[Federal Register Volume 78, Number 14 (Tuesday, January 22, 2013)]
[Notices]
[Pages 4554-4570]
[FR Doc No: 2013-01107]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-68640; File No. SR-NASDAQ-2012-109]

Self-Regulatory Organizations; The NASDAQ Stock Market LLC;
Notice of Filing of Amendment Nos. 1 and 2, and Order Granting
Accelerated Approval of Proposed Rule Change as Modified by Amendment
Nos. 1 and 2 To Amend the Listing Rules for Compensation Committees To
Comply With Rule 10C-1 Under the Act and Make Other Related Changes

January 11, 2013.

I. Introduction

    On September 25, 2012, The NASDAQ Stock Market LLC (``Nasdaq'' or
``Exchange'') filed with the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a
proposed rule change to modify the Exchange's rules for compensation
committees of listed issuers to comply with Rule 10C-1 under the Act
and make other related changes. The proposed rule change was published
for comment in the Federal Register on October 15, 2012.\3\ The
Commission subsequently extended the time period in which to either
approve the proposed rule change, disapprove the proposed rule change,
or institute proceedings to determine whether to disapprove the
proposed rule change, to January 13, 2013.\4\ The Commission received
eight comment letters on the proposed rule change,\5\ as well as a
response to the comment letters from Nasdaq.\6\ On December 12, 2012,
the Exchange filed Amendment No. 1 to the proposed rule change.\7\ On
January 4, 2013, the Exchange filed Amendment No. 2 to the proposed
rule change.\8\ This order approves the proposed rule change, as
modified by Amendment Nos. 1 and 2 thereto, on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 68013 (October 9,
2012), 77 FR 62563 (``Notice'').
    \4\ See Securities Exchange Act Release No. 68313 (November 28,
2012), 77 FR 71853 (December 4, 2012).
    \5\ See Letters to Elizabeth M. Murphy, Secretary, Commission,
from: J. Robert Brown, Jr., Director, Corporate & Commercial Law
Program, University of Denver Sturm College of Law, dated October
30, 2012 (``Brown Letter''); Dorothy Donohue, Deputy General
Counsel, Securities Regulation, Investment Company Institute, dated
November 1, 2012 (``ICI Letter''); Jeff Mahoney, General Counsel,
Council of Institutional Investors, dated November 1, 2012 (``CII
Letter''); Harold R. Carpenter, Chief Financial Officer, Pinnacle
Financial Partners, Inc., dated November 5, 2012 (``Pinnacle
Letter''); Brandon J. Rees, Acting Director, Office of Investment,
AFL-CIO, dated November 5, 2012 (``AFL-CIO Letter''); Carin Zelenko,
Director, Capital Strategies Department, International Brotherhood
of Teamsters, dated November 5, 2012 (``Teamsters Letter''); Wilson
Sonsini Goodrich & Rosati Professional Corporation, dated November
14, 2012 (``Wilson Sonsini Letter); and Robert B. Lamm, Chair,
Securities Law Committee, The Society of Corporate Secretaries &
Governance Professionals, dated December 7, 2012 (``Corporate
Secretaries Letter'').
    \6\ See Letter to Elizabeth M. Murphy, Secretary, Commission,
from Erika J. Moore, Associate General Counsel, Nasdaq, dated
December 12, 2012 (``Nasdaq Response Letter'').
    \7\ In Amendment No. 1, Nasdaq: (a) Added language to proposed
Rule 5605(d)(3) to set forth in detail the requirements of Rule 10C-
1(b)(2)-(4) regarding the authority of a compensation committee to
retain compensation advisers, the requirement that a listed company
fund such advisers, and the independence assessment required to be
made before selecting or receiving advice from such advisers, rather
than incorporating these details by reference as in the original
proposal, see infra notes 51-58 and accompanying text; (b) revised
the dates by which companies currently listed on Nasdaq will be
required to comply with the new rules, see infra notes 73-79 and
accompanying text; (c) revised the phase-in schedule for companies
that cease to be Smaller Reporting Companies to comply with the full
range of the new requirements, see infra notes 85-88 and
accompanying text; and (d) added a preamble to the new rules
clarifying that, during the transition periods until the new rules
apply, a company must continue to comply with the corresponding
provisions, if any, in the current rules, see infra note 73. In
Amendment No. 1 the Exchange also made conforming changes to the
Purpose section of the proposal, provided explanations for the
revisions, and clarified certain matters, see, e.g., infra notes 58,
194, and 199 and accompanying text; and also added, as Exhibit 3 to
the proposal, the form that it will provide for companies to certify
their compliance with the rules.
    \8\ In Amendment No. 2, Nasdaq revised the proposed rules to
state that the independence assessment of compensation advisers
required of compensation committees does not need to be conducted
for advisers whose roles are limited to those entitled to an
exception from the adviser disclosure rules under Item
407(e)(3)(iii) of Regulation S-K. See infra notes 59-60 and
accompanying text.
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II. Description of Proposed Rule Change

A. Background: Rule 10C-1 Under the Act

    On March 30, 2011, to implement Section 10C of the Act, as added by
Section 952 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010 (``Dodd-Frank Act''),\9\ the Commission proposed
Rule 10C-1 under the Act,\10\ which directs each national securities
exchange (hereinafter, ``exchange'') to prohibit the listing of any
equity security of any issuer, with certain exceptions, that does not
comply with the rule's requirements regarding compensation committees
of listed issuers and related requirements regarding compensation
advisers. On June 20, 2012, the Commission adopted Rule 10C-1.\11\
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    \9\ Public Law 111-203, 124 Stat. 1900 (2010).
    \10\ See Securities Act Release No. 9199, Securities Exchange
Act Release No. 64149 (March 30, 2011), 76 FR 18966 (April 6, 2011)
(``Rule 10C-1 Proposing Release'').
    \11\ See Securities Act Release No. 9330, Securities Exchange
Act Release No. 67220 (June 20, 2012), 77 FR 38422 (June 27, 2012)
(``Rule 10C-1 Adopting Release'').
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    Rule 10C-1 requires, among other things, each exchange to adopt
rules providing that each member of the compensation committee \12\ of
a listed issuer must be a member of the board of directors of the
issuer, and must otherwise be independent.\13\ In determining the
independence standards for members of compensation committees of listed
issuers, Rule 10C-1 requires the exchanges to consider relevant
factors, including, but not limited to: (a) The source of compensation
of the director, including any consulting, advisory or other
compensatory fee paid by the issuer to the director (hereinafter, the
``Fees Factor''); and (b) whether the director is affiliated with the
issuer, a subsidiary of the issuer or an affiliate of a subsidiary of
the issuer (hereinafter, the ``Affiliation Factor'').\14\
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    \12\ For a definition of the term ``compensation committee'' for
purposes of Rule 10C-1, see Rule 10C-1(c)(2)(i)-(iii).
    \13\ See Rule 10C-1(a) and (b)(1).
    \14\ See id. See also Rule 10C-1(b)(1)(iii)(A), which sets forth
exemptions from the independence requirements for certain categories
of issuers. In addition, an exchange may exempt a particular
relationship with respect to members of a compensation committee
from these requirements as it deems appropriate, taking into
consideration the size of an issuer and any other relevant factors.
See Rule 10C-1(b)(1)(iii)(B).
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    In addition, Rule 10C-1 requires the listing rules of exchanges to
mandate that compensation committees be given the authority to retain
or obtain the advice of a compensation adviser, and have direct
responsibility for the appointment, compensation and oversight of the
work of any compensation adviser they retain.\15\ The exchange rules
must also provide that each listed issuer provide for appropriate
funding for the payment of

reasonable compensation, as determined by the compensation committee,
to any compensation adviser retained by the compensation committee.\16\
Finally, among other things, Rule 10C-1 requires each exchange to
provide in its rules that the compensation committee of each listed
issuer may select a compensation consultant, legal counsel or other
adviser to the compensation committee only after taking into
consideration six factors specified in Rule 10C-1,\17\ as well as any
other factors identified by the relevant exchange in its listing
standards.\18\
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    \15\ See Rule 10C-1(b)(2).
    \16\ See Rule 10C-1(b)(3).
    \17\ See Rule 10C-1(b)(4). The six factors, which Nasdaq
proposes to set forth explicitly in its rules, are specified in the
text accompanying note 55, infra.
    \18\ Other provisions in Rule 10C-1 relate to exemptions from
the rule and a requirement that each exchange provide for
appropriate procedures for a listed issuer to have a reasonable
opportunity to cure any defects that would be the basis for the
exchange, under Rule 10C-1, to prohibit the issuer's listing.
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B. Nasdaq's Proposed Rule Change, as Amended

    To comply with Rule 10C-1, Nasdaq proposes to amend two sections of
its rules concerning corporate governance requirements for companies
listed on the Exchange: Rule 5605, ``Boards of Directors and
Committees,'' and Rule 5615, ``Exemptions from Certain Corporate
Governance Requirements.'' In addition, Nasdaq proposes to make some
other changes to its rules regarding compensation committees.
    To accomplish these changes, the Exchange proposes to replace
current paragraph (d) of Rule 5605, entitled ``Independent Director
Oversight of Executive Officer Compensation,'' with a new paragraph (d)
entitled ``Compensation Committee Requirements.'' Current paragraph (d)
provides that compensation of the executive officers of a listed
company must be determined, or recommended to the company's board for
determination, either by a compensation committee comprised solely of
``Independent Directors'' \19\; or, as an alternative to a formal
committee, by a majority of the board's Independent Directors in a vote
in which only Independent Directors participate (``Alternative
Option'').\20\
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    \19\ ``Independent Directors,'' as defined in Nasdaq Rule
5605(a)(2) and used herein, includes a two-part test for
independence. The rule sets forth seven specific categories of
directors who cannot be considered independent because of certain
discrete relationships (``the bright-line tests''); and also
provides that a listed company's board must make an affirmative
determination that each independent director has no relationship
that, in the opinion of the board, ``would interfere with the
exercise of independent judgment in carrying out the
responsibilities of a director.'' Id. See also the Interpretive
Material to Rule 5605.
    \20\ The current rule also provides that the chief executive
officer (``CEO'') may not be present during voting or deliberations
regarding the CEO's own compensation. See Rule 5605(d)(1).
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1. Compensation Committee Composition and Independence Standards
    First, Nasdaq proposes that each listed company be required to have
a compensation committee.\21\ The Alternative Option described above
would be eliminated. In addition, Nasdaq proposes that the compensation
committee be required to be composed of at least two members, each of
whom must be an Independent Director as defined in Nasdaq's rules and
also meet the additional independence requirements described below.\22\
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    \21\ See proposed Rule 5605(d)(2).
    \22\ Id. For the definition of ``Independent Director, see supra
note 19.
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    In discussing the proposed elimination of the Alternative Option,
Nasdaq stated that it had considered whether the Alternative Option
remains appropriate, ``given the heightened importance of compensation
decisions in today's corporate governance environment.'' The Exchange
concluded that ``there are benefits from a board having a standing
committee dedicated solely to oversight of executive compensation.''
\23\ In discussing the proposed requirement that the committee have at
least two members, the Exchange stated that ``[g]iven the importance of
compensation decisions to stockholders, Nasdaq believes that it is
appropriate to have more than one director responsible for these
decisions.'' \24\
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    \23\ See Notice, supra note 3, for the Exchange's more complete
explanation of its reasons for the proposed change, including a
discussion of whether eliminating the Alternative Option would pose
an undue hardship on Nasdaq-listed companies.
    \24\ See id. for the Exchange's more complete discussion of the
proposed size requirement.
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    Nasdaq also proposes that a compensation committee must have a
formal written charter.\25\ Under this provision, a listed company must
certify that it has adopted such a charter and that its compensation
committee will review and reassess the adequacy of that charter on an
annual basis.\26\
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    \25\ See proposed Nasdaq Rule 5605(d)(1). As discussed further
in Section II.B.3., a Smaller Reporting Company may adopt either a
formal written compensation committee charter or a board resolution
that specifies the committee's responsibilities and authority.
    \26\ The Commission notes that Rule 10C-1 does not require a
listed issuer specifically to have a charter. As noted above,
however, see supra notes 15-17 and accompanying text, Rule 10C-1
does require a compensation committee to have certain specified
authority and responsibilities. Often, listed issuers will specify
authority and responsibilities of this kind in a charter in any
case. The proposed rule requires them to have a charter, and to
include this authority and set of responsibilities in addition to
the required content discussed infra at text accompanying notes 27-
29.
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    The charter must specify the scope of the committee's
responsibilities and how it carries out those responsibilities,
including structure, processes, and membership requirements.\27\ It
must specify the committee's responsibility for determining or
recommending to the board for determination, the compensation of the
CEO and all other executive officers of the company, and provide that
the CEO may not be present during voting or deliberations on his or her
compensation.\28\ In addition, the charter must specify the committee's
responsibilities and authority set forth in the Exchange's rules with
respect to retaining its own advisers; appointing, compensating, and
overseeing such advisers; considering certain independence factors
before selecting advisers; and receiving funding from the company to
engage them, which are discussed in detail below.\29\
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    \27\ Proposed Rule 5605(d)(1)(A). Nasdaq states that this
requirement is copied from the Exchange's similar listing rule
relating to audit committee charters, Rule 5605(c)(1), except that
the annual review and reassessment requirement is written
prospectively, rather than retrospectively. The proposed rule change
includes a conforming revision to make the audit committee review
and reassessment prospective, as well. See Notice.
    \28\ Proposed Rule 5605(d)(1)(B)-(C). Nasdaq states that these
provisions are based upon Nasdaq's current compensation-related
listing rules, except that the Alternative Option discussed above is
not available under the proposed rule change. See supra note 21 and
accompanying text.
    \29\ See proposed Rule 5605(d)(1)(D) and infra notes 49-58 and
accompanying text. Because Smaller Reporting Companies are not
required to comply with the provisions relating to compensation
advisers in proposed Nasdaq Rule 5605(d)(3), see infra notes 62-67,
their charters or board resolutions are not required to reflect
these responsibilities.
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    Nasdaq's rules currently require each member of a listed company's
compensation committee to be an Independent Director as defined in
Nasdaq Rule 5605(a)(2).\30\ Rule 10C-1, as discussed above, provides
that exchange standards must require compensation committee members to
be independent, and further provides that each exchange, in determining
independence for this purpose, must consider relevant factors,
including the Fees Factor and Affiliation Factor described above. In
its proposal, Nasdaq discussed its consideration of these factors,\31\
and proposed the following \32\:
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    \30\ See supra note 19.
    \31\ Notice, supra note 3.
    \32\ These additional factors would not apply to the selection
of members of the compensation committee of a Smaller Reporting
Company. See infra note 64.

