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Director Independence, the Stock Exchanges, and the Role of the SEC (Part 2)

We are discussing the requirements that the exchanges adopt listing standards that set out the factors that must be considered in determining the independence of directors serving on the compensation committee.  The NYSE proposal is here; the Nasdaq proposal is here.

The Nasdaq proposal made some important strides.  The exchange proposed making compensation committees mandatory.  In addition, the exchange proposed to prohibit directors on the compensation committee from receiving any non-board related compensation, a requirement also applicable to the audit committee. 

But neither of the exchanges required that, as a relevant factor, boards take into account the fees paid to directors.  Moreover, they failed to do so despite the command in Section 10C that the factors include consideration of "the source of compensation of a member of the board of directors of an issuer".  Fees constitute compensation.

In addition, neither proposal explicitly required that the board, in determining director independence, take into account personal or business relationships between directors and executive officers.  The Nasdaq simply rejected the factor.  As it reasoned:

As discussed in the "Purpose" section above, Nasdaq reviewed its current and proposed listing rules and concluded that these rules are sufficient to ensure the independence of compensation committee members. Therefore, Nasdaq determined not to propose further independence requirements, other than those discussed above.

The NYSE did not explicitly add a reference to personal and business relationships to the proposed listing standard.  Instead the proposal would require consideration of “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 reference to a relationship with "the listed company" left unclear the importance of personal or business relationships between directors and officers that were otherwise unconnected to the issuer.   

The ambiguous language in the NYSE proposal could also be compared to the language used to describe the factors that had to be considered when the compensation committee selected a consultant.  In those circumstances, directors had to consider "[a]ny business or personal relationship of the compensation consultant, legal counsel or other adviser with a member of the compensation committee" and "[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 need to consider personal and business relationships in those circumstances was made explicit.

These issues are discussed in greater detail in Comment Letters: The Definition of Independent Directors Under the Listing Rules of the Stock Exchanges.  Indeed, the  proposals generated a number of comments.  The comments for the NYSE Proposal are here.  The Comments for the Nasdaq proposal are here.  These letters point out a number of concerns with the proposed rules.

The SEC ordinarily must rule on a proposald from an SRO within 45 days.  The Agency, however, issued a release that extended the period for approval until January 13.   Specifically, the Commission sought more time "to consider the coment letters that have been submitted".  

This is a new area for the Commission.  An attempt in the 1980s to impose listing standards on the exchanges (one share, one vote) was shot down by the courts.  Congress tampered with the definition of independent director for audit committees but gave the Commission little flexibility with respect to implementation. 

Section 10C, however, gives the Commission broad authority to prescribe the factors that must be considered in determining director independence on the compensation committee.  Like it or not, the Agency now has a primary role in determining director independence.  The outcome of the proposed listing standards will provide considerable insight into the role the SEC intends to take in this area. 

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