Corporate Governance, Rule 10C-1, and the SEC: The NYSE, Director Independence, and the Need to Consider Personal Relationships (Part 7B)
We are discussing the new listing standard adopted by the NYSE and approved by the SEC. Specifically we are addressing the debate over whether the NYSE should list as an explicit factor the need to consider business and personal relationships between executive officers and directors.
In response to Rule 10C-1, the NYSE added a new subsection that required the board, in considering director independence for those serving on the compensation committee, to consider:
all factors specifically relevant to determining whether a director has a relationship to the listed company which is material to that director’s ability to be independent from management in connection with the duties of a compensation committee member
The provision then listed the two factors mandated by Congress (compensation and affiliation) but noted that the board was "not limited" to these factors. A new paragraph of commentary to the provision discussed compensation and affiliation but made no mention of personal or business relationships.
In explaining the decision not to include any specific reference to personal and business relationships, the exchange had this to say:
The NYSE Exchanges note that the existing independence standards of the NYSE Exchanges all require the board to make an affirmative determination that there is no material relationship between the director and the company which would affect the director’s independence. Commentary to Section 303A.02(a) explicitly notes with respect to the board’s affirmative determination of a director’s independence that the concern is independence from management, and NYSE MKT and NYSE Arca have always interpreted their respective director independence requirements in the same way. Consequently, the NYSE Exchanges do not believe that any further clarification of this requirement is necessary.
The analysis ignored the fact that the existing language was susceptible to an interpretation that it extended only to relationships with the issuer. Indeed, this was more than an academic concern. Moreover, the new language for directors on the compensation committee repeated that the board had to consider whether the director "has a relationship to the listed company". While the NYSE had taken the position that personal and business relationships had to be considered, the interpretation was not explict and presumably unknown to some issuers.
Finally, the absence of any specific reference was in conflict with the standards for selecting a compensation consultant. When hiring a compensation consultant, committees were explicitly required to consider "[a]ny business or personal relationship of the compensation consultant, legal counsel, other adviser or the person employing the adviser with an executive officer of the listed company." In other words, the provision made the need to consider business and explicit relationships between executive officers and consultants explicit. No similar language appeared in the requirements of director independence.
The Commission acknowledged the issue in the release approving the NYSE's amendments to the listing standards. The Commission first noted that its statement in the release adopting Rule 10C-1 that the exchanges consider adding business and personal relationships was not designed to be mandatory. "[T]he Commission did not require exchanges to reach this conclusion and thus NYSE’s decision that such ties need not be included explicitly in its definition of independence does not render its proposal insufficient."
Nonetheless, the Commission noted the importance of considering these factors.
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 NYSE’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.
The statement by the Commission clarified that boards needed to consider business and personal relationships when determining director independence in general, not just in connection with the compensation committee.
The statement is a step forward. An SEC release now explicitly provides that personal and business relationships must be considered in determining director independence. Moreover, the consideration applies to all directors, not just those on the compensation committee. Boards will be able to learn about this interpretation without having to contact the NYSE directly.
At the same time, however, the interpretation is buried in a release about listing standards for compensation committees. It is not an obvious source to check for anyone seeking to understand the definition of director independence in the NYSE rules.
This is an example where commentators called for an explicit reference to personal and business relationships, the NYSE acknowledged that they must be considered, and the Commission affirmed the position. Yet when it comes to the language of the listing standard, there is no explicit reference and the confusing language remains.