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    With respect to the Fees Factor, Nasdaq proposes to adopt a
provision stating that each member of a compensation committee of a
listed company must not accept directly or indirectly any consulting,
advisory or other compensatory fee from the listed company or any of
its subsidiaries.\33\ In discussing its review of its current listing
rules and the Fees Factor, Nasdaq noted that its rules for audit
committees of listed companies, in meeting the criteria of Rule 10A-3
under the Act, prohibit an audit committee member from accepting such
fees. The Exchange concluded that ``there is no compelling
justification to have different standards for audit and compensation
committee members'' with respect to the Fees Factor.\34\
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    \33\ See proposed Rule 5605(d)(2)(A).
    \34\ See Notice.
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    As currently permitted under Nasdaq's rules for audit committee
members, however, the proposed rule would permit a compensation
committee member to receive fees for his or her membership on the
committee, on the company's board, or on any other board committee.\35\
In addition, a compensation committee member would be permitted to
receive fixed amounts of compensation under a retirement plan
(including deferred compensation) for prior service with the company,
provided that such compensation is not contingent in any way on
continued service.\36\
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    \35\ See supra note 33.
    \36\ Id.
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    With respect to the Affiliation Factor, Nasdaq proposes that, in
determining whether a director is eligible to serve on the compensation
committee, the company's board also must consider whether the director
is affiliated with the company, a subsidiary of the company, or an
affiliate of a subsidiary of the company to determine whether such
affiliation would impair the director's judgment as a member of the
compensation committee.\37\ In discussing its review of its current
rules and its consideration of the Rule 10C-1 requirement in this
area,\38\ the Exchange noted that its rules for audit committees of
listed companies, in meeting the criteria of Rule 10A-3 under the Act,
prohibit an audit committee member from being an affiliated person of
the issuer or any subsidiary thereof. The Exchange said that it
concluded, however, that ``such a blanket prohibition would be
inappropriate for compensation committees.'' \39\ Nasdaq believes that
``it may be appropriate for certain affiliates, such as representatives
of significant stockholders, to serve on compensation committees since
their interests are likely aligned with those of other stockholders in
seeking an appropriate executive compensation program.'' \40\
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    \37\ See proposed Rule 5605(d)(2)(A).
    \38\ See Notice.
    \39\ Id.
    \40\ Id.
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    Although Rule 10C-1 requires that exchanges consider ``relevant
factors'' not limited to the Fees and Affiliation Factors, Nasdaq
states that, after reviewing its current and proposed listing rules, it
concluded that these rules are sufficient to ensure the independence of
compensation committee members. The Exchange therefore determined not
to propose further independence requirements.\41\
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    \41\ Id.
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    Nasdaq proposes a cure period for a failure of a listed company to
meet its committee composition requirements. The proposed cure period
is the same as the cure period currently provided in Nasdaq's rules for
noncompliance with the requirement to have a majority independent
board.\42\ Under the provision, if a listed company fails to comply
with the compensation committee composition requirements due to one
vacancy, or if one compensation committee member ceases to be
independent due to circumstances beyond the member's reasonable
control, the company must regain compliance by the earlier of the next
annual shareholders meeting or one year from the occurrence of the
event that caused the noncompliance.\43\
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    \42\ See Rule 5605(b)(1)(A) regarding the majority board
requirement.
    \43\ See proposed Rule 5605(d)(4).
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    However, if the annual shareholders meeting occurs no later than
180 days following the event that caused the noncompliance, the company
instead has 180 days from the event to regain compliance. As explained
by Nasdaq, this provides a company at least 180 days to cure
noncompliance and would typically allow a company to regain compliance
in connection with its next annual meeting.\44\ The proposed rule also
requires a company relying on this provision to provide notice to
Nasdaq immediately upon learning of the event or circumstance that
caused the noncompliance.
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    \44\ See Notice.
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    Nasdaq's current rules relating to compensation committees include
an exception that allows a director who is not an Independent Director
to be appointed to such a committee under exceptional and limited
circumstances, as long as that director is not currently an executive
officer, an employee, or the family member of an executive officer.\45\
The exception applies, however, only if the committee is comprised of
at least three members and the company's board determines that the
individual's membership on the committee is required by the best
interests of the company and its shareholders.\46\ The exception is
retained under the proposed rule change, and permits a listed company
to avail itself of the allowance even for a director who fails the new
requirements regarding the Fees and Affiliation Factors.\47\ A
compensation committee member may not serve longer than two years under
this exception. In addition, a company relying on the exception must
make certain disclosures on its Web site or in its proxy statement
regarding the nature of the relationship and the reasons for the
determination.
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    \45\ See current Rule 5605(d)(3).
    \46\ See id.
    \47\ See proposed Rule 5605(d)(2)(b).
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    In its discussion of this provision,\48\ Nasdaq notes that its
rules for audit committees and nominations committees of listed
companies also include such an exception. The Exchange states that,
while these exceptions are used infrequently by its listed companies,
it believes that they are an important means to allow companies
flexibility as to board and committee membership and composition in
unusual circumstances. The Exchange further believes that the exception
may be particularly important for smaller companies.
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    \48\ See Notice.
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2. Authority of Committees to Retain Compensation Advisers; Funding;
and Independence of Compensation Advisers
    In its proposed rule change, as modified by Amendment No. 1,\49\
Nasdaq proposes to fulfill the requirements imposed by Rule 10C-
1(b)(2)-(4) under the Act by setting forth those requirements in full
in its own rules.\50\ Thus, proposed Nasdaq Rule 5605(d)(3), as
amended, provides that the compensation committee of a listed company
may, in its sole discretion,

retain or obtain the advice of a compensation consultant, legal counsel
or other adviser.\51\ Further, the compensation committee shall be
directly responsible for the appointment, compensation and oversight of
the work of any compensation consultant, legal counsel and other
adviser retained by the compensation committee.\52\ In addition, the
listed company must provide for appropriate funding, as determined by
the compensation committee, for payment of reasonable compensation to a
compensation consultant, legal counsel or any other adviser retained by
the compensation committee.\53\
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    \49\ See supra note 7. Nasdaq's proposal as submitted originally
incorporated the requirements of Rule 10C-1(b)(2)-(4) by reference.
The Exchange amended the proposal to set forth those requirements
explicitly.
    \50\ Rule 10C-1(b)(4) does not include the word ``independent''
before ``legal counsel'' and requires an independence assessment for
any legal counsel to a compensation committee, other than in-house
counsel. In setting forth the requirements of Rule 10C-1(b)(2) and
(3), Nasdaq has deleted the word ``independent'' prior to ``legal
counsel'' so as to avoid confusion.
    \51\ See Item 9 of Amendment No. 1.
    \52\ See id. The proposal, as amended, also includes a
provision, derived from Rule 10C-1, stating that nothing in these
rules may be construed: (i) To require the compensation committee to
implement or act consistently with the advice or recommendations of
the compensation consultant, legal counsel or other adviser to the
compensation committee; or (ii) to affect the ability or obligation
of a compensation committee to exercise its own judgment in
fulfillment of the duties of the compensation committee. Id.
    \53\ Id.
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    Proposed Nasdaq Rule 5605(d)(3), as amended, also sets forth
explicitly, in accordance with Rule 10C-1, that the compensation
committee may select, or receive advice from, a compensation
consultant, legal counsel or other adviser to the compensation
committee, other than in-house legal counsel, only after taking into
consideration the six factors set forth in Rule 10C-1 regarding
independence assessments of compensation advisers.\54\
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    \54\ See Rule 10C-1(b)(4).
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    The six factors, which are set forth in full in the proposed rule,
are: (i) The provision of other services to the issuer by the person
that employs the compensation consultant, legal counsel or other
adviser; (ii) the amount of fees received from the issuer by the person
that employs the compensation consultant, legal counsel or other
adviser, as a percentage of the total revenue of the person that
employs the compensation consultant, legal counsel or other adviser;
(iii) the policies and procedures of the person that employs the
compensation consultant, legal counsel or other adviser that are
designed to prevent conflicts of interest; (iv) any business or
personal relationship of the compensation consultant, legal counsel or
other adviser with a member of the compensation committee; (v) any
stock of the issuer owned by the compensation consultant, legal counsel
or other adviser; and (vi) any business or personal relationship of the
compensation consultant, legal counsel, other adviser or the person
employing the adviser with an executive officer of the issuer.\55\
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    \55\ Rule 10C-1(b)(4)(i)-(vi).
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    Proposed Rule 5605(d)(3), as amended, also clarifies that nothing
in the rule requires a compensation consultant, legal counsel or other
compensation adviser to be independent, only that the compensation
committee consider the enumerated independence factors before
selecting, or receiving advice from, a compensation adviser.\56\ It
further clarifies that compensation committees may select, or receive
advice from, any compensation adviser they prefer, including ones that
are not independent, after considering the six independence factors set
forth in the rule.\57\ In Amendment No. 1, Nasdaq emphasizes that a
compensation committee is not required to retain an independent
compensation adviser; rather, a compensation committee is required only
to conduct the independence analysis described in Rule 10C-1 before
selecting a compensation adviser.\58\
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    \56\ See id.
    \57\ See id.
    \58\ See Item 2 of Amendment No. 1.
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    In Amendment No. 2, Nasdaq added language to the provision
regarding the independence assessment of compensation advisers \59\ to
state that the compensation committee is not required to conduct an
independence assessment for a compensation adviser that acts in a role
limited to the following activities for which no disclosure is required
under Item 407(e)(3)(iii) of Regulation S-K: (a) Consulting on any
broad-based plan that does not discriminate in scope, terms, or
operation, in favor of executive officers or directors of the company,
and that is available generally to all salaried employees; and/or (b)
providing information that either is not customized for a particular
issuer or that is customized based on parameters that are not developed
by the adviser, and about which the adviser does not provide advice.
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    \59\ See proposed Rule 5605(d)(3), as amended by Amendment No.
2.
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    Nasdaq states that this exception copies language from Item
407(e)(3)(iii) of Regulation S-K, which provides a limited exception to
the Commission's requirement for a registrant to disclose any role of
compensation consultants in determining or recommending the amount and
form of a registrant's executive and director compensation.\60\ The
Exchange believes that its proposed exception from the independence
assessment requirement is appropriate because the types of services
excepted do not raise conflict of interest concerns, and noted that
this is the same reason for which the Commission excluded these types
of services from the disclosure requirement in Item 407(e)(3)(iii) of
Regulation S-K.\61\
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    \60\ See 17 CFR 229.407(e)(3)(iii).
    \61\ See Amendment No. 2.
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3. Application to Smaller Reporting Companies
    Rule 10C-1 includes an exemption for smaller reporting companies
from all the requirements included within the rule.\62\ Consistent with
this Rule 10C-1 provision, Nasdaq, as a general matter, proposes that a
smaller reporting company, as defined in Rule 12b-2 under the Act
(hereinafter, a ``Smaller Reporting Company''), not be subject to the
new requirements set forth in its proposal specifically to comply with
Rule 10C-1.\63\ Thus, Nasdaq proposes not to require Smaller Reporting
Companies to comply with the enhanced independence standards for
members of compensation committees relating to compensatory fees and
affiliation.\64\
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    \62\ See supra Section II.A.
    \63\ See proposed Rule 5605(d)(5).
    \64\ See supra text accompanying notes 33 and 37.
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    In addition, a Smaller Reporting Company will not be required to
include in its compensation committee charter (or, as discussed below,
in a board resolution) a grant of authority to the committee to retain
compensation advisers, a requirement that the company fund such
advisers, and a requirement that the committee consider independence
factors before selecting such advisers. As stated by Nasdaq, the
exception for Smaller Reporting Companies also means that the
compensation committees of such companies are not required to review
and reassess the adequacy of their charters on an annual basis.\65\ The
Exchange believes that this approach will minimize new costs imposed on
Smaller Reporting Companies and allow them some flexibility not allowed
for larger companies.
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    \65\ See Notice. In addition, a Smaller Reporting Company, like
other listed companies, will be required to certify that it has
adopted a formal written compensation committee charter (or, if it
so chooses, a board resolution) that specifies the scope of the
committee's responsibilities and its responsibility for determining
or recommending to the board for determination the compensation of
the CEO and other executive officers. See supra notes 27-28.
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    Nasdaq proposes not to exclude a Smaller Reporting Company,
however, from its proposal to require a listed

