The decision-making process for executive compensation will bear additional scrutiny under a new rule announced Wednesday by the Securities and Exchange Commission. Section 952 of the Dodd-Frank Act addresses the issue of executive compensation by focusing on the compensation committees formed by corporate boards, as well as the compensation advisers they may retain. It required that exchanges, under the direction of the SEC, adopt “listing standards.”

Under new Rule 10C-1, national securities exchanges are required to adopt listing standards requiring that each member of a company's compensation committee be a member of the board of directors and independent. Companies must meet the standards in order for their shares to continue trading on the exchange.

“This rule will help to enhance the board's decision-making process on executive compensation matters, particularly the selection, engagement and oversight of compensation advisers, and will provide more transparency with respect to conflicts of interest of consultants engaged by boards,” SEC Chairman Mary L. Schapiro said in a statement.

In developing a definition of independence, exchanges will be required to consider:

  • The source of compensation of a member of the board of directors, including any consulting, advisory or other compensatory fee paid by the company to such director
  • Whether a member of the board of directors of a company is affiliated with the company, a subsidiary of the company, or an affiliate of a subsidiary of the company

The rule requires that exchanges adopt standards allowing a compensation committee to select a compensation consultant, legal counsel or other adviser (other than in-house legal counsel) only after considering:

  • Whether the compensation consulting company employing the compensation adviser is providing any other services to the company
  • How much the compensation consulting company who employs the compensation adviser has received in fees from the company, as a percentage of that person's total revenue
  • What policies and procedures have been adopted by the compensation consulting company employing the compensation adviser to prevent conflicts of interest
  • Whether the compensation adviser has any business or personal relationship with a member of the compensation committee
  • Whether the compensation adviser owns any stock of the company
  • Whether the compensation adviser or the person employing the adviser has any business or personal relationship with an executive officer of the issuer

Exchanges are required to exempt the following four categories of companies from compensation committee independence requirements: limited partnerships; companies in bankruptcy proceedings; registered, open-end management investment companies; and any foreign private issuer that discloses in its annual report the reasons that the foreign private issuer does not have an independent compensation committee.

The SEC also amended its proxy disclosure rules, requiring that each company disclose in its annual meeting proxy materials for shareholders whether its board's compensation committee retained or obtained the advice of a compensation consultant. It requires a company to disclose 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 new rule and rule amendments will take effect 30 days after forthcoming publication in the Federal Register. No later than 90 days after effectiveness, each exchange must comply with the new rule. New listing standards must be approved by the SEC within one year of the new rule becoming effective.