee.\21\ On
the other hand, the NASDAQ Stock Market (``Nasdaq'') does not mandate
that a listed issuer have a compensation committee, but requires that
executive compensation be determined or recommended to the board for
determination either by a compensation committee composed solely of
independent directors or by a majority of the board's independent
directors in a vote in which only independent directors
participate.\22\ Some of the other exchanges have standards comparable
to the NYSE's and require their listed issuers to have independent
compensation committees.\23\ Other exchanges have standards comparable
to Nasdaq's and, in the absence of a compensation committee, require
executive compensation determinations to be made or recommended by a
majority of independent directors on the listed issuer's board.\24\
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\19\ By contrast, Section 3(a)(58) of the Exchange Act defines
an ``audit committee'' as ``a committee (or equivalent body)
established by and amongst the board of directors of an issuer for
the purpose of overseeing the accounting and financial reporting
processes of the issuer and audits of the financial statements of
the issuer; and * * * if no such committee exists with respect to an
issuer, the entire board of directors of the issuer.''
\20\ There are some exchanges registered under Section 6(a) of
the Exchange Act that have not adopted listing standards that
require executive compensation determinations for listed issuers to
be made or recommended by an independent compensation committee or
independent directors. However, these exchanges, which include the
BOX Options Exchange, International Securities Exchange, EDGA
Exchange, EDGX Exchange, BATS Y-Exchange, and C2 Options Exchange,
currently either trade securities only pursuant to unlisted trading
privileges or trade only standardized options. In addition, the
listing standards of certain exchanges that are registered with the
Commission for the purpose of trading security futures do not
address executive compensation matters. See Section II.B.1, below,
for a discussion of these types of exchanges.
\21\ See NYSE Listed Company Manual Section 303A.05. Section
303A.05 permits a listed issuer's board to allocate the
responsibilities of the compensation committee to another committee,
provided that the committee is composed entirely of independent
directors and has a committee charter. The NYSE exempts certain
issuers from this requirement, including controlled companies,
limited partnerships, companies in bankruptcy, and closed-end and
open-end management investment companies registered under the
Investment Company Act. See NYSE Listed Company Manual Section
303A.00.
\22\ See Nasdaq Rule 5605(d). Based on data supplied by Nasdaq,
we understand that fewer than 2% of its listed issuers utilize the
alternative of having independent board members, and not a
committee, oversee compensation. See also Nasdaq IM 5605-6 (stating
that the Nasdaq rule ``is intended to provide flexibility for a
[c]ompany to choose an appropriate board structure and to reduce
resource burdens, while ensuring [i]ndependent [d]irector control of
compensation decisions.''). Nasdaq exempts certain issuers from this
requirement, including asset-backed issuers and other passive
issuers, cooperatives, limited partnerships, management investment
companies registered under the Investment Company Act, and
controlled companies. See Nasdaq Rules 5615(a) and 5615(c)(2).
\23\ See NYSE Arca Rule 5.3(k)(4); National Stock Exchange Rule
15.5(d)(5); and NASDAQ OMX PHLX Rule 867.05.
\24\ See NASDAQ OMX BX Rule 4350(c)(3); NYSE Amex Company Guide
Section 805; Chicago Board Options Exchange Rule 31.10; Chicago
Stock Exchange Article 22, Rules 19(d) and 21; and BATS Exchange
Rule 14.10(c)(4).
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Proposed Rule 10C-1(b) would direct the exchanges to adopt listing
standards that would apply to a listed issuer's compensation committee
or, in the absence of such a committee, any other board committee that
performs functions typically performed by a compensation committee,
including oversight of executive compensation. Proposed Rule 10C-1(b),
however, would not require the independence listing requirements to
apply to members of the board who oversee executive compensation in the
absence of a board committee.\25\
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\25\ As noted, to the extent no board committee is authorized to
oversee executive compensation, under applicable listing standards,
board determinations with respect to executive compensation matters
may be made by the full board with only independent directors
participating. In such situations, under state corporate law, we
understand that action by the independent directors would generally
be considered action by the full board, not action by a committee.
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b. Comments on the Proposed Rule
Comments on this proposal were generally favorable. Many
commentators supported the functional approach of the proposed rule,
which would require compensation committee independence listing
standards to apply to any board committee charged with oversight of
executive compensation, regardless of its formal title.\26\ In response
to our request for comment on whether we should direct the exchanges to
apply the proposed rule's requirements to directors who oversee
executive compensation matters in the absence of a formal committee
structure, several commentators recommended that we do so,\27\ and two
of these commentators suggested that such a requirement would help
ensure that companies could not rely on technicalities or loopholes to
avoid independent director oversight of executive compensation.\28\
Another commentator, however, argued that the final rule should not
apply to independent directors who determine, or recommend to the
board, executive compensation matters in the absence of a formal
committee structure.\29\ This commentator believed that broadening the
scope of the rule to apply to a group of directors who determine
executive compensation in lieu of a formal committee is not clearly
mandated by Section 10C and would burden listed issuers that do not
have a board committee overseeing executive compensation, without
necessarily improving their oversight of executive compensation.\30\
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\26\ See, e.g., letters from Chris Barnard (``Barnard''), the
Chartered Financial Analyst Institute (``CFA'') and Railpen
Investments (``Railpen'').
\27\ See, e.g., letters from Barnard, Better Markets Inc.
(``Better Markets''), CFA, Georg Merkl (``Merkl''), National
Association of Corporate Directors (``NACD'') and Railpen.
\28\ See letters from NACD and Railpen.
\29\ See letter from the American Bar Association, Business Law
Section (``ABA'').
\30\ This commentator also noted that, ``[a]s a practical
matter, we understand that most listed companies that are
accelerated filers under the Exchange Act, and many listed companies
that are smaller reporting companies, already have compensation
committees or committees performing the functions of compensation
committees.'' Id.
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In the Proposing Release, we requested comment on whether the
exchanges should be prohibited from listing issuers that do not have
compensation committees. Several commentators supported the concept of
mandatory compensation committees for listed issuers, on the basis that
executive compensation deserves special, ongoing attention by a
dedicated working group of the board; a committee structure may promote
increased board expertise on compensation; and having a formal
committee would help promote accountability to shareholders.\31\
Several other commentators opposed such requirements, arguing that the
exchanges should be allowed broad discretion on how listed issuers
determine compensation matters.\32\
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\31\ See letters from the American Federation of Labor and
Congress of Industrial Organizations (``AFL-CIO''), the Council of
Institutional Investors (``CII''), Merkl and the Ohio Public
Employees' Retirement System (``OPERS'').
\32\ See letters from ABA, CFA and NACD.
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c. Final Rule
After considering the comments, we are adopting Rule 10C-1(b)
substantially as proposed. Under the final rule, the exchanges will be
directed to adopt listing standards that apply to any committee of the
board that performs functions typically performed by a compensation
committee, including oversight of executive compensation, whether or
not such committee also
[[Page 38425]]
performs other functions or is formally designated as a compensation
committee.\33\ In addition, the listing standards adopted by the
exchanges must also apply the director independence requirements of
Rule 10C-1(b)(1), the requirements relating to consideration of a
compensation adviser's independence in Rule 10C-1(b)(4), and the
requirements relating to responsibility for the appointment,
compensation and oversight of compensation advisers in Rules 10C-
1(b)(2)(ii) and (iii) to the members of a listed issuer's board of
directors who, in the absence of a board committee, oversee executive
compensation matters on behalf of the board of directors. We believe
this approach is an appropriate way to implement Section 10C. The
listing standards are intended to benefit investors by requiring that
the independent directors of a listed issuer oversee executive
compensation matters, consider independence criteria before retaining
compensation advisers and have responsibility for the appointment,
compensation and oversight of these advisers. We believe it would
benefit investors to implement Section 10C in a manner that does not
allow listed issuers to avoid these listing standards by simply not
having a compensation committee or another board committee oversee
executive compensation matters.
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\33\ For example, if a listed issuer has a ``corporate
governance committee'' or a ``human resources committee,'' the
responsibilities of which include, among other matters, oversight of
executive compensation, such committee will be subject to the
compensation committee listing requirements of the applicable
exchange.
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We have determined not to require the exchanges to apply the
listing standards relating to the compensation committee's authority to
retain compensation advisers, Rule 10C-1(b)(2)(i), or required funding
for payment of such advisers to directors who oversee executive
compensation matters outside of the structure of a formal board
committee, Rule 10C-1(b)(3). As noted above, we understand that action
by independent directors acting outside of a formal committee structure
would generally be considered action by the full board of directors. As
a result, we believe it is unnecessary to apply these requirements to
directors acting outside of a formal committee structure, as they
retain all the powers of the board of directors in making executive
compensation determinations.
We are implementing this change by defining the term ``compensation
committee'' so that it includes, for all purposes other than the
requirements relating to the authority to retain compensation advisers
in Rule 10C-1(b)(2)(i) and required funding for payment of such
advisers in Rule 10C-1(b)(3), the members of the board of directors who
oversee executive compensation matters on behalf of the board of
directors in the absence of a formal committee. For ease of reference
throughout this release, in our discussion of the final rules we are
adopting, references to an issuer's ``compensation committee'' include
any committee of the board that performs functions typically performed
by a compensation committee, including oversight of executive
compensation, whether or not formally designated as a ``compensation
committee,'' as well as, to the extent applicable, those members of a
listed issuer's board of directors who oversee executive compensation
matters on behalf of the board of directors in the absence of such a
committee.
The final rule will not require a listed issuer to have a
compensation committee or a committee that performs functions typically
assigned to a compensation committee. We believe this aspect of the
final rule is consistent with the requirements of Section 10C, which
does not direct us to require such a committee. Moreover, in light of
our determination to apply the requirements for director independence,
consideration of adviser independence, and responsibility for the
appointment, compensation and oversight of compensation advisers to
those members of a listed issuer's board of directors who oversee
executive compensation matters on behalf of the board of directors in
the absence of a formal committee, there will be little difference
between the requirements applicable to listed issuers that do not have
compensation committees as compared to those applicable to issuers that
do have compensation committees.
2. Independence Requirements
Proposed Rule 10C-1(b)(1) would require each member of a listed
issuer's compensation committee to be a member of the board of
directors and to be independent. We proposed to require that the
exchanges develop a definition of independence applicable to
compensation committee members after considering relevant factors,
including, but not limited to, the two factors enumerated in Section
10C(a)(3). We are adopting these requirements as proposed, except that,
as discussed above, this aspect of the final rule will also apply to
those members of a listed issuer's board of directors who oversee
executive compensation matters on behalf of the board of directors in
the absence of a board committee.
a. Proposed Rule
Most exchanges that list equity securities already require
directors on compensation committees or directors determining or
recommending executive compensation matters to be ``independent'' under
their general independence standards. Although independence
requirements and standards vary somewhat among the different exchanges,
listing standards generally prescribe certain bright-line independence
tests (including restrictions on compensation, employment and familial
or other relationships with the listed issuer or the executive officers
of the listed issuer that could interfere with the exercise of
independent judgment) that directors must meet in order to be
considered independent.\34\ For example, both NYSE and Nasdaq rules
preclude a finding of independence if the director is or recently was
employed by the listed issuer, the director's immediate family member
is or recently was employed as an executive officer of the listed
issuer, or the director or director's family member received
compensation from the listed issuer in excess of specified limits.\35\
In addition, under both NYSE and Nasdaq rules, directors may be
disqualified based on their or their family members' relationships with
a listed issuer's auditor, affiliation with entities that have material
business relationships with the listed issuer, or employment at a
company whose compensation committee includes any of the listed
issuer's executive officers.\36\ We note, however, that with the
exception of audit committee membership requirements, stock ownership
alone will not automatically preclude a director from being considered
independent under either NYSE or Nasdaq listing standards.\37\ The NYSE
and Nasdaq also require their listed issuers' boards to affirmatively
determine that each independent director either, in NYSE's case, has no
material relationship with the issuer \38\ or, in Nasdaq's case, has no
relationship which, in the opinion of the issuer's board of directors,
would interfere with the director's exercise of independent judgment in
carrying out his or her
[[Page 38426]]
responsibilities.\39\ The other exchanges have similar
requirements.\40\
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\34\ See NYSE Listed Company Manual Section 303A.02(b); Nasdaq
Rule 5605(a)(2).
\35\ See id.
\36\ See id.
\37\ See Commentary to NYSE Listed Company Manual Section
303A.02(a); Nasdaq Rule 5605; Nasdaq IM-5605.
\38\ See NYSE Rule 303A.02(a).
\39\ See Nasdaq Rule 4200(a)(15).
\40\ See, e.g., NYSE Arca Rule 5.3(k)(1) and NYSE AMEX Company
Guide Section 803.A.02.
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In addition to meeting exchange listing standards, there are other
reasons for members of the compensation committee to be independent.
For example, in order for a securities transaction between an issuer
and one of its officers or directors to be exempt from short-swing
profit liability under Section 16(b) of the Exchange Act, the
transaction must be approved by the full board of directors or by a
committee of the board that is composed solely of two or more ``Non-
Employee Directors,'' as defined in Exchange Act Rule 16b-3(b)(3).\41\
We understand that many issuers use their independent compensation
committees to avail themselves of this exemption.\42\ Similarly, if an
issuer wishes to preserve the tax deductibility of the amounts of
certain awards paid to executive officers, among other things, the
performance goals of such awards must be determined by a compensation
committee composed of two or more ``outside directors,'' as defined in
Section 162(m) of the Internal Revenue Code.\43\ The definitions of
``Non-Employee Director'' and ``outside director'' are similar to the
exchanges' definitions of independent director.
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\41\ As defined in Exchange Act Rule 16b-3(b)(3)(i) [17 CFR
240.16b-3(b)(3)(i)], a ``Non-Employee Director'' is a director who
is not currently an officer (as defined in Rule 16a-1(f)) of the
issuer or a parent or subsidiary of the issuer, or otherwise
currently employed by the issuer or a parent or subsidiary of the
issuer; does not receive compensation, either directly or
indirectly, from the issuer or a parent or subsidiary of the issuer
for services rendered as a consultant or in any capacity other than
as a director, except for an amount that does not exceed the dollar
amount for which disclosure would be required pursuant to Item
404(a) of Regulation S-K; and does not possess an interest in any
other transaction for which disclosure would be required pursuant to
Item 404(a) of Regulation S-K. In addition, Rule 16b-3(b)(3)(ii)
provides that a Non-Employee Director of a closed-end investment
company is a director who is not an ``interested person'' of the
issuer, as that term is defined in Section 2(a)(19) of the
Investment Company Act [15 U.S.C. 80a-2(a)(19)].
\42\ See letter from Sullivan & Cromwell LLP to Facilitating
Shareholder Director Nominations, Release No. 34-60089, available at
http://www.sec.gov/comments/s7-10-09/s71009-430.pdf. (``In our
experience, many compensation committee charters require their
members to meet the requirements of Rule 16b-3 and Section
162(m).''); Ira G. Bogner & Michael Krasnovsky, ``Exchange Rules
Impact Compensation Committee Composition,'' The Metropolitan
Corporate Counsel, Apr. 2004, at 17 (``Most compensation committees
of public companies include at least two directors that are `outside
directors' under Section 162(m) of the Internal Revenue Code * * *
and `non-employee directors' under Rule 16b-3 of the Securities
Exchange Act * * *.'').
\43\ A director is an ``outside director'' if the director (A)
is not a current employee of the publicly held corporation; (B) is
not a former employee of the publicly held corporation who receives
compensation for prior services (other than benefits under a tax-
qualified retirement plan) during the taxable year; (C) has not been
an officer of the publicly held corporation; and (D) does not
receive remuneration from the publicly held corporation, either
directly or indirectly, in any capacity other than as a director.
For this purpose, remuneration includes any payment in exchange for
goods or services. Section 162(m) of the Internal Revenue Code of
1986, as amended. Treas. Reg. Section 1.162-27(e)(3).
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The proposed rule would direct the exchanges to develop a
definition of independence applicable to compensation committee members
after considering relevant factors, including, but not limited to, a
director's source of compensation, including any consulting, advisory
or other compensatory fee paid by the issuer to such director, and
whether a director is affiliated with the issuer, a subsidiary of the
issuer, or an affiliate of a subsidiary of the issuer. We did not
propose to specify any additional factors that the exchanges must
consider in determining independence requirements for members of
compensation committees.
In proposing Rule 10C-1(b)(1), we considered the similarities and
differences between Section 952 of the Act and Section 301 of the
Sarbanes-Oxley Act of 2002.\44\ Section 301 of the Sarbanes-Oxley Act
added Section 10A(m)(1) to the Exchange Act,\45\ which required the
Commission to direct the exchanges to prescribe independence
requirements for audit committee members. Although the independence
factors in Section 10C(a)(1) are similar to those in Section
10A(m)(1)--and indeed, Section 952 of the Act essentially provides the
compensation committee counterpart to the audit committee requirements
of Section 301 of the Sarbanes-Oxley Act--one significant difference is
that Section 10C(a) requires only that the exchanges ``consider
relevant factors'' (emphasis added), which include the source of
compensation and any affiliate relationship, in developing independence
standards for compensation committee members, whereas Section 10A(m)
expressly states that certain relationships preclude independence: An
audit committee member ``may not, other than in his or her capacity as
a member of the audit committee * * * [a]ccept any consulting,
advisory, or other compensatory fee from the issuer; or [b]e an
affiliated person of the issuer or any subsidiary thereof'' (emphasis
added).\46\
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\44\ Public Law 107-204, 116 Stat. 745 (2002).
\45\ 15 U.S.C. 78j-1(m)(1).
\46\ See Section 10A(m) of the Exchange Act. Exchange Act Rule
10A-3 states that in order to be considered ``independent,'' an
audit committee member ``may not, other than in his or her capacity
as a member of the audit committee, the board of directors, or any
other board committee * * * [a]ccept directly or indirectly any
consulting, advisory, or other compensatory fee from the issuer or
any subsidiary thereof * * *.'' For non-investment company issuers,
the audit committee member also cannot be an affiliated person of
the issuer or its subsidiaries. For investment company issuers, the
audit committee member cannot be an ``interested person'' of the
issuer as defined in Section 2(a)(19) of the Investment Company Act.
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As a result, we interpret Section 10C as providing the exchanges
more discretion to determine the standards of independence that
compensation committee members are required to meet than they are
provided under Section 10A with respect to audit committee members.
Section 10A(m) prescribes minimum criteria for the independence of
audit committee members. In contrast, Section 10C gives the exchanges
the flexibility to establish their own minimum independence criteria
for compensation committee members after considering relevant factors,
including the two enumerated in Section 10C(a)(3). Accordingly, the
proposed rule would allow each exchange to establish its own
independence definition, subject to Commission review and approval
pursuant to Section 19(b) of the Exchange Act, provided the exchange
considers relevant factors in establishing its own standards, including
those specified in Section 10C(a)(3).
b. Comments on the Proposed Rule
Comments on this proposal were generally favorable. Many
commentators supported permitting the exchanges to establish their own
independence criteria for compensation committee members, provided they
consider the statutorily-required factors.\47\ One commentator claimed
that this approach would utilize the relative strengths and experiences
of the exchanges by avoiding a ``one size fits all'' approach and could
be more conducive to responding quickly to changes in corporate
governance.\48\ Another commentator noted that the proposal permitted
each exchange to develop more finely tuned listing rules that
[[Page 38427]]
reflect the particular characteristics of each exchange's listed
companies.\49\
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\47\ See, e.g., letters from ABA, Barnard, Sanjai Bhagat, et al.
(``Bhagat''), the Center on Executive Compensation (``CEC''), CFA,
Davis Polk & Wardwell LLP (``Davis Polk''), MarkWest Energy
Partners, L.P. (``MarkWest''), NYSE Euronext (``NYSE''), Pfizer Inc.
(``Pfizer'') and Sullivan & Cromwell LLP (``S&C'').
\48\ See letter from MarkWest.
\49\ See letter from ABA (noting that ``the average board size
of an S&P 100 company (which are primarily listed on the NYSE) is
approximately 50% larger than the average board size of a Silicon
Valley 150 company (which are primarily listed on Nasdaq'' and that
``[i]nvestors in these disparate categories of companies have
meaningfully different expectations and interests in the governance
context'').
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Allowing the exchanges the latitude to establish their own
independence criteria concerned some commentators, however.\50\ These
commentators cautioned against permitting the exchanges to establish
their own independence criteria and argued in support of a uniform
definition of independence across all exchanges.\51\ One of these
commentators claimed that uniform requirements would serve as a
deterrent to engaging in a ``race to the bottom.'' \52\ Another
commentator recommended that the exchanges' independence criteria
should preclude a finding of independence if a director fails to meet
the definitions of an ``outside'' director under Section 162(m) of the
Internal Revenue Code or a ``non-employee'' director under Exchange Act
Rule 16b-3(b)(3); is a party to a related party transaction that must
be disclosed pursuant to Item 404 of Regulation S-K; or has an
immediate family member who is employed by the company.\53\
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\50\ See, e.g., letters from the American Federation of State,
County and Municipal Employees (``AFSCME''), California Public
Employees' Retirement System (``CalPERS''), the Colorado Public
Employees' Retirement Association (``COPERA''), OPERS and USS.
\51\ See letters from CalPERS, Railpen and USS.
\52\ See letter from USS.
\53\ See letter from AFL-CIO.
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Some commentators urged us to require the exchanges to consider
additional factors in developing a definition of independence.\54\
Several commentators advocated that we should require the exchanges to
include business or personal relationships between a compensation
committee member and executive officers of the issuer as factors for
consideration,\55\ as well as board interlocks.\56\ Another commentator
believed that mandatory factors for consideration should include
linkages between a director's family members and the company or its
affiliates and a director's relationships with other directors.\57\ One
commentator believed that, in setting independence standards for
compensation committee members, the exchanges should be required to
consider all factors relevant to assessing the independence of a board
member, including personal, family and business relationships, and all
other factors that might compromise a board member's judgment on
matters relating to executive compensation.\58\
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\54\ See, e.g., letters from AFSCME, Better Markets, CFA, CII,
the State Board of Administration of Florida (``FLSBA'') and UAW
Retiree Medical Benefits Trust (``UAW'').
\55\ See, e.g., letters from AFL-CIO, AFSCME, CFA, CII, FLSBA
and UAW.
\56\ See, e.g., letters from AFSCME, CII, FLSBA and UAW.
\57\ See letter from CII.
\58\ See letter from Better Markets.
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Three commentators, including the NYSE, stated that we should not
specify additional mandatory factors that the exchanges must consider
in developing a definition of independence applicable to compensation
committee members.\59\ In particular, the NYSE expressed concern that
if the final rule specifies additional mandatory factors for
consideration, such factors would be understood by the exchanges and by
many boards of directors as the Commission's determination that such
relationships compromise director independence, which would thereby
effectively preempt the review of compensation committee independence
standards that the exchanges would be required to undertake under the
rule.\60\
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\59\ See letters from ABA, NYSE and the Society of Corporate
Secretaries and Governance Professionals (``SCSGP'').
\60\ See letter from NYSE.
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In the Proposing Release, we noted the concern of several
commentators \61\ that our rules implementing Section 10C not prohibit
directors affiliated with significant investors (such as private equity
funds and venture capital firms) from serving on compensation
committees. We requested comment on whether a director affiliated with
a shareholder with a significant ownership interest who is otherwise
independent would be sufficiently independent for the purpose of
serving on the compensation committee. Many commentators advocated that
a significant shareholder's stock ownership alone should not preclude
directors affiliated with the significant shareholder from serving on
an issuer's compensation committee.\62\ A number of these commentators
noted that equity ownership by directors serves to align the directors'
interests with those of the shareholders with respect to compensation
matters.\63\ According to one commentator, private equity funds
typically have a strong institutional belief in the importance of
appropriately structured and reasonable compensation arrangements, and
the directors elected by such funds are highly incentivized to
rigorously oversee compensation arrangements because the funds' income,
success and reputations are dependent on creating value for
shareholders.\64\ This commentator also noted that, while private
equity funds may seek to create shareholder value by strengthening or
replacing the management team of a portfolio company, such funds rarely
appoint partners or employees of their affiliated private equity firms
to serve as executives of portfolio companies.\65\
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\61\ To facilitate public input on the Act, the Commission has
provided a series of email links, organized by topic, on its Web
site at http://www.sec.gov/spotlight/regreformcomments.shtml. The
public comments we received on Section 952 of the Act before we
issued the Proposing Release are available on our Web site at http://www.sec.gov/comments/df-title-ix/executive-compensation/executive-compensation.shtml. Several of those commentators suggested that
stock ownership alone should not automatically disqualify a board
member from serving as an independent director on the compensation
committee. See, e.g., letters from ABA, Brian Foley & Company, Inc.,
Compensia, Davis Polk and Frederic W. Cook & Co., Inc. (``Frederic
Cook'').