company to have, and to certify that it has and will continue to have,
a compensation committee of at least two members, each of whom must be
an Independent Director as defined in the Exchange's Rule
5605(a)(2).\66\ In its discussion of the rules from which Smaller
Reporting Companies are not exempt, Nasdaq notes that its current
listing rules regarding compensation committees do not provide any
exemptions for Smaller Reporting Companies.\67\
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    \66\ See proposed Rule 5605(d)(5). See also proposed
interpretive material IM-5605-6. As noted above, listed companies
other than Smaller Reporting Companies and other exempted issuers
must comply with the additional independence requirements for
compensation committee members set forth in proposed Nasdaq Rule
5605(d)(2)(A). See discussion in Section II.B.1., supra.
    \67\ See Notice.
---------------------------------------------------------------------------

4. Exemptions
    Nasdaq proposes that its existing exemptions from the Exchange's
compensation-related listing rules currently in place, which are set
forth in Nasdaq Rule 5615, apply also to the new requirements of the
proposed rule change. These include exemptions for asset-backed issuers
and other passive issuers, cooperatives, limited partnerships,
management investment companies registered under the Investment Company
Act of 1940 (``registered management investment companies''), and
controlled companies.\68\ Nasdaq states that each of these categories
has ``traditionally been exempt from Nasdaq's compensation-related
listing rules,'' and believes that the reasons for the exemptions apply
to the new requirements, as well.\69\
---------------------------------------------------------------------------

    \68\ See Rule 5615(a)(1), (2), (4), and (5).
    \69\ See Notice. See also discussion below at note 76, infra,
for transition periods for companies that currently use the
Alternative Option and do not have compensation committees.
---------------------------------------------------------------------------

    Asset-backed issuers and other passive issuers have been exempted,
according to the Exchange, because they do not have a board of
directors or persons acting in a similar capacity and their activities
are limited to passively owning or holding (as well as administering
and distributing amounts in respect of) assets on behalf of or for the
benefit of the holders of the listed securities. Certain member-owned
cooperatives have been exempt, the Exchange states, because they do not
have a publicly traded class of common stock. Nasdaq further states
that the structure of limited partnerships requires that public
investors have limited rights and the general partners make all
significant decisions about the operation of the limited partnership,
and, as such, limited partners do not expect to have a voice in the
operations of the partnership. Registered management investment
companies, the Exchange states, are already subject to a pervasive
system of federal regulation in certain areas of corporate governance.
Controlled companies, by definition, are companies of which more than
50% of the voting power for the election of directors are held by an
individual, a group or another company, and the exemption for such
companies, as stated by Nasdaq, recognizes that majority shareholders
have the right to select directors and control certain key decisions,
such as executive officer compensation, by virtue of their ownership
rights.
    Concerning foreign private issuers, Nasdaq's current rules permit
any such issuer to follow its home country practice in lieu of many of
Nasdaq's corporate governance listing standards, including the
Exchange's compensation-related listing rules.\70\ This allowance is
granted on condition that the issuer discloses in its annual report
filed with the Commission each requirement that it does not follow and
describes the home country practice followed by the issuer in lieu of
such requirement.\71\ Nasdaq proposes that this allowance continue to
apply generally to the Exchange's compensation committee rules as
revised by the instant proposal on the same condition, namely that the
issuer discloses each requirement it does not follow and describes the
home country practice it follows in lieu of such requirement. However,
with respect, specifically, to the enhanced standards of independence
for compensation committees (concerning fees received by members and
their affiliations) Nasdaq proposes that, if a listed company follows
its home country practice, it must additionally disclose in its annual
report filed with the Commission the reasons why it does not have an
independent compensation committee as set forth in these standards.\72\
---------------------------------------------------------------------------

    \70\ See Rule 5615(a)(3). Under Nasdaq's listing rules,
``foreign private issuer'' has the same meaning as under Rule 3b-4
under the Exchange Act. See Rule 5005(a)(18). Nasdaq's listing rules
have traditionally provided qualified exemptions for foreign private
issuers so that such issuers are not required to do any act that is
contrary to a law, rule or regulation of any public authority
exercising jurisdiction over such issuer or that is contrary to
generally accepted business practices in the issuer's country of
domicile, except to the extent such exemptions would be contrary to
the public securities laws. See Securities Exchange Act Release No.
48745 (November 4, 2003), 68 FR 64154, 64165 (November 12, 2003)
(SR-NASD-2002-138).
    \71\ A Foreign Private Issuer that is not required to file its
annual report with the Commission on Form 20-F may make this
disclosure only on its Web site.
    \72\ As stated by Nasdaq, this proposed condition adopts the
requirements of Rule 10C-1(b)(1)(iii)(A)(4), which provides an
exemption from the independence requirements of Rule 10C-1 for a
``foreign private issuer that discloses in its annual report the
reasons that the foreign private issuer does not have an independent
compensation committee.''
---------------------------------------------------------------------------

5. Transition to the New Rules for Companies Listed as of the Effective
Date \73\
---------------------------------------------------------------------------

    \73\ During the transition periods described herein, until a
company is required to comply with a particular provision of the new
rules, the company must continue to comply with the corresponding
provision, if any, in the current rules, which are re-designated as
Rule 5605A(d) and IM-5605A-6 (``Sunsetting Provisions). See
Amendment No. 1, which added this clarification as a preamble to the
new Rule 5605(d). The addition mirrors a similar statement already
included in the original proposal as a preamble to the Sunsetting
Provisions.
---------------------------------------------------------------------------

    The proposed rule change, as amended, provides that certain of the
new requirements for listed companies will be effective on July 1,
2013.\74\ Specifically, as of that date, listed companies will be
required to comply with the provisions of the proposed rule change
relating to the authority of a compensation committee to retain
compensation consultants, legal counsel, and other compensation
advisers; the authority to fund such advisers; and the responsibility
of the committee to consider independence factors before selecting such
advisers.\75\ To the extent a company does not yet have a compensation
committee by that date,\76\ these provisions will apply to the
Independent Directors who determine, or recommend to the board for
determination, the compensation of the CEO and all other executive
officers of the company.\77\
---------------------------------------------------------------------------

    \74\ See proposed Rule 5605(d)(6), as modified by Amendment No.
1 to the proposed rule change. The original proposal provided that
these provisions were to be effective immediately.
    \75\ Id.
    \76\ A listed company that does not currently have a
compensation committee is not required to meet the requirement to
have such a committee until the earlier of its first annual meeting
after January 15, 2014, or October 31, 2014. See infra note 78 and
accompanying text.
    \77\ While the provisions of the proposed rule change relating
to the authority of a compensation committee to retain compensation
advisers, the company's obligation to fund such advisers, and the
responsibility of the committee to consider independence factors
before selecting such advisers must be assigned to the committee or
Independent Directors acting in lieu of a committee by July 1, 2013,
the requirement that they be included in a written committee charter
does not apply until a later date, as it is one of the remaining
provisions of the new compensation committee rule subject to the
transition period discussed below. Rule 5605(d)(6) states that
companies should consider under state corporate law whether to grant
the specific responsibilities and authority referenced through a
charter, resolution or other board action.

