Wednesday, August 20, 2008

NYSE and Nasdaq Conform Director Independence Standards to SEC Regulation S-K

The NYSE and Nasdaq have both amended their listing standards to conform their director independence requirements to the related party transaction requirements of Item 404 of Regulation S-K. Specifically, the SROs have raised the compensation bar from $100,000 to $120,000 for purposes of deeming a director independent. Separately, the NYSE also amended the independence requirement on relationship with the company’s auditor to allow an immediate family member of a director to be employed by the auditor so long as the relation is not a partner of the audit firm or working on the company’s audit. The SEC approved the Nasdaq rule changes in Release No. 34- 58335; and the changes to the NYSE’s Listed Company Manual in Release No. 34-58367.

The changes to Nasdaq Rule 4200(a)(15)(B) provide 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 (up from $120,000) during any period of twelve months within the preceding three years cannot be deemed an independent director. Item 404 of Regulation S-K requires public companies to disclose certain material information regarding the independence of directors, among other related persons associated with the company, and establishes $120,000 as the amount above which financial transactions and relationships.

The Commission believes that it is appropriate for Nasdaq to use this same threshold amount with regard to its definition of independent director as a bright line test to determine whether a director of a listed company would be precluded from being considered independent. The SEC noted 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 still have to make an affirmative determination 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.

NYSE

Similarly, the NYSE amended Section 303A.02(b)(ii) of its Listed Company Manual to provide that directors may not be deemed independent for purposes of Section 303A if they, or an immediate family member has received more than $120,000 (up from $100,000) in direct compensation from the listed company during a 12-month period within the last three years. The change reflects the SEC’s August 2006 amendment to the dollar threshold applicable to related party transactions that must be disclosed under Item 404 of Regulation S-K. Prior to the SEC’s amendment to Item 404, the applicable threshold for disclosures was $60,000.

The NYSE believes that the monetary threshold in its independence definition should be consistent with the amount in Item 404. Using a consistent standard 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.

Auditors and Relationship With Directors and Families

Separately, the NYSE amended the bright line test set out in Section 303A.02(b)(iii) of the Manual relating to a listed company’s internal or external auditor. The test currently precludes 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 (but not tax planning) practice; or the director or an immediate family member was within the last three years (but is a partner or employee of such a firm and personally worked on the listed company’s audit within that time).

The NYSE’s experience demonstrates that the current standard with respect to immediate family members has precluded a director from being deemed independent in cases even when an immediate family member had no relationship to the listed company’s audit. For example, the current test requires 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.

Thus, the test was modified with respect to a director’s immediate family member to cover only an immediate family member who 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 a partner or employee of such a firm and personally worked on the listed company’s audit within that time.