\62\ See, e.g., letters from ABA, AFSCME, Bhagat, CEC, Davis
Polk, Debevoise, Robert J. Jackson (``Jackson''), the Private Equity
Growth Capital Council (``PEGCC'') and SCSGP.
\63\ See, e.g., letters from CEC and Davis Polk.
\64\ See letter from PEGCC.
\65\ See id.
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One commentator did not believe that directors affiliated with
large shareholders should be permitted to serve on compensation
committees, noting that situations could arise where the director's
obligation to act in the best interest of all shareholders would
conflict with the director's or large shareholder's own interest.\66\
Two additional commentators noted that private equity and venture
capital firms may engage in significant transactions with an issuer,
and urged that all ties to the company be considered in evaluating the
independence of directors affiliated with significant shareowners.\67\
---------------------------------------------------------------------------
\66\ See letter from Barnard.
\67\ See letters from AFSCME and UAW.
---------------------------------------------------------------------------
Our proposed rule would require the exchanges to consider current
relationships between the issuer and the compensation committee member,
and we requested comment on whether relationships prior to a director's
appointment to the compensation committee or, for directors already
serving as compensation committee members when the new listing
standards take effect, prior to the effective date of the new listing
standards, should also be considered. Only two commentators expressed
support for establishing any such ``look-back'' period.\68\ One
commentator, although not supporting a look-back period, believed that
the decision of whether to require one should be determined not by the
Commission but
[[Page 38428]]
by the exchanges.\69\ Other commentators argued that a look-back period
was not necessary because the two largest exchanges (NYSE and Nasdaq)
currently impose look-back requirements on listed issuers in their
standards regarding director independence.\70\
---------------------------------------------------------------------------
\68\ See letters from Better Markets and CFA.
\69\ See letter from Davis Polk.
\70\ See letters from ABA and CEC.
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c. Final Rule
After consideration of the comments, we are adopting the
requirements as proposed, except that we are also extending them to
apply to those members of a listed issuer's board of directors who
oversee executive compensation matters on behalf of the board of
directors in the absence of a board committee. Under the final rule,
the exchanges will be directed to establish listing standards requiring
each member of a listed issuer's compensation committee to be a member
of the board of directors and to be independent. The final rule does
not require that exchanges establish a uniform definition of
independence. We believe this approach is consistent with the mandate
in Section 10C(a)(3). Further, given the wide variety of issuers that
are listed on exchanges, we believe that the exchanges should be
provided with flexibility to develop independence requirements
appropriate for the issuers listed on each exchange and consistent with
the requirements of Rule 10C-1(b)(1). Although this provides the
exchanges with flexibility to develop the appropriate independence
requirements, as discussed below, the independence requirements
developed by the exchanges will be subject to review and final
Commission approval pursuant to Section 19(b) of the Exchange Act.
In developing their own definitions of independence applicable to
compensation committee members, the exchanges will be required to
consider relevant factors, including, but not limited to:
A director's source of compensation, including any
consulting, advisory or compensatory fee paid by the issuer; and
Whether a director is affiliated with the issuer, a
subsidiary of the issuer, or an affiliate of a subsidiary of the
issuer.
The final rule does not specify any additional factors that the
exchanges must consider in determining independence requirements for
compensation committee members, nor does the final rule prescribe any
standards or relationships that will automatically preclude a finding
of independence. Because the rule's relevant factors cover the same
matters as the prohibitions in Section 10A(m)'s definition of audit
committee independence, we expect the exchanges to consider whether
those prohibitions should also apply to compensation committee members.
However, consistent with Section 10C, the exchanges are not required to
adopt those prohibitions in their requirements and will have
flexibility to consider other factors in developing their requirements.
As noted above and in the Proposing Release, Section 10C of the
Exchange Act does not require that the exchanges prohibit all
affiliates from serving on a compensation committee. In establishing
their independence requirements, the exchanges may determine that, even
though affiliated directors are not allowed to serve on audit
committees, such a blanket prohibition would be inappropriate for
compensation committees, and certain affiliates, such as
representatives of significant shareholders, should be permitted to
serve. However, in response to concerns noted by some commentators that
significant shareholders may have other relationships with listed
companies that would result in such shareholders' interests not being
aligned with those of other shareholders, we emphasize that it is
important for exchanges to consider other ties between a listed issuer
and a director, in addition to share ownership, that might impair the
director's judgment as a member of the compensation committee. For
example, the exchanges might conclude that personal or business
relationships between members of the compensation committee and the
listed issuer's executive officers should be addressed in the
definition of independence.\71\
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\71\ As the NYSE Listed Company Manual observes, ``the concern
is independence from management.'' See Commentary to NYSE Rule
303A.02(a). See also the Commentary to NYSE Rule 303A.02(a), which
discusses the wide range of circumstances that could signal
conflicts of interest or that might bear on the materiality of the
relationship between the director and the issuer.
---------------------------------------------------------------------------
Although each exchange must consider affiliate relationships in
establishing a definition of compensation committee independence, there
is no requirement to adopt listing standards precluding compensation
committee membership based on any specific relationships. Accordingly,
we do not believe it is necessary to separately define the term
``affiliate'' for purposes of Rule 10C-1. In addition, the final rule
does not impose any required look-back periods that must be
incorporated in exchange listing standards relating to the independence
of compensation committee members. We agree with commentators that the
determination of whether to impose a look-back period in evaluating
compensation committee member independence should be left to the
exchanges and note that the exchanges already incorporate various look-
back periods in their general criteria for director independence. In
this respect, the final rule is similar to Exchange Act Rule 10A-3,
which did not impose a mandatory look-back period for evaluating audit
committee member independence in light of look-back periods already
required by the exchanges for evaluating director independence
generally.
Consistent with the proposal, the exchanges' definitions of
independence for compensation committee members will be implemented
through proposed rule changes that the exchanges will be required to
file pursuant to Section 19(b) of the Exchange Act, which are subject
to the Commission's review and approval.\72\ Consistent with the
proposal, Rule 10C-1(a)(4) will require that each proposed rule change
submission include, in addition to any other information required under
Section 19(b) of the Exchange Act and the rules thereunder: a review of
whether and how the proposed listing standards satisfy the requirements
of the final rule; a discussion of the exchange's consideration of
factors relevant to compensation committee independence; and the
definition of independence applicable to compensation committee members
that the exchange proposes to adopt or retain in light of such
review.\73\ The Commission will then consider,
[[Page 38429]]
prior to final approval, whether the exchanges considered the relevant
factors outlined in Section 10C(a) and whether the exchanges' proposed
rule changes are consistent with the requirements of Section 6(b) and
Section 10C of the Exchange Act.
---------------------------------------------------------------------------
\72\ The standard of review for approving proposed exchange
listing standards is found in Section 19(b)(2)(C) of the Exchange
Act, which provides that ``[t]he Commission shall approve a proposed
rule change of a self-regulatory organization if it finds that such
proposed rule change is consistent with the requirements of this
title and the rules and regulations issued under this title that are
applicable to such organization.'' Under Section 6(b) of the
Exchange Act, the rules of an exchange must be ``designed to prevent
fraudulent and manipulative acts and practices, to promote just and
equitable principles of trade, to foster cooperation and
coordination with persons engaged in regulating, clearing, settling,
processing information with respect to, and facilitating
transactions in securities, to remove impediments to and perfect the
mechanism of a free and open market and a national market system,
and, in general, to protect investors and the public interest.''
\73\ A submission would be required even if an exchange believes
that its existing rules satisfy the requirements of Rule 10C-1. In
such a circumstance, the exchange's rule submission would explain
how the exchange's existing rules satisfy the requirements of Rule
10C-1, and the submission would be subject to the Commission's
review and approval.
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3. Authority To Retain Compensation Advisers; Responsibilities; and
Funding
Section 10C(c)(1) of the Exchange Act provides that the
compensation committee of a listed issuer may, in its sole discretion,
retain or obtain the advice of a ``compensation consultant,'' \74\ and
Section 10C(d) extends this authority to ``independent legal counsel
and other advisers.'' \75\ Both sections also provide that the
compensation committee shall be directly responsible for the
appointment, compensation and oversight of the work of compensation
advisers. Sections 10C(c)(1)(C) and 10C(d)(3) provide that the
compensation committee's authority to retain, and responsibility for
overseeing the work of, compensation advisers may not be construed to
require the compensation committee to implement or act consistently
with the advice or recommendations of a compensation adviser or to
affect the ability or obligation of the compensation committee to
exercise its own judgment in fulfillment of its duties. To ensure that
the listed issuer's compensation committee has the necessary funds to
pay for such advisers, Section 10C(e) provides that a listed issuer
shall provide ``appropriate funding,'' as determined by the
compensation committee, for payment of ``reasonable compensation'' to
compensation advisers.\76\
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\74\ See Exchange Act Section 10C(c)(1).
\75\ See Exchange Act Section 10C(d)(1).
\76\ See Exchange Act Section 10C(e).
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We proposed Rules 10C-1(b)(2) and (3) to implement these statutory
requirements. We are adopting these requirements substantially as
proposed.
a. Proposed Rule
Proposed Rule 10C-1(b)(2) would implement Sections 10C(c)(1) and
(d) by repeating the provisions set forth in those sections regarding
the compensation committee's authority to retain or obtain a
compensation adviser, its direct responsibility for the appointment,
compensation and oversight of the work of any compensation adviser, and
the related rules of construction. In addition, proposed Rule 10C-
1(b)(3) would implement Section 10C(e) by repeating the provisions set
forth in that section regarding the requirement to provide appropriate
funding for the payment of reasonable compensation, as determined by
the compensation committee, to compensation advisers.
In the Proposing Release, we noted that while the statute provides
that compensation committees of listed issuers shall have the express
authority to hire ``independent legal counsel,'' the statute does not
require that they do so. Similar to our interpretation \77\ of Section
10A(m) of the Exchange Act, which gave the audit committee authority to
engage ``independent legal counsel,'' \78\ we do not construe the
requirements related to independent legal counsel and other advisers as
set forth in Section 10C(d)(1) of the Exchange Act as requiring a
compensation committee to retain independent legal counsel or as
precluding a compensation committee from retaining non-independent
legal counsel or obtaining advice from in-house counsel or outside
counsel retained by the issuer or management.
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\77\ See Standards Relating to Listed Company Audit Committees,
Release No. 33-8220 (Apr. 9, 2003) [68 FR 18788], n. 114 (``As
proposed, the requirement does not preclude access to or advice from
the company's internal counsel or regular outside counsel. It also
does not require an audit committee to retain independent
counsel.'').
\78\ See Exchange Act Section 10A(m)(5)(``Each audit committee
shall have the authority to engage independent counsel and other
advisers, as it determines necessary to carry out its duties.'').
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b. Comments on the Proposed Rule
Many commentators expressed general support for the proposed
requirements.\79\ While several commentators suggested that
compensation committees should use, or be permitted to use, only
independent compensation advisers,\80\ other commentators agreed with
the interpretive position expressed in the Proposing Release that the
statute does not require a compensation committee to retain independent
legal counsel or preclude the compensation committee from retaining
non-independent legal counsel or obtaining advice from in-house counsel
or counsel retained by the issuer or management.\81\ One commentator
noted that the proposed rule should not be interpreted to ``apply to or
interfere with a compensation committee's dealings with legal counsel
from whom it may obtain advice, but which was not retained or selected
by the committee, such as in-house and company counsel. Thus, the
proposed language * * * should be clear that the requirement that
independent legal counsel and other advisers be subject to the direct
oversight of the compensation committee applies only to such counsel
and advisors who are specifically and separately retained by the
compensation committee.'' \82\ This commentator thought it would be
helpful to include the Commission's interpretation of the statute in
the text of the rule,\83\ although one commentator viewed such
clarification as unnecessary.\84\ One commentator asked that we clarify
whether the interpretive view expressed in the Proposing Release would
apply equally to compensation consultants--i.e., whether a compensation
committee could obtain advice from compensation consultants retained by
management.\85\
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\79\ See, e.g., letters from Barnard, CalSTRS, Davis Polk,
Pfizer and SCSGP.
\80\ See letters from AFL-CIO, Better Markets, CalPERS, CFA
Institute, CII, FLSBA and Railpen.
\81\ See, e.g., letters from ABA, CEC (noting that ``the
compensation committee is in the best position to determine whether
a particular advisor would be an appropriate advisor following a
review of all factors and subject to appropriate disclosure'') and
Merkl.
\82\ See letter from ABA.
\83\ See id.
\84\ See letter from Merkl.
\85\ See letter from Carl Struby.
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We asked for comment on whether we should define what constitutes
an ``independent legal counsel.'' One commentator stated, without
explanation, that it would not be necessary for us to define what
constitutes an ``independent legal counsel.'' \86\ Another commentator
believed that we should provide more guidance for issuers to determine
whether legal counsel is ``independent,'' so that listed issuers would
have greater assurance that they are in compliance with Exchange Act
Section 10C(d)(1).\87\
---------------------------------------------------------------------------
\86\ See letter from Merkl.
\87\ See letter from Robert M. Fields (Apr. 6,
2011)(``Fields'').
---------------------------------------------------------------------------
c. Final Rule
We are adopting the rule substantially as proposed, with
modifications to clarify that the scope of the requirements is limited
to only those compensation advisers retained by the compensation
committee and to apply the requirement that the compensation committee
be directly responsible for the appointment, compensation and oversight
of the work of any compensation adviser retained by the compensation
committee to those members of a listed issuer's board of directors who
oversee executive compensation matters on behalf of the board of
directors in the absence of a board committee. Under the final rules,
the exchanges will be directed to adopt listing standards that provide
that:
The compensation committee may, in its sole discretion,
retain or obtain the advice of a compensation adviser;
[[Page 38430]]
The compensation committee, which for this purpose
includes those members of a listed issuer's board of directors who
oversee executive compensation matters on behalf of the board of
directors in the absence of a board committee, shall be directly
responsible for the appointment, compensation and oversight of the work
of any compensation adviser retained by the compensation committee; and
Each listed issuer must provide for appropriate funding
for payment of reasonable compensation, as determined by the
compensation committee, to any compensation adviser retained by the
compensation committee.
Consistent with Sections 10C(c)(1)(c) and 10C(d)(3), the final rule may
not be construed to require the compensation committee to implement or
act consistently with the advice or recommendations of any adviser to
the compensation committee or to affect the ability or obligation of a
compensation committee to exercise its own judgment in fulfillment of
the duties of the compensation committee.
Consistent with our interpretation of Section 10C, the final rule
does not require compensation committees to retain or obtain advice
only from independent advisers. A listed issuer's compensation
committee may receive advice from non-independent counsel, such as in-
house counsel or outside counsel retained by management, or from a non-
independent compensation consultant or other adviser, including those
engaged by management. The final rule does not require a compensation
committee to be directly responsible for the appointment, compensation
or oversight of compensation advisers that are not retained by the
compensation committee, such as compensation consultants or legal
counsel retained by management. Rather, the direct responsibility to
oversee compensation advisers applies only to those advisers retained
by a compensation committee, and the obligation of the issuer to
provide for appropriate funding applies only to those advisers so
retained. Finally, in light of the provisions of our final rule and the
fact that commentators did not urge us to define ``independent legal
counsel,'' we do not believe such a definition is needed. \88\ We note
that the final rule requires the payment of reasonable compensation not
only to independent legal counsel but also to ``any other adviser'' to
the compensation committee, which includes any compensation advisers
retained by the compensation committee, such as attorneys and
consultants, whether or not they are independent.
---------------------------------------------------------------------------
\88\ Similarly, Exchange Act Rule 10A-3 provides that audit
committees must have the authority to engage ``independent counsel''
and that listed issuers must provide for appropriate funding of such
advisers. Independent counsel is not further defined in Rule 10A-3,
and we do not believe that there has been any uncertainty arising
from the absence of such a definition.
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4. Compensation Adviser Independence Factors
Section 10C(b) of the Exchange Act provides that the compensation
committee of a listed issuer may select a compensation adviser only
after taking into consideration the five independence factors specified
in Section 10C(b) as well as any other factors identified by the
Commission. In accordance with Section 10C(b), these factors would
apply to the selection of compensation consultants, legal counsel and
other advisers to the committee. The statute does not require a
compensation adviser to be independent, only that the compensation
committee of a listed issuer consider the enumerated independence
factors before selecting a compensation adviser. Section 10C(b)(2)
specifies that the independence factors identified by the Commission
must be competitively neutral \89\ and include, at minimum:
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\89\ Although there is no relevant legislative history, we
assume this requirement is intended to address the concern expressed
by the multi-service compensation consulting firms that the
disclosure requirements the Commission adopted in 2009 are not
competitively neutral because they do not address potential
conflicts of interest presented by boutique consulting firms that
are dependent on the revenues of a small number of clients. See
letter from Towers Perrin, commenting on Proxy Disclosure and
Solicitation Enhancements, Release No. 33-9052 (July 10, 2009),
available at http://www.sec.gov/comments/s7-13-09/s71309-90.pdf. The
list of independence factors in Section 10C(b)(2), which addresses
both multi-service firm ``other services'' conflicts and boutique
firm ``revenue concentration'' conflicts, is consistent with this
assumption.
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The provision of other services to the issuer by the
person that employs the compensation consultant, legal counsel or other
adviser;
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;
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;
Any business or personal relationship of the compensation
consultant, legal counsel or other adviser with a member of the
compensation committee; and
Any stock of the issuer owned by the compensation
consultant, legal counsel or other adviser.
We proposed to direct the exchanges to adopt listing standards
requiring the compensation committee of a listed issuer to consider the
five factors enumerated in Section 10C(b) of the Exchange Act prior to
selecting a compensation adviser. We are adopting the rule
substantially as proposed, but with some changes in response to
comments.
a. Proposed Rule
Proposed Rule 10C-1(b)(4) would direct the exchanges to adopt
listing standards that require the compensation committee of a listed
issuer to take into account the five factors identified in Section
10C(b)(2), in addition to any other factors identified by the relevant
exchange, before selecting a compensation adviser. Under the proposed
rule, the exchanges would have the ability to add other independence
factors that must be considered by compensation committees. In the
Proposing Release, we stated that we did not propose any additional
factors because we believed that the factors set forth in Section
10C(b) are ``generally comprehensive,'' although we solicited comment
as to whether there are any additional independence factors that should
be taken into consideration by a listed issuer's compensation
committee.\90\
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\90\ See Proposing Release, 76 FR at 18972.
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As noted above and in the Proposing Release, Section 10C does not
require compensation advisers to be independent--only that the
compensation committee consider factors that may bear upon
independence. As a result, we did not believe that it would be
appropriate to establish bright-line or numerical thresholds that would
affect whether or when the factors listed in Section 10C, or any
additional factors, must be considered by a compensation committee. For
example, we did not believe that our rules should provide that a
compensation committee must consider stock owned by an adviser only if
ownership exceeds a specified minimum percentage of the issuer's stock,
or that a committee must consider the amount of revenues that the
issuer's business represents for an adviser only if the percentage
exceeds a certain percentage of the adviser's revenues. Accordingly,
proposed Rule 10C-1(b)(4) would require the listing standards developed
by the exchanges to include
[[Page 38431]]
the independence factors set forth in the statute and incorporated into
the rule without any materiality or bright-line thresholds or
cutoffs.\91\
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\91\ As noted above, the exchanges would have the ability to add
other independence factors that must be considered by compensation
committees, and these additional factors could include materiality
or bright-line thresholds or cutoffs.
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b. Comments on the Proposed Rule
Comments on this proposal were mixed. A number of commentators
supported directing the exchanges to adopt listing standards that
require the compensation committee to take into account the five
factors enumerated in Section 10C, in addition to any other factors
identified by the exchanges.\92\ One multi-service compensation
consulting firm believed that the five factors listed in Section
10C(b)(2) were, in total, competitively neutral, but that, on an
individual basis, some of the factors were not competitively
neutral.\93\ This commentator suggested that we should provide an
instruction to the final rules to emphasize that the factors should be
considered in their totality and that no one factor should be viewed as
a determinative factor of independence. Another commentator argued that
the full effects of any independence factor on competition in the
rapidly evolving advisory industry are not entirely knowable, and that
the Commission should generally recommend factors that, when applied
equally across the full spectrum of existing firms, help in achieving
the goal of adviser independence.\94\
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\92\ See, e.g., letters from ABA, Pfizer, SCSGP and USS.
\93\ See letter from Aon Hewitt (``AON'').
\94\ See letter from Hodak Value Advisors.
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Several commentators argued that some or all of the five factors
identified in Section 10C(b)(2) and included in the proposed rule were
not competitively neutral.\95\ Multi-service consulting firms argued
that the consideration of other services provided to the issuer by the
person that employs the compensation consultant was not competitively
neutral as this factor would affect only multi-service firms. For their
part, smaller consulting firms argued that the consideration of the
amount of fees received from the issuer as a percentage of a firm's
total revenues was not competitively neutral because the likelihood of
revenue concentration would be greater in smaller firms.\96\ Three
commentators argued that our existing compensation consultant fee
disclosure requirements disproportionately affect multi-service
consulting firms, and suggested that we could improve the competitive
neutrality of our rules by requiring competitively neutral disclosure
of fees paid to all compensation consultants or advisers.\97\
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\95\ See, e.g., letters from Frederic Cook, Longnecker &
Associates (``Longnecker''), Mercer, Steven Hall & Partners
(``Steven Hall'') and Towers Watson (``Towers'').
\96\ See letters from Frederic Cook and Longnecker.
\97\ See letters from AON, Mercer and Towers.
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Many commentators urged us to add more independence factors to the
list of factors that could affect the independence of a compensation
adviser.\98\ Several commentators argued that we should include a
comparison of the amount of fees received for providing executive
compensation consulting services to the amount of fees received for
providing non-executive compensation consulting services.\99\ Other
commentators expressed support for requiring compensation committees to
consider any business or personal relationship between an executive
officer of the issuer and an adviser or the person employing the
compensation adviser.\100\ Some commentators, however, opposed adding
new factors to the list of factors identified in the proposed
rule,\101\ although one of these commentators acknowledged that it
would advise any compensation committee evaluating the independence of
a potential adviser to consider the business and personal relationships
between the issuer's executive officers and the adviser or adviser's
firm.\102\
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\98\ See, e.g., letters from ABA, AFL-CIO, AFSCME and USS.
\99\ See letters from AFL-CIO, AFSCME, Frederic Cook and UAW.
See also letter from Steven Hall (noting that the ``requirement that
a compensation committee consider the company's fees paid to a firm
as a percentage of the firm's overall fees seems to overlook the
more significant issue of the amount of fees the consulting firm
receives for services to the compensation committee as a percentage
of the total fees the firm receives including fees for other
services to the company'').
\100\ See, e.g., letters from ABA (supporting consideration of
relationships between adviser's employer and issuer's executive
officers), Better Markets, Merkl (supporting consideration of
relationships between either adviser or adviser's employer and
issuer's executive officers), and USS (supporting consideration of
relationships between adviser and issuer's executive officers). One
commentator supported requiring consideration of business or
personal relationships between an issuer's executive officers and
the compensation adviser, but not the adviser's employer. See letter
from Towers.
\101\ See, e.g., letters from AON, Meridian Compensation
Partners (``Meridian''), SCSGP and Steven Hall.
