Corporate Governance Alert

Corporate Governance Alert: Fresh "Independence" Testing Needed For NYSE - Traded Companies

The Sarbanes-Oxley Act of 2002 brought about numerous changes in corporate governance. Among them was a requirement that a public company's audit committee be entirely comprised of "independent" directors. As instructed by the Act, the SEC adopted Rule 240 which mandates that the national securities exchanges prohibit listings by companies that are not in compliance with the audit committee requirements specified by the Act. On November 4, 2003, the New York Stock Exchange adopted its Listed Company Manual Rule 303 A-02 providing for various director "independence" standards in response to the SEC's Rule. Under the NYSE tests, a director who has had any of several proscribed relationships or compensatory arrangements will not be considered "independent" until three years have elapsed from the cessation of such relationship or arrangement. These relationships or arrangements include: (a) former employment with the listed company, (b) receipt of $100,000 or more of direct compensation from the listed company, (c) affiliation with or employment by the listed company's auditor, (d) executive officer status with a company where a listed company's executive serves on the other company's compensation committee, and (e) association with a company that receives or pays sums from or to the listed company in an amount that exceeds the greater of $1 million or 2% of such company's gross revenues. To effectuate a smooth implementation of it's new "independence" testing requirements, NYSE adopted a temporary, phase-in rule which provides that, for the first year following adoption of Rule 303 A-02, the three-year look back period is converted to a one-year look back period. This one-year transitional rule, however, sunsets on November 3, 2004, and starting November 4, 2004, the look back period becomes three years.
What's the net result? A relationship or arrangement that existed on November 2, 2003 that would not have defeated a director's "independence" under the transitional rule may now, in fact, defeat "independence" under the permanent rule. This, of course, may place a listed company in the rather awkward position of having to dis-invite a current audit committee member from service until he or she regains "independence" under the permanent three-year look back rule.
Our "best practices" recommendation to NYSE listed companies: circulate a director's questionnaire prior to November 4, 2004 which re-tests for "independence" under a three-year look back period. Michael Raymond is a Member in Dickinson Wright’s Ann Arbor office. For additional information, please contact him at 734-623-1663 or