Corporate Governance, Rule 10C-1, and the SEC: Nasdaq and the Need for Compensation Committees (Part 2)

The Commission approved the listing standard from Nasdaq in Exchange Act Release No. 68640 (Jan. 11, 2013).  The listing standard is here.  Nasdaq filed a reponse to the comments on Dec. 12, 2012. 

In considering the requirements of Rule 10C-1, Nasdaq took the opportunity to undertake a more thorough revisions of the standards applicable to compensation committees, going beyond what the SEC had instructed in Rule 10C-1.  In doing so, Nasdaq strengthened some of the investor protections set out in the Rule.  This was particularly true with the decision to require listed companies to have a compensation committee.  See Rule 5605(d)(2). 

Nasdaq had traditionally given companies the choice of adopting a compensation committee or allowing the independent directors on the board to determine compensation.  See Exchange Act Release No. 67220 (June 20, 2012) ("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.").  That choice has now been eliminated.  Listed companies must have a separate compensation committee. 

The Commission applauded the step.  As the adopting release noted:

the heightened importance of compensation decisions and oversight of executive compensation in today’s environment, as well as the benefits that can result for investors of having a standing committee overseeing compensation matters, makes it appropriate and consistent with investor protection and the public interest under Section 6(b)(5) of the Act for Nasdaq to raise its standards in this regard.

The irony was that the requirement actually corrected a problem left in place by the SEC when it adopted Rule 10C-1.  The Rule gave companies an incentive not to form a compensation committee.  To the extent leaving compensation decisions to the majority of independent directors, boards could avoid some of the requirements applicable to compensation committees.  Thus, while compensation committees had the authority to hire independent compensation consultants, the independent directors on the board did not.  

The Commission apparently viewed this as unnecessary since the independent directors consisted of a majority of the board and could, therefore, compel the hiring of an independent compensation consultant.   See Exchange Act Release No. 67220 (June 20, 2012)  ("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."). 

The view was correct in the abstract but wrong in practice.  To the extent, for example, that an independent director did not attend the full meeting, the requisite majority might not be present.  Similarly, while the independent directors might constitute a majority, the requirement that they meet as a full board could discourage discussion of any step that the interested directors opposed.  In other words, interested directors were allowed to participate in the decision-making process and were in a position to possibly sway the outcome.

In any event, this issue has been taken off the table.  The NYSE requires listed companies to have a compensation committee.  Nasdaq now has the same requirement.  Under Rule 10C-1 and the Nasdaq listing standard, the compensation committee (which consists only of independent directors) has the authority to hire an independent compensation consultant.  As the Commission noted, the step would "trigger the additional protections for shareholders," a statement that would not have been the case had Rule 10C-1 applied the same standards to independent directors that it did to compensation committees.