---------------------------------------------------------------------------

    Regarding the remaining new provisions for compensation committees,
the proposed rule change, as amended, provides that, in order to allow
listed companies to make necessary adjustments in the course of their
regular annual meeting schedule, they will have until the earlier of
their first annual meeting after January 15, 2014, or October 31,
2014,\78\ to comply with these remaining provisions.\79\ A listed
company must certify to Nasdaq, no later than 30 days after the final
implementation deadline applicable to it, that it has complied with
Rule 5605(d).
---------------------------------------------------------------------------

    \78\ See proposed Rule 5605(d)(6), as modified by Amendment No.
1 to the proposed rule change. The original proposal had required
these provisions to be implemented by the company's second annual
meeting after the proposal was approved, but no later than December
31, 2014.
    \79\ The remaining provisions subject to this schedule include
IM-5605-6, which is new interpretive material to be included in the
text of Nasdaq's rules that elaborates on the compensation committee
requirements.
---------------------------------------------------------------------------

6. Phase-In Schedules: IPOs; Companies That Lose Their Exemptions;
Companies Transferring From Other Markets
    Nasdaq's existing rules permit a company listing in connection with
its initial public offering (``IPO'') to phase in its compliance with
the Exchange's independence requirements for compensation and
nominations committees,\80\ as follows: Each such committee must have
one independent member at the time of listing; a majority of members
must be independent within 90 days of listing; and all members of such
committees must be independent within one year of listing. The same
phase-in schedule is permitted for companies emerging from bankruptcy
\81\ and companies ceasing to be controlled companies.\82\ Nasdaq
proposes that this schedule continue to apply and that it remain the
same with respect to the new compensation committee composition
requirements set forth in the proposed rule change.\83\
---------------------------------------------------------------------------

    \80\ See Rule 5615(b)(1).
    \81\ See Nasdaq Listing Rule 5615(b)(2).
    \82\ See Nasdaq Listing Rule 5615(c)(3).
    \83\ Specifically, the phase-in schedule would apply to proposed
Rule 5605(d)(2).
---------------------------------------------------------------------------

    As stated by Nasdaq, this would mean that a company listing on the
Exchange in connection with its IPO, a company emerging from
bankruptcy, or a company ceasing to be a controlled company would be
permitted to phase in its compliance with the requirements that a
compensation committee have at least two members, that these members be
Independent Directors as defined in Nasdaq's rules, and that they meet
the enhanced standards of independence for compensation committees
(concerning fees received by members and their affiliations) adopted
pursuant to Rule 10C-1.\84\
---------------------------------------------------------------------------

    \84\ See Notice for an illustration provided by Nasdaq of how
the compensation committee composition requirement will interact
with the minimum size requirement.
---------------------------------------------------------------------------

    For a company that was, but has ceased to be, a Smaller Reporting
Company, the proposed rule change, as modified by Amendment No. 1,
establishes a phase-in schedule based on certain dates relating to the
company's change in status.\85\ Pursuant to Rule 12b-2 under the Act, a
company tests its status as a Smaller Reporting Company on an annual
basis as of the last business day of its most recently completed second
fiscal quarter (the ``Determination Date''). A company with a public
float of $75 million or more as of the Determination Date will cease to
be a Smaller Reporting Company as of the beginning of the fiscal year
following the Determination Date. Under Nasdaq's proposal, the day of
this change in status is the beginning of the phase-in period (``Start
Date'').\86\
---------------------------------------------------------------------------

    \85\ See proposed Rule 5605(d)(4), as amended. In the proposal
as originally submitted, the phase-in schedule was to be the same as
the phase-in schedule for a company listing in conjunction with an
IPO, and was to start to run on the due date of the filing with the
Commission in which the company is required to report that it is an
issuer other than a Smaller Reporting Company. In Amendment No. 1,
Nasdaq states that while the revised phase-in schedule is different
from what it originally proposed, the amended version will allow
companies sufficient time to adjust to the differences.
    \86\ See Amendment No. 1.
---------------------------------------------------------------------------

    By six months from the Start Date, the company will be required to
comply with Rule 5605(d)(3), which sets forth the provisions described
above relating to authority of a compensation committee to retain
compensation advisers, the requirement that the company fund such
advisers, and the requirement that the committee consider independence
factors before selecting such advisers. By six months from the Start
Date, the company will also be required to certify to Nasdaq (i) that
it has complied with the requirement in Rule 5605(d)(1) to adopt a
formal written compensation committee charter including the content
specified in Rule 5605(d)(1)(A)-(D) \87\; and (ii) that it has
complied, or within the applicable phase-in schedule will comply, with
the additional requirements in Rule 5605(d)(2)(A) regarding
compensation committee composition.
---------------------------------------------------------------------------

    \87\ See supra notes 26-29. This includes the provisions with
which the company is now required to comply relating to authority of
a compensation committee to retain compensation advisers, the
requirement that the company fund such advisers, and the requirement
that the committee consider independence factors before selecting
such advisers.
---------------------------------------------------------------------------

    Under the proposal, as amended, a company that has ceased to be a
Smaller Reporting Company will be permitted to phase in its compliance
with the enhanced independence requirements for compensation committee
members (relating to compensatory fees and affiliation) as follows: (i)
One member must satisfy the requirements by six months from the Start
Date; (ii) a majority of members must satisfy the requirements by nine
months from the Start Date; and (iii) all members must satisfy the
requirements by one year from the Start Date.\88\
---------------------------------------------------------------------------

    \88\ During the phase-in schedule, a company that has ceased to
be a Smaller Reporting Company will be required to continue to
comply with the rules previously applicable to it.
---------------------------------------------------------------------------

    However, because a Smaller Reporting Company is required to have a
compensation committee and such committee is required to be comprised
of at least two Independent Directors, a company that has ceased to be
a Smaller Reporting Company will not be permitted to use the phase-in
schedule for these requirements.
    Nasdaq proposes no changes to the phase-in schedule in its current
listing rules for companies transferring to Nasdaq from other
markets.\89\
---------------------------------------------------------------------------

    \89\ See Rule 5615(b)(3).
---------------------------------------------------------------------------

7. Conforming Changes and Correction of Typographical Errors
    Finally, Nasdaq proposes to make minor conforming changes to its
requirements relating to audit and nominations committees and to
correct certain typographical errors in its current corporate
governance requirements.\90\
---------------------------------------------------------------------------

    \90\ See Exhibit 5 of the proposed rule change.
---------------------------------------------------------------------------

III. Comments on the Proposed Rule Change and Nasdaq's Response

    As stated previously, the Commission received a total of eight
comment letters on the proposed rule change.\91\ Three commenters
expressed general support for the proposal, although one of these
commenters found it wanting in some respects and another believed that
it needed to be amended before being approved.\92\ Some commenters

supported specific provisions of the proposal,\93\ some opposed
specific provisions,\94\ and some sought clarification of certain
aspects of the proposal.\95\ Some commenters believed that the proposal
fell short of meeting the requirements of Rule 10C-1 and believed that
it should have been more stringent.\96\ These and other comments, as
well as Nasdaq's responses to some of the comments that raised issues
with the proposal, are summarized below.
---------------------------------------------------------------------------

    \91\ See supra note 5.
    \92\ See ICI Letter, which urged approval of the proposal;
Teamsters Letter, which strongly supported the proposal while
believing that it did not fully satisfy the requirements of Rule
10C-1 and that it did not go far enough in certain respects; and
Corporate Secretaries Letter, which generally supported the
proposal, but believed that certain of its aspects were
unnecessarily burdensome or not sufficiently clear such that the
proposal needed to be amended before being approved by the
Commission.
    \93\ See AFL-CIO Letter, Brown Letter, CII Letter, ICI Letter,
and Teamsters Letter.
    \94\ See AFL-CIO Letter, Brown Letter, and Pinnacle Letter. See
also CII Letter, which stated that it did not support certain
specific aspects of the proposal.
    \95\ See Pinnacle Letter and Corporate Secretaries Letter.
    \96\ See, e.g., AFL-CIO Letter, Brown Letter, CII Letter, and
Teamsters Letter.
---------------------------------------------------------------------------

A. Compensation Committee Composition

    Three commenters expressed support for Nasdaq's proposal to require
all listed companies to have standing compensation committees,\97\ and
two further supported the proposal that such committees have at least
two members.\98\ Three commenters supported the provision that requires
compensation committees to adopt a written charter.\99\
---------------------------------------------------------------------------

    \97\ See AFL-CIO Letter, CII Letter, and Teamsters Letter.
    \98\ See AFL-CIO Letter, Teamsters Letter.
    \99\ See AFL-CIO Letter, CII Letter, and Teamsters Letter.
---------------------------------------------------------------------------

    Two commenters opposed the proposal's absolute prohibition barring
a compensation committee member from receiving any fees from the
company.\100\ One of these commenters argued, for example, that such a
prohibition is ``unnecessarily prescriptive and effectively precludes
certain professionals, particularly attorneys, from compensation
committee service.'' \101\ In addition, this commenter argued, because
most Nasdaq companies have three committees that require Independent
Directors (audit, compensation, and nominations committees) and audit
committee members are already subject to a ``no compensatory fee''
restriction, adding the same restriction for compensation committee
membership would impose it ``on a very high percentage of the
independent directors.'' \102\ This commenter suggested that the
Commission reject the proposed rule and that, if Nasdaq determined to
maintain a prohibition, the prohibition should not be absolute. Rather,
this commenter argued, ``some level below a de minimus amount'' of fees
should be permitted and fees for service that have no relationship to
the work of the compensation committee should be excluded.\103\
---------------------------------------------------------------------------

    \100\ See Pinnacle Letter and Corporate Secretaries Letter.
    \101\ Pinnacle Letter. The commenter observed that the rule
would disqualify, for instance, a knowledgeable employment attorney
whose firm provides only a limited amount of real estate closing or
non-employment litigation services, and neither he nor his firm
provided employment or compensation advice to the company. Id.
    \102\ Id.
    \103\ Id.
---------------------------------------------------------------------------

    In a similar vein, the other commenter opposing an absolute bar
believed that it is important to companies that seek to maximize the
contributions of their directors not to be restricted by such a
prohibition, and expressed concern that the proposal would
``disproportionately impact small- and mid-cap companies, whose boards
tend to be smaller and who have fewer resources to engage non-employee
advisers and consultants.'' \104\ This commenter believed that a better
approach would be to have a company's board of directors consider such
consulting or advisory fees in making its determination as to whether
the member's receipt of such compensation would interfere with the
member's exercise of independent judgment.\105\
---------------------------------------------------------------------------

    \104\ Corporate Secretaries Letter.
    \105\ Id.
---------------------------------------------------------------------------

    In response, Nasdaq stated that it had carefully weighed the
potential benefits of the prohibition, and had determined that the
payment of direct or indirect fees from a company to a compensation
committee member ``could influence, or create the appearance of
influencing, the member's judgment and therefore render the member
unwilling or unable to provide a truly independent voice on executive
compensation decisions.'' \106\ Nasdaq acknowledged that the
prohibition will preclude certain professionals from service on
compensation committees, but stated that, ``given the heightened
importance of executive compensation decisions in today's business
environment,'' it believes that ``the goal of ensuring independent
compensation decisions outweighs the potential negative impact of
excluding a small group of individuals'' from such service.\107\
---------------------------------------------------------------------------

    \106\ See Nasdaq Response Letter.
    \107\ Id. See also infra text accompanying note 143.
---------------------------------------------------------------------------

    Three commenters generally supported Nasdaq's proposal that members
of compensation committees must not accept any consulting, advisory or
other compensatory fees,\108\ despite their own belief, generally, that
additional requirements or prohibitions should be imposed.\109\ Two of
these commenters believed, however, that the proposal falls short of
the requirements of Rule 10C-1, which, in their view, requires that
fees paid to a director for service on the company's board also be
considered.\110\ Another commenter argued that the language of Section
10C of the Act itself, as well as its legislative history, indicates
Congress's intent that such fees be considered.\111\ These commenters
believed that compensation for board service ``can, in certain
circumstances, impair independence,'' \112\ because ``high director
fees relative to other sources of income can compromise director
objectivity,'' \113\ and ``highly paid directors also may be more
inclined to approve large executive pay packages.'' \114\ One commenter
believed that the requirement of Section 10C of the Act and Rule 10C-1
to consider the source of compensation of a director goes further, and
applies to all types of compensation that a director may receive,
including compensation paid by any person, including non-issuers.\115\
---------------------------------------------------------------------------

    \108\ See AFL-CIO Letter, CII Letter, and Teamsters Letter.
    \109\ For a discussion of the additional kinds of rules these
comments favored relating to payments made to members of
compensation committees, and Nasdaq's response to their arguments,
see infra notes 123-127 and accompanying text.
    \110\ See AFL-CIO Letter and Teamsters Letter, noting that Rule
10C-1 requires the exchanges to consider a director's ``source of
compensation,'' and arguing that this phrase includes director fees.
In the proposal, Nasdaq stated that it does not believe that the
intent of the Dodd-Frank Act or Rule 10C-1 was to limit independence
based on director compensation. See Notice.
    \111\ See Brown Letter.
    \112\ Id.
    \113\ AFL-CIO Letter. See also Teamsters Letter, arguing that
directors who are highly paid ``may be more inclined to approve
large executive pay packages.''
    \114\ AFL-CIO Letter.
    \115\ See Brown Letter.
---------------------------------------------------------------------------

