Nasdaq Proposes Tweaks to Compensation Committee Independence Requirements

Arthur H. Kohn is a partner at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb memorandum by Michael Albano, Mary Alcock, and Jonathan Reinstein.

On November 26, 2013, the Nasdaq Stock Market filed a proposal to amend its listing rules implementing Rule 10C-1 of the Securities Exchange Act of 1934, governing the independence of compensation committee members. [1] Currently, Nasdaq Listing Rule 5605(d)(2)(A) and IM-5605-6 employ a bright line test for independence that prohibits compensation committee members from accepting directly or indirectly any consulting, advisory or other compensatory fees from the company or any subsidiary. The requirement is subject to exceptions for fees received for serving on the board of directors (or any of its committees) or fixed amounts of compensation under a retirement plan for prior service with the company provided that such compensation is not contingent on continued service.

This bright line prohibition is more stringent than the Rule 10C-1 mandate, which only requires that listing rules obligate boards to consider compensatory fees when determining independence for compensation committee purposes. Nasdaq’s current bright line rule has posed challenges for some issuers such as portfolio companies of private equity firms that have been taken public, particularly when the company pays [2] management fees to the private equity sponsor or one of its affiliated entities of which the compensation committee member is an employee or partner.

Based on the potential burden the bright line approach places on companies’ ability to recruit eligible directors, Nasdaq has proposed to replace its rule, and its exceptions for board fees and retirement plan compensation, with a requirement that all compensation received from a company be considered in the independence determination. For this purpose, “company” includes any parent or subsidiary, which is intended to cover entities controlled by the company and consolidated with the company’s financial statements as filed with the U.S. Securities and Exchange Commission (but not if the company reflects such entity solely as an investment in its financial statements). The revision would make the rule consistent with the mandate of Rule 10C-1 and mirror the NYSE listing standards.

Notwithstanding the proposed change, compensation committee members would still be required to be “Independent Directors” within the meaning of Listing Rule 5605(a)(2), which imposes thresholds on the amount of fees that may be received by them. Under Rule 5605(a)(2), the term “Independent Director” excludes any director who: (i) accepted compensation from the company exceeding $120,000 during a 12-month period within the prior three years; or (ii) is a partner, controlling shareholder or executive officer of an organization to which the company made, or from which the company received, payments for property or services in the current or any of the past three fiscal years that exceed the greater of 5% of the recipient’s consolidated gross revenues for that year or $200,000.

Nasdaq has also proposed changes to Listing Rule 5605(d)(2)(A) and IM-5605-6 to elaborate on the affiliation prong of the compensation committee independence test. Rule 10C-1 requires that consideration be given in independence determinations to whether a compensation committee member is affiliated with the issuer, a subsidiary of the issuer or an affiliate of a subsidiary of the issuer. Listing Rule 5605(d)(2)(A) would be revised to clarify that in affirmatively determining the independence of any director who will serve on the compensation committee, the board of directors must consider all factors specifically relevant to determining whether a director has a relationship to the company that is material to that director’s ability to be independent from management in connection with the duties of a compensation committee member. However, as the proposal notes, this would not constitute a substantive change since the “Independent Director” definition already requires the board to make an affirmative determination that the director has no relationship with the company that would interfere with the exercise of independent judgment. IM-5605-6 would also be revised to state that when considering any affiliate relationship a director has with a company, one of its subsidiaries, or an affiliate of one of its subsidiaries, “the board should consider whether the affiliate relationship places the director under the direct or indirect control of the Company or its senior management, or creates a direct relationship between the director and members of senior management, in each case of a nature that would impair the director’s ability to make independent judgments about the Company’s executive compensation.” Both of these changes would align Nasdaq’s approach to the affiliation prong of Rule 10C-1 with that employed by the NYSE.

The proposal calls for a 21-day comment period from the date of publication in the Federal Register. Nasdaq has emphasized the need for prompt implementation of these changes since companies are required to comply with the enhanced independence standards under Rule 10C-1 by the earlier of their first annual meeting after January 15, 2014, or October 31, 2014.


[1] See SR-NASDAQ-2013-147, available at
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[2] While the prohibition does not contain a look-back period, compensation committee members must also be “Independent Directors” as defined in Listing Rule 5605(a)(2), and each of the bright-line tests under that definition includes a three-year look-back period.
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