Issues for Compensation Committees to Consider: Consultant Conflict of Interest Test and Adviser Independence Review

Issues for Compensation Committees to Consider: Consultant Conflict of Interest Test and Adviser Independence Review

May 29 2013

In response to new SEC and stock exchange rules, Compensation Committees at most public companies must: (i) ensure that their Committee charter incorporates any changes required as of July 1, 2013; (ii) review, evaluate and disclose whether a Compensation Consultant has a conflict of interest, and if so, the nature of such conflict and how it is being addressed; and (iii) consider the independence of any Compensation Adviser prior to selecting or receiving advice from such Adviser.  These changes have been adopted to meet requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted in 2010.  Certain controlled companies and smaller reporting companies are exempt from the new requirements.

Updating Compensation Committee Charters
Committee Charters must address the specific authorities and responsibilities of the Compensation Committee as detailed in the NYSE and Nasdaq exchange listing standards.  Given that the listing requirements include new authorities and responsibilities effective July 1, 2013, most companies listed on NYSE and Nasdaq must review and will likely need to amend their Compensation Committee Charter.

Evaluating and Disclosing Compensation Consultant Conflict of Interest
As of January 2013, the Securities and Exchange Commission (“SEC”) requires all companies subject to the proxy rules to disclose conflicts of interest of any Compensation Consultant in proxy statements for an annual or special shareholders meeting.[1] Compensation Committees must use the six factors enumerated by the SEC to consider whether a Compensation Consultant has a conflict of interest (the “Six Factors”). 
The proxy disclosure must identify any conflict of interest that arose during the course of the Compensation Consultant’s work with the Committee and how such conflict is being addressed by the Committee.  It is important to note that this requirement applies only to Consultants retained by the Compensation Committee (unless the Committee has no such consultant) and does not apply to “Compensation Advisers” (as defined below). 

Assessing Compensation Adviser Independence
As of July 1, 2013, Compensation Committees must also use the Six Factors to assess the independence of Compensation Advisers.  “Compensation Adviser” includes any person or entity providing compensation advice to the Committee (i.e., outside legal counsel, accountants, any Compensation Consultants), regardless of whether such Adviser is retained directly by the Committee.  Compensation Adviser does not include: (i) internal corporate legal counsel, or (ii) advisers providing (a) consulting on any broad-based plan that does not discriminate in scope, terms, or operate in favor of executive or directors and that is available generally to all salaried employees, or (b) information that either is not customized or that is only customized based on parameters not developed by the Adviser and for which the Adviser does not provide advice.

Committees must assess the independence of an Adviser prior to considering such Adviser’s advice.  Therefore, Compensation Committees may be tasked with assessing the independence of a number of advisers at least annually.  The results of the independence review are for internal purposes only (i.e., not to be disclosed) and Committees are not precluded from considering advice from nonindependent Advisers.

Conflict of Interest Test versus Independence Review
Both the Conflict of Interest Test (applicable only to Compensation Consultants) and the Independence Review (applicable to all Compensation Advisers) rely upon the Six Factors.  However, the Committee should keep in mind that the application, timing and impact of these two reviews differ in a few important ways:


Conflict of Interest

Assessment of Independence

Applies only to Compensation Consultant



Applies to all Compensation Advisers  


Complete prior to considering advice



Complete following fiscal year end


Complete prior to selecting Compensation Adviser



Responsibility reflected in Committee Charter
(Exchange listing requirement)



Proxy disclosure required
(Regulation S-K Item 407(e)(3)(iii))



Given the impact of the required Conflict of Interest evaluation and required disclosure (as opposed to the assessment of independence for internal purposes only), we focus the reminder of this Alert on the Conflict of Interest Test and required disclosure.  For a more detailed description of the applicable SEC rules on conflict of interest (“SEC Rules”) and the NYSE’s and Nasdaq’s then proposed listing requirements with respect to the independence assessment of compensation advisors, please see our October Client Alert.

