Prompted by a request for interpretive guidance, on April 1, 2014, the NYSE proposed to relax its bright line director independence tests in certain limited circumstances, so that “a director may be deemed independent of a company that has been the subject of a spin-off transaction regardless of the fact that such director or his employer had a relationship with the former parent of such spun-off company.” The new interpretation is reflected in a rule filing that the NYSE has submitted to the SEC for approval.
In applying the three-year look back period in its bright line director independence tests to directors of a spun-off company, the NYSE focuses on the date of deconsolidation,i.e., the date of the spin off. See NYSE’s Corporate Governance Standards Frequently Asked Questions (“FAQs”), FAQ C-3A. The release illustrates this as follows: “For example, a director who was employed by the parent could not be deemed to be an independent director of the spinco until three years after the spin-off. Similarly, if the relationship between the parent and the director’s company had ended prior to the spin-off and two years of the applicable look-back period had elapsed at the time of the separation, that director could not be independent with respect to the spinco until one year after the separation.” This guidance is “a recognition that a director that has been non-independent of a parent will generally be non-independent of a spun off business unit.”
Recognizing that in large companies with several business units, “a director or his employer may have a relationship with one business unit while having no connection with another business unit of the same company,” the NYSE now proposes to relax its bright line independence tests in situations where the employer of a director of a spun-off company did not provide services to any of the businesses that have become part of the spun-off entity. Therefore, “the Exchange will not apply the bright line independence tests . . . to a director of Spinco whose employer had a relationship with the former parent that impaired such director’s independence with respect to the consolidated entity if (i) the director’s employer had no relationship during the applicable look-back period with any of the businesses spun-off into Spinco and (ii) none of the senior executives of Spinco were senior . . . executives of the former parent or any business unit of the former parent company that had a business relationship with the director’s employer during the applicable period.” (Emphasis added.) The general director independence test would continue to apply, which requires an affirmative determination by the board that the director does not have a “material relationship” with the spun-off company.
While the new interpretation specifically addresses only the situation where the director is an employee of another company that does business with the former parent (i.e., the bright line independence test in Section 303A.02(b)(v) of the Listed Company Manual), the scope of the new interpretation is broader as it provides that “the NYSE has applied the same logic to other Section 303A.02(b) bright line independence tests” as well.
Why the NYSE chose to indirectly expand the scope of the new interpretation, instead of being more precise as to how the same logic would extend to other bright line independence tests, is unclear. In this regard, it seems that the logic of the new interpretation can more easily be applied to some of the bright line independence tests than to others. For example, where a director was employed by a business unit of the parent that is not part of the businesses being spun off, it would seem logical to conclude that the director’s independence with respect to the spun-off company is not impaired under Section 303A.02(b)(i). Similarly, where a director provided services (and received direct compensation in excess of $120,000 during a twelve-month period) to a business unit of the parent company that is not part of the businesses being spun off, it would seem logical to conclude that the director’s independence with respect to the spun-off company is not impaired under Section 303A.02(b)(ii). On the other hand, it is less clear if and how the same logic would extend to Section 303A.02(b)(iii)(director has a relationship to the parent company’s auditors) or Section 303A.02(b)(iv)(interlocking directorates). Finally, one would assume that the logic of the new interpretation also extends to situations where an immediate family member of a director had a relationship only with a business unit of the parent that is not part of the businesses being spun off. In any event, before applying the logic of the new interpretation to other bright line tests, it would seem prudent to consult the NYSE staff.
Cryptically described in the release as “a rule change that constitutes a stated interpretation with respect to the meaning, administration and enforcement” of the director independence tests, the new interpretation is not actually being implemented by way of an amendment to Section 303A.02(b), which sets forth the bright line independence tests, or its official commentary. Rather, the new interpretation will be reflected in a revised FAQ C-3A.