Corporate Governance

The SEC and the Erosion of Director Independence (Part 1)

By J. Robert Brown

The NYSE has proposed and the Commisson has approved amendments to the listing standards governing the definition of director independence.  Before the amendment, Section 303A.02(b)(ii) of the NYSE contained a categorical rule providing that directors lose their independence if they receive more than $100,000 in direct compensation.  The rule was adopted in the post-SOX reform era and was little more than a sop to those critical of the existing state of corporate governance. 

Thus, the amount does not include directors fees, something that can result in payments to directors in the vicinity of $700,000.  In other words, a director making $700,000 in fees is independent under the rules of the NYSE while a director making $100,000 in fees and $100,001 in "direct" income is not.  Go figure but this is the system that the Commission has allowed.  

Add in that there is anenforcement problem with the independence requirements at the NYSE.  Rather than exercise increased supervision over the NYSE, the Commission has chosen to bring its own enforcement proceedings in connection with director independence.  

With that in mind, we note that the Commission recently approved amendments to the rules of the NYSE that weaken, albeit modestly, the definition of  independence.  The amendments raise the amount of "direct compensation" that can be earned from $100,000 to $120,000.  The reason?  Absolutely nothing related to the notion of independence.  Instead, it was done to bring the rules into better harmony with the SEC requirements for related party transactions in Item 404 of Regulation S-K.  The Commission had previously raised the threshold for conflict of interest transactions that must be reported from $60,000 to $120,000.  According to the NYSE: "Using a consistent standard would enahance the NYSE's abilty 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."

It's a curious way to deal with an assessment problem not by doing anything designed to faciliate assessment but by simply eliminating the enforcement obligation.  Moreover, the carefully worded explanation noted that companies were "not necessarily" required to disclose the compensation.  In fact, Item 402 provides that the director compensation table must include "[c]onsulting fees earned," irrespective of the amount.  In other words, the NYSE often had available information about payments made to directors for amounts between $100,000 and $120,000.  In other words, the NYSE was using Item 404 (self interested transactions) as the excuse to raise the threshold when the issue was one primarily of exeuctive compensation and should have been resolved with reference to Item 402. 

There is one more change that we will discuss. 

Full post as published by The Race to the Bottom on August 28, 2008 (boomark / email).