The NYSE and NASDAQ generally require that members of listed com- pany compensation committees be independent.
Both the NYSE and NASDAQ have adopted specific rules as to who can qualify as an independent director, and both markets require that the board of directors of a listed company make an affirmative determination, which must be publicly disclosed, that each director designated as “independent” has no material relationship with the company that would impair his or her independence. Such disqualifying relationships can include commercial, industrial, banking, consulting, legal, accounting, charitable and familial relationships, among others. However, ownership of a significant amount of stock, or affiliation with a major shareholder, should not, in and of it- self, preclude a board of directors from determining that an individual is independent. In addition, the listing standards of both the NYSE and the NASDAQ set forth circumstances that, per se, constitute bars to a deter- mination of independence.
As a general matter, a director will be viewed as independent only if the director is a non-management director free of any material family relation- ship or any material business relationship, other than stock ownership and the directorship, with the company or its management, and has been free of such relationships for three years. The following relationships bar a director from satisfying the independence standards of the NYSE or the NASDAQ, as applicable:
44 For additional discussion of the NYSE and the NASDAQ independence requirements,
see Wachtell, Lipton, Rosen & Katz, Nominating and Corporate Governance Committee
• the director is, or has been within the last three years, an em- ployee45 of the company;46
• an immediate family member of the director is, or has been within the last three years, an executive officer of the company; • the director is a current partner (or employee, under the NYSE rules) of a firm that is the company’s external auditor (or inter- nal auditor, under the NYSE rules);
• an immediate family member of the director is a current partner of a firm that is the company’s external auditor (or internal au- ditor, under the NYSE rules);
• under the NYSE rules, an immediate family member of the di- rector is a current employee of the company’s internal or exter- nal auditor and personally works on the company’s audit; • the director or an immediate family member was, within the
last three years, a partner or employee of a firm that is the company’s external auditor (or internal auditor, under the NYSE rules) and personally worked on the company’s audit within that time;
• under the NYSE rules, the director or an immediate family member of the director is, or has been within the last three years, an executive officer of another company where any of the company’s present executive officers at the same time serves or served on that other company’s compensation com- mittee;
• under the NASDAQ rules, the director or an immediate family member of the director is an executive officer of another entity where, at any time during the past three years, any of the exec- utive officers of the issuer served on the compensation commit- tee of such other entity;
• under the NYSE rules, the director is a current employee, or an immediate family member of the director is a current executive officer, of a company that has made payments to, or received payments from, the company for property or services in an amount that, in any of the last three fiscal years, exceeds the
45
Both the NYSE and the NASDAQ provide that employment as an interim executive officer does not, in and of itself, disqualify a director from being considered independent following such employment. Under the NASDAQ rules, however, such interim employ- ment cannot last more than one year.
46 Both the NYSE and the NASDAQ define “company” to include a parent or subsidiary
greater of $1 million or 2% of such other company’s consoli- dated gross revenues;
• under the NASDAQ rules, the director or an immediate family member of the director is a partner, controlling shareholder or an executive officer of any organization to which the company made, or from which the company received, payments for property or services in the current or any of the past three fiscal years that exceed 5% of the recipient’s consolidated gross rev- enues for that year or $200,000, whichever is more;47
• under the NYSE rules, the director or an immediate family member of the director has received during any 12-month peri- od within the last three years more than $120,000 in direct compensation48 from the company (other than in director and committee fees and pension or other forms of deferred com- pensation for prior service (provided that such compensation is not contingent in any way on continued service) and compen- sation received by an immediate family member for service as a non-executive employee);49 and
• under the NASDAQ rules, the director or an immediate family member of the director received any compensation50 from the company in excess of $120,000 during any 12-month period within the last three years (other than director or committee fees, benefits under qualified retirement plans or nondiscre-
47
The NASDAQ rules exclude from the calculation payments arising solely from in- vestments in the company’s securities and payments under nondiscretionary charitable contribution matching programs.
48 The NYSE rules focus on direct compensation. Consequently, investment income
from the company (such as dividend or interest income) would not count toward the $120,000 threshold. In addition, the NYSE’s focus on “direct” compensation means that bona fide and documented reimbursement of expenses also may be excluded. Note, however, that the NYSE considers payments to a director’s solely owned business entity to be direct compensation.
49
The NYSE rules also permit companies to exclude from the $120,000 threshold com- pensation received by a director for former service as an interim executive officer of the company.
50 Unlike the NYSE rules, the NASDAQ rules are not limited to direct compensation.
Accordingly, even indirect compensation must be included in the calculation of the $120,000 threshold. For instance, the NASDAQ provides that political contributions to the campaign of a director or an immediate family member of the director would be con- sidered indirect compensation, and, as such, must be included for purposes of the $120,000 threshold.
tionary compensation and payments received by an immediate family member for service as a non-executive employee).51 When evaluating the independence of any director who will serve on the compensation committee, NYSE rules require a board of directors to con- sider all relevant factors that could impair independent judgments about executive compensation, including, but not limited to, (1) the source of compensation of such director, including any consulting, advisory or other compensatory fee paid by the company, and (2) whether the director is affiliated with the company or one of its subsidiaries or affiliates. NASDAQ rules prohibit compensation committee members from accept- ing any consulting, advisory or other compensatory fees from the compa- ny or its subsidiaries (other than directors’ fees).
Independence determinations must be based on all relevant facts and cir- cumstances. Thus, even if a director meets all the bright-line criteria set out above, a board of directors is still required to make an affirmative de- termination that the director has no material relationship with the compa- ny. Under NYSE rules, the principles underlying the determination of in- dependence also must be publicly disclosed in the company’s annual report or proxy statement. The NYSE rules also provide that the board of directors may adopt and disclose categorical standards to assist it in mak- ing determinations of independence and may make a general disclosure if a director meets these standards. The company must disclose any such standard the board of directors adopts. Any determination of independ- ence for a director who does not meet such standards must be specifically explained. In addition, under the SEC disclosure rules, for each director that is identified as independent, the company must describe, by specific category or type, any transactions, relationships or arrangements (other than transactions already disclosed as related-party transactions) that were considered by a board of directors under the company’s applicable director independence standards (e.g., the NYSE or the NASDAQ independence rules).
In limited circumstances, NASDAQ permits one director who does not meet its independence rules to serve on the compensation committee with- out disqualifying the compensation committee from considering the com- pensation matters that ordinarily would be entrusted to it had it been fully independent. Specifically, if a compensation committee is comprised of at least three members, one non-independent director (who is not a current
51 The NASDAQ rules also permit companies to exclude compensation received by a
director for service as an interim executive officer; provided that such service did not last longer than one year.
officer or employee or a family member of an officer or employee) may be appointed to the compensation committee if the board of directors, under exceptional and limited circumstances, determines that such individual’s membership on the compensation committee is required for the best inter- ests of the company and its shareholders. If the board of directors takes this approach, it must disclose in the proxy statement for the next annual meeting subsequent to such determination (or, if the company does not file a proxy, in its annual report on Form 10-K or 20-F) the nature of the rela- tionship and the reasons for the determination. A member appointed un- der this exception may serve a maximum of two years. The NYSE does not provide a similar exemption.
In addition, newly listed companies on the NYSE or the NASDAQ need only one independent member of the compensation committee at the time of the company’s initial public offering, a majority of independent mem- bers within 90 days of listing,52 and a fully independent committee within one year of listing.
B. Internal Revenue Code Section 162(m) Membership Require-