    In its response to comments, Nasdaq stated that companies typically
adopt a uniform compensation policy that applies to all directors, not
only those who serve on compensation committees, such that ``a
requirement to determine eligibility for compensation committee service
based on director fees would lead to no meaningful distinction among
directors.'' \116\ In addition, Nasdaq stated, ``directors should be
adequately compensated to ensure that they devote appropriate time and
attention to their roles and responsibilities.'' Nasdaq also observed
that, to the extent a conflict of interest exists because directors set
their own compensation, companies must disclose director compensation,
and investors will become aware of excessive or non-customary director

compensation through this means.\117\ The Exchange further cited to the
requirement in its rules that a company board make an affirmative
determination that each Independent Director has no relationship that,
in the opinion of the board, would interfere with his or her
independent judgment in carrying out director responsibilities, and
that a board could therefore consider director fees in this
context.\118\
---------------------------------------------------------------------------

    \116\ Nasdaq Response Letter.
    \117\ Id.
    \118\ Id.
---------------------------------------------------------------------------

    With respect to the other prong of Nasdaq's independence standard
for compensation committee members, one commenter stated that it did
not object to the Exchange's proposal to require the board of a listed
company to consider whether a director is affiliated with the company
or any of its subsidiaries and their affiliates in determining
eligibility for compensation committee membership.\119\ Another
commenter, on the other hand, expressed disappointment that the
Exchange did not propose a ban on such affiliations, maintaining that
``affiliated persons--such as a large shareholder seeking a change in
control of the company--may have interests or investment time horizons
that differ from shareholders generally.'' \120\
---------------------------------------------------------------------------

    \119\ See CII Letter.
    \120\ See Teamsters Letter.
---------------------------------------------------------------------------

    In response to the latter commenter, Nasdaq stated that it had
considered whether to adopt such a prohibition, but concluded that
``such a blanket prohibition would be inappropriate for compensation
committee members.'' \121\ The Exchange believed that it may be
desirable for representatives of significant stockholders in a listed
company to serve on its compensation committee ``since their interests
are aligned with other stockholders in seeking a rational compensation
program.'' \122\
---------------------------------------------------------------------------

    \121\ Nasdaq Response Letter.
    \122\ Id.
---------------------------------------------------------------------------

    Some commenters believed that the proposed rule should explicitly
require the board of a listed company, when considering affiliations of
a director in determining eligibility for the compensation committee,
to consider personal or business relationships between the director and
the company's executive officers.\123\ As expressed by one commenter,
``too many corporate directors have significant personal, financial or
business ties to the senior executives that they are responsible for
compensating.'' \124\
---------------------------------------------------------------------------

    \123\ See AFL-CIO Letter, Brown Letter, CII Letter, Teamsters
Letter.
    \124\ AFL-CIO Letter. See also Teamsters Letter.
---------------------------------------------------------------------------

    Some commenters believed that related party transactions should
explicitly be included as a relevant factor in determining independence
for members of compensation committees.\125\ The additional
requirements suggested by commenters also included disqualification of
a director from membership on the compensation committee if an
immediate family member of the director received compensation in excess
of $120,000 a year from the company even if that family member was not
an executive officer of the company; \126\ or if the director has, or
in the past five years has had, a personal contract with the company,
an executive officer of the company, or any affiliate of the
company.\127\
---------------------------------------------------------------------------

    \125\ See AFL-CIO Letter and Teamsters Letter.
    \126\ See AFL-CIO Letter and Teamsters Letter. Nasdaq's
definition of Independent Director already disqualifies a director
from membership on the compensation committee if an immediate family
member of the director received in excess of $120,000 from the
company and also was an executive officer of the company.
    \127\ See CII Letter.
---------------------------------------------------------------------------

    Nasdaq responded that its definition of Independent Directors, in
addition to the bright-line tests of independence that it imposes,\128\
requires a company's board to make an affirmative determination that
each such director has no relationship that, in the opinion of the
board, would interfere with the exercise of independent judgment in
carrying out the responsibilities of a director.\129\ ``This
bifurcation,'' Nasdaq stated, ``recognizes that [Nasdaq] cannot in its
rules legislate every possible relationship between a [company] and its
directors and therefore empowers the board, which must be comprised of
a majority of Independent Directors, to assess the relevant
relationships.''
---------------------------------------------------------------------------

    \128\ See supra note 19.
    \129\ See Nasdaq Response Letter.
---------------------------------------------------------------------------

    Several commenters read a statement made by the Commission in
adopting Rule 10C-1 as indicating that no single factor could determine
a director's independence,\130\ and believed that such a position
undermines the intent of the rule.\131\ Two commenters explicitly
sought clarification from Nasdaq that a single factor can result in the
loss of independence.\132\
---------------------------------------------------------------------------

    \130\ See AFL-CIO Letter, Brown Letter, Teamsters Letter.
    \131\ See, e.g., Teamsters Letter.
    \132\ See AFL-CIO Letter, Brown Letter.
---------------------------------------------------------------------------

    In its response letter, Nasdaq confirmed that a director cannot be
independent if he or she fails any of the bright-line prohibitions in
the definition of Independent Director or accepts directly or
indirectly any consulting, advisory, or other fee from the company or
any of its subsidiaries. The Exchange stated that its proposals
``operate to exclude directors who fail these tests from serving on the
compensation committee.'' \133\
---------------------------------------------------------------------------

    \133\ Nasdaq Response Letter.
---------------------------------------------------------------------------

    Some of the above commenters expressed the belief, in general, that
the definition of an independent director should be more narrowly
drawn, that the bright-line tests of independence should be
strengthened, and that the standards of independence should be uniform
for all committees requiring Independent Directors.\134\
---------------------------------------------------------------------------

    \134\ See CII Letter, AFL-CIO Letter, Teamsters Letter.
---------------------------------------------------------------------------

    Several commenters did not support the exception proposed by Nasdaq
\135\ to allow a director who fails to meet the enhanced independence
standards for compensation committees to be appointed to such a
committee under exceptional and limited circumstances, provided that
the director is not currently an executive officer, an employee, or the
family member of an executive officer.\136\ These commenters noted
that, while providing a cure period when an independent director loses
his or her independent status, Section 10C of the Act does not provide
an exception to allow the appointment of a non-independent director in
the first instance.\137\ One commenter expressed the belief that the
cure period provides sufficient flexibility for companies when a
director ceases to be independent, such that this additional exception
is not necessary.\138\ One commenter added that the standard set by the
proposed rule for permitting the exception to be used--when the
appointment is in ``the best interests of the Company and its
Shareholders''--is ``vague and ill-defined.'' \139\
---------------------------------------------------------------------------

    \135\ See supra note 47.
    \136\ See AFL-CIO Letter, Brown Letter, CII Letter.
    \137\ See, e.g., CII Letter.
    \138\ See AFL-CIO Letter.
    \139\ Brown Letter.
---------------------------------------------------------------------------

    Nasdaq responded that its proposal is consistent with Rule 10C-1,
which permits an exchange to exempt from the enhanced independence
requirements ``a particular relationship with respect to members of the
compensation committee, as each national securities exchange * * *
determines is appropriate, taking into consideration the size of an
issuer and any other relevant factors.'' \140\ Nasdaq noted that the
exception for exceptional and limited circumstances has been included
in its rules for oversight of executive compensation committees

since they were implemented.\141\ The Exchange stated that the
exception has been used throughout its life--albeit infrequently--and
that the Exchange therefore believes that it adds value to its
rules.\142\ The Exchange added that it believed that it is appropriate
to allow a listed company the flexibility afforded by the provision and
that it is particularly important for a smaller company ``that may have
relationships that require such flexibility,'' and that, in this way,
the exception also addresses concerns raised by some commenters that
the proposal to prohibit a compensation committee member from accepting
directly or indirectly any consulting, advisory or other compensatory
fee from the company is overly prescriptive.\143\
---------------------------------------------------------------------------

    \140\ Rule 10C-1(b)(1)(iii)(B).
    \141\ Nasdaq Response Letter. In response to the concern that a
board could use a non-independent director indefinitely, Nasdaq
noted that it tracks the use of the exception and can exercise its
discretionary authority to apply additional or more stringent
criteria for the initial or continued listing of particular
securities and deny use of the exception to any company that the
Exchange believes is abusing it. See id.
    \142\ Id.
    \143\ Id.
---------------------------------------------------------------------------

B. Compensation Adviser Independence Factors

    The Commission received letters from three commenters relating to
the provision of the proposed rule change that requires a compensation
committee to take into consideration the factors set forth in the
proposal in the selection of a compensation consultant, legal counsel,
or other adviser to the committee.\144\
---------------------------------------------------------------------------

    \144\ See Wilson Sonsini Letter, CII Letter, and Corporate
Secretaries Letter.
---------------------------------------------------------------------------

    One commenter believed that Nasdaq's proposed rule could be read as
requiring a compensation committee to consider the independence factors
set forth in Rule 10C-1 only when selecting independent counsel, rather
than any outside legal counsel that might provide legal advice to a
compensation committee.\145\ The commenter sought an explicit statement
from Nasdaq that a compensation committee is not required to consider
the enumerated independence factors with respect to any outside legal
counsel, ``other than in circumstances where the compensation committee
has determined it is advisable to retain independent legal counsel,
such as in the case of an investigation or litigation.'' \146\
Otherwise, the commenter believed, the proposed rule ``may cause an
unnecessary expenditure of resources by companies that feel compelled
to conduct an independent analysis of all counsel providing advice to
the Committee.'' \147\
---------------------------------------------------------------------------

    \145\ See Wilson Sonsini Letter.
    \146\ Id.
    \147\ Id.
---------------------------------------------------------------------------

    In its response letter, Nasdaq disagreed with this commenter's
reading of Rule 10C-1, stating that, while a compensation committee is
not required to retain an independent compensation adviser, the
compensation committee is required to conduct the independence analysis
set forth in Rule 10C-1 before selecting any compensation adviser other
than in-house legal counsel.\148\
---------------------------------------------------------------------------

    \148\ See Nasdaq Response Letter.
---------------------------------------------------------------------------

    A second commenter believed that at least one additional factor
should be considered: ``whether the compensation committee consultants,
legal counsel, or other advisers require that their clients
contractually agree to indemnify or limit their liability.'' \149\ The
commenter believed that such contractual provisions ``raise conflict of
interest red flags'' that every compensation committee should consider
in determining the independence of the consultant.\150\
---------------------------------------------------------------------------

    \149\ CII Letter.
    \150\ Id.
---------------------------------------------------------------------------

    Another commenter, while generally supporting the Nasdaq proposal,
maintained that the required independence assessment will be ``time-
consuming and burdensome'' due to the scope of information that will
need to be gathered in order to conduct the required independence
assessment.\151\ This commenter believed that uncertainty over the
scope of the requirement could have a counterproductive effect of
discouraging compensation committees from obtaining the advice of
advisers subject to the rule, particularly in situations where quick
action is required of the compensation committee, and further
identified a number of specific issues that it believed the Exchange
should address to provide greater clarity regarding the standard.\152\
---------------------------------------------------------------------------

    \151\ Corporate Secretaries Letter.
    \152\ The Commission notes that Nasdaq addressed some of the
commenter's concerns in Amendment No. 2.
---------------------------------------------------------------------------

C. Opportunity to Cure Defects

    One commenter supported the rule proposed by the Exchange to permit
issuers a period of time, under specified conditions, to cure failures
to comply with the independence requirements for compensation committee
members.\153\ The commenter was concerned, however, that the proposed
rules did not specify a cure period for any other form of non-
compliance with the new rules.\154\ The commenter believed that a
company should be allowed to take corrective action within a reasonable
time after the company's senior executives learn of the non-compliance.
---------------------------------------------------------------------------