What is a Conflict of Interest?
At a very basic level, this question is critical to an evaluation of whether a conflict of interest exists and is simultaneously almost unanswerable.  The SEC Rules do not provide bright-line tests or thresholds that a Compensation Committee may use to identify when a Compensation Consultant has a “conflict of interest.”  Instead, the Committee must consider the Six Factors, as well as other relevant factors, bearing in mind that no one factor is determinative, and evaluate whether, given all the facts and circumstances considered by the Committee, a conflict exists. 

So, how will a Compensation Committee know if there is a conflict of interest?  Many believe that Directors will know one when they see one.  However, it is certainly possible that, given the same facts and circumstances, one Committee will find a conflict of interest where another finds no such conflict exists.  Are there any bright-line tests that Committees can universally agree should constitute a conflict?  What if the families of the Consultant and CEO go on vacation together is this necessarily a conflict?  What if the Consultant and CEO go together, but alone?  What if they play golf together once a week?  Once a month? 

Perceived Conflict of Interest.  The SEC Rules provide that a company need not disclose what is only a “perceived” conflict of interest; however, Compensation Committees will inevitably have to ask themselves whether, from a transparency perspective, even a perceived conflict of interest should be disclosed.  If a news source printed a story about the perceived conflict of interest, would Directors be willing/able to assert in their defense that no real conflict of interest actually existed?  Might they have been better off disclosing the perceived conflict upfront?

How to Evaluate Whether a Conflict of Interest Exists

The Six Factors.  Starting in the 2013 proxy season, a company must disclose a conflict of interest raised as a result of any work performed by a Compensation Consultant, the nature of such conflict and how it was addressed.[2]  This requirement to disclose how the conflict was “addressed” appears to require in practice that the conflict be cured so that the consultant may be independent, although this is not explicitly stated. 

The Six Factors should be considered in their totality, with no one factor necessarily evidencing a conflict of interest.  When applying these factors, the Committee must evaluate the consulting firm, individual consultants within such firm, and, in certain instances, the consultants’ family members.  Who the Committee evaluates depends (partly) on which factor is being considered:

Six Factors to Evaluate a Conflict of Interest

Committee Must Consider the Factor with Respect to:

Compensation Consultant’s Firm as a Whole

Individual Consultant(s) Serving the Committee

Immediate Family Members of each Individual Consultant

Provision of other services to company




Fees received from company as a percentage of total revenue




Policies and procedures in place to prevent conflict of interest




Business or personal relationship with a member of Compensation Committee




Business or personal relationship with an executive officer




Stock ownership in company




Other Relevant Considerations.
  In addition to the Six Factors, the Committee must also consider “other relevant factors” when evaluating whether a Compensation Consultant has a conflict of interest.  Again, these additional factors will unfortunately depend on the facts and circumstances.

Concerns and Considerations when Applying the Six Factors
There are several important issues for a Compensation Committee to consider and understand prior to a conflict of interest evaluation.  Below we address some of the more significant considerations:

