Under the Exchange Act, as amended by the Dodd-Frank Act, each member of the Committee must be an independent member of the Board. In addition, in order to take advantage of certain exemptions from the deduction limitation on employee compensa- tion under Section 162(m) of the Code and the short-swing profit recovery rules under the Exchange Act, each member of the Committee must also qualify as an “outside director” for purposes of Section 162(m) and a “non-employee director” for purposes of Section 16 of the Exchange Act.
Eligibility to Serve
Independence for Exchange Purposes
Even prior to the enactment of the Dodd-Frank Act, the NYSE and Nasdaq required Committee members to be independent under their general standards on director inde- pendence. Under these general standards, the NYSE and Nasdaq apply their own tests (objective and subjective, respectively) to determine whether or not a director is indepen- dent. With the enactment of the Dodd-Frank Act, the NYSE and Nasdaq were required to develop additional independence requirements specific to members of the Committee. The NYSE and Nasdaq standards for Committee member independence are generally consistent with each other. Each member must qualify as independent pursuant to the general standards on independence and, in addition, the Board must make an affirma- tive determination that each Committee member is independent after considering the following factors:
• whether the Committee member receives compensation from any person or entity
(including any consulting, advisory or other compensatory fees paid by the Company to the Committee member) that would impair the Committee member’s ability to make independent judgments about the Company’s executive compensation; and
• whether an affiliate relationship places the Committee member under the direct or
indirect control of the Company or its senior management or whether it creates a direct relationship between the director and senior management, in each case of a nature that would impair the Committee member’s ability to make independent judg- ments about the Company’s executive compensation.
Both the NYSE and Nasdaq generally allow a listed issuer to cure a failure to comply with the independence standards applicable to Committee members. If a Committee member ceases to be independent for reasons outside of the Committee member’s control, the member may continue to serve on the Committee without disqualifying the Company until the earlier of its next annual shareholders’ meeting or the one-year anniversary of the event that caused the Committee member to no longer be independent. The Committee member independence requirements are also subject to transition relief periods for IPOs, spinoffs, carve-outs, companies emerging from bankruptcy and certain other circumstances.
Section 162(m) Requirements
As discussed in Chapter 8, Section 162(m) of the Code imposes a limit of $1 million on the amount of compensation that a public company may deduct in any calendar year with respect to compensation paid to certain covered employees. However, “performance- based compensation” is not subject to the Section 162(m) deduction limitation. In order to qualify as “performance-based compensation,” among other requirements, a committee consisting solely of two or more “outside directors” must: approve the award; establish the performance goals within a specified period after the commencement of the applicable performance period; and certify in writing prior to payment of the compen- sation that the performance goals were satisfied.
The regulations under Section 162(m) provide that a director is an “outside director” of the Company if the following requirements are met:
• the director is not a current employee of the Company;
• the director is not a former employee of the Company who receives compensation for
prior services (other than under a tax-qualified retirement plan) during the taxable year;
• the director has not been an officer of the Company; and
• the director does not receive remuneration from the Company, either directly or
indirectly, in any capacity other than as a director. A director will be viewed as having received remuneration in a capacity other than as a director if payment for non-director services is made:
» to an entity in which the director has a beneficial ownership interest of greater than 50% (in which case the amount is considered paid when actually paid (and throughout the remainder of the Company’s taxable year) and, if earlier, throughout the period any obligation to pay the remuneration was in force);
» during the Company’s preceding taxable year to an entity (a “minority-owned entity”) in which the director has a beneficial ownership interest of at least 5% but not more than 50% (other than de minimis amounts); or
» during the Company’s preceding taxable year to an entity (an “employing entity”) by which the director is employed or self-employed other than as a director (other than de minimis amounts).
“Performance-based compensation” is not subject to
the Section 162(m) deduction limitation.
For the foregoing purposes, amounts paid to a minority-owned or employing entity generally are de minimis if they did not exceed 5% of the entity’s gross revenues for its taxable year ending with or within the Company’s preceding tax year, though amounts in excess of $60,000 are not de minimis if paid to a minority-owned entity or if paid for personal services (e.g., legal, accounting, banking or consulting services) to an employing entity.
Rule 16b-3 Requirements
As discussed in Chapter 9, Section 16(b) of the Exchange Act provides that certain Company insiders are generally liable to the Company for any profits resulting from the sale of Company equity securities within six months following an acquisition. Rule 16b-3 under the Exchange Act provides an important exception for awards granted to an officer or director where the grant is approved by a committee composed solely of two or more “non-employee directors.”
Rule 16b-3 provides that a director is a “non-employee director” if the following require- ments are met:
• the director does not receive more than $120,000 in compensation from the Company
for services rendered in any capacity other than as a director of the Company; and
• the director does not have an interest in any “related party” transaction for which
disclosure would be required in the Company’s proxy statement pursuant to Item 404(a) of Regulation S-K.
Disclosure under Item 404(a) is generally required for any transaction since the beginning of the Company’s last fiscal year, or for any currently proposed transaction, in which the Company was or is to be a participant for which the amount involved exceeds $120,000 and in which any “related person” had or will have a direct or indirect material interest. The term “related person” generally means any director or executive officer of the Company or his or her immediate family members, any nominee for director or his or her immediate family members, or a beneficial owner of more than 5% of the Company’s voting securities or his or her immediate family members.