    \153\ See Corporate Secretaries Letter.
    \154\ See id. The commenter mentioned, in particular, the
requirement that the committee may obtain advice from a consultant
or adviser only after assessing that individual's independence. The
commenter believed that inadvertent violations of this requirement
could arise, for example, if a person is appearing before a
compensation committee solely to provide information or other
services, and the individual then on a solicited or unsolicited
basis makes a statement that could be viewed as providing advice on
executive compensation. In the absence of a cure mechanism, the
commenter believed, the company would be in violation of the listing
standard and have no recourse.
---------------------------------------------------------------------------

D. Exemptions

    The Commission received one comment letter supporting the
Exchange's proposal to exempt investment companies from the Rule 10C-1
requirements.\155\ As the commenter noted, although Rule 10C-1 exempts
certain entities, including registered open-end management investment
companies, from the enhanced independence requirements for members of
compensation committees, it did not explicitly exempt other types of
registered management investment companies, including closed-end funds,
from any of the requirements of Rule 10C-1. Under the Nasdaq proposal,
both closed-end and open-end funds would be exempt from all the
requirements of the rule.
---------------------------------------------------------------------------

    \155\ See ICI Letter.
---------------------------------------------------------------------------

    The commenter supported this aspect of the proposal, stating that
both open-end and closed-end funds typically are externally managed and
do not employ executives or by their nature have employees. The
commenter believed that such funds are adequately governed by other
federal regulation with respect to corporate governance matters,
generally, and compensation matters, specifically.\156\
---------------------------------------------------------------------------

    \156\ Id.
---------------------------------------------------------------------------

E. Transition Period

    One commenter voiced support for the transition period proposed by
Nasdaq for compliance with the new compensation committee independence
standard, but believed that the Exchange should provide a longer period
for companies to satisfy proposed Rule 5605(d)(3), relating to the
authority of a compensation committee to retain compensation
consultants, legal counsel, and other compensation advisers; the
authority to fund such advisers; and the responsibility of the

committee to consider independence factors before selecting such
advisers.\157\
---------------------------------------------------------------------------

    \157\ See Corporate Secretaries Letter. The Commission notes
that the commenter's letter was submitted prior to Nasdaq's
submission of Amendment No. 1, in which the Exchange revised the
proposed transition period for compliance with Rule 5605(d)(3).
---------------------------------------------------------------------------

IV. Discussion

    After careful review, the Commission finds that the Nasdaq
proposal, as amended, is consistent with the Act and the rules and
regulations thereunder applicable to a national securities
exchange.\158\ In particular, the Commission finds that the amended
proposed rule change is consistent with the requirements of Section
6(b) of the Act,\159\ as well as with Section 10C of the Act \160\ and
Rule 10C-1 thereunder.\161\ Specifically, the Commission finds that the
proposed rule change, as amended, is consistent with Section 6(b)(5) of
the Act,\162\ which requires that the rules of a national securities
exchange be designed, among other things, to prevent fraudulent and
manipulative acts and practices; to promote just and equitable
principles of trade; to remove impediments to and perfect the mechanism
of a free and open market and a national market system, and, in
general, to protect investors and the public interest; and not be
designed to permit, among other things, unfair discrimination between
issuers.
---------------------------------------------------------------------------

    \158\ In approving the Nasdaq proposed rule change, as amended,
the Commission has considered its impact on efficiency, competition
and capital formation. 15 U.S.C. 78c(f).
    \159\ 15 U.S.C. 78f(b).
    \160\ 15 U.S.C. 78j-3.
    \161\ 17 CFR 240.10C-1.
    \162\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    The development and enforcement of meaningful listing standards for
a national securities exchange is of substantial importance to
financial markets and the investing public. Meaningful listing
standards are especially important given investor expectations
regarding the nature of companies that have achieved an exchange
listing for their securities. The corporate governance standards
embodied in the listing rules of national securities exchanges, in
particular, play an important role in assuring that companies listed
for trading on the exchanges' markets observe good governance
practices, including a reasoned, fair, and impartial approach for
determining the compensation of corporate executives. The Commission
believes that the Nasdaq proposal will foster greater transparency,
accountability, and objectivity in the oversight of compensation
practices of listed issuers and in the decision-making processes of
their compensation committees.
    In enacting Section 10C of the Act as one of the reforms of the
Dodd-Frank Act,\163\ Congress resolved to require that ``board
committees that set compensation policy will consist only of directors
who are independent.'' \164\ In June 2012, as required by this
legislation, the Commission adopted Rule 10C-1 under the Act, which
directs the national securities exchanges to prohibit, by rule, the
initial or continued listing of any equity security of an issuer (with
certain exceptions) that is not in compliance with the rule's
requirements regarding issuer compensation committees and compensation
advisers.
---------------------------------------------------------------------------

    \163\ See supra note 9.
    \164\ See H.R. Rep. No. 111-517, Joint Explanatory Statement of
the Committee of Conference, Title IX, Subtitle E ``Accountability
and Executive Compensation,'' at 872-873 (Conf. Rep.) (June 29,
2010).
---------------------------------------------------------------------------

    In response, Nasdaq submitted the proposed rule change, which
includes rules intended to comply with the requirements of Rule 10C-1
and additional provisions designed to strengthen the Exchange's listing
standards relating to compensation committees. The Commission believes
that the proposed rule change satisfies the mandate of Rule 10C-1 and
otherwise will promote effective oversight of its listed issuers'
executive compensation practices.
    The Commission notes that a number of the commenters generally
supported the proposed rule change, although some commenters offered
suggestions to clarify or improve various provisions of Nasdaq's
proposal. The Commission believes that the proposed rule change, as
modified by Amendment Nos. 1 and 2, appropriately revises Nasdaq's
rules for compensation committees of listed companies, for the
following reasons:

A. Compensation Committee Composition and Charter

    The Commission believes that it is reasonable for Nasdaq to require
each company listed on its market to have a compensation committee.
Although the Alternative Option to a formal committee in the Exchange's
current rules may have been useful to a small number of companies,\165\
the Commission agrees that 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. In making this determination the Commission
is aware that Rule 10C-1 does not require listed companies of national
securities exchanges to have a committee dedicated to compensation
matters. Nevertheless, it is consistent with Section 6(b)(5) of the Act
for Nasdaq to require all its listed companies to have an independent
compensation committee overseeing executive compensation matters
because of the importance and accountability to investors that such a
formal structure can provide.\166\ The Commission also notes that some
of the other requirements of Rule 10C-1 apply only when a company has a
committee overseeing compensation matters.\167\ Thus, the requirement
to have a compensation committee will trigger the additional
protections for shareholders created by these requirements.
---------------------------------------------------------------------------

    \165\ As stated by Nasdaq, as of June 30, 2012, only 25 of its
2,636 listed companies relied on the Alternative Option in lieu of
having a standing compensation committee. See Notice.
    \166\ See, e.g., Section 303A.05 of the New York Stock Exchange
(``NYSE'') Listed Company Manual, which does not provide for an
Alternative Option as is currently allowed under Nasdaq rules.
    \167\ Under Rule 10C-1, the provisions of Rule 10C-1(b)(2)(i)
(concerning the authority to retain or obtain the advice of a
compensation adviser) and Rule 10C-1(b)(3) (concerning funding for
compensation advisers) do not apply to members of the board of
directors who oversee executive compensation matters on behalf of
the board of directors outside a committee structure.
---------------------------------------------------------------------------

    Similarly, the Commission believes that it is appropriate for
Nasdaq to raise its standards to require the compensation committee of
each issuer to have at least two members, instead of permitting a sole
individual to be responsible for compensation policy, and that this
furthers investor protection and the public interest in accordance with
Section 6(b)(5). In light of the importance of compensation matters,
the added thought and objectivity that is likely to result when two or
more individuals deliberate over how much a listed company should pay
its executives, and what form such compensation should take, is
consistent with the goal of promoting more accountability to
shareholders on executive compensation matters. Moreover, given the
complexity of executive compensation packages for corporate executives,
it is reasonable for Nasdaq to require listed companies to have the
input of more than one committee member on such matters. Finally, we
note that, as Nasdaq stated in its filing, only a small number of

currently listed companies have a compensation committee of only one
member. The Commission believes that, with the transition period
proposed by Nasdaq for such companies to add an additional member, the
two-member requirement will not be an onerous burden for such companies
and should actually strengthen their review of compensation matters.
    The proposal by the Exchange to require a compensation committee to
have a written charter detailing the committee's authority and
responsibility is also consistent with Section 6(b)(5) of the Act and
will help listed companies to comply with the rules being adopted by
Nasdaq to fulfill its mandate under Rule 10C-1. For example, as noted
above, under Nasdaq's proposal the charter must set forth the
compensation committee's responsibilities as well as the specific
authority concerning compensation advisers as required under Rule 10C-
1.\168\ A written charter will also provide added transparency for
shareholders regarding how a company determines compensation and may
clarify and improve the process itself. In this regard, the Commission
notes that Nasdaq's requirement that listed companies review and
reassess the adequacy of the compensation's committee charter on an
annual basis will also help to ensure accountability and transparency
on an on-going basis. The Commission also notes that several exchanges
already require their compensation committees to have written
charters.\169\
---------------------------------------------------------------------------

    \168\ The Commission notes that the provision that is required
in the charter regarding the authority of the committee to retain
compensation advisers, the requirement that the company fund such
advisers, and the requirement that the committee consider
independence factors before selecting such advisers does not apply
under the Nasdaq proposal to Smaller Reporting Companies. See supra
notes 62-65 and accompanying text.
    \169\ See, e.g., NYSE Listed Company Manual, Section 303A.05.
---------------------------------------------------------------------------

    As discussed above, under Rule 10C-1 the exchanges must adopt
listing standards that require each member of a compensation committee
to be independent, and to develop a definition of independence after
considering, among other relevant factors, the source of compensation
of a director, including any consulting, advisory or other compensatory
fee paid by the issuer to the director as well as whether the director
is affiliated with the issuer or any of its subsidiaries or their
affiliates.
    The Commission notes, however, that Rule 10C-1 leaves it to each
exchange to formulate a final definition of independence for these
purposes, subject to review and final Commission approval pursuant to
Section 19(b) of the Act. As the Commission stated in the Rule 10C-1
Adopting Release, ``given the wide variety of issuers that are listed
on exchanges, we believe that the exchanges should be provided with
flexibility to develop independence requirements appropriate for the
issuers listed on each exchange and consistent with the requirements of
the independence standards set forth in Rule 10C-1(b)(1).''\170\ This
discretion comports with the Act, which gives the exchanges the
authority, as self-regulatory organizations, to propose the standards
they wish to set for companies that seek to be listed on their markets,
consistent with the Act and the rules and regulations thereunder, and,
in particular, Section 6(b)(5) of the Act.
---------------------------------------------------------------------------

    \170\ As explained further in the Rule 10C-1 Adopting Release,
prior to final approval, the Commission will consider whether the
exchanges' proposed rule changes are consistent with the
requirements of Section 6(b) and Section 10C of the Exchange Act.
---------------------------------------------------------------------------

    As noted above, in addition to retaining its existing independence
standards that currently apply to board and compensation committee
members, which include certain bright-line tests, Nasdaq has determined
to adopt a definition that prohibits a director who receives
compensation or fees from a listed company (other than, among other
things, director compensation) from serving on the company's
compensation committee.\171\
---------------------------------------------------------------------------

    \171\ See supra note 33-36 and accompanying text.
---------------------------------------------------------------------------

    As the Exchange noted in its proposal, under the bright-line tests
of its general rules for director independence, directors can still be
considered independent and serve on listed companies' compensation
committees if they receive fees that do not exceed certain
thresholds.\172\ This is in contrast to Nasdaq's requirements to serve
on a listed company's audit committee, which bar a director who
receives any compensatory fees from the company. In considering the
Fees Factor under Rule 10C-1, Nasdaq stated that it did not see any
compelling justification to set a different standard with respect to
the acceptance of compensatory fees for members of the compensation
committee than for members of audit committees.
---------------------------------------------------------------------------