\102\ See letter from Steven Hall.
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In the Proposing Release, we requested comment on the application
of the independence factors to different categories of advisers.
Several commentators requested that we stipulate that a compensation
committee conferring with or soliciting advice from the issuer's in-
house or outside legal counsel would not be required to consider the
independence factors with respect to such counsels.\103\ These
commentators believed that a compensation committee should be required
to consider the independence factors only when the committee itself
selects a compensation adviser, but not when it receives advice from,
but does not select, an adviser.\104\ Moreover, two of these
commentators questioned the usefulness of the independence assessment
as it relates to in-house legal counsel, outside legal counsel to an
issuer or a compensation adviser retained by management, as they are
not held out, or considered by the compensation committee, to be
independent.\105\
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\103\ See letters from ABA, Davis Polk, McGuire Woods and S&C.
\104\ See letters from ABA and McGuire Woods.
\105\ See letters from ABA and S&C.
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On the other hand, a number of commentators argued that the
compensation adviser independence requirements should apply to any
legal counsel that provides advice to the compensation committee.\106\
One of these commentators argued that the language of Section 10C(b)(1)
is unambiguous and that the final rules should clarify that exchange
listing standards must require compensation committees to consider the
independence factors whenever a committee receives advice from legal
counsel, regardless of whether or not the committee selected
counsel.\107\
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\106\ See, e.g., letters from Better Markets, Robert M. Fields
(Apr. 29, 2011), Richard Thalheimer and Towers.
\107\ See letter from Towers.
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We also requested comment on whether we should include materiality,
numerical or other thresholds that would limit the circumstances in
which a compensation committee is required to consider the independence
factors. Several commentators opposed including such materiality,
numerical or other bright-line thresholds in the rule.\108\ These
commentators expressed concern that such thresholds may not be
competitively neutral and could reduce the flexibility compensation
committees have to select advisers best-suited to the issuer. A number
of commentators supported a materiality threshold with respect to the
stock ownership factor. One commentator suggested that consideration of
this factor should be required only if an individual beneficially owns
in excess of 5% of an outstanding class of an issuer's equity
[[Page 38432]]
securities.\109\ Another commentator suggested a threshold of $50,000
in fair market value or 5,000 shares of a listed issuer's stock, below
which an adviser's stock ownership would not be deemed to affect his or
her independence.\110\ Other commentators suggested that compensation
committees should be required to consider only stock owned by the lead
adviser and not stock owned by other employees on the adviser's
team.\111\
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\108\ See letters from Longnecker, McGuireWoods, Meridian, SCSGP
and Towers.
\109\ See letter from Steven Hall.
\110\ See letter from ABA.
\111\ See letters from AON and Mercer.
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Comments were mixed as to whether the final rule should clarify the
phrases ``provision of other services'' or ``business or personal
relationships,'' as used in proposed Rule 10C-1(b)(4). Some
commentators thought no further clarification of the phrase ``provision
of other services'' was necessary,\112\ and another commented that it
``is better to have a general principle than to have exhaustive
detailed rules that may leave loopholes for services that may impair
the independence of an advisory firm.'' \113\ Two commentators
suggested defining the phrase to expressly exclude certain
services.\114\ For example, one commentator suggested excluding advice
related to broad-based, non-discriminatory plans or surveys.\115\
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\112\ See letters from AON and Towers.
\113\ See letter from Merkl.
\114\ See letters from Hodak and Mercer.
\115\ See letter from Mercer.
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Some commentators urged that we further define the phrase
``business or personal relationship.'' \116\ One commentator suggested
that we should define ``business relationship'' to expressly exclude
any non-commercial relationship between an adviser and a member of the
issuer's compensation committee, provided that such relationship does
not result in significant monetary or economic gain to either party,
and that we should define ``personal relationship'' to include only
familial relationships.\117\ Another commentator argued that business
or personal relationships that are more casual in nature may not be
relevant to adviser independence and suggested limiting consideration
of such relationships to those that would ``more likely than not'' have
a ``material adverse effect'' on an individual's independence.\118\ Two
commentators thought it would be helpful if we provided examples of the
types of relationships to be considered, in order to guide compensation
committees as they consider the breadth of possible relationships that
might impair adviser independence.\119\ Another commentator thought it
was unnecessary for us to further define the phrase because the
``myriad possible definitions and considerations are unlikely to be
fully encompassed by such a definition.'' \120\
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\116\ See, e.g., letters from AON and Meridian.
\117\ See letter from Meridian.
\118\ See letter from AON.
\119\ See letters from Merkl and Towers.
\120\ See letter from Mercer.
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A few commentators also urged that we clarify the scope of
individuals whose relationships would need to be considered in the
context of evaluating adviser independence. One commentator recommended
limiting the required consideration to the individual adviser who
renders services to the compensation committee,\121\ and another
commentator similarly recommended limiting the required consideration
to the lead consultant, counsel or adviser to the committee, but not to
other members of the adviser's team serving the compensation
committee.\122\
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\121\ See letter from Meridian.
\122\ See letter from Mercer (noting that the more junior
members of the team rarely interact directly with the compensation
committee).
---------------------------------------------------------------------------
We requested comment on whether we should require disclosure of a
compensation committee's process for selecting advisers. Many
commentators criticized this idea, citing concerns about extending
already lengthy proxy statement discussions of executive compensation
and expressing doubt that additional disclosure of the process for
selecting advisers would provide any useful information to
investors.\123\ However, some commentators thought such disclosure
could be useful in providing transparency as to whether compensation
committees were following the required process for selecting
advisers.\124\
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\123\ See, e.g., letters from CFA Institute and Frederic Cook.
\124\ See, e.g., letter from Better Markets.
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c. Final Rule
After considering the comments, we are adopting the requirements
substantially as proposed, but with some revisions. As discussed above,
this aspect of the final rule will also apply to those members of a
listed issuer's board of directors who oversee executive compensation
matters on behalf of the board of directors in the absence of a board
committee. We have also decided to include one additional independence
factor that compensation committees must consider before selecting a
compensation adviser. Under the final rule, the exchanges will be
directed to adopt listing standards that require a compensation
committee to take into account the five factors enumerated in Section
10C(b)(2), as well as any business or personal relationships between
the executive officers of the issuer and the compensation adviser or
the person employing the adviser. This would include, for example,
situations where the chief executive officer of an issuer and the
compensation adviser have a familial relationship or where the chief
executive officer and the compensation adviser (or the adviser's
employer) are business partners. We agree with commentators who stated
that business and personal relationships between an executive officer
and a compensation adviser or a person employing the compensation
adviser may potentially pose a significant conflict of interest that
should be considered by the compensation committee before selecting a
compensation adviser.\125\
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\125\ See, e.g., letters from ABA, Better Markets, Merkl and
USS.
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As was proposed, the final rule does not expand the stock ownership
factor to require consideration of stock owned by the person employing
a compensation adviser. As we noted in the Proposing Release, we
interpret ``any stock of the issuer owned by the compensation
consultant, legal counsel, or other adviser'' to include shares owned
by the individuals providing services to the compensation committee and
their immediate family members.
Other than the additional factor described above, the final rules
will not require the listing standards to mandate consideration of
independence factors beyond those set forth in Section 10C(b)(2). We
believe that these six factors, when taken together, are competitively
neutral, as they will require compensation committees to consider a
variety of factors that may bear upon the likelihood that a
compensation adviser can provide independent advice to the compensation
committee, but will not prohibit committees from choosing any
particular adviser or type of adviser. We agree with the commentator
who suggested that the factors should be considered in their totality
and that no one factor should be viewed as a determinative factor of
independence.\126\ We do not believe it is necessary, however, to
provide an instruction to this effect, as the final rule directs the
exchanges to require consideration of all of the specified factors. In
response to concerns echoed by a number of commentators, we emphasize
that neither the Act nor our final rule requires a compensation adviser
to be independent, only that the
[[Page 38433]]
compensation committee consider the enumerated independence factors
before selecting a compensation adviser. Compensation committees may
select any compensation adviser they prefer, including ones that are
not independent, after considering the six independence factors
outlined in the final rule.\127\
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\126\ See letter from AON.
\127\ The listing standards do not, of course, override any
duties imposed on directors by applicable state law relating to the
selection of compensation advisers.
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In response to comments,\128\ we are including an instruction to
the final rule to provide that a compensation committee need not
consider the six independence factors before consulting with or
obtaining advice from in-house counsel. Commentators noted that it is
routine for in-house counsel to consult with, and provide advice to,
the compensation committee on a variety of issues, such as, for
example, the terms of an existing benefit plan or how a proposed
employment contract would interrelate with other company
agreements.\129\ We agree with these commentators that, as in-house
legal counsel are company employees, they are not held out to be
independent. In addition, we do not believe compensation committees
consider that in-house counsel serve in the same role or perform a
similar function as a compensation consultant or outside legal counsel.
---------------------------------------------------------------------------
\128\ See letters from ABA, Davis Polk and S&C.
\129\ See letters from Davis Polk and S&C.
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This instruction will not affect the obligation of a compensation
committee to consider the independence of outside legal counsel or
compensation consultants or other advisers retained by management or by
the issuer. We believe that information gathered from an independence
assessment of these categories of advisers will be useful to the
compensation committee as it considers any advice that may be provided
by these advisers. In addition, excluding outside legal counsel or
compensation consultants retained by management or by the issuer from
the required independence assessment may not be competitively neutral,
since, as some commentators pointed out, they often perform the same
types of services as the law firms and compensation consultants
selected by the compensation committee.\130\ Accordingly, we are
including an instruction to the final rule that provides that a listed
issuer's compensation committee is required to conduct the independence
assessment outlined in Rule 10C-1(b)(4) with respect to any
compensation consultant, legal counsel or other adviser that provides
advice to the compensation committee, other than in-house legal
counsel.
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\130\ See letters from Jackson and Towers.
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The final rule, like our proposal, does not include any
materiality, numerical or other thresholds that would narrow the
circumstances in which a compensation committee is required to consider
the independence factors specified in the rule. We are concerned that
adding materiality or other bright-line thresholds may not be
competitively neutral. The absence of any such thresholds means that
all facts and circumstances relevant to the six factors will be
presented to the compensation committee for its consideration of the
independence of a compensation adviser, and not just those factors that
meet a prescribed threshold. For similar reasons, the final rule does
not further define the phrases ``provision of other services'' or
``business or personal relationship.''
Consistent with the proposed rule, the final rule does not require
listed issuers to describe the compensation committee's process for
selecting compensation advisers pursuant to the new listing standards.
We are sensitive to the concerns of commentators that adding such
disclosure would increase the length of proxy statement disclosures on
executive compensation without necessarily providing additional
material information to investors.
5. Opportunity To Cure Defects
Section 10C(f)(2) of the Exchange Act specifies that our rules must
provide for appropriate procedures for an issuer to have a reasonable
opportunity to cure any defects that would be the basis for a
prohibition of the listing of an issuer's securities as a result of its
failure to meet the requirements set forth in Section 10C, before
imposition of such prohibition.\131\ To implement this requirement, we
proposed Rule 10C-1(a)(3), which would require the exchanges to
establish such procedures if their existing procedures are not
adequate. We are adopting the rule as proposed.
---------------------------------------------------------------------------
\131\ See Exchange Act Section 10C(f)(2).
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a. Proposed Rule
Proposed Rule 10C-1(a)(3) would provide that the exchange listing
standards required by Rule 10C-1 must allow issuers a reasonable
opportunity to cure violations of the compensation committee listing
requirements. The proposed rule did not set forth specific procedures
for curing violations of compensation committee listing requirements,
but specified that the listing standards may provide that if a member
of a compensation committee ceases to be independent for reasons
outside the member's reasonable control, that person, with notice by
the issuer to the applicable exchange, may remain a compensation
committee member of the listed issuer until the earlier of the next
annual shareholders' meeting of the listed issuer or one year from the
occurrence of the event that caused the member to be no longer
independent. Proposed Rule 10C-1(a)(3) was patterned after similar
provisions contained in Exchange Act Rule 10A-3(a)(3).\132\
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\132\ 17 CFR 240.10A-3(a)(3).
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b. Comments on the Proposed Rule
Commentators generally supported proposed Rule 10C-1(a)(3). Two
commentators favored requiring the exchanges to provide issuers the
same opportunity to cure non-compliance with the compensation committee
listing requirements as they have with respect to audit committee
requirements.\133\ In response to our request for comment on whether we
should direct the exchanges to adopt specific procedures for curing
non-compliance, several commentators were opposed to requiring the
exchanges to establish any such specific procedures.\134\ One
commentator, however, urged us to direct the exchanges to establish
more limited procedures for curing defects.\135\
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\133\ See letters from Debevoise and CalPERS.
\134\ See, e.g., letters from Davis Polk and Merkl.
\135\ See letter from Better Markets.
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We also requested comment as to whether listed issuers that have
just completed initial public offerings should be given additional time
to comply with the compensation committee independence requirements, as
is permitted by Exchange Act Rule 10A-3(b)(1)(iv)(A) with respect to
audit committee independence requirements. Several commentators
supported providing newly listed issuers with additional time to comply
with the compensation committee listing requirements.\136\ The NYSE
argued that the exchanges should have the flexibility to permit an
issuer applying for listing in connection with an initial public
offering to have additional time to comply with compensation committee
requirements.\137\ The NYSE also requested that we clarify that the
authority the exchanges would have under Rule 10C-1(a)(3) to provide
issuers an opportunity to cure defects is
[[Page 38434]]
not limited to situations where a previously independent compensation
committee member loses his or her independent status for reasons
outside his or her control.\138\
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\136\ See, e.g., letters from ABA, Davis Polk, Merkl and NYSE.
\137\ See letter from NYSE.
\138\ See id.
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c. Final Rule
After consideration of the comments, we are adopting Rule 10C-
1(a)(3) as proposed. Similar to Exchange Act Rule 10A-3(a)(3), the
final rule requires the exchanges to provide appropriate procedures for
listed issuers to have a reasonable opportunity to cure any
noncompliance with the compensation committee listing requirements that
could result in the delisting of an issuer's securities. The exchanges'
rules may also provide that if a member of a listed issuer's
compensation committee ceases to be independent for reasons outside the
member's reasonable control, that person, with notice by the issuer to
the applicable exchange, may remain a compensation committee member of
the listed issuer until the earlier of the next annual shareholders'
meeting of the listed issuer or one year from the occurrence of the
event that caused the member to be no longer independent. The
exchanges' authority to provide issuers an opportunity to cure defects
is not limited to situations where a previously independent
compensation committee member loses his or her independent status for
reasons outside his or her control.
As we noted in the Proposing Release, we believe that existing
listing standards and delisting procedures of most of the exchanges
satisfy the requirement for there to be reasonable procedures for an
issuer to have an opportunity to cure any defects on an ongoing basis.
Most exchanges have already adopted procedures to provide issuers with
notice and opportunity for a hearing, an opportunity for an appeal and
an opportunity to cure defects before their securities are
delisted.\139\ Nonetheless, we expect that the rules of each exchange
would provide for definite procedures and time periods for compliance
with the final rule requirements to the extent they do not already do
so.
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\139\ See, e.g., NYSE Listed Company Manual Section 801-805;
Nasdaq Equity Rules 5800 Series; NYSE AMEX Company Guide Section
1009 and Part 12; Chicago Board Options Exchange Rule 31.94; Chicago
Stock Exchange Article 22, Rules 4, 17A, and 22; Nasdaq OMX BX Rule
4800 series; Nasdaq OMX PHLX Rule 811. Neither NYSE Arca nor the
National Stock Exchange has a rule that specifically requires listed
companies to be given an opportunity to submit a plan to regain
compliance with corporate governance listing standards other than
audit committee requirements; issuers listed on these exchanges,
however, are provided notice, an opportunity for a hearing, and an
opportunity for an appeal prior to delisting. See NYSE Arca Rule
5.5(m); National Stock Exchange Rule 15.7 and Chapter X.
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We have not made any modifications to Rule 10C-1(a)(3) with respect
to newly listed issuers. As discussed in more detail in Section II.B.2
of this release, in accordance with Exchange Act Section 10C(f)(3), our
final rule will authorize the exchanges to exempt categories of issuers
from the requirements of Section 10C. We believe this authority will
allow the exchanges to craft appropriate limited exceptions from the
required compensation committee listing standards for newly listed and
other categories of listed issuers, subject to Commission review and
approval pursuant to Section 19(b) of the Exchange Act.
B. Implementation of Listing Requirements
1. Exchanges and Securities Affected
We proposed to apply the requirements of Section 10C only to
exchanges that list equity securities. In addition, the proposed rule
would require that the exchanges adopt listing standards in compliance
with the rule only with respect to issuers with listed equity
securities. Along with the exemptions contained in Section 10C, the
proposed rule would also exempt security futures products and
standardized options. We are adopting the rule as proposed.
a. Proposed Rule
Section 10C(a) provides that the Commission shall direct the
exchanges to prohibit the listing of any ``equity security'' of an
issuer (other than several types of exempted issuers) that does not
comply with the compensation committee member independence
requirements. In contrast, Section 10C(f)(1), which states generally
the scope of the compensation committee and compensation adviser
listing requirements, provides that the Commission shall 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'' (emphasis added).
The Senate-passed version of the bill did not distinguish between
equity and non-equity securities, referencing only the prohibition
against the listing of ``any security'' of an issuer not in compliance
with the independence requirements.\140\ The initial House-passed
version would have required the Commission to adopt rules to direct the
exchanges to prohibit the listing of ``any class of equity security''
of an issuer that is not in compliance with the compensation committee
independence standards, as well as with any of the other provisions of
that section, including the provisions relating to compensation
advisers.\141\ According to a press release issued by the House
Financial Services Committee, this language was added during
deliberations by that committee to clarify that the compensation
committee independence standards would apply only to ``public
companies, not to companies that have only an issue of publicly-
registered debt.'' \142\ Because the Senate-passed version of the bill
(which did not specify ``equity'' securities) was used as the base for
the conference draft, it appears that addition of ``equity'' securities
in Section 10C(a) of the conference draft was deliberate. Unlike the
House-passed bill, however, the final bill specifically references
equity securities only in connection with compensation committee member
independence requirements.
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\140\ See H.R. 4173, 111th Cong. Sec. 952 (as passed, with
amendments, by the Senate on May 20, 2010).
\141\ See H.R. 4173, 111th Cong. Sec. 2003 (as passed by the
House of Representatives on Dec. 11, 2009).
\142\ See Press Release, Financial Services Committee Passes
Executive Compensation Reform, July 28, 2009, available at: http://democrats.financialservices.house.gov/press/PRArticle.aspx?NewsID=520.
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As we noted in the Proposing Release, the NYSE currently exempts
issuers whose only listed securities are debt securities from the
compensation committee listing requirements that apply to issuers
listing equity securities.\143\ In addition, Exchange Act Rule 3a12-11
exempts listed debt securities from most of the requirements in our
proxy and information statement rules.\144\ Finally, most, if not all,
issuers with only listed debt securities, other than foreign private
issuers, are privately held.\145\ In light of the
[[Page 38435]]
legislative history and our and the exchanges' historical approach to
issuers with only listed debt securities, we noted in the Proposing
Release that we view the requirements of Section 10C as intended to
apply only to issuers with listed equity securities.\146\
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\143\ See NYSE Listed Company Manual Section 303A.00.
\144\ In adopting this rule, the Commission determined that debt
holders would receive sufficient protection from the indenture, the
Trust Indenture Act, the proxy rules' antifraud proscriptions, and
the Exchange Act rules that facilitate the transmission of materials
to beneficial owners. See Exemptive Relief and Simplification of
Filing Requirements for Debt Securities To Be Listed on a National
Securities Exchange, Release No. 34-34922 (Nov. 1, 1994) [59 FR
55342].
\145\ Based on a review of information reported on Forms 10-K,
20-F and 40-F and current public quotation and trade data on issuers
whose debt securities are listed on an exchange, such as the NYSE
Listed and Traded Bonds and NYSE Amex Listed Bonds, we estimate that
there are approximately 83 issuers that list only debt securities on
an exchange. Of these 83 issuers, approximately 45 are wholly-owned
subsidiaries that would be exempt from proposed Exchange Act Rule
10C-1 pursuant to Section 10C(g) of the Act. None of these 83
issuers has a class of equity securities registered under Section 12
of the Exchange Act.
\146\ Although Section 10C is, in many respects, similar to the
audit committee independence requirements contained in Section
10A(m), there are differences in some of the statutory language. In
this regard, we note that the requirements included in Section
10A(m) of the Exchange Act, as set forth in Section 301 of the
Sarbanes-Oxley Act, are applicable generally to ``listed
securities,'' and no reference is made to equity securities.
Therefore, although Section 10A(m) applies to issuers whether they
have listed debt or equity, we do not believe this should
necessarily prescribe the scope of Section 10C.
---------------------------------------------------------------------------
Accordingly, we proposed to apply Rule 10C-1 only to exchanges that
list equity securities, and to direct these exchanges to adopt listing
standards implementing our rule only as to issuers that are seeking to
list or have listed equity securities. We noted in the Proposing
Release that proposed Rule 10C-1 would not currently apply to FINRA,
the only existing national securities association registered under
Section 15A(a) of the Exchange Act, as FINRA does not list any
securities and does not have listing standards under its rules.\147\
Nevertheless, as Section 10C specifically references national
securities associations, proposed Rule 10C-1 would apply to any
registered national securities association that lists equity securities
in the future.\148\
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\147\ Similarly, we stated that we did not expect the National
Futures Association, which is a national securities association
registered under Section 15A(k) for the limited purpose of
regulating the activities of members who are registered as broker-
dealers in security futures products, see note 8, above, to develop
listing standards regarding compensation committees in compliance
with proposed Rule 10C-1. See Proposing Release, 76 FR at 18974, n.
73.
\148\ The OTC Bulletin Board (OTCBB) and the OTC Markets Group
(previously known as the Pink Sheets and Pink OTC Markets) will not
be affected by Rule 10C-1, and therefore issuers whose securities
are quoted on these interdealer quotation systems similarly will not
be affected, unless their securities also are listed on a national
securities exchange. The OTCBB is an ``interdealer quotation
system'' for over-the-counter securities that is operated by FINRA.
(Exchange Act Rule 15c2-11 defines the term ``interdealer quotation
system.'' 17 CFR 240.15c2-11.) It does not, however, have a listing
agreement or arrangement with the issuers whose securities are
quoted on the system and are not considered listed, as that term is
defined and used in Rule 10C-1. See Rules 10C-1(a)(2) and (c)(3).
Although market makers may be required to review and maintain
specified information about an issuer and to furnish that
information to FINRA, the issuers whose securities are quoted on the
OTCBB are not required to submit any information to the system. The
OTC Markets Group is not a registered national securities exchange
or association, nor is it operated by a registered national
securities exchange or association, and thus is not covered by the
terms of the final rule.
---------------------------------------------------------------------------
Under proposed Rule 10C-1(a), exchanges would be required, to the
extent that their listing standards did not conform with Rule 10C-1, to
issue or amend their listing rules, subject to Commission review, to
comply with the new rule. As noted in the Proposing Release, an
exchange that lists or trades security futures products (as defined in
Exchange Act Section 3(a)(56)) \149\ may register as an exchange under
Section 6(g) of the Exchange Act solely for the purpose of trading
those products. As the Exchange Act definition of ``equity security''
includes security futures on equity securities,\150\ exchanges whose
only listed equity securities are security futures products \151\ would
be required to comply with Rule 10C-1 absent an applicable exemption.
Given that Section 10C(f) of the Exchange Act makes no distinction
between exchanges registered pursuant to Section 6(a)--such as the NYSE
and Nasdaq--and those registered pursuant to Section 6(g), we did not
propose a wholesale exemption from the requirements of Rule 10C-1 for
those exchanges registered solely pursuant to Section 6(g).
---------------------------------------------------------------------------
\149\ Exchange Act Section 3(a)(56) defines the term ``security
futures product'' to mean ``a security future or any put, call,
straddle, option, or privilege on any security future.'' 15 U.S.C.
