The SEC just approved new listing standards for the NYSE and Nasdaq with respect to compensation committees of the board. The listing standards were mandated by Dodd-Frank and Rule 10C-1 of the Exchange Act.
These listing standards had a unique significance. The SEC has had a bit of a tortured history with respect to listing standards as a means of elevating corporate governance. The efforts to do so in the 1980s were shot down by the DC Circuit (remember the one share, one vote rule?). In the first few years of the new millennium, the SEC apparently pressured the exchanges to reform their governance requirements but nonetheless left the drafting and initiation of the requirements to the exchanges.
Congress stepped into the process in Sarbanes Oxley and required the adoption of listing standards that regulated audit committees. See Section 10A of the Exchange Act. The SEC was instructed to implement the requirement by rule. See Rule 10A-3, 17 CFR 240.10A-3. Thus, for the first time since Business Roundtable, the SEC was back in the business of scripting listing standards for the exchanges.
Section 10A addressed a number of important issues. Audit committees were to have certain authority (to hire and fire the auditor), certain powers (to determine their own funding), and certain membership criteria (super-independent directors who were unaffiliated with the issuer and received no compensation from the issuer except fees for serving on the board). In prescribing these requirements, Congress left little to the imagination. The SEC received hardly any discretion in the implementation of the requirement. Thus, the SEC was simply a conduit for the requirements imposed by Congress.
Dodd-Frank required the adoption of listing standards that regulated compensation committees of the board. See Section 10C of the Exchange Act. As with SOX, Congress instructed the SEC to oversee the implementation of the requisite listing standards, which it did through the adoption of Rule 10C-1. Congress, however, went beyond the approach taken in SOX. It gave the SEC some discretionary authority in the area.
Most noticeably, Congress required that the listing standards delineate the "relevant factors" that must be considered by the board in determining director independence on the compensation committee. While explicitly setting out two of the factors (affiliation with the issuer and compensation other than fees from the issuer), Congress left it to the Commission to determine whether other factors should be considered. The SEC for the first time had the authority to define director independence.
As we will see from the ultimate outcome of the rulemaking effort, the SEC shied away from any significant involvement in the debate over the definition of director independence. Despite a number of comments urging the Commission to take a more robust role, the resulting rules included only the factors required by Congress: affiliation and compensation.
Neither exchange, for example, explicitly required boards to consider personal and business relationships between directors on the compensation committee and executive management. Moreover, in considering compensation paid to directors, neither exchange required that the board consider the fees or the fee structure, despite evidence that Congress intended that they do so.
We will first discuss the new listing standards. In the last post, we will speculate about why the SEC handled the manner in the way that it did and discuss some possible changes that may improve the decision making process.