“The Temp” was a 1993 thriller about a cookie company executive and a killer temp. The critics were unimpressed (Faye Dunaway won a Razzie award for “Worst Supporting Actress”).
This week, we look at the situation when a director of a public company serves as an interim CEO. We certainly hope the company’s shareholders were pleased by this temp’s performance — but what impact will the director’s service have on director independence?
First, the Easy Part
A director currently serving as the company’s interim CEO is not considered independent. This is true under NYSE listing rules (Commentary to Rule 303A.02(b)(i)), NASDAQ listing rules (IM-5605 to Rule 5605(a)(2)). In addition, an interim CEO would likely flunk both tests under Exchange Act Rule 10A-3, which prohibits listed companies’ audit committee members from (i) accepting any compensation from the company (other than for service as a director) and (ii) being an affiliate of the company.
Several Shades of Gray
After an interim CEO gig, things get more complicated.
- NASDAQ rules do not preclude a director from being independent after serving as interim CEO for up to one year. However, interim CEO service of more than one year would preclude a director’s independence for three years. Rule 5605(a)(2)(A).
- NYSE rules also do not preclude a director from being independent after interim CEO service. For this purpose, unlike NASDAQ, the NYSE does not expressly limit interim CEO service. The NYSE has noted its receipt, in the rulemaking process, of requests to exempt interim CEOs who served for less than one year. Although the NYSE did not adopt this standard, practitioners typically take the position that past service as interim CEO for up to one year does not preclude a director’s independence under NYSE rules. Conceivably, under appropriate circumstances, past service as interim CEO for a longer period, such as 18 months, might not preclude a director’s independence. If you find yourself in that situation, let’s talk. As with NASDAQ, a director’s past service as CEO on a non-interim basis would preclude the director’s independence for three years. Rule 303A.02(b)(i).
- Exchange Act Rule 10A-3 would not automatically preclude audit committee service after interim CEO service because Rule 10A-3 focuses on a director’s current, rather than past, compensation from the company or status as an affiliate. As a result, a director could qualify as independent under Rule 10A-3 immediately after serving as interim CEO.
- Even so, proxy advisory firms and their institutional investor clients may see things differently. For example, ISS and other proxy advisors apply their own director independence standards when making voting recommendations to their clients. ISS will conclude that a director can never qualify as independent after serving as interim CEO for more than 18 months. For interim CEO service between 12 and 18 months, ISS will (i) review the employment agreement with the interim CEO to determine if the agreement contained severance pay, long-term health and pension benefits or other provisions typically contained in employment agreements for permanent, non-temporary CEOs and (ii) consider whether a formal search process was underway for a permanent CEO at the time.
This table summarizes these standards:
Effects of Interim CEO Service on Director Independence
Click here to view table.
What’s in a Name?
There is no technical requirement for the director to have had the “Interim” prefix before the CEO title. However, having the “Interim” tag in the title would reduce the chance that anyone would miss the interim nature of the director’s prior CEO role. If the director’s CEO title did not include an express “Interim” tag, the company should consider publicly announcing the interim nature of the director’s service as CEO and also publicly announce a concurrent search for a permanent CEO. The company should also consider memorializing the arrangement in a writing expressly stating that the director will hold the title of CEO on an interim basis until the company can identify and hire a permanent CEO.