78c(a)(56).
\150\ Section 3(a)(11) of the Exchange Act defines the term
``equity security'' as any stock or similar security; or any
security future on any such security; or any security convertible,
with or without consideration, into such a security, or carrying any
warrant or right to subscribe to or purchase such a security; or any
such warrant or right; or any other security which the Commission
shall deem to be of similar nature and consider necessary or
appropriate, by such rules and regulations as it may prescribe in
the public interest or for the protection of investors, to treat as
an equity security.
\151\ Exchanges currently registered solely pursuant to Section
6(g) of the Exchange Act include the Board of Trade of the City of
Chicago, Inc.; the CBOE Futures Exchange, LLC; the Chicago
Mercantile Exchange, Inc.; One Chicago, LLC; the Island Futures
Exchange, LLC; and NQLX LLC.
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However, as discussed below, we proposed to exempt security futures
products from the scope of proposed Rule 10C-1. Accordingly, we noted
in the Proposing Release that, to the extent the final rule exempted
the listing of security futures products from the scope of Rule 10C-1,
any exchange registered solely pursuant to Section 6(g) of the Exchange
Act and that lists and trades only security futures products would not
be required to file a rule change in order to comply with Rule 10C-1.
We proposed to exempt security futures products and standardized
options from the requirements of Rule 10C-1. Although the Exchange Act
defines ``equity security'' to include any security future on any stock
or similar security, the Commodity Futures Modernization Act of 2000
(the ``CFMA'') \152\ permits the exchanges to trade futures on
individual securities and on narrow-based security indices (``security
futures'') \153\ without such securities being subject to the
registration requirements of the Securities Act of 1933 (the
``Securities Act'') and the Exchange Act so long as they are cleared by
a clearing agency that is registered under Section 17A of the Exchange
Act \154\ or that is exempt from registration under Section
17A(b)(7)(A) of the Exchange Act. In December 2002, we adopted rules
that provide comparable regulatory treatment for standardized
options.\155\
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\152\ Public Law 106-554, 114 Stat. 2763 (2000).
\153\ Exchange Act Section 3(a)(56) [15 U.S.C. 78c(a)(56)], and
Commodities Exchange Act Section 1a(32) [7 U.S.C. la(32)] define
``security futures product'' as a security future or any put, call,
straddle, option, or privilege on any security future.
\154\ 15 U.S.C. 78q-1.
\155\ See Release No. 33-8171 (Dec. 23, 2002) [68 FR 188]. In
that release, we exempted standardized options issued by registered
clearing agencies and traded on a registered national securities
exchange or on a registered national securities association from all
provisions of the Securities Act, other than the antifraud provision
of Section 17, as well as the Exchange Act registration
requirements. Standardized options are defined in Exchange Act Rule
9b-1(a)(4) [17 CFR 240.9b-1(a)(4)] as option contracts trading on a
national securities exchange, an automated quotation system of a
registered securities association, or a foreign securities exchange
which relate to option classes the terms of which are limited to
specific expiration dates and exercise prices, or such other
securities as the Commission may, by order, designate.
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The clearing agency for security futures products and standardized
options is the issuer of these securities,\156\ but its role as issuer
is fundamentally different from an issuer of equity securities of an
operating company. The purchasers of security futures products and
standardized options do not, except in the most formal sense, make an
investment decision based on the issuer. As a result, information about
the clearing agency's business, its officers and directors and its
financial statements is much less
[[Page 38436]]
relevant to investors in these securities than information about the
issuer of the underlying security. Similarly, the investment risk in
these securities is determined by the market performance of the
underlying security rather than the results of operations or
performance of the clearing agency, which is a self-regulatory
organization subject to regulatory oversight. Furthermore, unlike a
conventional issuer, the clearing agency does not receive the proceeds
from the sales of security futures products or standardized
options.\157\
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\156\ See Fair Administration and Governance of Self-Regulatory
Organizations; Disclosure and Regulatory Reporting by Self-
Regulatory Organizations; Recordkeeping Requirements for Self-
Regulatory Organizations; Ownership and Voting Limitations for
Members of Self-Regulatory Organizations; Ownership Reporting
Requirements for Members of Self-Regulatory Organizations; Listing
and Trading of Affiliated Securities by a Self-Regulatory
Organization, Release No. 34-50699 (Nov. 18, 2004) [69 FR 71126], at
n. 260 (``Standardized options and security futures products are
issued and guaranteed by a clearing agency. Currently, all
standardized options and security futures products are issued by the
Options Clearing Corporation (`OCC').'').
\157\ However, the clearing agency may receive a clearing fee
from its members.
---------------------------------------------------------------------------
In recognition of these fundamental differences, we provided
exemptions for security futures products and standardized options from
the audit committee listing requirements in Exchange Act Rule 10A-
3.\158\ Specifically, Rule 10A-3(c) exempts the listing of a security
futures product cleared by a clearing agency that is registered
pursuant to Section 17A of the Exchange Act or that is exempt from
registration pursuant to Section 17A(b)(7)(A) and the listing of a
standardized option issued by a clearing agency that is registered
pursuant to Section 17A of the Exchange Act. For the same reasons that
we exempted these securities from Rule 10A-3, we proposed to exempt
these securities from Rule 10C-1.
---------------------------------------------------------------------------
\158\ See Exchange Act Rules 10A-3(c)(4) and (5).
---------------------------------------------------------------------------
b. Comments on the Proposed Rule
Commentators generally agreed that Section 10C should apply only to
issuers with listed equity securities.\159\ Some commentators argued
that the proposed rule should apply to all domestic exchanges and
public companies without exception.\160\ These commentators did not
specifically comment on whether the statute is intended to apply only
to issuers with listed equity securities. One commentator recommended
that we exempt only exchanges that do not list equity securities and
agreed that our proposed exemption for security futures products and
standardized options is necessary or appropriate in the public interest
and consistent with the protection of investors.\161\
---------------------------------------------------------------------------
\159\ See, e.g., letters from Debevoise and PEGCC.
\160\ See letters from CII and FLSBA.
\161\ See letter from Merkl.
---------------------------------------------------------------------------
c. Final Rule
After consideration of the comments, we are adopting the proposals
without change. As adopted, the final rule will:
Require all exchanges that list equity securities, to the
extent that their listing standards do not already comply with the
final rule, to issue or amend their listing rules to comply with the
new rule;
Provide that exchange listing standards required by the
new rule need apply only to issuers with listed equity securities; and
Exempt security futures products cleared by a clearing
agency that is registered pursuant to Section 17A of the Exchange Act
or that is exempt from registration pursuant to Section 17A(b)(7)(A)
and standardized options that are issued by a clearing agency that is
registered pursuant to Section 17A of the Exchange Act.
2. Exemptions
Section 10C of the Exchange Act has four different provisions
relating to exemptions from some or all of the requirements of Section
10C:
Section 10C(a)(1) provides that our rules shall direct the
exchanges to prohibit the listing of any equity security of an issuer
that is not in compliance with the compensation committee member
independence requirements of Section 10C(a)(2), other than an issuer
that is in one of five specified categories--controlled companies,
limited partnerships, companies in bankruptcy proceedings, open-end
management investment companies registered under the Investment Company
Act \162\ and foreign private issuers that disclose in their annual
reports the reasons why they do not have an independent compensation
committee;
---------------------------------------------------------------------------
\162\ 15 U.S.C. 80a-1 et seq.
---------------------------------------------------------------------------
Section 10C(a)(4) provides that our rules shall authorize
the exchanges to exempt a particular relationship from the independence
requirements applicable to compensation committee members, as each
exchange determines is appropriate, taking into consideration the size
of the issuer and any other relevant factors;
Section 10C(f)(3) provides that our rules shall authorize
the exchanges to exempt any category of issuer from the requirements of
Section 10C as the exchanges determine is appropriate, and that, in
making such determinations, the exchanges must take into account the
potential impact of the requirements on smaller reporting issuers; and
Section 10C(g) specifically exempts controlled companies,
as defined in Section 10C(g), from all of the requirements of Section
10C.
We proposed Rule 10C-1(b)(1)(iii)(A) to exempt the five categories
of issuers enumerated in Section 10C(a)(1); Rule 10C-1(b)(1)(iii)(B) to
authorize the exchanges to exempt a particular relationship from the
independence requirements applicable to compensation committee members,
as each exchange determines is appropriate, taking into consideration
the size of the issuer and other relevant factors; Rule 10C-1(b)(5)(i)
to permit the exchanges to exempt any category of issuer from the
requirements of Section 10C, as each exchange determines is
appropriate, taking into consideration the potential impact of such
requirements on smaller reporting issuers; and Rule 10C-1(b)(5)(ii) to
exempt controlled companies from the requirements of Rule 10C-1. We are
adopting the proposals with changes made in response to comments.
a. Proposed Rule
i. Issuers Not Subject to Compensation Committee Independence
Requirements
As noted above, Exchange Act Section 10C(a)(1) provides that our
rules shall direct the exchanges to prohibit the listing of any equity
security of an issuer, other than an issuer that is in one of five
specified categories, that is not in compliance with the compensation
committee member independence requirements of Section 10C(a)(2).
Accordingly, we proposed to exempt controlled companies, limited
partnerships, companies in bankruptcy proceedings, open-end management
investment companies registered under the Investment Company Act and
foreign private issuers that provide annual disclosures to shareholders
of the reasons why the foreign private issuer does not have an
independent compensation committee from these requirements.
Under Section 10C(g)(2) of the Exchange Act, a ``controlled
company'' is defined as an issuer that is listed on an exchange and
that holds an election for the board of directors of the issuer in
which more than 50% of the voting power is held by an individual, a
group or another issuer. We proposed to incorporate this definition
into Rule 10C-1(c)(2). Section 10C did not define the terms ``limited
partnerships'' or ``companies in bankruptcy proceedings.'' As noted in
the Proposing Release, we believe that a limited partnership is
generally understood to mean a form of business ownership and
association consisting of one or more general partners who are fully
liable for the debts and obligations of the partnership and one or more
limited partners whose liability is limited to the amount
invested.\163\ We also noted in
[[Page 38437]]
the Proposing Release that the phrase ``companies in bankruptcy
proceedings'' is used in several Commission rules without
definition.\164\ Accordingly, we did not further define either term in
proposed Rule 10C-1(c).
---------------------------------------------------------------------------
\163\ See Unif. Ltd. P'ship Act Sec. Sec. 102, 303 and 404
(2001).
\164\ See, e.g., Section 55(a)(3)(A) of the Investment Company
Act [15 U.S.C. 80a-54(a)(3)(A)]; Item 1107(k) of Regulation AB [17
CFR 229.1107(k)]; and Rule 457 under the Securities Act [17 CFR
230.457].
---------------------------------------------------------------------------
Section 10C does not define the term ``open-end management
investment company.'' As discussed in the Proposing Release, under the
Investment Company Act, an open-end management investment company is an
investment company, other than a unit investment trust or face-amount
certificate company, that offers for sale or has outstanding any
redeemable security of which it is the issuer.\165\ We proposed to
define this term in proposed Rule 10C-1(c) by referencing Section
5(a)(1) of the Investment Company Act.
---------------------------------------------------------------------------
\165\ See Sections 4 and 5(a)(1) of the Investment Company Act
[15 U.S.C. 80a-4 and 80a-5(a)(1)]. Open-end and closed-end
management investment companies registered under the Investment
Company Act are generally exempt from current exchange listing
standards that require listed issuers to either have a compensation
committee or to have independent directors determine, recommend, or
oversee specified executive compensation matters. See, e.g., NYSE
Listed Company Manual Section 303A.00; Nasdaq Rule 5615(a)(5); NYSE
Arca Rule 5.3; NYSE AMEX Company Guide Section 801.
---------------------------------------------------------------------------
Under Section 10C(a)(1), a foreign private issuer that provides
annual disclosure to shareholders of the reasons why the foreign
private issuer does not have an independent compensation committee
would be exempt from the compensation committee member independence
requirements. Exchange Act Rule 3b-4 defines ``foreign private issuer''
as ``any foreign issuer other than a foreign government, except for an
issuer that has more than 50% of its outstanding voting securities held
of record by U.S. residents and any of the following: a majority of its
officers and directors are citizens or residents of the United States,
more than 50% of its assets are located in the United States, or its
business is principally administered in the United States.'' \166\
Since this definition applies to all Exchange Act rules, we did not
believe it was necessary to include a cross-reference to Rule 3b-4 in
our proposed rules.
---------------------------------------------------------------------------
\166\ 17 CFR 240.3b-4(c).
---------------------------------------------------------------------------
In the Proposing Release, we noted that certain foreign private
issuers have a two-tier board, with one tier designated as the
management board and the other tier designated as the supervisory or
non-management board. Similar to our approach to Rule 10A-3, proposed
Rule 10C-1(b)(1)(iii) would clarify that in the case of foreign private
issuers with two-tier boards of directors, the term ``board of
directors'' means the supervisory or non-management board. Accordingly,
to the extent the supervisory or non-management board forms a separate
compensation committee, proposed Rule 10C-1 would apply to that
committee, with the exception of the committee member independence
requirements, assuming the foreign private issuer discloses why it does
not have an independent compensation committee in its annual report.
ii. Exemption of Relationships and Other Categories of Issuers
As noted above, Section 10C(a)(4) of the Exchange Act provides that
the Commission's rules shall permit an exchange to exempt a particular
relationship from the compensation committee independence requirements,
as such exchange deems appropriate, taking into consideration the size
of the issuer and any other relevant factors. In addition, as noted
above, Section 10C(f)(3) provides that our rules shall authorize an
exchange to exempt a category of issuers from the requirements of
Section 10C, as the exchange determines is appropriate, taking into
account the potential impact of the Section 10C requirements on smaller
reporting issuers. To implement these provisions, we proposed Rule 10C-
1(b)(1)(iii)(B), which would authorize the exchanges to establish
listing standards that exempt particular relationships between members
of the compensation committee and listed issuers that might otherwise
impair the member's independence, taking into consideration the size of
an issuer and any other relevant factors, and Rule 10C-1(b)(5)(i),
which would allow the exchanges to exempt categories of listed issuers
from the requirements of Section 10C, as each exchange determines is
appropriate. In determining the appropriateness of categorical issuer
exemptions, the exchanges would be required, in accordance with the
statute, to consider the potential impact of the requirements of
Section 10C on smaller reporting issuers.\167\
---------------------------------------------------------------------------
\167\ See Exchange Act Section 10C(f)(3)(B). Section 10C of the
Exchange Act includes no express exemptions for smaller reporting
companies. Some exchanges currently have limited exemptions from
requirements to have a majority independent board or a three-member
audit committee for smaller issuers--for example, NYSE Amex and the
Chicago Stock Exchange permit smaller issuers to have a 50%
independent board and a minimum of two members on the issuer's audit
committee. See NYSE Amex Company Guide Section 801(h); Chicago Stock
Exchange Article 22, Rules 19(a), 19(b)(1)(C)(iii), and 21(a).
Section 10C(f)(3) expressly requires the exchanges to take into
account the potential impact of the listing requirements on smaller
reporting issuers when exercising the exemptive authority provided
to them by our rules.
---------------------------------------------------------------------------
Other than the five categories of issuers in Section 10C(a)(1), we
did not propose to exempt any relationship or any category of issuer
from the compensation committee member independence requirements under
Section 10C(a)(1). Instead of including specific exemptions, the
proposed rule generally would leave the determination of whether to
exempt particular relationships or categories of issuers to the
discretion of the exchanges, subject to our review in the rule filing
process. Because listed issuers frequently consult the exchanges
regarding independence determinations and committee responsibilities,
in the proposal we explained that we believed that the exchanges are in
the best position to identify any relationships or categories of
issuers that may merit exemption from the compensation committee
listing requirements.
b. Comments on the Proposed Rule
Comments on the proposals were generally favorable. Commentators
generally supported the proposed approach of deferring to the exchanges
any decisions to exempt any categories of issuers or particular
relationships that might compromise committee member independence.\168\
One commentator expressed concern that the proposed definition of
``controlled companies'' would not exempt some listed issuers that are
controlled companies under applicable listing standards, but do not
actually hold director elections, such as some limited liability
companies.\169\ This commentator recommended that we revise the
definition of ``controlled companies'' in proposed Rule 10C-1(c)(2) so
that it would encompass companies that do not actually hold director
elections but have more than 50% of the voting power for the election
of directors held by an individual, a group or another company.
---------------------------------------------------------------------------
\168\ See, e.g., letters from NYSE and S&C.
\169\ See letter from Vinson & Elkins LLP (``V&E'').
---------------------------------------------------------------------------
In the Proposing Release, we requested comment on whether we should
exempt any types of issuers, such as registered management investment
companies, foreign private issuers or smaller reporting companies,\170\
from some or all of the requirements of Section 10C. The NYSE stated
its view that the express exclusion of certain types of issuers in
[[Page 38438]]
Section 10C(a)(1) should not prevent an exchange from exempting other
types of issuers, and urged us to clarify that the general exemptive
authority exchanges would have under Rule 10C-1 is not limited to
smaller reporting companies.\171\
---------------------------------------------------------------------------
\170\ See Exchange Act Rule 12b-2 for the definition of
``smaller reporting company.''
\171\ See letter from NYSE.
---------------------------------------------------------------------------
Several commentators urged us to exempt all foreign private issuers
from the requirements of Section 10C.\172\ Another commentator urged us
to exempt smaller reporting companies from the requirements of Section
10C because smaller reporting companies may experience more difficulty
than other issuers in finding independent directors who are willing to
serve on their boards.\173\ Other commentators, however, believed that
we should not exempt foreign private issuers or smaller reporting
companies from the requirements of Section 10C.\174\ Several of these
commentators supported uniform application of compensation committee
independence requirements to all public companies.\175\ One commentator
believed that domestic companies should not face a stricter regime than
foreign companies and suggested that foreign companies could be given a
time frame within which they would be required to meet the listing
standards that apply to domestic companies.\176\
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\172\ See letters from ABA, Davis Polk and SAP AG.
\173\ See letter from ABA.
\174\ See letters from CalPERS, CII, FLSBA, the Local Authority
Pension Fund Forum (``LAPFF''), Merkl, Railpen and USS.
\175\ See letters from CII, FLSBA and USS.
\176\ See letter from LAPFF.
---------------------------------------------------------------------------
One commentator urged us to exempt all registered investment
companies from the requirements of Section 10C.\177\ This commentator
noted that registered investment companies are subject to the
requirements of the Investment Company Act, including, in particular,
requirements concerning potential conflicts of interest related to
investment adviser compensation. The commentator also noted that most
registered investment companies are externally managed, do not have
compensated executives and, therefore, do not need compensation
committees to oversee executive compensation.
---------------------------------------------------------------------------
\177\ See letter from the Investment Company Institute
(``ICI'').
---------------------------------------------------------------------------
c. Final Rule
After consideration of the comments, we are adopting the rule with
revisions in response to comments. Rule 10C-1(b)(1)(iii) will exempt
from the compensation committee member independence listing standards
required under Rule 10C-1(a) limited partnerships, companies in
bankruptcy proceedings, registered open-end management investment
companies and foreign private issuers that provide annual disclosures
to shareholders of the reasons why the foreign private issuer does not
have an independent compensation committee.
As we proposed, we are also exempting controlled companies from the
requirements of Rule 10C-1. In light of Section 10C(g)'s general
exemption for controlled companies, we have eliminated the specific
exemption for controlled companies from the compensation committee
member independence listing standards in final Rule 10C-1(b)(1)(iii).
We believe this specific exemption from the compensation committee
member independence listing standards for controlled companies is
unnecessary in light of the broader exemption for controlled companies
provided by final Rule 10C-1(b)(5)(ii).
In response to comments that our proposed definition of controlled
company would not exempt listed issuers that would otherwise be
controlled companies but for the fact that they do not hold director
elections, we are modifying the definition of controlled company in the
final rule. Under the final rule, a controlled company will be defined
as a listed company in which more than 50% of the voting power for the
election of directors is held by an individual, a group or another
company. We have removed from the definition the phrase ``holds an
election for the board of directors.'' The revised definition of
``controlled company'' will more closely follow the definition of the
term currently used by the NYSE and Nasdaq.\178\ Although the
definition in the final rule is slightly broader than the definition of
``controlled company'' in Section 10C(g)(2), we believe this
modification is consistent with the statutory intent to exempt from the
requirements of Section 10C those companies that are in fact controlled
by a shareholder or group of shareholders, regardless of whether
director elections are actually held.
---------------------------------------------------------------------------
\178\ See NYSE Listed Company Manual Section 303A.00 and Nasdaq
Rule 5615(c).
---------------------------------------------------------------------------
In addition to controlled companies, we are exempting smaller
reporting companies, as defined in Exchange Act Rule 12b-2, from the
requirements of Rule 10C-1.\179\ As noted above, one commentator urged
us to exempt smaller reporting companies from the requirements of
Section 10C because smaller reporting companies may experience more
difficulty than other issuers in finding independent directors who are
willing to serve on their boards.\180\ This commentator also noted that
the compensation committees of smaller reporting companies often do not
hire outside compensation consultants, both because their compensation
programs tend to be ``relatively simple'' and also because smaller
reporting companies ``often cannot afford to hire outside experts.''
\181\
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\179\ Approximately 1%, 25% and 53% of the operating companies
listed on the NYSE, the Nasdaq Stock Market, and NYSE Amex,
respectively, are smaller reporting companies. See Memorandum to
File No. S7-13-11, dated May 8, 2012, concerning information on
listed smaller reporting companies, which is available at http://www.sec.gov/comments/s7-13-11/s71311-60.pdf.
\180\ See letter from ABA.
\181\ See id.
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We recognize that some commentators opposed such an exemption,\182\
but we believe, on balance, that an exemption is appropriate. In 2006,
when we substantially revised our executive compensation disclosure
rules, we adopted new scaled executive compensation disclosure
requirements for smaller companies in recognition of the fact that the
``executive compensation arrangements of small business issuers
generally are so much less complex than those of other public companies
that they do not warrant the more extensive disclosure requirements
imposed on companies that are not small business issuers and related
regulatory burdens that could be disproportionate for small business
issuers.'' \183\ In light of those findings with respect to smaller
reporting companies' less complex executive compensation arrangements,
we are not persuaded that the additional burdens of complying with Rule
10C-1 are warranted for smaller reporting companies.
---------------------------------------------------------------------------
\182\ See letters from CalPERS, CII, FLSBA, Merkl and Railpen.
These commentators did not provide specific reasons for their
opposition, other than two commentators noting that the matters
addressed in Section 10C are relevant to all public companies. See
letters from CII and FLSBA.
\183\ See Executive Compensation and Related Person Disclosure,
Release No. 33-8732A (Aug. 29, 2006) [71 FR 53158], at 53192 (``2006
Executive Compensation Release''). In 2007, we adopted a new
eligibility standard for ``smaller reporting companies'' to replace
the ``small business issuer'' definition then found in Item 10 of
Regulation S-B. See Smaller Reporting Company Regulatory Relief and
Simplification, Release No. 33-8876 (Dec. 19, 2007) [73 FR 934].