    \172\ See Nasdaq Listing Rules 5605(a)(2)(B) and (D).
---------------------------------------------------------------------------

    The Commission notes that, while two commenters opposed Nasdaq's
proposed outright bar on the receipt of these fees,\173\ other
commenters believed that the Exchange's proposal relating to
compensatory fees fell short of Rule 10C-1's requirements \174\ or
otherwise proposed additional requirements.\175\ In response to the
commenters opposing the fee prohibition, the Exchange stated that it
carefully weighed the benefits and burdens of its proposal and
concluded that a director's receipt of compensatory fees from a company
(other than compensation for board and board committee service or
compensation under a retirement plan for prior service with the company
as described above \176\) could render the member unwilling or unable
to provide a truly independent voice on executive compensation
decisions.\177\ The Exchange further stated that, although certain
individuals may be excluded from the compensation committee because of
the proposal's fee restriction, the restriction was warranted given the
heightened importance of executive compensation decisions in today's
business environment.
---------------------------------------------------------------------------

    \173\ See Corporate Secretaries Letter and Pinnacle Letter and
supra notes 100-105 and accompanying text.
    \174\ See AFL-CIO Letter, Brown Letter, and Teamsters Letter,
maintaining that Nasdaq's proposal ``falls short'' of the Rule 10C-1
provision requiring exchanges to consider a director's source of
compensation. See also supra notes 123-127 and accompanying text.
    \175\ See, e.g., CII Letter (``the Council's policies on
independence relating to the acceptance of compensatory fees are
clearly more narrowly drawn than those of [Nasdaq's proposal]'').
    \176\ See supra notes 35-36 and accompanying text.
    \177\ See Nasdaq Response Letter, supra note 6.
---------------------------------------------------------------------------

    The Commission believes that the Exchange has complied with Rule
10C-1 and Section 10C and that the proposed compensatory fee
restriction, which is designed to protect investors and the public
interest, is consistent with the requirements of Section 6(b)(5) of the
Act. The Commission notes that the compensatory fee restriction will
help to ensure that compensation committee members cannot receive
directly or indirectly fees that could potentially influence their
decisions on compensation matters.
    The Commission recognizes that some commenters did not believe that
the Nasdaq proposal went far enough because the Exchange did not
adequately consider the compensation that directors receive for board
or committee service in formulating its standards of independence for
service on the compensation committee, and, in particular, the levels
to which such compensation may rise.\178\ The Commission notes,
however, that, as Nasdaq stated, to the extent a conflict of interest
exists because directors set their

own compensation, companies must disclose director compensation, and
investors will become aware of excessive or non-customary director
compensation through this means.\179\ In addition, a company board must
make an affirmative determination that each Independent Director has no
relationship that, in the opinion of the board, would interfere with
his or her independent judgment in carrying out director
responsibilities, and a board could therefore consider director
compensation in that context. The Commission believes that these
arguments are sufficient to find that Nasdaq has complied with the
requirements of Rule 10C-1 in this regard.
---------------------------------------------------------------------------

    \178\ As stated by commenters, ``[h]igh director fees relative
to other sources of income can compromise director objectivity'' and
``[h[ighly paid directors also may be more inclined to approve large
executive pay packages.'' AFL-CIO Letter. See also Teamsters Letter.
    \179\ See Nasdaq Response Letter.
---------------------------------------------------------------------------

    With respect to the Affiliation Factor of Rule 10C-1, Nasdaq has
concluded that an outright bar from service on a company's compensation
committee of any director with an affiliation with the company, its
subsidiaries, and their affiliates is inappropriate for compensation
committees. Nasdaq's existing independence standards will also continue
to apply to those directors serving on the compensation committee.
Nasdaq maintains that it may be appropriate for certain affiliates,
such as representatives of significant stockholders, to serve on
compensation committees ``since their interests are likely aligned with
those of other stockholders in seeking an appropriate executive
compensation program.'' In spite of the argument of one commenter in
favor of an outright ban on affiliations with the company,\180\ the
Commission believes that Nasdaq's approach of requiring boards only to
consider such affiliations is reasonable and consistent with the
requirements of the Act.
---------------------------------------------------------------------------

    \180\ See Teamsters Letter and supra note 120 and accompanying
text.
---------------------------------------------------------------------------

    The Commission notes that Congress, in requiring the Commission to
direct the exchanges to consider the Affiliation Factor, did not
declare that an absolute bar was necessary. Moreover, as the Commission
stated in the Rule 10C-1 Adopting Release, ``In establishing their
independence requirements, the exchanges may determine that, even
though affiliated directors are not allowed to serve on audit
committees, such a blanket prohibition would be inappropriate for
compensation committees, and certain affiliates, such as
representatives of significant shareholders, should be permitted to
serve.'' \181\ In determining that Nasdaq's affiliation standard is
consistent with Sections 6(b)(5) and 10C under the Act, the Commission
notes that Nasdaq's proposal requires a company's board, in selecting
compensation committee members, to consider whether any such
affiliation would impair a director's judgment as a member of the
compensation committee. We believe that this should give companies the
flexibility to assess whether a director who is an affiliate, including
a significant shareholder, should or should not serve on the company's
compensation committee, depending on the director's particular
affiliations with the company.
---------------------------------------------------------------------------

    \181\ Rule 10C-1 Adopting Release. At the same time, the
Commission noted that significant shareholders may have other
relationships with the listed company that would result in such
shareholders' interests not being aligned with those of other
shareholders and that the exchanges may want to consider these other
ties between a listed issuer and a director. While the Exchange did
not adopt any additional factors, the current affiliation standard
would still allow a company to prohibit a director whose
affiliations ``impair the director's judgment'' as a member of the
committee. See also infra notes 183-184.
---------------------------------------------------------------------------

    As to consideration by Nasdaq of whether it should adopt any
additional relevant independence factors, the Exchange stated that it
reviewed its rules in the light of Rule 10C-1, but concluded that its
existing rules together with its proposed rules are sufficient to
ensure committee member independence. The Commission believes that,
through this review, the Exchange has complied with the requirement
that it consider relevant factors, including, but not limited to, the
Fees and Affiliation Factors in determining its definition of
independence for compensation committee members. The Commission does
not agree with the commenters who argued that the Exchange's proposal
falls short of the requirements and/or intent of Section 10C of the Act
and Rule 10C-1.\182\ The Commission notes that Rule 10C-1 requires each
exchange to consider relevant factors in determining independence
requirements for members of a compensation committee, but does not
require the final definition and the rules imposed on listed companies
to reflect any such additional factors.
---------------------------------------------------------------------------

    \182\ See supra notes 110-111 and accompanying text.
---------------------------------------------------------------------------

    As noted above, several commenters argued that Nasdaq should
require other ties between directors and the company, including
business and personal relationships with executives of the company, to
be considered by boards in making independence determinations.\183\ The
Commission did emphasize in the Rule 10C-1 Adopting Release that ``it
is important for exchanges to consider other ties between a listed
issuer and a director * * * that might impair the director's judgment
as a member of the compensation committee,'' \184\ and noted that ``the
exchanges might conclude that personal or business relationships
between members of the compensation committee and the listed issuer's
executive officers should be addressed in the definition of
independence.'' However, the Commission did not require exchanges to
reach this conclusion and thus Nasdaq's decision that such ties need
not be included explicitly in its definition of independence does not
render its proposal insufficient.
---------------------------------------------------------------------------

    \183\ See supra notes 123-124 and accompanying text.
    \184\ Id.
---------------------------------------------------------------------------

    In explaining why it did not include, specifically, personal and
business relationships as a factor, Nasdaq cites its standards for
Independent Directors, generally, which require the board of directors
of a listed issuer to make an affirmative determination that each such
director has no relationship that, in the opinion of the board, would
interfere with the exercise of independent judgment in carrying out the
responsibilities of a director.\185\ All compensation committee members
must meet the general independence standards under Nasdaq's rules in
addition to the two new criteria being adopted herein. The Commission
therefore expects that boards, in fulfilling their obligations, will
apply this standard to each such director's individual responsibilities
as a board member, including specific committee memberships such as the
compensation committee. Although personal and business relationships,
related party transactions, and other matters suggested by commenters
are not specified either as bright-line disqualifications or explicit
factors that must be considered in evaluating a director's
independence, the Commission believes that compliance with Nasdaq's
rules and the provision noted above would demand consideration of such
factors with respect to compensation committee members, as well as to
all Independent Directors on the board.
---------------------------------------------------------------------------

    \185\ See Nasdaq Rule 5605(a)(2).
---------------------------------------------------------------------------

    The Commission does not believe that Nasdaq is required in the
current proposed rule change to consider further revisions of its
independence rules as suggested by some commenters,\186\ although it
may wish to do so in the future. Finally, notwithstanding the concern
of some

commenters,\187\ the Commission confirms that Rule 10C-1 does not mean
that a director cannot be disqualified on the basis of one factor
alone. Although Nasdaq does not state this explicitly, the Commission
believes that nothing in Rule 10C-1 or in Nasdaq's current or proposed
rules implies otherwise.
---------------------------------------------------------------------------

    \186\ See supra note 134 and accompanying text.
    \187\ See supra notes 130-132 and accompanying text.
---------------------------------------------------------------------------

    Nasdaq proposes that the ``Exceptional and Limited Circumstances''
provision in its current rules, which allows one director who fails to
meet the Exchange's Independent Director definition to serve on a
compensation committee under certain conditions, apply to the enhanced
independence standards discussed above that the Exchange is adopting to
comply with Rule 10C-1. The Commission believes that the discretion
granted to each exchange by Rule 10C-1, generally, to determine the
independence standards it adopts to comply with the Rule includes the
leeway to carve out exceptions to those standards, as long as they are
consistent with the Act. Nasdaq also cites, in justifying the
exception, the provision of Rule 10C-1 that permits an exchange to
exempt a particular relationship with respect to members of the
compensation committee as the exchange determines is appropriate,
taking into consideration the size of an issuer and any other relevant
factors. In this respect, Nasdaq states that the exception, although
infrequently used, has been valuable, and states that the flexibility
afforded by the exception is particularly important for a smaller
company.
    Regarding the justification for such an exception, the Commission
notes that it long ago approved as consistent with the Act the same
exception and concept in the context of Nasdaq's definition of
Independent Director under Exchange Rule 5605(a)(2),\188\ with respect
to compensation committees, as well as for nominations committees and
audit committees. Although the additional independence standards
required by Rule 10A-3 for audit committees are not subject to this
exception, the Commission notes that Rule 10C-1 grants exchanges more
discretion than Rule 10A-3 when considering independence standards for
compensation committee membership. One commenter was also concerned
that the board could include a non-independent director indefinitely on
its compensation committee by using the exception.\189\ The Commission
notes that a member appointed under the Exceptional and Limited
Circumstances provision may not serve longer than two years. Further,
in the Nasdaq Response Letter, the Exchange stated that it tracks the
use of the exception by listed companies and would have discretion in
its rules to deny the use of the exception if it thought a company was
abusing it.\190\
---------------------------------------------------------------------------

    \188\ See supra note 19.
    \189\ See Brown Letter.
    \190\ See supra note 141.
---------------------------------------------------------------------------

B. Authority of Committees to Retain Compensation Advisers; Funding;
and Independence of Compensation Advisers and Factors

    As discussed above, Nasdaq proposes to set forth explicitly in its
rules the requirements of Rule 10C-1 regarding a compensation
committee's authority to retain compensation advisers, its
responsibilities with respect to such advisers, and the listed
company's obligation to provide appropriate funding for payment of
reasonable compensation to a compensation adviser retained by the
committee.\191\ As such, the Commission believes these provisions meet
the mandate of Rule 10C-1 and are consistent with the Act.
---------------------------------------------------------------------------