  • Which Compensation Consultant must be evaluated?  Under the SEC Rules, the Compensation Committee must consider whether a conflict of interest exists with respect to any Compensation Consultant required to be disclosed in the company’s annual proxy statement.  Based on 2009 SEC guidance, many companies have taken the position that if a Compensation Committee has its own consultant, then other Compensation Consultant s, including those retained by management; need not be included in the proxy disclosure.[3]  While the SEC indicated that the 2009 guidance still applies, the SEC confused the matter by stating that “the new [conflict of interest disclosure] requirement will apply to any Compensation Consultant whose work must be disclosed… regardless of whether the compensation consultant was retained by management or the compensation committee….”[4]
    • Considerations:  As applicable, companies should revisit whether to continue to disclose only the Compensation Committee’s consultant in the annual proxy or whether to apply the conflict of interest test (and therefore all other required Compensation Consultant  proxy disclosure) to all Compensation Consultant s, even those retained by management.[5]
  • Which individual consultants within a firm should be evaluated?  Who qualifies as an “individual adviser serving the compensation committee” is not defined; but the SEC expressed an unwillingness to limit this requirement to the most senior Adviser serving the committee.[6]  Committees may take a conservative approach when applying these factors by including all members of a consulting team; however, this may result in a significant number of evaluations.
    • Considerations:  Until further guidance is provided, Committees should consider evaluating only those members of a consulting team responsible for providing advice to the Committee.  This approach would exclude more junior team members and save the Committee from evaluating individuals unlikely to produce results that are meaningful when evaluating whether a conflict exists. 
  • How will the information gathered be used?  The Six Factors require a significant amount of confidential information from a Compensation Consultant.  For example, a consultant must disclose to the Committee the total fees received from the company as a percentage of the firm’s total revenue.  If fees are deemed by the Committee to pose a conflict to be disclosed, such disclosure could competitively harm the consulting firm.
    • Considerations:  Compensation Consultants and Committees should consider how to protect information gathered while also complying with this requirement. 
  • Gathering the required stock ownership information.  The SEC stated that the stock ownership of each individual consultant and his/her immediate family must be considered.  “Immediate Family” is not defined in the SEC Rules.  The NYSE and Nasdaq define immediate family as a person’s spouse, parents, children and siblings, whether by blood, marriage or adoption or anyone residing in the same home, excluding domestic employees.[7]  Applying this broad definition would impose a heavy burden and is unlikely to provide meaningful results to the Committee when considering whether a conflict of interest exists.  For example, is data collected on company stock owned by an individual Consultant’s step-sister who lives in a separate home meaningful for the Committee’s evaluation of a conflict of interest?
    • Considerations:  Until further guidance is provided, Committees should consider limiting the review of stock ownership by family to only those family members living in the same household as the individual Consultant.  This more limited definition, which is already used in the SEC’s beneficial ownership reporting rules, is more likely to produce information relevant to the Committee’s assessment of a conflict.[8]
  • Determining what qualifies as a business or personal relationship.  A “business or personal relationship” is intentionally not defined in the SEC Rules.  Situations likely to arise will lead to debate both at the Compensation Committee and consulting firm level and will likely result in varied and potentially overly conservative interpretations.
    • Considerations:  We expect Committees will assess situations on a case-by-case basis in determining whether a business or personal relationship exists between the consultant and company executives or Directors.  Committees will have to decide whether slight relationships do or do not rise to the level of a conflict of interest.  Committees also will have to consider what would constitute satisfactory “cures” if a business or personal relationship does present a conflict of interest.  For example, how should the following relationships be interpreted:
      • D serves as a member of Compensation Committees at Companies X and Y; Individual Z is the Compensation Consultant to both such Committees.
      • Firm W is Compensation Consultant to the Compensation Committees at Companies X and Y; D serves as a member of Compensation Committee at Company X and is also an executive at Company Y.
      • Same facts, except Firm W is the Compensation Consultant to management at Company Y.
  • How much weight should each factor get?  According to the SEC, “no one factor should be viewed as a determinative factor,” however, the SEC also stated that “business and personal relationships between an executive officer and a compensation advisor or a person employing the compensation Adviser may potentially pose a significant conflict of interest that should be considered by the Compensation Committee before selecting a compensation Adviser.”[9]
    • Considerations:  Committees should proactively consider their tolerance for certain factors.  For example, does stock ownership in the company concern a Committee?  What about when compared to a personal relationship between a Director and a consultant? 
  • Elective disclosure by the company.  The SEC Rules only require that the company include disclosure in the annual proxy (i) in a year when any Directors are up for election and (ii) when the committee finds that a Compensation Consultant had a conflict of interest.  There is no requirement to disclose that the conflict of interest evaluation was performed and that no conflicts were found.
    • Considerations:  While not required, as appropriate, companies should consider disclosing that a conflict of interest evaluation was performed and that no conflict was found.  This would support the assertion (if made) that the compensation consulting firm serving the Compensation Committee is independent.
  • Timing of the conflicts of interest review.  The conflict of interest disclosure, along with most disclosure in a company’s CD&A, is retrospective.  However, the NYSE and Nasdaq rules require (as of July 1, 2013) that the Compensation Committee evaluate the Six Factors before it retains a Compensation Consultant.[10]  Even in the case of an on-going retention, leaving a conflict of interest review until the end of a reporting period leaves the company susceptible to needing to disclose and react to a conflict of interest, foreclosing a more proactive/preventative approach.
    • Considerations:  Compensation consultants and Committees should complete this evaluation at the start of an engagement and annually thereafter (preferably early in a fiscal year).  This review will need to be added to the Compensation Committee’s annual calendar or agenda.  Engaged Compensation Consultants should undertake to update information relevant to the Six Factors evaluation if any significant changes occur during the year.
  • Conflict of interest evaluation form.  Compensation consultants and Committees are in the process of assessing whether the consulting firm or the Committee should generate the conflicts evaluation certification or form.
    • Considerations:  Due to the unique nature of each consulting firm and engagement, Committees should consider soliciting a conflict of interest certification from consulting firms.