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We appreciate that these burdens for listed smaller reporting
companies may not be significant given that such issuers are already
subject to listing standards requiring directors on compensation
committees or directors determining or recommending executive
compensation
[[Page 38439]]
matters to be ``independent'' under the exchanges' general independence
standards. We do believe, however, that exempting smaller reporting
companies from the listing standards mandated by Rule 10C-1 can offer
cost savings to these listed issuers to the extent that an exchange, in
connection with the listing standards review required by Rule 10C-1,
chooses to create a new independence standard for compensation
committee members that is more rigorous than its existing standards--
for example, a new standard could address personal or business
relationships between members of the compensation committee and the
listed issuer's executive officers. Issuers subject to the exchange's
new standard may need to replace existing compensation committee
members, and incur the associated costs, if the existing members do not
qualify as independent under the new standard. In addition, although
listed smaller reporting companies do not often engage outside
compensation consultants, there would be cost savings to these listed
issuers from not having to comply with the listing standards involving
the compensation committee's engagement and oversight of compensation
advisers. For example, the exchanges are required to adopt listing
standards that require the compensation committee to consider the six
independence factors listed in Rule 10C-1(b)(4) before selecting a
compensation adviser. To comply with these listing standards,
compensation committees will likely need to create procedures for
collecting and analyzing information about potential compensation
advisers before they can receive advice from such advisers, which would
require the listed issuers to incur costs. We expect, however, that a
portion of these cost savings would likely be offset by the costs that
smaller reporting companies may incur to comply with the new
requirement to disclose compensation consultants' conflicts of
interest, which is described in Section II.C below. In light of these
considerations, we do not believe it is necessary to require the
exchanges to go through the process of proposing to exempt smaller
reporting companies in the Section 19(b) rule filing process, since we
have concluded that it is appropriate to provide this exemption in any
event. Accordingly, we are exempting smaller reporting companies from
the requirements of Rule 10C-1.\184\
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\184\ When an issuer loses its smaller reporting company status,
it will be required to comply with the listing standards applicable
to non-smaller reporting companies. We anticipate that the exchanges
will provide for a transition period for issuers that lose smaller
reporting company status, similar to what they currently have for
issuers that lose controlled company status. See, e.g., NYSE Listed
Company Manual Section 303A.00; Nasdaq Rule 5615(c)(3).
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We are adopting Rules 10C-1(b)(1)(iii)(B) and 10C-1(b)(5)(i)
substantially as proposed. Rule 10C-1(b)(1)(iii)(B) authorizes the
exchanges to exempt a particular relationship from the compensation
committee member independence requirements, as the exchanges deem
appropriate, taking into consideration the size of the issuer and any
other relevant factors. Rule 10C-1(b)(5)(i) authorizes the exchanges to
exempt any category of issuers from the requirements of Section
10C,\185\ as each exchange determines is appropriate, taking into
consideration the potential impact of the requirements on smaller
reporting issuers. In response to comment, we are clarifying that the
final rule does not prohibit the exchanges from considering other
relevant factors as well. The final rule will allow the exchanges
flexibility to propose transactions or categories of issuers to exempt,
subject to our review and approval under the Exchange Act Section 19(b)
rule filing process. As we noted in the Proposing Release, we believe
that relying on the exchanges in this manner to exercise the exemptive
authority expressly granted to them under the final rules is consistent
with the requirements of Section 10C and will result in more effective
determinations as to the types of relationships and the types of
issuers that merit an exemption.\186\
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\185\ As noted in the Proposing Release, Rule 10C-1(b)(5)(i)
does not provide the authority for the exchanges to exempt listed
issuers from the disclosure requirements under Item 407 of
Regulation S-K, which include Section 10C(c)(2)'s compensation
consultant disclosure requirements.
\186\ We note that the Jumpstart Our Business Startups Act,
Public Law 112-106, 126 Stat. (2012) (the ``JOBS Act''), which was
enacted on April 5, 2012, creates a new category of issuer, an
``emerging growth company,'' under the Securities Act and the
Exchange Act. See Section 2(a)(19) of the Securities Act [15 U.S.C.
77b(a)(19)]; Section 3(a)(80) of the Exchange Act [15 U.S.C.
78c(a)(80)]. An emerging growth company is defined as an issuer that
had total annual gross revenues of less than $1 billion during its
most recently completed fiscal year. Existing listing standards
provide no accommodation for this category of issuer, and the JOBS
Act does not require that exchanges do so. The rules we are adopting
will permit the exchanges to consider, subject to the Commission's
review and approval, whether any exemptions from the listing
standards required by Rule 10C-1 are appropriate for emerging growth
companies or any other category of issuer.
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As noted by one commentator, most registered investment companies
do not have compensated employees or compensation committees.\187\
Therefore, the requirements of Rule 10C-1, which does not itself
require any issuer to have a compensation committee, will not affect
most registered investment companies or impose any compliance
obligations on them.\188\ This commentator did not explain why, in the
infrequent case where a registered investment company has compensated
executives and a compensation committee (which are not addressed by
Investment Company Act requirements related to investment adviser
compensation), the registered investment company should be exempt from
the requirements that apply to all other listed issuers with
compensation committees. We believe that the exchanges are in a better
position to determine the appropriate treatment of registered
investment companies that have compensated executives and compensation
committees, if any.
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\187\ See letter from ICI.
\188\ We do not believe that any board committee or members of
the board of a registered investment company or business development
company would be a ``compensation committee'' under Rule 10C-1
solely as a result of carrying out the board's responsibilities
under Rule 38a-1 under the Investment Company Act to approve the
designation and compensation of the fund's chief compliance officer.
Under Rule 38a-1, the approval of a majority of the board's
independent directors is required. See 17 CFR 270.38a-1(a)(4).
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C. Compensation Consultant Disclosure and Conflicts of Interest
Section 10C(c)(2) of the Exchange Act requires that, in any proxy
or consent solicitation material for an annual meeting (or a special
meeting in lieu of the annual meeting), each issuer must disclose, in
accordance with regulations of the Commission, whether:
The compensation committee has retained or obtained the
advice of a compensation consultant; and
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.
We proposed amendments to Item 407 of Regulation S-K to require
issuers to include the disclosures required by Section 10C(c)(2) in any
proxy or information statement for an annual meeting (or special
meeting in lieu of an annual meeting) at which directors are to be
elected. After consideration of the comments, we are adopting a
modified version of the proposal.
1. Proposed Rule
Item 407 of Regulation S-K currently requires Exchange Act
registrants that are subject to the proxy rules, other than registered
investment companies, to provide certain disclosures concerning their
compensation committees and the use of compensation consultants. Item
407(e)(3)(iii) generally requires
[[Page 38440]]
registrants to disclose ``any role of compensation consultants in
determining or recommending the amount or form of executive and
director compensation,'' including:
Identifying the consultants;
Stating whether such consultants were engaged directly by
the compensation committee or any other person;
Describing the nature and scope of the consultants'
assignment, and the material elements of any instructions given to the
consultants under the engagement; and
Disclosing the aggregate fees paid to a consultant for
advice or recommendations on the amount or form of executive and
director compensation and the aggregate fees for additional services if
the consultant provided both and the fees for the additional services
exceeded $120,000 during the fiscal year.\189\
\189\ See current Items 407(e)(3)(iii)(A) and (B) [17 CFR
229.407(e)(3)(iii)(A) and 229.407(e)(3)(iii)(B)]. Fee disclosure,
however, is not required for compensation consultants that work with
management if the compensation committee has retained a separate
consultant. In promulgating these requirements, we recognized that,
in this situation, the compensation committee may not be relying on
the compensation consultant used by management, and therefore
potential conflicts of interest are less of a concern. See Proxy
Disclosure Enhancements, Release No. 33-9089 (Dec. 16, 2009) [74 FR
68334] (``Proxy Disclosure Enhancements Release'').
The current item excludes from the disclosure requirement any role of
compensation consultants limited to consulting on any broad-based plan
that does not discriminate in scope, terms or operation in favor of
executive officers or directors of the registrant and that is available
generally to all salaried employees, or limited to providing
information that either is not customized for a particular registrant
or is customized based on parameters that are not developed by the
compensation consultant, and about which the compensation consultant
does not provide advice.\190\
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\190\ See Item 407(e)(3)(iii). In adopting this exclusion, the
Commission determined (based on comments it received on the rule
proposal) that the provision of such work by a compensation
consultant does not raise conflict of interest concerns that warrant
disclosure of the consultant's selection, terms of engagement or
fees. See Proxy Disclosure Enhancements Release.
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As we noted in the Proposing Release, the trigger for disclosure
about compensation consultants under Section 10C(c)(2) is worded
differently from the existing disclosure trigger under Item
407(e)(3)(iii). Under Section 10C(c)(2), an issuer must disclose
whether the ``compensation committee retained or obtained the advice of
a compensation consultant.'' By contrast, existing Item 407 requires
disclosure, with limited exceptions, whenever a compensation consultant
plays ``any role'' in determining or recommending the amount or form of
executive or director compensation. Given the similarities between the
disclosure required by Section 10C(c)(2) and the disclosure required by
Item 407(e)(3)(iii), we proposed amendments to integrate Section
10C(c)(2)'s disclosure requirements with the existing disclosure rule.
Specifically, as proposed, revised Item 407(e)(3)(iii) would include a
disclosure trigger consistent with the statutory language and would,
therefore, require issuers to disclose whether the compensation
committee had ``retained or obtained'' the advice of a compensation
consultant during the issuer's last completed fiscal year. If so, the
issuer would also be required to provide related disclosures describing
the consultant's assignment, any conflicts of interest raised by the
consultant's work, and how such conflicts were being addressed. In
addition, our proposed rule would alter the existing consultant fee
disclosure requirements to include the same disclosure trigger. We
noted in the Proposing Release that we believed the practical effect of
this change would be minimal, as it would be unusual for a consultant
to play a role in determining or recommending the amount of executive
compensation without the compensation committee also retaining or
obtaining the consultant's advice.
Our proposed integrated disclosure requirement would no longer
provide an exception from the requirement to disclose the role of a
compensation consultant where that role is limited to consulting on any
broad-based plan that does not discriminate in scope, terms or
operation in favor of executive officers or directors of the registrant
and that is available generally to all salaried employees, or limited
to providing information that either is not customized for a particular
issuer or is customized based on parameters that are not developed by
the consultant and about which the consultant does not provide advice.
As we explained in the Proposing Release, we believed this would be
``consistent with the purposes of Section 10C(c)(2), which is to
require disclosure about compensation consultants and any conflicts of
interest they have in a competitively neutral fashion.'' \191\ Under
the proposed amendments, disclosure about the compensation consultant's
role and conflicts of interest would be required even if the consultant
provided only advice on broad-based plans or non-customized benchmark
data. We proposed, however, that the compensation consultant fee
disclosure requirements currently included in Item 407(e)(3) would
continue to include exceptions for cases where a consultant's role is
limited to providing these types of services.
---------------------------------------------------------------------------
\191\ See Proposing Release, 76 FR at 18980.
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In order to clarify certain terms contained in Section 10C(c)(2)
and used in the proposed rules, we proposed to add an instruction to
Item 407(e)(3) to clarify the meaning of the phrase ``obtained the
advice.'' The proposed instruction would provide that a compensation
committee or management will have ``obtained the advice'' of a
compensation consultant if it ``has requested or received advice from a
compensation consultant, regardless of whether there is a formal
engagement of the consultant or a client relationship between the
compensation consultant and the compensation committee or management or
any payment of fees to the consultant for its advice.'' In addition, we
proposed an instruction that identified the five independence factors
that Section 10C requires a listed issuer's compensation committee to
consider before selecting a compensation adviser as among the factors
that issuers should consider in determining whether there is a conflict
of interest that may need to be disclosed.
Finally, under the proposed amendments, these disclosures would be
required only in a proxy or information statement for an annual meeting
(or special meeting in lieu of an annual meeting) at which directors
are to be elected and would apply to issuers subject to our proxy
rules, whether listed or not, and whether they are controlled companies
or not.
2. Comments on the Proposed Rule
Comments on the proposed amendments were mixed, with the exception
of our proposal to require the disclosures called for by Section
10C(c)(2) only in proxy or information statements for meetings at which
directors are to be elected, which commentators generally
supported.\192\
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\192\ See, e.g., letters from ABA, AON and Debevoise.
---------------------------------------------------------------------------
Several commentators expressed general support for our proposal to
require disclosure about compensation consultants' conflicts of
interest.\193\ Some of these commentators noted that timely disclosure
of conflicts is needed to allow investors to adequately monitor
[[Page 38441]]
compensation committee performance.\194\ For this reason, another
commentator noted that disclosure concerning compensation consultant
conflicts of interest ``is most appropriately required in the context
of other corporate governance disclosures that are most relevant in the
context of making voting decisions with respect to the election of
directors.'' \195\
---------------------------------------------------------------------------
\193\ See, e.g., letters from AFSCME, CII, FLSBA, Hermes, OPERS
and UAW.
\194\ See letters from CII and FLSBA.
\195\ See, e.g., letter from ABA.
---------------------------------------------------------------------------
Several commentators expressed general support for integrating the
Section 10C(c)(2) disclosure requirements into the existing
compensation consultant disclosure requirements contained in Item
407(e)(3)(iii) of Regulation S-K.\196\ One of these commentators
believed that a combined rule with a single trigger for disclosure
would benefit issuers and investors by simplifying the disclosure
requirement and enhancing the clarity of the disclosure.\197\ One
commentator opposed integrating the disclosure requirements of Section
10C(c)(2) into Item 407(e)(3)(iii), and believed that a better approach
would be to retain the existing disclosure trigger in Item
407(e)(3)(iii) and include a separate disclosure item within Item 407
to address conflict of interest disclosure requirements.\198\ This
commentator also criticized our proposed amendments because they would
narrow the disclosure currently required by Item 407(e)(3)(iii) by
excluding those compensation consultants that may have participated in
executive compensation determinations but were not actually retained by
the compensation committee.\199\ Another commentator supported our
proposal to integrate the disclosure requirements, but believed it was
unnecessary to modify the wording of Item 407(e)(3)(iii) to include the
``retain or obtain the advice'' disclosure trigger included in the
Act.\200\ This commentator noted that issuers and consulting firms had
already made significant adjustments to their business practices in
light of the existing Item 407(e)(3) requirements and that it would be
costly and unnecessary to make additional adjustments if the wording of
the existing rules is changed simply to mirror the language included in
the Act.\201\
---------------------------------------------------------------------------
\196\ See, e.g., letters from Davis Polk, Debevoise, Meridian,
Pfizer and UAW.
\197\ See letter from Meridian.
\198\ See letter from ABA.
\199\ See id.
\200\ See letter from AON.
\201\ See id.
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A significant number of commentators expressed concern over the
proposed instruction to clarify the phrase ``obtained the advice.''
\202\ These commentators believed that the proposed instruction was too
broad and could potentially cover director education programs,
unsolicited survey results and publications that contain executive
compensation data, which they believed were not intended to be covered
by Section 10C(c)(2).\203\ A number of these commentators recommended
modifications to the instruction, including:
---------------------------------------------------------------------------
\202\ See, e.g., letters from AON, CEC, Davis Polk, Mercer,
Meridian, Pearl Meyer & Partners (``Pearl Meyer''), McGuireWoods,
NACD, Pfizer, SCSGP and Towers.
\203\ See, e.g., letters from Davis Polk, Meridian, NACD and
Towers.
---------------------------------------------------------------------------
Excluding insubstantial or unsolicited interaction with a
compensation committee; \204\
---------------------------------------------------------------------------
\204\ See, e.g., letters from Davis Polk and Meridian.
---------------------------------------------------------------------------
Clarifying that the phrase ``obtained the advice''
excludes materials prepared for management by a compensation consultant
engaged by management, even if such materials are made available to the
compensation committee; \205\ and
---------------------------------------------------------------------------
\205\ See letters from Davis Polk and Towers.
---------------------------------------------------------------------------
Clarifying that ``advice'' has not been obtained unless
the compensation consultant provides a recommendation to the committee
regarding the amount or form of executive compensation.\206\
---------------------------------------------------------------------------
\206\ See letters from Pfizer and SCSGP.
---------------------------------------------------------------------------
A few commentators supported our proposal to require disclosure
about the role of compensation consultants even where that role is
limited to consulting on broad-based plans or providing non-customized
benchmark information.\207\ Many more commentators, however, opposed
eliminating the current disclosure exclusions under Item 407(e)(3) and
recommended that we extend those disclosure exclusions to the new
disclosure requirements.\208\ Some of these commentators noted that,
when the disclosure exemptions in Item 407(e)(3)(iii) were adopted in
December 2009, the Commission stated that consulting on broad-based
plans or providing non-customized benchmark data did not raise conflict
of interest concerns that would warrant disclosure of the consultant's
selection, terms of engagement or fees.\209\ Another commentator
believed that retaining the existing disclosure exclusions in Item
407(e)(3)(iii) would be consistent with the purposes of Section
10C(c)(2) because a consulting firm that provided only non-customized
benchmark data to a compensation committee would not be providing
``advice'' to the compensation committee.\210\
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\207\ See, e.g., letters from AFSCME and UAW.
\208\ See, e.g., letters from ABA, AON, CEC, Davis Polk,
Debevoise, Meridian, SCSGP, Towers and U.S. Chamber of Commerce
(Apr. 28, 2011) (``Chamber'').
\209\ See, e.g., letter from ABA and Davis Polk.
\210\ See letter from SCSGP.
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Commentators generally supported our proposal to identify the five
factors in proposed Rule 10C-1(b)(4)(i) through (v) as among the
factors that should be considered in determining whether a conflict of
interest exists,\211\ though some commentators suggested additional
factors that they believed should be considered.\212\ In the Proposing
Release, we requested comment on whether we should include the
appearance of a conflict of interest in our interpretation of what
constitutes a ``conflict of interest'' that must be disclosed under the
proposed amendments. A few commentators believed that we should require
disclosure of the appearance of a conflict of interest or potential
conflicts of interest.\213\ One of these commentators argued that
including potential conflicts is necessary because actual conflicts of
interest can be difficult to identify with precision.\214\ Other
commentators believed that we should not require disclosure of either
an appearance of a conflict of interest or a potential conflict of
interest, for various reasons, such as: potential conflicts were not
covered by the text of Section 10C(c)(2); \215\ potential conflicts
would be difficult to define and would not provide investors with
additional material information regarding the compensation consultant
relationship; \216\ and compensation committees are not reluctant or
unable to conclude that a conflict of interest exists.\217\
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\211\ See letters from AON and Towers.
\212\ See, e.g., letters from AFSCME (urging consideration of
the ratio between fees paid for executive compensation and non-
executive compensation consulting work, as well as equity ownership
and incentive compensation arrangements of consultants) and Merkl
(urging consideration of private and business relationships between
the person employing the adviser and executive officers or members
of the compensation committee, as well as stock ownership by the
person that employs the adviser, if it is material).
\213\ See letters from Better Markets, OPERS, and Towers.
\214\ See letter from Better Markets.
\215\ See letters from ABA, AON, and Mercer.
\216\ See letter from ABA.
\217\ See letter from AON.
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Many commentators requested that we clarify that the amendments to
Item 407(e)(3)(iii) apply only to board committees that are charged
with determining executive compensation, and not to any committee of
the board, if separate, that oversees the compensation of non-employee
[[Page 38442]]
directors.\218\ Several of these commentators noted that in many
instances, a committee other than the company's compensation committee,
such as a governance committee, determines the compensation of the
company's non-executive directors.\219\
---------------------------------------------------------------------------
\218\ See, e.g., letters from CEC, Chamber, Davis Polk, Pfizer,
and SCSGP.
\219\ See letters from CEC and Chamber.
---------------------------------------------------------------------------
We requested comment on whether we should extend the Section
10C(c)(2) disclosure requirements to compensation advisers other than
compensation consultants. Comments were mixed. A number of commentators
believed we should require conflicts of interest disclosure for all
types of advisers, including legal counsel.\220\ One commentator stated
that extending the disclosure requirements to legal counsel would
benefit the investing public in its consideration of compensation
issues.\221\ Another commentator noted that requiring such disclosure
would allow investors to determine whether the compensation committee
had the benefit of independent legal advice in making compensation
determinations.\222\ Other commentators felt that conflicted
compensation advisers of any kind could not be relied upon to serve the
best interests of the issuer and its shareholders.\223\ Two
commentators opposed extending the proposed disclosure requirements to
legal counsel.\224\ One of these commentators believed that the
specific statutory reference in Section 10C(c)(2) to ``compensation
consultants'' reflects a deliberate policy choice by Congress to limit
the additional required disclosures to compensation consultants
alone.\225\
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\220\ See, e.g., letters from Better Markets, CII, Fields,
FLSBA, Jackson, and Towers.
\221\ See letter from Fields.
\222\ See letter from Jackson.
\223\ See letters from CII and FLSBA.
\224\ See letters from ABA and McGuire Woods.
\225\ See letter from McGuire Woods.
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The proposed rule would apply to issuers that are required to
comply with the proxy rules. One commentator supported our proposal to
require controlled companies to provide disclosures relating to
compensation consultants and conflicts of interest raised by the
consultants' work.\226\ Three commentators were opposed to this
proposed requirement,\227\ and one of them questioned the value of
requiring disclosure of a compensation consultant's conflicts of
interest in cases where the composition of the board of directors and
compensation committee is subject to the direction of a control person
or group.\228\ One commentator supported our proposal to require
smaller reporting companies to provide disclosures relating to
compensation consultant conflicts of interest, noting that ``[w]e are
not aware of any particular problems smaller reporting companies have
had with the existing rules, and we do not believe the additional rules
mandated by Dodd-Frank will be any more burdensome on smaller reporting
companies.'' \229\
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\226\ See letter from AON.
\227\ See letters from ABA, Debevoise, and Merkl.
\228\ See letter from Debevoise.
\229\ See letter from AON.
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We received few comments on our proposal to extend the disclosure
requirements to Exchange Act registrants that are not listed issuers.
Two commentators supported our proposal.\230\ One commentator who
opposed the proposal believed that extending the disclosure
requirements of Section 10C(c)(2) to non-listed issuers is not required
by Section 10C or for the protection of investors.\231\
---------------------------------------------------------------------------
\230\ See letters from AON and Merkl.
\231\ See letter from Debevoise.
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Several commentators agreed that we should not amend Forms 20-F or
40-F to require foreign private issuers that are not subject to our
proxy rules to provide annual disclosure of the type required by
Section 10C(c)(2).\232\ Two of these commentators noted that imposing
such requirements would be inconsistent with the current disclosure
paradigm for compensation matters, which generally defers to a foreign
private issuer's home country rules.\233\ One commentator, however,
expressed the view that foreign private issuers should have to comply
with the same compensation consultant disclosure requirements as
domestic issuers.\234\
---------------------------------------------------------------------------
\232\ See letters from ABA, AON, Debevoise, and SAP.
\233\ See letters from Debevoise and SAP.
\234\ See letter from Merkl.
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3. Final Rule
After consideration of the comments, we are adopting a modified
version of the proposed amendments. The amendments we are adopting
implement the disclosure requirements of Section 10C(c)(2) while
preserving the existing disclosure requirements under Item 407(e)(3).
a. Disclosure Requirements
Rather than integrating the new disclosure requirements with the
existing compensation consultant disclosure provisions, as proposed, we
are retaining the existing disclosure trigger and requirements of Item
407(e)(3)(iii) and adding a new subparagraph to Item 407(e)(3) to
require the disclosures mandated by Section 10C(c)(2)(B). With respect
to Section 10C(c)(2)(A), which requires an issuer to disclose whether
its compensation committee retained or obtained the advice of a
compensation consultant, we believe existing Item 407(e)(3)(iii)
implements this disclosure requirement, as it requires disclosure, with
certain exceptions discussed more fully below, of any role compensation
consultants played in determining or recommending the amount or form of
executive and director compensation. As we noted in the Proposing
Release, we believe it would be unusual for a compensation consultant
to play ``any role'' in determining or recommending the amount of
executive compensation without the compensation committee also
retaining or obtaining the compensation consultant's advice.
With respect to the disclosures mandated by Section 10C(c)(2)(B),
we are persuaded by comments noting that our proposal to use the
``retain or obtain the advice'' disclosure trigger included in Section
10C could result in unnecessary, and potentially costly, adjustments by
issuers and consulting firms that have adapted their business practices
in light of the existing Item 407(e)(3)(iii) disclosure requirements.
In addition, we note the comment pointing out that our proposal would
eliminate the existing requirement to disclose the role of compensation
consultants retained by management rather than the compensation
committee. Consequently, we have concluded that this change to the
existing requirement is not appropriate. In lieu of our proposal to
integrate the Section 10C(c)(2) disclosure requirements with the
existing disclosure rule, we have determined to adopt a new disclosure
provision, new Item 407(e)(3)(iv), to implement Section 10C(c)(2).