    \191\ The Commission notes that, in Amendment No. 1, Nasdaq
revised its proposed rule text to set forth these requirements in
full.
---------------------------------------------------------------------------

    As discussed above, the proposed rule change requires the
compensation committee of a listed company to consider the six factors
relating to independence that are enumerated in the proposal before
selecting a compensation consultant, legal counsel or other adviser to
the compensation committee. The Commission believes that this provision
is consistent with Rule 10C-1 and Section 6(b)(5) of the Act.
    As noted above, one commenter believed that Rule 10C-1 could be
read as not requiring a compensation committee to consider the
enumerated independence factors with respect to regular outside legal
counsel and sought confirmation of this reading from Nasdaq.\192\ This
reading is incorrect and Nasdaq has amended its rule language to
clarify this issue. The Commission notes that Rule 10C-1 includes an
instruction that specifically requires a compensation committee to
conduct the independence assessment with respect to ``any compensation
consultant, legal counsel or other adviser that provides advice to the
compensation committee, other than in-house counsel.'' \193\ To avoid
any confusion, Nasdaq, in Amendment No. 1, added rule text that
reflects this instruction in its own rules.\194\
---------------------------------------------------------------------------

    \192\ See supra notes 145-146 and accompanying text.
    \193\ See Instruction to paragraph (b)(4) of Rule 10C-1.
    \194\ See supra note 54 and accompanying text.
---------------------------------------------------------------------------

    In approving this aspect of the proposal, the Commission notes that
compliance with the rule requires an independence assessment of any
compensation consultant, legal counsel, or other adviser that provides
advice to the compensation committee, and is not limited to advice
concerning executive compensation. However, Nasdaq has proposed, in
Amendment No. 2, to add language to the provision regarding the
independence assessment of compensation advisers \195\ to state that
the compensation committee is not required to conduct an independence
assessment for a compensation adviser that acts in a role limited to
the following activities for which no disclosure is required under Item
407(e)(3)(iii) of Regulation S-K: (a) Consulting on any broad-based
plan that does not discriminate in scope, terms, or operation, in favor
of executive officers or directors of the company, and that is
available generally to all salaried employees; and/or (b) providing
information that either is not customized for a particular issuer or
that is customized based on parameters that are not developed by the
adviser, and about which the adviser does not provide advice. Nasdaq
states that this exception is based on Item 407(e)(3)(iii) of
Regulation S-K, which provides a limited exception to the Commission's
requirement for a registrant to disclose any role of compensation
consultants in determining or recommending the amount and form of a
registrant's executive and director compensation.\196\
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    \195\ See proposed Rule 5605(d)(3), as amended by Amendment No.
2.
    \196\ See 17 CFR 229.407(e)(3)(iii).
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    The Commission views Nasdaq's proposed exception as reasonable, as
the Commission determined, when adopting the compensation consultant
disclosure requirements in Item 407(e)(3)(iii), that the two excepted
categories of advice do not raise conflict of interest concerns.\197\
The Commission also made similar findings when it noted it was
continuing such exceptions in the Rule 10C-1 Adopting Release,
including excepting such roles from the new conflict of interest
disclosure rule required to implement Section

10C(c)(2). The Commission also believes that the exception should allay
some of the concerns raised by the commenters regarding the scope of
the independence assessment requirement. Based on the above, the
Commission believes these limited exceptions are consistent with the
investor protection provisions of Section 6(b)(5) of the Act.
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    \197\ See Proxy Disclosure Enhancements, Securities Act Release
No. 9089 (Dec. 19, 2009), 74 FR 68334 (Dec. 23, 2009), at 68348
(``We are persuaded by commenters who noted that surveys that
provide general information regarding the form and amount of
compensation typically paid to executive officers and directors
within a particular industry generally do not raise the potential
conflicts of interest that the amendments are intended to
address.'').
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    Regarding the belief of another commenter that the independence
assessment requirement could discourage compensation committees from
obtaining the advice of advisers,\198\ the Commission notes that, as
already discussed, nothing in the proposed rule prevents a compensation
committee from selecting any adviser that it prefers, including ones
that are not independent, after considering the six factors. In this
regard, in Amendment No. 1 Nasdaq added specific rule language stating,
among other things, that nothing in its rule requires a compensation
adviser to be independent, only that the compensation committee must
consider the six independence factors before selecting or receiving
advice from a compensation adviser.\199\
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    \198\ See Corporate Secretaries Letter and supra note 151 and
accompanying text.
    \199\ See supra notes 56-58 and accompanying text.
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    Regarding the commenter's concern over the burdens that the
Exchange proposal imposes,\200\ the Commission notes that Rule 10C-1
explicitly requires exchanges to require consideration of these six
factors.\201\ Moreover, five of the six factors were dictated by
Congress itself in the Dodd-Frank Act. As previously stated by the
Commission in adopting Rule 10C-1, the requirement that compensation
committees consider the independence of potential compensation advisers
before they are selected should help assure that compensation
committees of affected listed companies are better informed about
potential conflicts, which could reduce the likelihood that they are
unknowingly influenced by conflicted compensation advisers.\202\ The
changes to Nasdaq's rules on compensation advisers should therefore
benefit investors in Nasdaq listed companies and are consistent with
the requirements in Section 6(b)(5) of the Act that rules of the
exchange further investor protection and the public interest.
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    \200\ See supra note 151 and accompanying text.
    \201\ The Commission also does not agree with the argument of
one commenter that Nasdaq must require compensation committees to
specifically consider, among the independence factors relating to
compensation advisers, whether such an adviser requires that clients
contractually agree to indemnify or limit their liability. See CII
Letter. The Commission views as reasonable the Exchange's belief
that the six factors set forth in Rule 10C-1 are sufficient for the
required independence assessment.
    \202\ See Rule 10C-1 Adopting Release, supra note 11.
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    Finally, one commenter requested guidance ``on how often the
required independence assessment should occur.'' \203\ This commenter
observed that it ``will be extremely burdensome and disruptive if prior
to each such [compensation committee] meeting, the committee had to
conduct a new assessment.'' The Commission anticipates that
compensation committees will conduct such an independence assessment at
least annually.
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    \203\ See Corporate Secretaries Letter.
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C. Application to Smaller Reporting Companies

    The Commission believes that the requirement for Smaller Reporting
Companies, like all other listed companies, to have a compensation
committee, composed solely of Independent Directors, with at least two
members is reasonable and consistent with the protection of investors.
The Commission notes that Nasdaq's rules for compensation committees
have not made a distinction for Smaller Reporting Companies in the
past. However, consistent with the exemption of Smaller Reporting
Companies from Rule 10C-1, the Exchange has decided not to require
Smaller Reporting Companies to meet its proposed new independence
requirements as to compensatory fees and affiliation as well as the
requirements concerning compensation advisers.
    Nasdaq will also require a Smaller Reporting Company to adopt a
formal written compensation committee charter or board resolution that
specifies the compensation committee's responsibilities and authority,
but the company will not be required to review and reassess the
adequacy of the charter or board resolution on an annual basis. This is
different from other Nasdaq listed companies, which must include the
committee's responsibilities and authority specifically in a formal
written charter and must review the charter's adequacy on an annual
basis.
    The Commission believes that these provisions are consistent with
the Act and do not unfairly discriminate between issuers. The
Commission believes that, for similar reasons to those for which
Smaller Reporting Companies are exempted from the Rule 10C-1
requirements, it makes sense for Nasdaq to provide some flexibility to
Smaller Reporting Companies regarding whether the compensation
committee's responsibilities should be set forth in a formal charter or
through board resolution. Further, because a Smaller Reporting Company
does not need to include in its charter or board resolution the
additional provisions regarding compensation advisers that Nasdaq is
requiring all other listed companies to include to comply with Rule
10C-1,\204\ and in view of the potential additional costs of an annual
review, it is reasonable not to require a Smaller Reporting Company to
conduct an annual assessment of its charter or board resolution.
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    \204\ As discussed supra notes 64-65 and accompanying text, the
charter or board resolution of a Smaller Reporting Company will not
be required to include, like the charters of other listed companies,
a grant of authority to the committee to retain compensation
advisers, a requirement that the company fund such advisers, and a
requirement that the committee consider independence factors before
selecting such advisers, because Smaller Reporting Companies are not
subject to these requirements.
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D. Opportunity To Cure Defects

    Rule 10C-1 requires the rules of an exchange to provide for
appropriate procedures for a listed issuer to have a reasonable
opportunity to cure any defects that would be the basis for the
exchange, under Rule 10C-1, to prohibit the issuer's listing. Rule 10C-
1 also specifies that, with respect to the independence standards
adopted in accordance with the requirements of the Rule, an exchange
may provide a cure period until the earlier of the next annual
shareholders meeting of the listed issuer or one year from the
occurrence of the event that caused the member to be no longer
independent.
    The Commission notes that the cure period that Nasdaq proposes for
companies that fail to comply with the enhanced independence
requirements designed to comply with Rule 10C-1 is not exactly the same
as the cure period that the Rule sets forth as an option.\205\ The
Nasdaq proposal adds the proviso that, if the annual shareholders
meeting occurs no later than 180 days following the event that caused
the noncompliance, the company instead has 180 days from the event to
regain compliance.
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    \205\ See supra notes 42-44 and accompanying text.
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    The Commission believes that, although the cure period proposed by
Nasdaq gives a company more leeway in certain circumstances than the
cure period suggested under Rule 10C-1, the accommodation is fair and
reasonable. As a general matter, it allows all companies at least 180
days to cure noncompliance. To give a specific example, the proposal
would afford a company additional time to comply,

than the Rule 10C-1 option, where a member of the compensation
committee ceases to be independent two weeks before the company's next
annual meeting. The Commission further notes that it has approved a
similar cure period in the context of other Nasdaq corporate governance
requirements.\206\
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    \206\ See Securities Exchange Act Release No. 54421 (September
11, 2006), 71 FR 54698 (September 18, 2006) (approval of File No.
NASDAQ-2006-011, modifying the cure period available to an issuer
that loses an independent director or audit committee member).
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    The Commission agrees with the understanding of the commenter who
believed that Rule 10C-1 requires that an exchange provide a company an
opportunity to cure any defects in compliance with any of the new
requirements.\207\ The Commission believes that Nasdaq's general due
process procedures for the delisting of companies that are out of
compliance with the Exchange's rules satisfy this requirement.\208\ In
particular, Nasdaq's rules provide that, unless continued listing of
the company raises a public interest concern, when a company is
deficient in compliance with, among other rules, Rule 5605, which
includes the Exchange's standards for compensation committees, the
listed company may submit a plan for compliance. The rules permit the
Exchange's staff to extend the deadline for regaining compliance, under
established parameters, and, if the company does not regain compliance
within the time period provided by all applicable staff extensions--at
which point the staff will immediately issue a determination indicating
the date on which the company's securities will be suspended--a company
can still request review by a hearings panel.
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    \207\ See supra note 154 and accompanying text.
    \208\ See, generally, Nasdaq Rule 5810.
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    The Commission believes that these general procedures for companies
out of compliance with listing requirements, in addition to the
particular cure provisions for failing to meet the new independence
standards, adequately meet the mandate of Rule 10C-1 and also are
consistent with investor protection and the public interest since they
give a company a reasonable time period to cure non-compliance with
these important requirements before they will be delisted.

E. Exemptions

    As discussed above, asset-backed issuers and other passive issuers,
cooperatives, limited partnerships, registered management investment
companies, and controlled companies are exempt from Nasdaq's existing
rules relating to compensation, and Nasdaq proposes to extend the
exemptions for these entities to the new requirements of the proposed
rule change. The Commission notes that Rule 10C-1 allows exchanges to
exempt from the listing rules adopted pursuant to Rule 10C-1 certain
categories of issuers, as the national securities exchange determines
is appropriate.\209\ The Commission believes that, given the specific
characteristics of the aforementioned types of issuers,\210\ it is