Looking forward
In accordance with the NYSE and Nasdaq listing requirements, we strongly urge companies to prepare for the following:

  • Compensation Committee responsibility and authority over Compensation Consultants and Advisers and charter amendments
    • Compensation Committee charters must be revised by July 1, 2013, to reflect certain responsibilities and authority over Advisers specified in the respective NYSE and Nasdaq exchange listing requirements.
  • Independence Review
    • As discussed above, as of July 1, 2013, a Compensation Committee may select or receive advice from a Compensation Adviser only after conducting an assessment of such Adviser’s independence.  A Committee is not precluded from using a nonindependent Adviser; nevertheless, the requisite assessment must first be completed.
  • Compensation Committee Independence
    • Enhanced independence criteria for members of the Compensation Committee must be satisfied by the earlier of the first annual shareholders meeting after January 15, 2014, or October 31, 2014.
  • Nasdaq Compensation Committee and charter requirements
    • Nasdaq companies that do not have a Compensation Committee or formal written charter will need to have them in place by the earlier of the first annual shareholders meeting after January 15, 2014, or October 31, 2014.
      • For Nasdaq companies without a formal Compensation Committee as of July 1, 2013, the independent Directors on the Board must undertake the new responsibilities and authority by that date.
    • A Company must certify to Nasdaq, no later than 30 days after the final implementation deadline applicable to it, that it has complied with the Compensation Committee Requirements under these new Nasdaq rules.

Steven C. Root


  1. See Regulation S-K Item 407(e)(3)(iii).
  2. See Regulation S-K Item 407(e)(3)(iii).  This disclosure obligation applies to proxy and information statements for annual meetings at which Directors will be elected occurring on or after January 1, 2013. 
  3. The SEC clarified that “[f]ee and related disclosure for consultants that work with management (whether for only executive compensation consulting services, or for both executive compensation consulting and other non-executive compensation consulting services) is not required if the board has its own consultant.”  The Proxy Disclosure Enhancements, Release No. 33-9089 (Dec. 16, 2009) [74 FR 68334].
  4. SEC Adopting Release p. 77
  5. Please note that this ambiguity does not exist with respect to the compensation committee’s assessment of a compensation advisor’s independence using these same Six Factors.  In other words, the Compensation Committee is not required to evaluate the Six Factors before management retains a Compensation Consultant, but must do so on a backward-looking basis in order to disclose conflicts of interest the consultant may have.  See Adopting Release p. 29.
  6. SEC Adopting Release p. 38 and 39.
  7. SEC Adopting Release p. 40 and NYSE Listed Company Manual General Commentary to Section 303A.02(b): Nasdaq Listing Rule 5605(a)(2)(A).
  8. See 17 C.F.R. § 240.13d-3.
  9. SEC Adopting Release p. 40 and 41.
  10. Please note, this is not to be confused with the timing considerations with respect to the Compensation Adviser Independence Review.  The Conflict of Interest Test for a Compensation Consultant is retrospective while the Independence Review is prospective.