Recent Developments Regarding Director Independence

September 2, 2008

Several noteworthy developments recently occurred regarding director independence.  First, on August 8, 2008, the Securities and Exchange Commission (the "SEC") approved amendments to the definition of “independent director” under the NASDAQ Stock Market Rules, which have gone into effect.  Second, on August 12, 2008, the New York Stock Exchange (the “NYSE”) filed rule changes with the SEC to amend two of its director independence tests; these rules do not require SEC approval and apply beginning September 11, 2008.  Finally, on August 5, 2008, the SEC announced the settlement of an enforcement action involving a former director who failed to disclose a business relationship with the auditor of three companies on whose boards he served, thereby causing the companies to violate the federal securities laws.

NASDAQ Amendments

The SEC approved an amendment to NASDAQ Rule 4200(a)(15), which sets forth several tests to determine whether a director of a listed company is independent.[1]  Prior to the amendment, Rule 4200(a)(15)(B) provided that a director would not be considered independent if the director or an immediate family member accepted any compensation from the listed company in excess of $100,000 during any period of 12 consecutive months within the three years preceding the determination of independence (excluding compensation for board or board committee service, compensation paid to an immediate family member as a non-executive employee, benefits paid under a tax-qualified retirement plan and non-discretionary compensation).  The amendment increased the dollar threshold from $100,000 to $120,000.  This amendment was adopted in response to the SEC’s 2006 amendment to Item 404 of Regulation S-K, which increased to $120,000 the dollar threshold applicable to disclosure of related party transactions.  The NASDAQ rule change has gone into effect.

New York Stock Exchange Amendments 

The NYSE amendments modify the bright line independence tests set forth in Section 303A.02(b) of the NYSE Listed Company Manual in two respects.[2]  The first amendment modifies Section 303A.02(b)(ii) to increase from $100,000 to $120,000 the amount of direct compensation (other than director or committee fees and pension or other forms of deferred compensation for prior service), that a director or members of a director’s immediate family may receive from a listed company in a 12-month period within the prior three years and still be considered an independent director.  As with the similar NASDAQ amendment, the NYSE’s amendment was adopted to align the NYSE rules with the disclosure requirements set forth in Item 404 of Regulation S-K. 

The second amendment modifies Section 303A.02(b)(iii), the auditor affiliation test, as it applies to a director’s immediate family members.  Prior to the amendment, a director could not be deemed independent if:  the director or an immediate family member was a current partner of the company’s internal or external auditor; the director was a current employee of the audit firm; the director had an immediate family member who was a current employee of the firm and who participated in the firm’s audit, assurance or tax compliance practice; or the director or an immediate family member had been, within the last three years, a partner or employee of the firm and personally worked on the listed company’s audit within that time.  The amendment provides that a director may still be considered independent if the director’s immediate family member currently works for the company’s auditor, as long as the immediate family member is not a partner of the company’s auditor or is not personally involved (and has not been personally involved for the past three years) in the company’s audit.  The NYSE indicated that it adopted this amendment because the prior bright-line test had the effect of precluding a director from being considered independent even in cases when a director’s immediate family member had no connection to the listed company’s audit, such as where a director’s child takes an entry level job in the audit practice of a company’s auditor upon graduating from college and has no involvement in the company’s audit.  This amendment also brings the NYSE standards more in line with the independence tests used by NASDAQ and the American Stock Exchange.

The NYSE amendments do not require SEC approval and apply beginning on September 11, 2008.

SEC Enforcement Action

On August 5, 2008, the SEC announced a settled enforcement action against Mark C. Thompson, a former outside director of three public companies, for failing to disclose a business relationship he had with the outside auditor of the public companies on whose boards he served.[3]  While serving as a director, Mr. Thompson created a series of audio CDs for the outside auditor to provide to prospective audit and non-audit clients for business development purposes.  He failed to fully include the details of his business relationship with the outside auditor on any of the director and officer (D&O) questionnaires he completed; he also failed to submit a D&O questionnaire for one of the companies until after his resignation.  As a result, the proxy statements filed by the companies requesting shareholder approval of the retention of the outside auditor did not disclose Mr. Thompson’s relationship with the outside auditor.  In addition, during his service as a director, Mr. Thompson signed three annual reports and one audit committee report claiming the outside auditor was independent, even though Mr. Thompson’s relationship with the outside auditor impaired the outside auditor’s independence and caused the companies to lack independently audited financial statements.  The SEC determined that Mr. Thompson’s actions, or inactions, caused each of the three companies to violate the federal securities laws.

As part of the settlement, Mr. Thompson disgorged $100,662.33, the director fees he received, plus $23,254.94 in interest, for failing to make these disclosures and as a result, causing violations of Sections 13(a) and 14(a) and Rules 13a-1, 14a-3 and 14a-9 of the Securities Exchange Act of 1934, as amended.  The SEC also issued a cease and desist order to keep Mr. Thompson from causing any additional violations of the federal securities laws. 

What Companies Should Do Now

In light of the NYSE and NASDAQ rule amendments and SEC enforcement action discussed above, we encourage companies to consider taking the following actions:

1.  For companies listed on the NYSE with categorical independence standards, amending these categorical standards to reflect the rule amendments.

2.  Revising company D&O questionnaires to reflect the rule amendments.

3.  Reminding directors and officers of the importance of submitting complete and accurate D&O questionnaires.

4.  Reminding directors of the need to bring to the company’s attention any changes that might impact the director’s independence, and sending quarterly notices to directors, as part of board packages or otherwise, to remind them of the need to inform the company of any changes that may affect their independence.


[1]   The SEC release (Release No. 34-58335) is available at: 

[2]   The SEC release (Release No. 34-58367) is available at:

[3]   The SEC Administrative Proceeding is available at:

Gibson, Dunn & Crutcher LLP

  Gibson, Dunn & Crutcher’s Securities Regulation and Corporate Governance Practice Group is available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work, or any of the following:
John F. Olson (202-955-8522, [email protected]), 
Ronald O. Mueller (202-955-8671, [email protected]), 
Amy L. Goodman (202-955-8653, [email protected])
Gillian McPhee (202-955-8230, [email protected]),
Elizabeth A. Ising (202-955-8287, [email protected]),
Tracy L. Schampers (202-887-3745, [email protected]), or
James J. Moloney (949-451-4343, [email protected]).

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