Under Item 407(e)(3)(iii), registrants will continue to be required
to disclose ``any role of compensation consultants in determining or
recommending the amount or form of executive and director
compensation.'' Specifically, registrants will continue to be required
to:
Identify the consultants;
State whether such consultants were engaged directly by
the compensation committee or any other person;
Describe the nature and scope of the consultant's
assignment and the material elements of any instructions given to the
consultants under the engagement; and
Disclose the aggregate fees paid to a consultant for
advice or recommendations on the amount or form of executive and
director
[[Page 38443]]
compensation and the aggregate fees for additional services if the
consultant provided both and the fees for the additional services
exceeded $120,000 during the fiscal year.\235\
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\235\ The rule will continue not to require fee disclosure for
compensation consultants that work with management if the
compensation committee has retained a separate compensation
consultant. As we noted in the Proxy Disclosure Enhancements
Release, in this situation, the compensation committee may not be
relying on the compensation consultant retained by management and
potential conflicts of interest are therefore less of a concern.
---------------------------------------------------------------------------
With respect to the new requirement in Item 407(e)(3)(iv) to
disclose compensation consultant conflicts of interest, we have decided
to use the ``any role'' disclosure trigger rather than the ``obtained
or retained the advice'' trigger included in Section 10C. Hence, the
new requirement will apply to any compensation consultant whose work
must be disclosed pursuant to Item 407(e)(3)(iii), regardless of
whether the compensation consultant was retained by management or the
compensation committee or any other board committee. We believe that
this approach is consistent with the meaning of the words ``retained or
obtained'' (emphasis added) in Section 10C, as there will be little
practical difference in the application of the two disclosure triggers
as they relate to consultants advising on executive compensation
matters. Based on the comments on this aspect of the proposal, we also
believe that the existing disclosure trigger is well-understood by
issuers. Because we are not changing the disclosure trigger, we no
longer find it necessary to include an instruction to clarify when a
compensation committee has ``obtained'' advice. We are persuaded by
commentators who expressed the view that the instruction, as proposed,
was overly broad.
As is the case with our existing requirement to disclose the role
of compensation consultants in determining or recommending the amount
or form of executive and director compensation, issuers will be
required to comply with the new disclosure requirement relating to
compensation consultant conflicts of interest in a proxy or information
statement for an annual meeting (or special meeting in lieu of an
annual meeting) at which directors are to be elected. Although Section
10C(c)(2) is not explicitly limited to proxy statements for meetings at
which directors will be elected, we believe this approach is
appropriate in light of the approach in our rules to disclosure of
compensation consultant matters generally.
This new subparagraph will apply to issuers subject to our proxy
rules, including controlled companies, non-listed issuers and smaller
reporting companies.\236\ Although Section 10C(c)(2) does not mandate
this disclosure for issuers that will not be subject to the listing
standards required by Rule 10C-1, we believe that investors are better
served by requiring all issuers subject to our proxy rules to provide
timely disclosure of compensation consultants' conflicts of interests,
which will enable investors to adequately monitor compensation
committee performance and will help investors make better informed
voting decisions with respect to the election of directors, including
members of the compensation committee. Under the final amendments,
issuers subject to our proxy rules will be required to disclose, with
respect to any compensation consultant that is identified pursuant to
Item 407(e)(3)(iii) as having played a role in determining or
recommending the amount or form of executive and director compensation,
whether 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. As commentators generally supported our proposal to
identify the independence factors that a compensation committee must
consider before selecting a compensation adviser as among the factors
that should be considered in determining whether a consultant conflict
of interest exists, the final amendments will include an instruction to
Item 407(e)(3) noting that, in deciding whether there is a conflict of
interest that may need to be disclosed, issuers should, at a minimum,
consider the six factors set forth in Rule 10C-1(b)(4)(i) through (vi).
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\236\ Foreign private issuers that are not subject to our proxy
rules will not be required to provide this disclosure. Registered
investment companies are subject to separate proxy disclosure
requirements set forth in Item 22 of Schedule 14A, which do not
include the compensation consultant disclosure requirement in Item
407(e)(3) of Regulation S-K. See Item 7(g) of Schedule 14A. As we
proposed, registered investment companies will continue to provide
disclosure under Item 22 and will not be subject to the amendments
to Item 407(e) adopted in this release.
---------------------------------------------------------------------------
We are sensitive to the additional burdens placed on issuers from
the expansion of disclosure obligations under our rules. In light of
those concerns, the final rule will not require disclosure of potential
conflicts of interest or an appearance of a conflict of interest, nor
will it require disclosure with respect to compensation advisers other
than compensation consultants. These additional disclosures are not
mandated by Section 10C, and we are not persuaded that the additional
burdens of requiring this disclosure are justified by the potential
benefit to investors.
b. Disclosure Exemptions
We proposed to eliminate the disclosure exemption in Item 407(e)(3)
for compensation consulting services involving only broad-based, non-
discriminatory plans and the provision of non-customized survey data.
Several commentators opposed to the proposed elimination noted that,
when the disclosure exemptions in Item 407(e)(3)(iii) were adopted in
December 2009, we stated that consulting on broad-based plans or
providing non-customized benchmark data did not raise conflict of
interest concerns that would warrant disclosure of the consultant's
selection, terms of engagement, or fees.\237\ We continue to believe
that compensation consulting work limited to these activities does not
raise conflict of interest concerns. Accordingly, consulting on broad-
based plans and providing non-customized benchmark data will continue
to be exempted from the compensation consultant disclosure requirements
under Item 407(e)(3), including the new conflicts of interest
disclosure required in our rules implementing Section 10C(c)(2).
---------------------------------------------------------------------------
\237\ See letters from ABA, Davis Polk and SCSGP.
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c. Disclosure Regarding Director Compensation
Several commentators requested that we clarify that the proposed
amendments to Item 407(e)(3)(iii) apply only to board committees that
are charged with determining executive compensation and not to other
committees that oversee the compensation of non-employee
directors.\238\ We believe these comments were prompted by our
proposal, described above, to replace the existing disclosure trigger
in Item 407(e)(3)(iii) with our proposed trigger, which referenced
compensation consultants retained by the compensation committee. As
discussed above, we have determined to retain the existing disclosure
trigger in Item 407(e)(3), which requires disclosure of the role played
by compensation consultants in determining or recommending ``executive
and director compensation'' (emphasis added).
---------------------------------------------------------------------------
\238\ See, e.g., letters from CEC, Chamber, Davis Polk, Pfizer,
and SCSGP.
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Issuers are currently required to discuss in proxy and information
statements the role played by
[[Page 38444]]
compensation consultants in determining or recommending the amount or
form of director compensation, including the nature and scope of their
assignment and any material instructions or directions governing their
performance under the engagement and to provide fee disclosure, all to
the same extent that the disclosure is required regarding executive
compensation. In light of the approach we are taking to the new
disclosure requirement generally, which is to add the new requirement
to the existing disclosure requirements using the existing triggers, we
believe it is appropriate to apply the compensation consultant conflict
of interest disclosure requirement to director compensation in the same
manner as executive compensation. We believe this will benefit
investors by providing for more complete and consistent disclosures on
how the board manages compensation-related conflicts of interest.
Accordingly, to the extent consulting on director compensation raises a
conflict of interest on the part of the compensation consultant,
disclosure would be required in response to new Item 407(e)(3)(iv).
D. Transition and Timing
The Act did not establish a specific deadline by which the listing
standards promulgated by the exchanges must be in effect. To facilitate
timely implementation of the proposals, we proposed that each exchange
must provide to the Commission, no later than 90 days after publication
of our final rule in the Federal Register, proposed listing rules or
rule amendments that comply with our final rule. Further, we proposed
that each exchange would need to have final rules or rule amendments
that comply with our final rule approved by the Commission no later
than one year after publication of our final rule in the Federal
Register.
Comments were mixed on these proposals. One commentator did not
believe that the 90-day period would afford the exchanges enough time
to draft the proposed rules or rule amendments or to work through
related concerns or issues.\239\ The only comment letter we received
from an exchange, however, indicated that the 90-day period would be
adequate.\240\ The exchange recommended, however, that instead of
obligating exchanges to have rules approved by the Commission within
any set timeframe, we should instead require exchanges to respond to
any written comments issued by the Commission or its staff within 90
days.
---------------------------------------------------------------------------
\239\ See letter from Debevoise.
\240\ See letter from NYSE.
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Two commentators requested that we clarify that the exchanges may
provide their listed issuers a transition period to come into
compliance with the listing standards required by Rule 10C-1.\241\ Two
other commentators requested that the Commission include a transition
period for newly listed issuers directly in Rule 10C-1.\242\ One of
these commentators also recommended a two-year delayed phase-in period
for smaller reporting companies, if they are not exempted entirely from
the compensation committee and independence requirements and consultant
disclosures.\243\ Another commentator requested that we establish a
specific time period by which all listed issuers must comply with an
exchange's new or amended rules meeting the requirements of our final
rules.\244\ This commentator believed that a longer time frame, such as
a year, would give listed issuers sufficient time to comply with the
new standards.
---------------------------------------------------------------------------
\241\ See letters from NYSE and S&C.
\242\ See letters from ABA and Davis Polk.
\243\ See letter from ABA.
\244\ See letter from Debevoise.
---------------------------------------------------------------------------
After consideration of the comments, we are adopting the
implementation period as proposed. We believe that retaining the
requirement for each exchange to have final rules or rule amendments
that comply with our final rule approved by the Commission no later
than one year after publication of our final rule in the Federal
Register will ensure that the exchanges work expeditiously and in good
faith to meet the requirements of the new rule. We also note that Rule
10A-3 included a similar requirement with a significantly shorter
compliance period.\245\ Although the final rule does not provide an
extended transition period for newly listed issuers, we note that the
exemptive authority provided to the exchanges under the final rule
permits them to propose appropriate transition periods. As noted above,
we are exempting smaller reporting companies from the requirements of
Rule 10C-1.
---------------------------------------------------------------------------
\245\ The release adopting Rule 10A-3 was published in the
Federal Register on April 16, 2003. The exchanges were required to
have final rules or rule amendments that complied with Rule 10A-3
approved by the Commission no later than December 1, 2003.
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Section 10C(c)(2) provides that the compensation consultant
conflict of interest disclosure would be required with respect to
meetings occurring on or after the date that is one year after the
enactment of Section 10C, which was July 21, 2011; however, the statute
also requires these disclosures to be ``in accordance with regulations
of the Commission,'' and, prior to the adoption of these new rules, our
regulations have not required such disclosures to be made. We recognize
that issuers will need to implement disclosure controls and procedures
to collect and analyze information relevant to whether their
compensation consultants have a conflict of interest. As a result, we
have decided to require compliance with new Item 407(e)(3)(iv) in any
proxy or information statement for an annual meeting of shareholders
(or a special meeting in lieu of the annual meeting) at which directors
will be elected occurring on or after January 1, 2013.
III. Paperwork Reduction Act
A. Background
Certain provisions of the final rule and rule amendments contain
``collection of information'' requirements within the meaning of the
Paperwork Reduction Act of 1995 (``PRA'').\246\ We published a notice
requesting comment on the collection of information requirements in the
Proposing Release for the rule amendments, and we submitted these
requirements to the Office of Management and Budget (``OMB'') for
review in accordance with the PRA.\247\ The titles for the collection
of information are:
---------------------------------------------------------------------------
\246\ 44 U.S.C. 3501 et seq.
\247\ 44 U.S.C. 3507(d) and 5 CFR 1320.11.
---------------------------------------------------------------------------
(1) ``Regulation 14A and Schedule 14A'' (OMB Control No. 3235-
0059);
(2) ``Regulation 14C and Schedule 14C'' (OMB Control No. 3235-
0057); and
(3) ``Regulation S-K'' (OMB Control No. 3235-0071).\248\
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\248\ The paperwork burden from Regulation S-K is imposed
through the forms that are subject to the disclosure requirements in
Regulation S-K and is reflected in the analysis of these forms. To
avoid a Paperwork Reduction Act inventory reflecting duplicative
burdens, for administrative convenience we estimate the burden
imposed by Regulation S-K to be a total of one hour.
---------------------------------------------------------------------------
Regulation S-K was adopted under the Securities Act and Exchange
Act; Regulations 14A and 14C and the related schedules were adopted
under the Exchange Act. The regulations and schedules set forth the
disclosure requirements for proxy and information statements filed by
companies to help investors make informed investment and voting
decisions. The hours and costs associated with preparing, filing and
sending the schedules constitute reporting and cost burdens imposed by
each collection of information. An agency may not conduct or sponsor,
and a person is not required to respond to,
[[Page 38445]]
a collection of information unless it displays a currently valid OMB
control number. Compliance with the new rule and rule amendments will
be mandatory. Responses to the information collections will not be kept
confidential, and there is no mandatory retention period for the
information disclosed.
B. Summary of the Final Rules
As discussed in more detail above, we are adopting new Rule 10C-1
under the Exchange Act and amendments to Item 407(e)(3) of Regulation
S-K. Rule 10C-1 will direct the exchanges to prohibit the listing of
any equity security of an issuer, subject to certain exceptions, that
is not in compliance with several enumerated standards relating to the
issuer's compensation committee and the process for selecting a
compensation adviser to the compensation committee. Rule 10C-1 will not
impose any collection of information requirements on the exchanges or
on listed issuers.
The amendments to Item 407(e)(3) will require issuers, other than
registered investment companies,\249\ to disclose, in any proxy or
information statement relating to an annual meeting of shareholders (or
a special meeting in lieu of an annual meeting) at which directors are
to be elected, whether the work of any compensation consultant that has
played any role in determining or recommending the amount or form of
executive and director compensation (other than any role limited to
consulting on any broad-based plan that does not discriminate in scope,
terms, or operation, in favor of executive officers of the registrant,
and that is available generally to all salaried employees; or providing
information that either is not customized for a particular registrant
or that is customized based on parameters that are not developed by the
compensation consultant, and about which the compensation consultant
does not provide advice) has raised a conflict of interest. If so, the
issuer must also disclose the nature of the conflict and how the
conflict is being addressed.
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\249\ Registered investment companies are subject to separate
proxy disclosure requirements set forth in Item 22 of Schedule 14A,
which do not include the compensation consultant disclosure
requirement in Item 407(e)(3) of Regulation S-K. See Item 7(g) of
Schedule 14A. As we proposed, registered investment companies will
continue to provide disclosure under Item 22 and will not be subject
to the amendments to Item 407(e) adopted in this release.
---------------------------------------------------------------------------
C. Summary of Comment Letters and Revisions to Proposals
In the Proposing Release, we requested comment on our PRA burden
hour and cost estimates and the analysis used to derive such estimates.
Only one commentator specifically addressed our PRA analysis and burden
estimates of the proposed amendments.\250\ This commentator asserted
that some of the estimates we used to calculate the burden hours of the
proposed amendments may be inaccurate, which could result in our
underestimating the actual burden of the amendments. This commentator,
however, did not provide any alternative burden hour or cost estimates
for us to consider and did not identify any particular estimates
included in the Proposing Release that it believed to be inaccurate.
---------------------------------------------------------------------------
\250\ See letter from Chamber.
---------------------------------------------------------------------------
In response to comments on the proposals, we have made
modifications to the rule proposals that will reduce the compliance
burden on issuers. First, the final rule amendments leave intact the
existing exemption from the requirement to disclose the role of a
compensation consultant where that role is limited to providing advice
on broad-based plans and information that either is not customized for
a particular issuer or is customized based on parameters that are not
developed by the consultant and about which the consultant does not
provide advice. Accordingly, issuers will be required to provide less
disclosure than would have been required under the proposed amendments.
Second, we have retained the existing disclosure trigger in Item
407(e)(3) and eliminated the proposed instruction regarding whether a
compensation committee has ``obtained the advice'' of a compensation
consultant. Based on comments received that issuers are already
familiar with and have adopted business practices to comply with the
existing disclosure trigger, we believe retaining the existing
disclosure trigger will make it easier for issuers to determine whether
conflict of interest disclosure is required for a particular
compensation consultant.
D. Revisions to PRA Reporting and Cost Burden Estimates
As a result of the changes described above, we have reduced our
reporting and cost burden estimates for the collection of information
under the final amendments. The final rule amendments to Item 407(e)(3)
of Regulation S-K will require additional disclosure in proxy or
information statements filed on Schedule 14A or Schedule 14C of whether
the work of a compensation consultant that has played any role in
determining or recommending the amount or form of executive and
director compensation, with certain exceptions, has raised a conflict
of interest, and, if so, the nature of the conflict and how the
conflict is being addressed. The instruction to Item 407(e)(3)(iv)
provides that an issuer, in determining whether there is any such
conflict, should consider the same six independence factors that the
compensation committee of a listed issuer is required to consider
before selecting a compensation adviser. For purposes of the PRA, we
now estimate that the total annual increase in the paperwork burden for
all companies to prepare the disclosure that would be required under
the proposed amendments will be approximately 11,970 hours of in-house
personnel time and approximately $1,596,000 for the services of outside
professionals.\251\ We estimate that the amendments to Item 407(e)(3)
of Regulation S-K would impose on average a total of two incremental
burden hours per issuer. These estimates include the time and the cost
of collecting the required information, preparing and reviewing
responsive disclosure, and retaining records. We continue to believe it
is appropriate to assume that the burden hours associated with the
amendments will be comparable to the burden hours related to similar
disclosure requirements under our current rules regarding compensation
consultants. Our estimates, as well as their reasonableness, were
presented to the public for consideration, and we received no
alternative burden hour or cost estimates in response.\252\
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\251\ Our estimates represent the average burden for all
issuers, both large and small.
\252\ See Proxy Disclosure Enhancements Release (in which the
Commission estimated the average incremental disclosure burden for
the rule amendments to Item 407(e)(3) relating to compensation
consultants to be three hours).
---------------------------------------------------------------------------
The table below shows the total annual compliance burden, in hours
and in costs, of the collection of information pursuant to the final
amendments to Item 407(e)(3) of Regulation S-K.\253\ The burden
estimates were calculated by multiplying the estimated number of
responses by the estimated average amount of time it would take an
issuer to prepare and review the adopted disclosure requirements. The
portion of the burden carried by outside professionals is reflected as
a cost, while the portion of the burden carried by the issuer
internally is reflected in hours. For purposes of the PRA, we estimate
that 75% of the burden of preparation of Schedules 14A and 14C is
carried by
[[Page 38446]]
the issuer internally and that 25% of the burden of preparation is
carried by outside professionals retained by the issuer at an average
cost of $400 per hour. There is no change to the estimated burden of
the collections of information under Regulation S-K because the burdens
that this regulation imposes are reflected in our burden estimates for
Schedules 14A and 14C.
---------------------------------------------------------------------------
\253\ For convenience, the estimated hour and cost burdens in
the table have been rounded to the nearest whole number.
Table 1--Estimated Incremental Paperwork Burden Under the Final Rules for Schedules 14A and 14C
--------------------------------------------------------------------------------------------------------------------------------------------------------
Total
Number of Incremental incremental Internal External Professional
responses (A) burden hours/ burden hours company time professional costs
\254\ form (B) (C)=(A)*(B) (D) time (E) (F)=(E)*$400
--------------------------------------------------------------------------------------------------------------------------------------------------------
Sch. 14A................................................ 7,300 2 14,600 10,950 3,650 $1,460,000
Sch. 14C................................................ 680 2 1,360 1,020 340 136,000
-----------------------------------------------------------------------------------------------
Total............................................... 7,980 .............. 15,960 11,970 3,990 $1,596,000
--------------------------------------------------------------------------------------------------------------------------------------------------------
IV. Economic Analysis
---------------------------------------------------------------------------
\254\ The information in this column is based on the number of
responses for these schedules as reported in the OMB's Inventory of
Currently Approved Information Collections, available at http://www.reginfo.gov/public/do/PRAMain;jsessionid=D37174B5F6F9148DB767D63DF6983A65.
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A. Background and Summary of the Rule Amendments
As discussed above, we are adopting a new rule and rule amendments
to implement Section 10C of the Exchange Act, as added by Section 952
of the Act. Section 10C of the Exchange Act requires us to adopt rules
directing the exchanges to prohibit the listing of any equity security
of an issuer, with certain exceptions, that is not in compliance with
several enumerated standards regarding compensation committees. In
addition, Section 10C(c)(2) requires each listed issuer to disclose in
any proxy or consent solicitation material for an annual meeting of
shareholders (or a special meeting in lieu of the annual meeting), in
accordance with Commission regulations, whether the issuer's
compensation committee retained or obtained the advice of a
compensation consultant; whether 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 rule and
rule amendments we are adopting implement these mandates, and also
include the following provisions:
New Rule 10C-1 will direct the exchanges to adopt listing
standards that apply to any board committee that oversees executive
compensation, whether or not such committee performs other functions or
is formally designated as a ``compensation committee.''
The exchanges will be directed to apply the required
listing standards, other than those relating to the authority to retain
compensation advisers in Rule 10C-1(b)(2)(i) and required funding for
payment of such advisers in Rule 10C-1(b)(3), also to those members of
a listed issuer's board of directors who, in the absence of a board
committee performing such functions, oversee executive compensation
matters on behalf of the board of directors.
With respect to the factors required by Section 10C(b) of
the Exchange Act, we are adopting one additional independence factor
that compensation committees must consider before engaging a
compensation adviser.
An instruction to final Rule 10C-1(b)(4) will provide that
the compensation committee of a listed issuer is not required to
consider the independence factors before consulting with or receiving
advice from in-house counsel.
We are exempting security futures products, standardized
options, and smaller reporting companies from the scope of Rule 10C-1.
For purposes of Rule 10C-1, we are modifying the
definition of a controlled company, which is exempt from Rule 10C-1, to
be a listed company in which more than 50% of the voting power for the
election of directors is held by an individual, a group or another
company, which is consistent with the definition used by the NYSE and
Nasdaq.
The final rules will require the disclosures relating to
compensation consultant conflicts of interest called for by Section
10C(c)(2) only in proxy or information statements for meetings at which
directors are to be elected.
The compensation consultant conflicts of interest
disclosure requirement will apply when a compensation consultant plays
``any role'' in ``determining or recommending the amount or form of
executive and director compensation,'' other than any role limited to
consulting on broad-based plans or providing non-customized benchmark
data, which is consistent with the existing Item 407(e)(3)(iii) of
Regulation S-K standard.
The compensation consultant conflicts of interest
disclosure requirement will apply to all issuers subject to our proxy
rules, including controlled companies, smaller reporting companies and
non-listed issuers.
The compensation consultant conflicts of interest
disclosure requirement will require disclosure of compensation
consultant conflicts of interest that relate to director compensation,
in addition to executive compensation.
The instruction to the compensation consultant conflicts
of interest disclosure requirement provides that an issuer, in
determining whether there is a conflict of interest, should consider
the same six independence factors that the compensation committee of a
listed issuer is required to consider before selecting a compensation
adviser.
We are sensitive to the costs and benefits imposed by our rules.
The discussion below attempts to address both the costs and benefits of
Section 10C, as well as the incremental costs and benefits of the rule
and rule amendments we are adopting within our discretion to implement
Section 10C. These two types of costs and benefits may not be entirely
separable to the extent our discretion is exercised to realize the
benefits that we believe were intended by Section 952 of the Act.
Section 23(a)(2) of the Exchange Act requires us, when adopting rules
under the Exchange Act, to consider the impact that any new rule would
have on competition.\255\ In addition, Section 23(a)(2) prohibits us
from adopting any rule that would impose a burden on competition not
necessary or appropriate in furtherance of the purposes of the Exchange
Act. Section 2(b) of the Securities Act \256\ and Section 3(f) of the
Exchange Act \257\ require us, when engaging in rulemaking where we
[[Page 38447]]
are required to consider or determine whether an action is necessary or
appropriate in the public interest, to consider, in addition to the
protection of investors, whether the action will promote efficiency,
competition and capital formation. We have integrated our consideration
of those issues into this economic analysis.
---------------------------------------------------------------------------
\255\ 15 U.S.C. 78w(a)(2).
