NASDAQ and Disclosure of Third-Party Compensation for Directors

Lori Zyskowski is a Partner and member of the Securities Regulation and Corporate Governance, and Financial Institutions Practice Groups at Gibson, Dunn & Crutcher LLP. This post is based on a Gibson Dunn publication by Ms. Zyskowski and Gillian McPhee.

NASDAQ has proposed changes to its listing standards to require disclosure of third-party compensation arrangements for directors and nominees. After withdrawing an initial proposal on this subject, NASDAQ has revised the proposal, and it has been published in the Federal Register for public comment. Comments are due on or before April 26, 2016. The proposal is available here, and a redline showing proposed changes to the rule text begins on page 21 of the document.

Under amendments NASDAQ is proposing to Rule 5250(b), NASDAQ companies would have to disclose all agreements and arrangements between any director, or director nominee, and any third party that provide for compensation or other payments in connection with the individual’s candidacy or service as a director. The proposed rule would be construed broadly to apply to both compensation and other forms of payment, such as health insurance. The disclosure requirement would not apply to reimbursement of expenses incurred in connection with serving as a nominee. The proposal also addresses the following aspects of the proposed disclosure requirement:

  • Timing of disclosure. The proposed rule would require disclosure of third-party compensation “either” on a company’s website or in the proxy statement for the next annual meeting. Accordingly, where companies appoint directors during the year, it does not appear that waiting until the next proxy statement to disclose the compensation would comply with the rule. Instead, companies could comply by including the material terms of a third-party compensation arrangement in the Form 8-K disclosure announcing the appointment. Form 8-K requires disclosure of “any arrangement or understanding between [a] new director and any other persons, naming such persons, pursuant to which such director was selected as a director.” If a company opts to make the initial disclosure on its website, the proposed rule is silent on the time frame for doing so. After the initial disclosure, a third-party compensation arrangement “is subject to the continuous disclosure requirements of the proposed rule on an annual basis.” The disclosure requirement ceases to apply upon the earlier of the director’s departure from the board or one year after termination of the compensation arrangement.
  • Directors designated by private equity firms, hedge funds and similar firms. For employees of private equity funds, hedge funds and other investment firms who routinely serve on the boards of portfolio companies as part of their job duties, the proposed rule would not apply to compensation that predates their appointment to a company’s board, so long as the compensation has been otherwise publicly disclosed (for example, in the compensation tables in a proxy statement or as part of the individual’s director biography). It would appear that this exception would require investment firms to disclose compensation paid to employees serving on portfolio company boards or at least to quantify what portion of the compensation paid to such employees is allocated to service on the portfolio company board. If the individual’s compensation is “materially increased” in connection with appointment to the board of a portfolio company, the proposed rule would require disclosure of the difference between the new and previous compensation.
  • Proxy contests. The proposal clarifies that companies need not separately disclose third-party compensation paid to directors or nominees in connection with a proxy contest if it has already been disclosed under SEC rules applicable to proxy materials distributed by the parties running the proxy contest. However, this exception would apply only to initial disclosure of the compensation. Thereafter, the compensation would be subject to “the continuous disclosure requirements of the proposed rule on an annual basis.”
  • “Cure” provisions for potential non-compliance. The proposed rule also addresses what would happen if third-party compensation is not disclosed because a company is not aware of it. Companies would not be in violation of the proposed rule if: (a) they make “reasonable efforts” to identify third-party compensation, including asking each director or nominee in a manner designed to allow timely disclosure; and (b) they disclose any compensation promptly upon discovering it. Disclosure would be required through a Form 8-K or press release. It does not appear that website disclosure would be sufficient in this instance. If a company is considered in violation of the proposed rule, the company would have to submit a “plan to regain compliance” showing NASDAQ that the company has processes and procedures designed to identify and disclose third-party compensation. Companies would have 45 days to submit such a plan for review by the staff of NASDAQ’s Listing Qualifications Department.

The proposal also discusses third-party compensation and director independence. NASDAQ’s initial rule proposal noted that NASDAQ would be conducting a survey to obtain feedback about whether to propose additional rules on various aspects of third-party compensation arrangements, including how they may impact independence. The survey closed in March, and the revised proposal indicates that any additional rules in this area will be the subject of a separate rulemaking. NASDAQ also reminded companies about its definition of “independence” for directors, noting that the definition excludes any director with any relationship that, in the opinion of the board, would preclude the director from being independent. Accordingly, boards that are not already doing so should be sure to consider any third-party compensation arrangements in assessing the independence of directors and director candidates. NASDAQ’s rule on compensation committee independence (found in Rule 5605(d)(2)(A)) also specifically requires that boards consider this compensation in assessing whether directors meet the heightened independence criteria applicable to service on the compensation committee.

Companies are encouraged to consider commenting on the proposal. Practical issues that companies may confront in applying the rule—and where further clarification may be warranted in a final rule—include: (a) the timing of the initial disclosure when a director joins the board; (b) for directors appointed by private equity and other investment firms, how companies should determine the amount of compensation that is disclosable (for example, it is not uncommon for directors to have a carried interest based in part on the firm’s ownership of the company’s stock); and (c) how companies should proceed in situations where they are unable to obtain compensation information from a third party for confidentiality or other reasons, despite reasonable efforts. Companies may also wish to provide feedback on the director independence considerations relevant to third-party compensation arrangements.

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