The NYSE and Nasdaq each recently amended the definition of "independent director" to increase from $100,000 to $120,000 the amount of compensation that an independent director may receive from a listed company in a 12-month period. In addition, the NYSE amended the definition of "independent director" to allow an immediate family member of an independent director to be employed by the company’s auditor provided the immediate family member is not a partner of the auditor or working on the company’s audit.
As amended, Nasdaq Rule 4200(a)(15)(B) provides that a director of a listed company who accepted, or has a family member who accepted, any compensation from the company in excess of $120,000 during any period of 12 consecutive months within the preceding three years cannot be deemed to be an independent director. Excluded under the test is compensation for board services or certain interim executive positions, compensation paid to a family member who is an employee (other than an executive officer), and certain deferred compensation. In approving the rule change, the SEC noted that Item 404 of Regulation S‑K requires a public company to disclose certain transactions involving the company and any "related person" (including a director) in which the amount involved exceeds $120,000. The SEC concluded that "it is appropriate for Nasdaq to use this same threshold amount with regard to its definition of ‘independent director’ in Nasdaq Rule 4200(a)(15) as a ‘bright line’ test to determine whether a director of a listed company would be precluded from being considered independent."
The SEC further noted, however, that "even if a director (or a family member) received less than $120,000 in compensation from the listed company, the company’s board still would have to make an affirmative decision [under Nasdaq Rule 4200(a)(15)] that the director has no relationship with the listed company that, in the board’s opinion, would interfere with the exercise of his or her independent judgment in carrying out the responsibilities of a director."
The SEC approved the amendment of Nasdaq Rule 4200(a)(15)(B) in Release No. 34-58335, effective as of August 8, 2008.
The NYSE likewise amended Section 303A.02(b)(ii) of the Listed Company Manual to increase from $100,000 to $120,000 the amount of compensation that an independent director or an immediate family member could receive from a listed company during any 12-month period within the preceding three years. Excluded under this test is compensation similar to that excluded under the Nasdaq test. In approving the rule change, the SEC adopted the NYSE’s summary of the purpose of and basis for the rule change which stated that using an independence standard consistent with Item 404 of Regulation S‑K "would enhance the NYSE’s ability to assess compliance with the independent director requirements because companies are required to disclose compensation in excess of $120,000, but are not necessarily required to disclose compensation between $100,000 and $120,000."
Notwithstanding these rule changes, Audit Committee members remain subject to additional, more stringent requirements under Nasdaq Rule 4350(d) and Section 303A.06 of the Listed Company Manual and Exchange Act Rule 10A‑3(a)(3).
In addition, the NYSE amended its test relating to an independent director’s affiliation with the listed company’s internal or external auditor. Prior to the amendment, Section 303A 02(b)(iii) of the Listed Company Manual precluded a director from being deemed independent if:
- the director or an immediate family member is a current partner of a firm that is the company’s internal or external auditor;
- the director is a current employee of such a firm;
- the director has an immediate family member who is a current employee of such a firm and who participates in the firm’s audit, assurance or tax compliance (tax planning excluded) practice; or
- the director or an immediate family member was within the last three years (but is no longer) a partner or employee of such a firm and personally worked on the listed company’s audit within that time.
As amended, this provision precludes a director from being deemed independent only if the immediate family member:
- is a current partner of the company’s internal or external auditor;
- is a current employee of such a firm and personally works on the listed company’s audit; or
- was within the last three years (but is no longer) a partner or employee of such a firm and personally worked on the listed company’s audit within that time.
In approving the rule changes, the SEC noted that the "NYSE’s current test has required a listed company’s board to conclude that a director may no longer be deemed independent when the director’s child took an entry-level job in the audit practice of the listed company’s external auditor upon graduation from college, notwithstanding the fact that the child was a low-level employee in a different region and had no involvement with the listed company’s audit."
The SEC approved the amendments of Sections 303A.02(b)(ii) and (iii) in Release No. 34-58367, effective as of September 11, 2008.
These amendments to the NYSE’s and Nasdaq’s tests for director independence have not been free from criticism.
It should be noted that Nasdaq Rule 4350(c)(1) provides a cure period if a listed company fails to comply with the requirement that a majority of the board be comprised of independent directors, while Section 303A.01 of the Listed Company Manual does not. If the resignation of an independent director causes a NYSE listed company to no longer have a majority of independent directors, the company must notify the NYSE of its failure to meet a continued listing standard and file a Form 8‑K under Item 3.01 (Notice of Delisting or Failure to Satisfy a Continued Listing Rule or Standard; Transfer of Listing).
For further information, please contact Peter M. Menard at (213) 617-5483.