\256\ 15 U.S.C. 77b(b).
\257\ 15 U.S.C. 78c(f).
---------------------------------------------------------------------------
In the Proposing Release, we solicited comment on the costs and
benefits of the proposed rules, whether the proposed rule and rule
amendments would place a burden on competition, and the effect of the
proposal on efficiency, competition, and capital formation. Only one
commentator specifically addressed the cost-benefit analysis we
included in the Proposing Release or our analysis of whether the
proposals would burden competition or impact efficiency, competition,
and capital formation.\258\ This commentator argued that the proposals
would impose additional compensation disclosure and director
independence requirements that could be burdensome and result in
additional disclosure of an issuer's use of compensation consultants,
without in every case providing meaningful benefit to issuers or
investors, and that could also confuse investors or deter investors
from ``reading proxy materials by increasing their length and density
without pruning other, less pertinent, or dated disclosures.'' \259\ As
discussed throughout this release, we have made numerous revisions to
the proposed rules in order to address these concerns and reduce
compliance burdens where consistent with investor protection. Other
commentators addressed specific aspects of the proposed rule amendments
that identified possible costs, benefits, or effects on efficiency,
competition or capital formation, which we discuss in more detail
below.
---------------------------------------------------------------------------
\258\ See letter from Chamber.
\259\ Id.
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B. Benefits and Costs, and Impact on Efficiency, Competition and
Capital Formation
1. Section 10C of the Exchange Act, as Added by Section 952 of the Act
New Rule 10C-1 implements the listing standard requirements of
Section 10C by directing the exchanges to prohibit the listing of any
equity security of an issuer that is not in compliance with the
following standards:
Each member of the compensation committee of the issuer
must be a member of the issuer's board of directors and independent
according to independence criteria determined by each exchange
following consideration of specified factors;
The compensation committee of each issuer must be directly
responsible for the appointment, compensation, retention and oversight
of the work of any compensation adviser retained by the committee, and
each such compensation adviser must report directly to the compensation
committee;
Each compensation committee must have the authority to
retain independent legal counsel and other compensation advisers;
The compensation committee of each issuer may select a
compensation adviser only after assessing the adviser's independence
using specified factors; and
Each issuer must provide appropriate funding, as
determined by the compensation committee, for payment of reasonable
compensation to compensation advisers retained by the compensation
committee.
Under the final rule, subject to our review in accordance with
Section 19(b) of the Exchange Act, an exchange may exempt any category
of issuers from the compensation committee listing requirements and any
particular relationships from the compensation committee member
independence requirements, as the exchange determines is appropriate,
after consideration of the impact of the requirements on smaller
reporting issuers and other relevant factors.
The rules we are adopting are intended to benefit both issuers and
investors. The final rules are expected to help achieve Congress's
intent that listed issuers' board committees that set compensation
policy consist only of directors who are independent. By requiring
compensation committees to consider the independence of potential
compensation advisers before they are selected, the final rules should
also help assure that compensation committees of affected listed
issuers are better informed about potential conflicts, which could
reduce the likelihood that they are unknowingly influenced by
conflicted compensation advisers. The provisions of the listing
standards that will require compensation committees to be given the
authority to engage, oversee and compensate independent compensation
advisers should bolster the access of board committees of affected
listed issuers that are charged with oversight of executive
compensation to the resources they need to make better informed
compensation decisions. Taken as a whole, these requirements could
benefit issuers and investors to the extent they enable compensation
committees to make better informed decisions regarding the amount or
form of executive compensation.
The listing standard provisions of the rule and rule amendments
will also result in certain costs to exchanges and affected listed
issuers. Final Rule 10C-1 directs the exchanges to prohibit the listing
of any equity security of an issuer that is not in compliance with
Section 10C's compensation committee and compensation adviser
requirements. Exchanges will incur direct costs to comply with the
rule, as they will need to review their existing rules and propose
appropriate rule changes to implement the requirements of Rule 10C-1.
Once the exchanges have adopted listing standards required by Rule 10C-
1, listed issuers will incur costs in assessing and demonstrating their
compliance with the new listing standards. We note that these costs are
primarily imposed by statute.
The adoption of new listing standards may have some distributional
effects as some listed issuers may seek to list on foreign exchanges or
other markets to avoid compliance with listing requirements that an
exchange develops. To the extent they do so, listed issuers would incur
costs in seeking to transfer their listings, and exchanges that lose
issuer listings would, as a result, lose related fees and trading
volume. We believe that any such effect would be minimal as the
exchanges already require directors on compensation committees or
directors determining or recommending executive compensation matters
for domestic issuers to be ``independent'' under their general
independence standards.\260\
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\260\ See, e.g., NYSE Listed Company Manual Section 303A.05(a)
and Nasdaq Rule 5605(d). Foreign private issuers are permitted under
these listing standards to follow home country practice with respect
to executive compensation oversight.
---------------------------------------------------------------------------
As required by Section 10C, Rule 10C-1 directs the exchanges to
develop a definition of independence applicable to compensation
committee members after considering the relevant factors set forth in
Exchange Act Section 10C(a)(3). These factors include:
A director's source of compensation, including any
consulting, advisory or compensatory fee paid by the issuer; and
whether a director is affiliated with the issuer, a
subsidiary of the issuer, or an affiliate of a subsidiary of the
issuer.
We are not adopting any additional factors that the exchanges must
consider in determining independence requirements for compensation
committee members. Instead, Rule 10C-1 affords the exchanges latitude
in
[[Page 38448]]
determining the required independence standards. Several commentators
indicated that the proposed rule would permit the exchanges to
determine listing standards that take into account the characteristics
of each exchange's listed issuers.\261\ We believe that affording the
exchanges flexibility in determining the required independence
standards, subject to our review pursuant to Section 19(b) of the
Exchange Act, will result in more efficient and effective
determinations as to the types of relationships that should preclude a
finding of independence with respect to membership on a board committee
that oversees executive compensation. We believe that because listed
issuers frequently consult the exchanges regarding independence
determinations, the exchanges will be in the best position to identify
the types of relationships that are likely to compromise the ability of
an issuer's compensation committee to make impartial determinations on
executive compensation.
---------------------------------------------------------------------------
\261\ See letters from ABA and NYSE.
---------------------------------------------------------------------------
We acknowledge, however, that because exchanges compete for
listings, they may have an incentive to propose standards that issuers
will find less onerous. This could affect investor confidence in the
degree of independent oversight of executive compensation at issuers
listed on exchanges with less onerous standards and could also result
in costs to exchanges that adopt relatively more rigorous standards, to
the extent they lose issuer listings as a result.
In accordance with Section 10C(a)(1), Rule 10C-1(b)(1)(iii) exempts
limited partnerships, companies in bankruptcy proceedings, registered
open-end management investment companies and foreign private issuers
that provide annual disclosures to shareholders of the reasons why the
foreign private issuer does not have an independent compensation
committee from the compensation committee member independence listing
standards required under Rule 10C-1(a). With respect to the
independence requirements of Rule 10C-1, we have not provided any
exemptions for categories of issuers beyond those specified in Section
10C(a)(1). The final rule, however, exempts smaller reporting
companies, controlled companies, security futures products and
standardized options from all of the requirements of Rule 10C-1,
including the independence requirements. Under Rule 10C-1, exchanges
are provided the authority to propose additional exemptions for
appropriate categories of issuers. An exchange that exercises this
authority will incur costs to evaluate what exemptions to propose and
to make any required rule filings pursuant to Section 19(b) of the
Exchange Act.
We are implementing the disclosure requirements of Section 10C by
adopting amendments to Item 407(e)(3) of Regulation S-K. Given the
number of discretionary choices that we have made in implementing this
provision of Section 10C, we discuss the amendments to Item 407 as a
whole below.
2. Discretionary Amendments
As adopted, new Rule 10C-1 will direct the exchanges to adopt
listing standards that apply to any committee of the board that
oversees executive compensation, whether or not such committee performs
other functions or is formally designated as a ``compensation
committee.'' Some exchange listing standards currently require issuers
to form compensation or equivalent committees, and others permit
independent directors to oversee specified compensation matters in lieu
of the formation of a compensation or equivalent committee. The final
rule will also direct the exchanges to apply the required listing
standards relating to director independence, consideration of a
compensation adviser's independence and responsibility for the
appointment, compensation and oversight of compensation advisers to
those members of a listed issuer's board of directors who, in the
absence of a board committee performing such functions, oversee
executive compensation matters on behalf of the board of
directors.\262\ Several commentators supported our proposal to apply
the Section 10C requirements to all board committees that oversee
executive compensation, and also recommended that the requirements also
apply to those independent directors who oversee executive compensation
in lieu of a board committee.\263\ We believe these aspects of the rule
will help achieve the objectives of the statute and benefit listed
issuers by providing clarity and reducing any uncertainty about the
application of Section 10C. Moreover, this should benefit investors
because it will limit the ability of listed issuers to avoid the
compensation committee independence requirements under Section 10C
simply by delegating oversight of executive compensation to a board
committee that is not formally designated as the ``compensation
committee,'' but performs that function or to directors acting outside
of a formal committee structure.
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\262\ With respect to these aspects of the rule, we have defined
``compensation committee'' to include those board members who
oversee executive compensation matters on behalf of the board of
directors in the absence of a board committee. In our discussion of
the final rule throughout this release, references to an issuer's
``compensation committee'' include, unless the context otherwise
requires, any committee of the board that performs functions
typically performed by a compensation committee, including oversight
of executive compensation, whether or not formally designated as a
``compensation committee,'' as well as, to the extent applicable,
those members of a listed issuer's board of directors who oversee
executive compensation matters on behalf of the board of directors
in the absence of such a committee.
\263\ See, e.g., letters from Barnard, CFA and Railpen.
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If we did not apply Rule 10C-1 to apply the requirements relating
to director independence, consideration of the independence of
compensation advisers and responsibility for the appointment,
compensation and oversight of compensation advisers to directors who
oversee executive compensation matters in the absence of a board
committee, issuers could be incentivized to seek to list on exchanges
that do not require the formation of a compensation or equivalent
committee in order to avoid having to comply with the compensation
committee independence standards that would otherwise apply. Our
decision to apply the requirements relating to director independence,
consideration of the independence of compensation advisers and
responsibility for the appointment, compensation and oversight of
compensation advisers to these directors should minimize any such
incentive. As a result, we believe this application also minimizes any
potential costs that issuers might incur to alter their existing
committee structure or seek to list on a different exchange to avoid
having to comply with the new standards, as well as any related costs
that exchanges would incur from any resulting loss of issuer listings,
related fees, and trading volume. These impacts may not be significant,
however, since the exchanges' existing requirements already impose
independence requirements on directors who oversee executive
compensation matters. Finally, we note that, in overseeing executive
compensation matters, these independent directors are acting as the
board of directors, and the same board processes that attend to other
types of board decisions--e.g., scheduling meetings, preparing review
materials, attending meetings, preparing and reviewing meeting
minutes--also presumably attend to board decisions about executive
compensation. Accordingly, we do not believe that the application of
the requirements relating
[[Page 38449]]
to director independence, consideration of the independence of
compensation advisers and responsibility for the appointment,
compensation and oversight of compensation advisers to directors who
oversee executive compensation matters in the absence of a board
committee will result in any disproportionate incremental burdens for
issuers that do not have a compensation committee or any other board
committee that oversees executive compensation.
As required by Section 10C(g), controlled companies are exempt from
all requirements of Rule 10C-1 pursuant to final Rule 10C-1(b)(5)(ii).
Rule 10C-1 as adopted includes a slightly broader definition of
``controlled company'' than the definition provided in Section 10C.
Under Section 10C(g)(2) of the Exchange Act, a ``controlled company''
is defined as an issuer that is listed on an exchange and that holds an
election for the board of directors of the issuer in which more than
50% of the voting power is held by an individual, a group or another
issuer. We proposed to incorporate this definition into Rule 10C-
1(c)(2). In response to comments that our proposed definition would not
exempt listed issuers that would otherwise be controlled companies but
for the fact that they do not hold director elections,\264\ we have
removed from the definition the phrase ``holds an election for the
board of directors'' in order to align the definition in Rule 10C-1
more closely to the definition of controlled company currently used by
the NYSE and Nasdaq. This change will eliminate any unnecessary
compliance burdens for listed issuers that do not hold director
elections but satisfy the definition of ``controlled company'' pursuant
to listing standards of the NYSE, Nasdaq and other exchanges with a
similar definition.
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\264\ See letter from V&E.
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Under Rule 10C-1(b)(4), the exchanges are directed to adopt listing
standards that require a compensation committee to take into account
the five independence factors enumerated in Section 10C(b)(2) before
selecting a compensation adviser. In addition to these five factors, we
are including in the final rule one additional independence factor that
must be considered before a compensation adviser is selected: any
business or personal relationships between the executive officers of
the issuer and the compensation adviser or the person employing the
adviser. Several commentators supported requiring compensation
committees to consider any business or personal relationship between an
executive officer of the issuer and an adviser or the person employing
the compensation adviser.\265\ This would include, for example,
situations where the chief executive officer of a listed issuer and the
compensation adviser have a familial relationship or where the chief
executive officer and the compensation adviser (or the adviser's
employer) are business partners. We agree with commentators that such
relationships would be relevant to an assessment of the independence of
the compensation adviser and believe that adding this factor
complements the five independence factors enumerated in Section
10C(b)(2). Adding this factor should help compensation committees reach
better informed decisions in selecting compensation advisers since any
business or personal relationship that a compensation adviser, or the
person employing the adviser, may have with an executive officer may be
relevant to assessing whether there is a conflict of interest. Section
10C(b) mandates that the independence factors to be considered must be
competitively neutral among categories of compensation advisers and
that compensation committees must be able to retain the services of
members of any such category. We believe that the six factors included
in the final rule, when considered as a whole, are competitively
neutral and that this requirement will therefore not inhibit
competition among categories of compensation advisers.
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\265\ See, e.g., letters from ABA, Better Markets, Merkl and
USS.
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We have included an instruction to Rule 10C-1(b)(4) that provides
that the compensation committee of a listed issuer is not required to
consider the independence factors with respect to in-house counsel with
whom the compensation committee consults or obtains advice. Several
commentators noted that, as in-house legal counsel are employees of the
issuer, they are not held out to be independent.\266\ As such, the
benefits of requiring the compensation committee to consider the
independence factors with respect to in-house counsel would seem to be
minimal. We do not believe that our determination to exclude in-house
counsel from this required consideration will negatively impact
competition among compensation advisers, as we do not believe
compensation committees consider that in-house counsel serve in the
same role as a compensation consultant or outside legal counsel.
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\266\ See letters from Davis Polk and S&C.
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As adopted, the final rule exempts security futures products and
standardized options from the scope of Rule 10C-1. We believe that
exempting security futures products and standardized options is
appropriate because these securities are fundamentally different than
the equity securities of an operating company. This exemption will
benefit the issuers of these securities and the exchanges on which such
securities trade by providing clarity and eliminating any regulatory
uncertainty about the application of Section 10C to these products.
In addition, we are exempting smaller reporting companies from the
requirements of Rule 10C-1. We appreciate that the burdens of complying
with the listing standards mandated by Rule 10C-1 for listed smaller
reporting companies may not be significant given that such issuers are
already subject to listing standards requiring directors on
compensation committees or directors determining or recommending
executive compensation matters to be ``independent'' under the
exchanges' general independence standards. We do believe, however, that
exempting smaller reporting companies from the listing standards
mandated by Rule 10C-1 can offer cost savings to these issuers to the
extent that an exchange, in connection with the listing standards
review required by Rule 10C-1, chooses to create a new independence
standard for compensation committee members that is more rigorous than
its existing standards--for example, a new standard could address
personal or business relationships between members of the compensation
committee and the listed issuer's executive officers. Issuers subject
to the exchange's new standard may need to replace existing
compensation committee members, and incur the associated costs, if they
do not qualify as independent under the new standard. In addition,
although listed smaller reporting companies do not often engage outside
compensation consultants, there would be cost savings to these listed
issuers from not having to comply with the listing standards involving
the compensation committee's engagement and oversight of compensation
advisers. For example, the exchanges are required to adopt listing
standards that require the compensation committee to consider the six
independence factors listed in Rule 10C-1(b)(4) before selecting a
compensation adviser. To comply with these listing standards,
compensation committees will likely need to create
[[Page 38450]]
procedures for collecting and analyzing information about potential
compensation advisers before they can receive advice from such
advisers, which would require the listed issuers to incur costs. We
expect, however, that a portion of these cost savings would likely be
offset by the costs that smaller reporting companies may incur in order
to comply with the new disclosure requirements in Item 407(e)(3)(iv) of
Regulation S-K relating to compensation consultants' conflicts of
interest.
We are adopting amendments to Item 407(e)(3) of Regulation S-K to
implement the disclosure requirements of Section 10C(c)(2). Under these
amendments, issuers subject to our proxy rules will be required to
disclose whether the work of any compensation consultant that has
played any role in determining or recommending the form or amount of
executive and director compensation has raised a conflict of interest,
and, if so, the nature of the conflict and how the conflict is being
addressed. Issuers subject to our existing proxy disclosure rules must
already discuss the role played by compensation consultants in
determining or recommending the amount or form of executive and
director compensation, including the nature and scope of their
assignment and any material instructions or directions governing their
performance under the engagement. The current item excludes from the
disclosure requirement any role of compensation consultants limited to
consulting on any broad-based plan that does not discriminate in scope,
terms or operation in favor of executive officers or directors of the
registrant and that is available generally to all salaried employees,
or limited to providing information that either is not customized for a
particular registrant or is customized based on parameters that are not
developed by the compensation consultant, and about which the
compensation consultant does not provide advice. We believe the
amendments complement our existing disclosure requirements by
increasing the transparency of issuers' policies regarding compensation
consultant conflicts of interest for all issuers subject to the
existing disclosure requirement.
The final amendments preserve the existing disclosure requirements
under Item 407(e)(3), including the disclosure trigger in Item
407(e)(3)(iii) of ``any role'' played by the consultant and the
disclosure exemption for compensation consulting services involving
only broad-based, non-discriminatory plans and the provision of non-
customized survey data. Some commentators suggested that retaining the
existing disclosure trigger in Item 407(e)(3)(iii) and including a
separate disclosure item within Item 407 to address the conflict of
interest disclosure requirements of Section 10C(c)(2)(B) would be the
better approach to implement Section 10C(c)(2) requirements.\267\
Additionally, commentators contended that eliminating the disclosure
exemptions in Item 407(e)(3)(iii) would be inconsistent with our past
determination that consulting on broad-based plans or providing non-
customized benchmark data did not raise conflict of interest concerns
that warrant disclosure of the consultant's selection, terms of
engagement or fees.\268\ We agree with these commentators and believe
that the amendment to Item 407(e)(3) that we are adopting, which
retains the existing disclosure exemptions, is the better approach to
implementing Section 10C(c)(2)'s requirements. By retaining the
existing disclosure trigger and disclosure exemptions under Item
407(e)(3)(iii), the final amendments will require disclosure of
conflicts of interest only when a compensation consultant's role is
otherwise required to be disclosed. We believe this will promote
efficiency by mitigating an issuer's compliance burden in situations
where a compensation consultant does not provide ``analytical input,
discretionary judgment or advice.'' \269\
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\267\ See, e.g., letter from ABA.
\268\ See letters from ABA, Chamber and SCSGP.
\269\ See letter from SCSGP.
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To promote comprehensive disclosure about compensation consultants,
the amendments to Item 407(e)(3) extend the disclosure requirements of
Section 10C(c)(2) to proxy and information statements where action is
to be taken with respect to an election of directors, as well as to
conflicts of interests for compensation consultants who play any role
in determining or recommending the amount or form of director
compensation. Existing Item 407(e)(3) already requires these proxy and
information statements to include disclosure about any role of
compensation consultants in determining or recommending the amount or
form of executive compensation and director compensation, including the
nature and scope of their assignment, any material instructions or
directions governing their performance under the engagement, and
specified information with respect to fees paid to the compensation
consultants.
Several commentators supported applying the new disclosure
requirements to all Exchange Act issuers subject to our proxy
rules.\270\ However, other commentators believed that this is not
required by Section 10C and opposed extending the disclosure
requirements to non-listed issuers.\271\ We are expanding the statutory
disclosure requirement to those categories of issuers that will not be
subject to the listing standards adopted by the exchanges pursuant to
Rule 10C-1, including non-listed issuers, smaller reporting companies
and controlled companies, because we believe that timely disclosure of
compensation consultants' conflicts of interests will enable investors
in these categories of issuers to better monitor compensation committee
performance and will help investors make better informed voting
decisions with respect to the election of directors, including members
of the compensation committee. In addition, this would promote
consistent disclosure on these topics among reporting companies and
should benefit investors by fostering comparability of disclosure of
compensation practices across companies.
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\270\ See, e.g., letters from AON and Merkl.
\271\ See letter from Debevoise.
---------------------------------------------------------------------------
Non-listed issuers, smaller reporting companies and controlled
companies may incur additional costs to develop more formalized
selection processes than they otherwise would have absent such a
disclosure requirement. For example, even though they will not be
subject to the listing standard requiring compensation committees to
consider independence factors before selecting a compensation adviser,
in light of this disclosure requirement, at the time any compensation
consultant is selected, compensation committees of non-listed issuers,
smaller reporting companies and controlled companies may devote time
and resources to analyzing and assessing the independence of the
compensation consultant and addressing and resolving any conflicts of
interest.\272\ Although the disclosure
[[Page 38451]]
requirement does not prohibit a compensation committee from selecting a
compensation consultant of its choosing, some committees may elect to
engage new, alternative or additional compensation consultants after
considering what disclosure might be required under our final rules.
Such decisions could result in additional costs to issuers, including
costs related to termination of existing services and search and
engagement costs to retain new consultants. In addition, costs may
increase if an issuer decides to engage multiple compensation
consultants for services that had previously been provided by a single
consultant. We believe these potential costs are likely to be limited
because our existing disclosure rules already require disclosure of any
role played by compensation consultants in determining or recommending
the amount or form of executive and director compensation, including
the nature and scope of their assignment, any material instructions or
directions governing their performance under the engagement, and
specified information with respect to fees paid to the compensation
consultants. To the extent the new requirement to disclose compensation
consultant conflicts of interest results in an issuer significantly
modifying its consultant selection processes, we believe it would also
likely result in such issuer making better-informed choices regarding
compensation consultant selection.
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\272\ For purposes of the PRA, we estimated that the total
annual increase in the paperwork burden for all companies to prepare
the disclosure that would be required under the proposed amendments
will be approximately 11,970 hours of in-house personnel time and
approximately $1,596,000 for the services of outside professionals.
One commentator asserted that some of the estimates we used to
calculate the burden hours of the proposed amendments may be
inaccurate, which could result in our underestimating the PRA burden
of the final amendments. See letter from Chamber. As described in
the discussion of the PRA, we received no alternative paperwork
burden hour or cost estimates in response to our estimate of the
paperwork burden in the Proposing Release. We believe our reduced
paperwork burden estimate is reasonable in light of the
modifications we have made to the proposals to reduce the compliance
burden on issuers.
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To the extent that providing advice on director compensation raises
a conflict of interest on the part of a compensation consultant,
disclosure would be required in response to new Item 407(e)(3)(iv).
Issuers are currently required to discuss in proxy and information
statements the role played by compensation consultants in determining
or recommending the amount or form of director compensation to the same
extent that the disclosure is required regarding executive
compensation. In light of the approach we are taking to the new
disclosure requirement generally, which is to add the new requirement
to the existing disclosure requirements using the existing triggers, we
determined that the compensation consultant conflict of interest
disclosure requirement should apply to director compensation in the
same manner as executive compensation. We believe this will benefit
investors by providing for more complete and consistent disclosures on
how the board manages compensation-related conflicts of interest.
The amendments to Regulation S-K may promote efficiency and
competitiveness of the U.S. capital markets by increasing the
transparency of executive compensation decision-making processes.
