Corporate Governance, Rule 10C-1, and the SEC: The NYSE, Director Independence, and Personal Relationships (Part 7A)
The NYSE Listing Standard for Compensation Committees was adopted in Exchange Act Release No. 68639 (Jan. 11, 2013). The standards are here. The NYSE responded to some of the comments made on the proposal in a letter dated January 2013.
The NYSE provides that a director, to be independent, must have "no material relationship with the listed company." NYSE Rule 303A.02. The language suggests that the focus for determining director independence is on relationships with the issuer. The language is susceptible to, and has been interpreted to mean, that relationships between executive officers and directors are not part of the equation. In other words, independence turns entirely on the relationship between a director and the issuer.
The confusion was exacerbated by the commentary to the provision. The NYSE noted that it was impossible to list all factors that would bear "on the materiality of a director's relationship to a listed company," again emphasizing relationships to the issuer. Moreover, in listing examples of disqualifying relationships, the comment included "commercial, industrial, banking, consulting, legal, accounting, charitable and familial relationships, among others." In other words, there was no mention of personal or business relationships except for the one reference to family. But family was already required to be considered when determining whether one of the categorical exceptions to independence applied. See NYSE Listing Standard 303A.02(b).
The listing standard and commentary to the listing standard made only one oblique reference to relationships with management. The last sentence of the commentary noted that "as the concern is independence from management, the Exchange does not view ownership of even a significant amount of stock, by itself, as a bar to an independence finding."
Despite the lack of clarity, the NYSE has objected to any interpretation suggesting that business and personal relationships are not part of the independence calculation. Nonetheless, the listing standard itself does not contain any explicit statement to that effect. Moreover, for those relying on the plain meaning of the listing standard (material relationships with the issuer), there may be no reason to look for alternative interpretations.
The need to add an explicit requirement that boards consider personal and business relationships between executive officers and directors in determining director independence came up in the context of the new listing standards governing compensation committees. Section 10C of the Exchange Act and the SEC in Rule 10C-1 required the exchanges to define the "relevant factors" used in determining independence on the compensation committee.
Section 10C listed two of them, "the source of compensation of such director" and any affiliation with the listed company. Congress, however, contemplated that other factors could be added to the list and the Commission left it up to the exchanges to determine whether their definition should include other relevant factors.
In doing so, the Commission more or less instructed the exchanges to consider whether the factors should include "personal or business relationships" between directors on the compensation committee and executive management. As the adopting release for Rule 10c-1 noted:
in response to concerns noted by some commentators that significant shareholders may have other relationships with listed companies that would result in such shareholders’ interests not being aligned with those of other shareholders, we emphasize that it is important for exchanges to consider other ties between a listed issuer and a director, in addition to share ownership, that might impair the director’s judgment as a member of the compensation committee. For example, 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.
We will see how the exchanges responded to this advise in the next post.