Several noteworthy developments occurred during summer 2008 in the area of director independence. Both the New York Stock Exchange (NYSE) and NASDAQ amended their bright-line independence tests on the receipt of direct compensation from listed companies, and the NYSE also amended its independence test on relationships with a listed company's outside auditor. In addition, the Securities and Exchange Commission (SEC) announced the settlement of an enforcement action involving a former director who did not disclose a business relationship with the auditor of three companies on whose boards he served, causing the companies to violate the federal securities laws.

NASDAQ Amendments
Effective August 8, 2008, 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. Previously, NASDAQ rules provided that a director could not be independent if the director or an immediate family member accepted compensation from a listed company in excess of $100,000 during any period of 12 consecutive months within the three years preceding the determination of independence (with limited exceptions for compensation such as board fees and salaries of immediate family members who are not executive officers). The amendment increased the dollar threshold from $100,000 to $120,000. NASDAQ adopted the amendment in response to the SEC's 2006 changes to Item 404 of Regulation S-K, which increased to $120,000 the dollar threshold applicable to disclosure of related party transactions.

NYSE Amendments
The NYSE amendments modified the bright-line independence tests in Section 303A.02(b) of the NYSE Listed Company Manual in two respects. First, like NASDAQ, the NYSE increased the threshold in its test on direct compensation from $100,000 to $120,000 in order to align this test with the SEC's threshold for disclosure of related party transactions.

Second, the NYSE modified its auditor affiliation test as it applies to a director's immediate family members. Previously, a director could not be independent if: (1) the director or an immediate family member was a current partner of the company's internal or outside auditor; (2) the director was a current employee of the audit firm; (3) the director had an immediate family member who was a current employee of the firm and participated in the firm's audit, assurance, or tax compliance practice; or (4) 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. As amended, the NYSE rule provides that a director may still be considered independent if the director's immediate family member currently works for the company's outside auditor, as long as the immediate family member is not a partner at the auditor or is not personally involved (and has not been personally involved for the past three years) in the company's audit. According to the NYSE, it made this change 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 aligns the NYSE standards with the independence tests used by NASDAQ and the American Stock Exchange. The NYSE amendments became effective beginning September 11, 2008.

SEC Enforcement Action
On August 5, 2008, the SEC announced a settled enforcement action against a former outside director of three public companies for not disclosing a business relationship he had with the outside auditor of these companies. (Release No. 34-58310, available at www.sec.gov/litigation/admin/2008/ 34-58310.pdf.) While on the companies' boards, the director created a series of audio CDs for the outside auditor to provide to prospective audit and non-audit clients for business development purposes. The director did not include the full details of his business relationship with the outside auditor on the directors and officers (D&O) questionnaires he completed for the companies, and he did not submit a D&O questionnaire for one of the companies until after his resignation from the board. As a result, the proxy statements filed by the companies requesting shareholder ratification of the retention of the outside auditor did not disclose the director's relationship with the outside auditor. In addition, during his service, the director signed three annual reports and one audit committee report indicating that the outside auditor was independent, even though the director's relationship with the outside auditor impaired auditor independence and caused the companies to lack independently audited financial statements. The SEC determined that the director's actions, or inactions, caused each of the three companies to violate the federal securities laws.

As part of the settlement, the director disgorged $100,662, the director fees he received, plus $23,255 in interest, for failing to make these disclosures and, as a result, causing violations of the Securities Exchange Act of 1934. The SEC also issued an order requiring the director to cease and desist from committing or causing additional violations of the federal securities laws.

What Companies Should Do Now
In light of the NYSE and NASDAQ rule amendments and the SEC enforcement action discussed above, companies should consider taking the following actions:

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

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

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

4. Remind directors of the need to bring to the company's attention any changes that might impact their independence, and send 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.