Increased transparency may improve the ability of investors to make
better informed voting and investment decisions, which may encourage
more efficient capital allocation and formation. Some commentators
asserted that the increased disclosure should improve the ability of
investors to monitor performance of directors responsible for
overseeing compensation consultants, thus enabling them to make more
informed voting and investment decisions.\273\
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\273\ See, e.g., letters from CalSTRS and FLSBA.
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The amendments also may affect competition among compensation
consultants. By requiring disclosure of the existence of compensation
consultant conflicts of interest and how those conflicts of interest
are addressed, the new disclosure requirement may lead compensation
committees to engage in more thorough and deliberative analyses of
adviser independence. This could result in the selection of
compensation advisers that are more independent or impartial than might
otherwise be chosen, which, in turn, could promote more effective
executive compensation practices. The amendments may also incentivize
compensation consultants to adopt policies that serve to minimize any
conflicts of interest and for compensation committees to avoid hiring
consultants perceived as having a conflict of interest.
V. Final Regulatory Flexibility Act Analysis
This Final Regulatory Flexibility Analysis (``FRFA'') has been
prepared in accordance with the Regulatory Flexibility Act.\274\ This
FRFA relates to new Exchange Act Rule 10C-1, which will require the
exchanges to prohibit the listing of an equity security of an issuer
that is not in compliance with several enumerated requirements relating
to the issuer's compensation committee, and to amendments to Item
407(e)(3) of Regulation S-K, which will require new disclosure from
issuers regarding any conflict of interest raised by the work of a
compensation consultant that has played a role in determining or
recommending the form or amount of executive and director compensation.
---------------------------------------------------------------------------
\274\ 5 U.S.C. 603.
---------------------------------------------------------------------------
A. Need for the Amendments
We are adopting the new rule and rule amendments to implement
Section 10C of the Exchange Act. Exchange Act Rule 10C-1 directs the
exchanges to prohibit the listing of the equity securities of any
issuer that does not comply with Section 10C's compensation committee
and compensation adviser requirements. The amendments to Regulation S-K
will require issuers to provide certain disclosures regarding their use
of compensation consultants and how they address compensation
consultant conflicts of interest.
B. Significant Issues Raised by Public Comments
In the Proposing Release, we requested comment on any aspect of the
IRFA, including the number of small entities that would be affected by
the proposed rules, the nature of the impact, how to quantify the
number of small entities that would be affected, and how to quantify
the impact of the proposed rule and amendments. We did not receive
comments specifically addressing the IRFA. However, some commentators
addressed aspects of the proposed rules that could potentially affect
small entities. In particular, one commentator expressed concern that
smaller issuers may experience difficulty in locating qualified
candidates to serve on compensation committees who could meet the
independence standards that will be developed by the exchanges.\275\
This commentator advocated that smaller companies should be exempted
from all or parts of the amendments.
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\275\ See letter from ABA.
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C. Small Entities Subject to the Final Rules
The final rules will affect some companies that are small entities.
The Regulatory Flexibility Act defines ``small entity'' to mean ``small
business,'' ``small organization,'' or ``small governmental
jurisdiction.'' \276\ The Commission's rules define ``small business''
and ``small organization'' for purposes of the Regulatory Flexibility
Act for each of the types of entities regulated by the Commission.
Exchange Act Rule 0-10(e) \277\ provides that the term ``small
business'' or ``small organization,'' when referring to an exchange,
means any exchange that: (1) Has been exempted from the reporting
requirements of Exchange Act Rule
[[Page 38452]]
601; \278\ and (2) is not affiliated with any person (other than a
natural person) that is not a small business or small organization, as
defined under Exchange Act Rule 0-10. No exchanges are small entities
because none meet these criteria. Securities Act Rule 157 \279\ and
Exchange Act Rule 0-10(a) \280\ define a company, other than an
investment company, to be a ``small business'' or ``small
organization'' if it had total assets of $5 million or less on the last
day of its most recent fiscal year. The final rules will affect small
entities that have a class of equity securities that are registered
under Section 12 of the Exchange Act. We estimate that there are
approximately 457 such registrants, other than registered investment
companies, that may be considered small entities. An investment
company, including a business development company, is considered to be
a ``small business'' if it, together with other investment companies in
the same group of related investment companies, has net assets of $50
million or less as of the end of its most recent fiscal year.\281\ We
believe that the amendments to Regulation S-K will affect some small
entities that are business development companies that have a class of
securities registered under Section 12 of the Exchange Act. We estimate
that there are approximately 28 business development companies that may
be considered small entities.
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\276\ 5 U.S.C. 601(6).
\277\ 17 CFR 240.0-10(e).
\278\ 17 CFR 242.601.
\279\ 17 CFR 230.157.
\280\ 17 CFR 240.0-10(a).
\281\ 17 CFR 270.0-10(a).
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D. Reporting, Recordkeeping and Other Compliance Requirements
Under new Exchange Act Rule 10C-1, the exchanges will be directed
to prohibit the listing of an equity security of an issuer that is not
in compliance with Section 10C's compensation committee and
compensation adviser requirements. These requirements relate to:
The independence of compensation committee members;
The authority of the compensation committee to retain
compensation advisers;
The compensation committee's responsibility to assess
factors that affect the independence of compensation advisers before
their selection by the compensation committee; and
The compensation committee's responsibility for the
appointment, compensation, and oversight of the work of compensation
advisers retained by the compensation committee; and funding for
consultants and other advisers retained by the compensation committee.
Rule 10C-1 will not impose any reporting or recordkeeping
obligations on the exchanges, or any issuers with equity securities
listed on an exchange. Furthermore, the rule does not require a listed
issuer to establish or maintain a compensation committee. As discussed
in more detail below, we have exempted smaller reporting companies from
the requirements of Rule 10C-1. We do not believe the new rule will
have a significant impact on small entities because the listing
requirements will apply only to issuers that have equity securities
listed on an exchange and that are not smaller reporting
companies.\282\ All of the exchanges generally impose a combination of
quantitative requirements such as market capitalization, minimum
revenue, and shareholder equity thresholds that an issuer must satisfy
in order to be listed on the exchange. Consequently, the substantial
majority of small entities are not listed on an exchange but are quoted
on the OTC Bulletin Board or the OTC Markets Group.\283\ Rule 10C-1
will not apply to the OTC Bulletin Board or the OTC Markets Group, and
therefore small entities whose securities are quoted on these
interdealer quotation systems would not need to comply with any listing
standards developed under the rule by the exchanges. Small entities
that are listed on an exchange and that are not smaller reporting
companies would generally need to comply with the standards adopted by
the exchange pursuant to Rule 10C-1 if they wish to have their equity
securities listed on the exchange. Small entities subject to these
listing standards may need to spend additional time and incur
additional costs to comply with these standards. Consistent with
Section 10C(f)(3), the final rule will allow the exchanges flexibility
to propose exemptions for small entities, subject to our review and
approval under the Exchange Act Section 19(b) rule filing process.
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\282\ Based on data obtained from the Thomson Financial's
Worldscope database, we estimate that as of December 31, 2010, there
were two exchange-listed small entities that would not qualify as a
smaller reporting company.
\283\ Based on information retrieved from the Thomson
Financial's Worldscope database, we estimate that as of December 31,
2010, there were less than twelve issuers that had total assets of
$5 million or less listed on an exchange.
In 2011, the Commission approved a proposal from NASDAQ OMX BX
to create a new listing market, the BX Venture Market, which allows
issuers meeting minimal quantitative requirements--including those
with fewer than $5 million in assets--to list on that exchange. A BX
Venture Market-listed company is required to meet qualitative
requirements that are, in many respects, similar to those required
for listing on Nasdaq or other exchanges, including a requirement to
have independent directors make decisions regarding the compensation
of executive officers. See Self-Regulatory Organizations; NASDAQ OMX
BX, Inc.; Order Granting Approval of Proposed Rule Change and
Amendment No. 1 Thereto and Notice of Filing and Order Granting
Accelerated Approval to Amendment No. 2 Thereto to Create a Listing
Market on the Exchange, Release No. 34-64437 (May 6, 2011) [76 FR
27710]. We understand that this new market has not yet listed any
issuers or become operational. Small entities eligible to list on
this market that are not smaller reporting companies would be
subject to the listing standards required by Rule 10C-1.
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The amendments to Item 407(e)(3) of Regulation S-K will impose some
reporting and recordkeeping obligations on small entities. Under the
amendments, an issuer will be required to disclose whether the work of
any compensation consultant that has played a role in determining or
recommending the amount or form of executive and director compensation
has raised any conflict of interest and, if so, the nature of the
conflict and how the conflict is being addressed. This disclosure
requirement will apply equally to both large and small issuers. One
commentator has noted that many small entities do not use the services
of a compensation consultant,\284\ which should significantly minimize
the impact of the reporting and recordkeeping requirements under the
amendments on small entities.
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\284\ See letter from ABA.
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E. Agency Action to Minimize Effect on Small Entities
The Regulatory Flexibility Act directs us to consider alternatives
that would accomplish our stated objectives, while minimizing any
significant adverse impact on small entities. In connection with the
proposals, we considered the following alternatives:
Establishing different compliance or reporting
requirements or timetables that take into account the resources
available to small entities;
Clarifying, consolidating or simplifying compliance and
reporting requirements under the rules for small entities;
Using performance rather than design standards; and
Exempting small entities from all or part of the
requirements.
In connection with Exchange Act Rule 10C-1, we considered, but did
not establish, different compliance requirements, or an exemption, for
small entities. As noted above, very few small entities list their
securities on an exchange. The substantial majority of small entities
with publicly held equity
[[Page 38453]]
securities are quoted on the OTC Bulletin Board and the OTC Markets
Group. As these interdealer quotation systems are not affected by Rule
10C-1, the substantial majority of small entities will not be affected
by the requirements under the rule.
In addition, we are providing an exemption from the requirements in
Rule 10C-1 for smaller reporting companies. We estimate that as of
December 31, 2010, the most recent data available, most of the small
entities that were listed on an exchange would qualify as a smaller
reporting company.\285\ Smaller reporting companies that are listed on
an exchange are already subject to listing standards requiring
directors on compensation committees or directors determining or
recommending executive compensation matters to be ``independent'' under
the exchanges' general independence standards. Accordingly, we do not
believe that the additional burdens of complying with Rule 10C-1 are
warranted for smaller reporting companies.
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\285\ Based on data obtained from the Thomson Financial's
Worldscope database, we estimate that as of December 31, 2010, there
were two exchange-listed small entities that would not qualify as a
smaller reporting company.
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In addition, under Rule 10C-1, the exchanges will be expressly
authorized to exempt particular categories of issuers from the
requirements of Section 10C and particular relationships from the
compensation committee membership requirements of Section 10C(a),
taking into account the potential impact of the requirements on smaller
reporting issuers. Because of the close relationship and frequent
interaction between the exchanges and their listed issuers, we believe
the exchanges will be in the best position to determine additional
types of issuers, including any small entities that are not smaller
reporting companies, that should be exempted from the listing
requirements under the rule.
In connection with the amendments to Regulation S-K, we considered
alternatives, including establishing different compliance or reporting
requirements that take into account the resources available to small
entities, clarifying or simplifying compliance and reporting
requirements under the amendments for small entities, using performance
rather than design standards, and exempting small entities from all or
part of the amendments. We considered, but did not establish, different
compliance requirements, or an exemption, for small entities. Although
we believe it is appropriate to exempt smaller reporting companies from
Rule 10C-1 because we do not believe that the additional burdens of
complying with Rule 10C-1 are warranted for smaller reporting
companies, we are unable to reach the same conclusion with respect to
the disclosure requirements of amended Item 407(e)(3).
In our view, mandating uniform and comparable disclosures for all
issuers subject to our proxy rules is consistent with the statute and
will promote investor protection. We believe that investors have an
interest in, and would benefit from disclosure regarding, conflicts of
interest involving compensation consultants, to the extent that they
are used by small entities. Several commentators opposed providing an
exemption to small issuers and noted that the required disclosure would
provide investors with additional information that would allow them to
make better informed investment and voting decisions.\286\ Different
compliance requirements or an exemption from the amendments to
Regulation S-K for small entities would interfere with achieving the
goal of enhancing the information provided to all investors.
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\286\ See, e.g., letters from CalPERS, FLSBA and RailPen.
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The amendments to Regulation S-K clarify, consolidate and simplify
the compliance and reporting requirements for all entities, including
small entities. Under the amendments, disclosure will only be required
if a compensation consultant plays a role in determining or
recommending the form or amount of executive and director compensation
and the compensation consultant's work raises a conflict of interest.
Although we believe the disclosure requirements are clear and
straightforward, we have attempted to further clarify, consolidate and
simplify the compliance and reporting requirements, by including an
instruction to the amendments to provide guidance to issuers as to when
a conflict of interest may be present that would require disclosure.
Final Rule 10C-1 uses a mix of performance and design standards. We
are not specifying the procedures or arrangements an issuer or
compensation committee must develop to comply with the listing
standards required by Rule 10C-1, but compensation committees will be
required to consider the factors specified in Rule 10C-1(b)(4) when
conducting the required independence assessments. The amendments to
Regulation S-K employ design standards rather than performance
standards, as Section 10C(c)(2) mandates the specific disclosures that
must be provided. Moreover, based on our past experience, we believe
specific disclosure requirements will promote consistent and comparable
disclosure among all companies, and the amendments are intended to
result in more comprehensive and clear disclosure.
VI. Statutory Authority and Text of the Amendments
The amendments contained in this release are being adopted under
the authority set forth in Sections 6, 7, 10, and 19(a) of the
Securities Act and Sections 3(b), 10C, 12, 14, 23(a) and 36 of the
Exchange Act.
List of Subjects in 17 CFR Parts 229 and 240
Reporting and recordkeeping requirements, Securities.
Text of the Amendments
For the reasons set out in the preamble, the Commission amends
title 17, chapter II, of the Code of Federal Regulations as follows:
PART 229--STANDARD INSTRUCTIONS FOR FILING FORMS UNDER SECURITIES
ACT OF 1933, SECURITIES EXCHANGE ACT OF 1934 AND ENERGY POLICY AND
CONSERVATION ACT OF 1975--REGULATION S-K
0
1. The general authority citation for part 229 is revised and the
sectional authorities are removed to read as follows:
Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j, 77k, 77s, 77z-2,
77z-3, 77aa(25), 77aa(26), 77ddd, 77eee, 77ggg, 77hhh, 77iii, 77jjj,
77nnn, 77sss, 78c, 78i, 78j, 78j-3, 78l, 78m, 78n, 78n-1, 78o, 78u-
5, 78w, 78ll, 78mm, 80a-8, 80a-9, 80a-20, 80a-29, 80a-30, 80a-31(c),
80a-37, 80a-38(a), 80a-39, 80b-11, and 7201 et seq.; and 18 U.S.C.
1350, unless otherwise noted.
0
2. Section 229.407 is amended by adding paragraph (e)(3)(iv) and an
instruction to paragraph (e)(3)(iv) to read as follows:
Sec. 229.407 (Item 407) Corporate governance.
* * * * *
(e) * * *
(3) * * *
(iv) With regard to any compensation consultant identified in
response to Item 407(e)(3)(iii) whose work has raised any conflict of
interest, disclose the nature of the conflict and how the conflict is
being addressed.
Instruction to Item 407(e)(3)(iv).
For purposes of this paragraph (e)(3)(iv), the factors listed in
Sec. 240.10C-1(b)(4)(i) through (vi) of this chapter are
[[Page 38454]]
among the factors that should be considered in determining whether a
conflict of interest exists.
* * * * *
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
0
3. The general authority citation for Part 240 is revised to read as
follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i,
78j, 78j-1, 78j-3, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4,
78p, 78q, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29,
80a-37, 80b-3, 80b-4, 80b-11, and 7201 et seq.; and 18 U.S.C. 1350,
and 12 U.S.C. 5221(e)(3), unless otherwise noted.
* * * * *
0
4. Add an undesignated center heading following Sec. 240.10A-3 to read
as follows:
Requirements Under Section 10C
0
5. Add Sec. 240.10C-1 immediately following the new undesignated
center heading to read as follows:
Sec. 240.10C-1 Listing standards relating to compensation committees.
(a) Pursuant to section 10C(a) of the Act (15 U.S.C. 78j-3(a)) and
section 952 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010 (Pub. L. 111-203, 124 Stat. 1900):
(1) National securities exchanges. The rules of each national
securities exchange registered pursuant to section 6 of the Act (15
U.S.C. 78f), to the extent such national securities exchange lists
equity securities, must, in accordance with the provisions of this
section, prohibit the initial or continued listing of any equity
security of an issuer that is not in compliance with the requirements
of any portion of paragraph (b) or (c) of this section.
(2) National securities associations. The rules of each national
securities association registered pursuant to section 15A of the Act
(15 U.S.C. 78o-3), to the extent such national securities association
lists equity securities in an automated inter-dealer quotation system,
must, in accordance with the provisions of this section, prohibit the
initial or continued listing in an automated inter-dealer quotation
system of any equity security of an issuer that is not in compliance
with the requirements of any portion of paragraph (b) or (c) of this
section.
(3) Opportunity to cure defects. The rules required by paragraphs
(a)(1) and (a)(2) of this section must provide for appropriate
procedures for a listed issuer to have a reasonable opportunity to cure
any defects that would be the basis for a prohibition under paragraph
(a) of this section, before the imposition of such prohibition. Such
rules may provide that if a member of a compensation committee ceases
to be independent in accordance with the requirements of this section
for reasons outside the member's reasonable control, that person, with
notice by the issuer to the applicable national securities exchange or
national securities association, may remain a compensation committee
member of the listed issuer until the earlier of the next annual
shareholders meeting of the listed issuer or one year from the
occurrence of the event that caused the member to be no longer
independent.
(4) Implementation. (i) Each national securities exchange and
national securities association that lists equity securities must
provide to the Commission, no later than 90 days after publication of
this section in the Federal Register, proposed rules or rule amendments
that comply with this section. Each submission must include, in
addition to any other information required under section 19(b) of the
Act (15 U.S.C. 78s(b)) and the rules thereunder, a review of whether
and how existing or proposed listing standards satisfy the requirements
of this rule, a discussion of the consideration of factors relevant to
compensation committee independence conducted by the national
securities exchange or national securities association, and the
definition of independence applicable to compensation committee members
that the national securities exchange or national securities
association proposes to adopt or retain in light of such review.
(ii) Each national securities exchange and national securities
association that lists equity securities must have rules or rule
amendments that comply with this section approved by the Commission no
later than one year after publication of this section in the Federal
Register.
(b) Required standards. The requirements of this section apply to
the compensation committees of listed issuers.
(1) Independence. (i) Each member of the compensation committee
must be a member of the board of directors of the listed issuer, and
must otherwise be independent.
(ii) Independence requirements. In determining independence
requirements for members of compensation committees, the national
securities exchanges and national securities associations shall
consider relevant factors, including, but not limited to:
(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.
(iii) Exemptions from the independence requirements. (A) The
listing of equity securities of the following categories of listed
issuers is not subject to the requirements of paragraph (b)(1) of this
section:
(1) Limited partnerships;
(2) Companies in bankruptcy proceedings;
(3) Open-end management investment companies registered under the
Investment Company Act of 1940; and
(4) Any foreign private issuer that discloses in its annual report
the reasons that the foreign private issuer does not have an
independent compensation committee.
(B) In addition to the issuer exemptions set forth in paragraph
(b)(1)(iii)(A) of this section, a national securities exchange or a
national securities association, pursuant to section 19(b) of the Act
(15 U.S.C. 78s(b)) and the rules thereunder, may exempt from the
requirements of paragraph (b)(1) of this section a particular
relationship with respect to members of the compensation committee, as
each national securities exchange or national securities association
determines is appropriate, taking into consideration the size of an
issuer and any other relevant factors.
(2) Authority to retain compensation consultants, independent legal
counsel and other compensation advisers. (i) The compensation committee
of a listed 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, independent legal counsel or other adviser.
(ii) The compensation committee shall be directly responsible for
the appointment, compensation and oversight of the work of any
compensation consultant, independent legal counsel and other adviser
retained by the compensation committee.
(iii) Nothing in this paragraph (b)(2) shall be construed:
(A) To require the compensation committee to implement or act
consistently with the advice or recommendations of the compensation
consultant, independent legal counsel
[[Page 38455]]
or other adviser to the compensation committee; or
(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.
(3) Funding. Each listed issuer must 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 to a compensation consultant, independent legal counsel or
any other adviser retained by the compensation committee.
(4) Independence of compensation consultants and other advisers.
The compensation committee of a listed issuer may select a compensation
consultant, legal counsel or other adviser to the compensation
committee only after taking into consideration the following factors,
as well as any other factors identified by the relevant national
securities exchange or national securities association in its listing
standards:
(i) The provision of other services to the issuer by the person
that employs the compensation consultant, legal counsel or other
adviser;
(ii) 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;
(iii) 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;
(iv) Any business or personal relationship of the compensation
consultant, legal counsel or other adviser with a member of the
compensation committee;
(v) Any stock of the issuer owned by the compensation consultant,
legal counsel or other adviser; and
(vi) Any business or personal relationship of the compensation
consultant, legal counsel, other adviser or the person employing the
adviser with an executive officer of the issuer.
Instruction to paragraph (b)(4) of this section: A listed issuer's
compensation committee is required to conduct the independence
assessment outlined in paragraph (b)(4) of this section with respect to
any compensation consultant, legal counsel or other adviser that
provides advice to the compensation committee, other than in-house
legal counsel.
(5) General exemptions. (i) The national securities exchanges and
national securities associations, pursuant to section 19(b) of the Act
(15 U.S.C. 78s(b)) and the rules thereunder, may exempt from the
requirements of this section certain categories of issuers, as the
national securities exchange or national securities association
determines is appropriate, taking into consideration, among other
relevant factors, the potential impact of such requirements on smaller
reporting issuers.
(ii) The requirements of this section shall not apply to any
controlled company or to any smaller reporting company.
(iii) The listing of a security futures product cleared by a
clearing agency that is registered pursuant to section 17A of the Act
(15 U.S.C. 78q-1) or that is exempt from the registration requirements
of section 17A(b)(7)(A) (15 U.S.C. 78q-1(b)(7)(A)) is not subject to
the requirements of this section.
(iv) The listing of a standardized option, as defined in Sec.
240.9b-1(a)(4), issued by a clearing agency that is registered pursuant
to section 17A of the Act (15 U.S.C. 78q-1) is not subject to the
requirements of this section.
(c) Definitions. Unless the context otherwise requires, all terms
used in this section have the same meaning as in the Act and the rules
and regulations thereunder. In addition, unless the context otherwise
requires, the following definitions apply for purposes of this section:
(1) In the case of foreign private issuers with a two-tier board
system, the term board of directors means the supervisory or non-
management board.
(2) The term compensation committee means:
(i) A committee of the board of directors that is designated as the
compensation committee; or
(ii) In the absence of a committee of the board of directors that
is designated as the compensation committee, a committee of the board
of directors performing functions typically performed by a compensation
committee, including oversight of executive compensation, even if it is
not designated as the compensation committee or also performs other
functions; or
(iii) For purposes of this section other than paragraphs (b)(2)(i)
and (b)(3), in the absence of a committee as described in paragraphs
(c)(2)(i) or (ii) of this section, the members of the board of
directors who oversee executive compensation matters on behalf of the
board of directors.
(3) The term controlled company means an issuer:
(i) That is listed on a national securities exchange or by a
national securities association; and
(ii) Of which more than 50 percent of the voting power for the
election of directors is held by an individual, a group or another
company.
(4) The terms listed and listing refer to equity securities listed
on a national securities exchange or listed in an automated inter-
dealer quotation system of a national securities association or to
issuers of such securities.
(5) The term open-end management investment company means an open-
end company, as defined by Section 5(a)(1) of the Investment Company
Act of 1940 (15 U.S.C. 80a-5(a)(1)), that is registered under that Act.
By the Commission.
Dated: June 20, 2012.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2012-15408 Filed 6-26-12; 8:45 am]
BILLING CODE 8011-01-P