The NYSE and the Problems of Director Independence: The Need for SEC Reform (Part 4)

In determining whether directors are independent, the rules of the NYSE require boards to consider material relationships with the company, not with officers and directors.  When Black & Decker took this position publicly, the NYSE intervened and Black & Decker issued a correcting press release.  Yet the NYSE has not made its own public statement or changed the plain language of the rule. Moreover, the Black & Decker press release setting out the Exchange's position has been taken down by the company.

It demonstrates that while investors can be relatively certain that "independent" directors on NYSE traded companies do not have a material financial relationship with the company (except fees), they cannot be certain that the directors do not have a material financial relationship with other directors and executive officers.  Based upon the plain language of the NYSE listing standard, it is apparent that some companies are not screening for this potential conflict.  Nor has the Exchange made clear that they must.

The matter also shows weaknesses in the SEC's oversight of listing standards.  The Commission has been aware that relationships deemed immaterial by the board of a public company might nonetheless be considered material by investors.  As a result, the SEC requires companies to disclose matters considered but rejected as immaterial.  Specifically, Item 407(a)(3) of Regulation S-K provides: 

• For each director . . . that is identified as independent, describe by specific category or type, any transactions, relationships or arrangements . . . that were considered by the board of directors under the applicable independence definitions in determining that the director is independent. 

The requirement was added in 2006 as part of the reforms to the executive compensation regime.  As the adopting release makes clear, however, companies only need to disclose categories of potential conflicts rather than the conflict itself.

• Under our proposals, disclosure of the specific details of each such transaction, relationship or arrangement would have been required. Several commenters objected to providing this disclosure, given the potential for extensive detail about these types of transactions, relationships or arrangements, and some suggested instead providing disclosure by category or type of transaction. In response to the commenters, we have revised the disclosure requirement to permit transactions, relationships or arrangements of each director or director nominee to be described by the specific category or type. Consistent with the rule proposals, the amended rule requires that the disclosure be made on a director by director basis, with separate disclosure of categories or types of transactions, relationships or arrangements for each director and director nominee. We have also adopted an instruction indicating that the description of the category or type must be sufficiently detailed so that the nature of the transactions, relationships or arrangements is readily apparent.

But the disclosure requirement is only as good as the relevant definitions employed by the stock exchanges.  In other words, because at least some companies traded on the NYSE do not, apparently, interpret the applicable listing standard to require consideration of personal relationships among the directors, these types of relationships will not be considered and will not be subject to disclosure under Item 407.  

Item 407 needs to be amended to require companies to disclose all material relationships between directors and the company and among directors and executive officers.  Moreover, the requirement likewise ought to require disclosure of the specific relationships considered but not deemed material, not just the categories.  In short, the requirements of Item 407 need to rewritten to provide for material information about director independence that is not dependent upon the vagaries of the interpretations adopted by the assorted stock exchanges.