The revelation in a Wall Street Journal article last month [Hyatt Director Gets a Status Makeover, Aug. 24, Subscription required.] once again raises the question of what criteria are used to determine a public company director’s independence.
Prior to the hotel company’s proxy disclosure in April that Penny Pritzker is no longer considered among the board’s independent directors, the fact that she is the first cousin to the Chair Thomas Pritzker isn’t the reason she is no longer considered independent. In fact, it was because she recently took over a family enterprise that leases office space to Hyatt for its headquarters in Chicago. According to the Journal article, when Pritzker was designated an independent director last fall various businesses where she was chair or president did about $3 million a year in transactions with Hyatt. [See the Hyatt SEC disclosure.]
Although the listing standards of the NYSE and Nasdaq are somewhat specific about director independence, boards are left to their own devices to determine who is independent because of three words: “no material relationship.” The actual NYSE standards state: “no director qualifies as ‘independent’ unless the board of directors affirmatively determines that the director has ‘no material relationship’ with the listed company, either directly or as a partner, shareholder or officer of an organization that has a relationship with the company.”
The Nasdaq standards are similar. Nasdaq's rules provide that an independent director is a person other than an officer or employee of the company or its subsidiaries or any other individual having a relationship that, in the opinion of the company's board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.
A 2003 client memo by Akin Gump Strauss Hauer & Feld LLP [Read article here.] spells out the listing standards for both exchanges.
The thrust of the Wall Street Journal article is that although Hyatt decided to “undesignate” Pritzker as an independent director, there are other directors whose independence should be called into question. And if the board listened to the corporate governance experts quoted in the article (Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware; and Beverly Behan, a corporate board consultant ), Hyatt might not meet the independence majority rule at all.
By no means is Hyatt alone, and that’s why I think boards of all public companies should take a hard look at how they determine director independence. If anything, whether or not a company has an independent non-executive chair, it might be advantageous to have a strong lead director. In addition to helping formulate the meeting agendas and meeting with the independent directors, it might make sense to have that person work with the governance and nominating committee to create clear standards for independence.
In a recent Director Notes report called “Enhanced Disclosure in the Dow 30 and Select Financial Companies: Board Leadership Structure,” [Conference Board membership required.] the authors Louis L. Goldberg and Justine Lee of Davis Polk & Wardwell LLP cite The Conference Board Commission on Public Trust and Private Enterprise’s 2003 recommendations to achieve a balance of powers: separation of the chair and CEO roles with an independent director as chair and appointment of a lead, presiding or senior independent director.
They wrote: “Preferably, he or she should meet the independence requirements. The presiding director (or other equivalent designation) would have such responsibilities as: chairing executive sessions; serving as the principal liaison between management and independent directors; and working closely with the chairman to finalize board meeting agendas. The lead or presiding director would also be in charge of meetings of independent directors and have approval over information flow to the board and other operational aspects.”
It’s clear the definition of independence for directors is something company boards have been struggling with. But maybe it’s not so much the boards’ fault that there seems to be no best practices for tackling this problem. Maybe it’s the rules-based system the SEC and exchanges have embraced to ensure independence. Other than delisting a company, which rarely happens for not having enough independent directors, there really is no penalty for not abiding by the rule. Usually what happens is that when a company knows it may momentarily fall below the independence majority threshold, it discloses the fact to the exchange while it seeks a new independent director.
Maybe what boards should do is take a look at what their brethren in India’s state-owned companies do. Instead of just enforcing independence rules, the different administrative ministries grant special status to those companies that add independent directors to their board. That Maharatna status gives those companies more autonomy to clear projects without government approval. There’s an even higher status, navratna, which gives those eligible companies enhanced financial powers. But as of June 12, only four companies qualified. [Read Economic Times article here.]
True, such a setup flies in the face of a free market economy, but the idea of rewarding good behavior instead of trying to penalize for not following a rule without a clear definition may be the way to go if the SEC and the exchanges truly want to have truly independent-led boards.
Gary Larkin is a research associate in the corporate leadership department at The Conference Board in New York. His research focuses on corporate governance, including succession planning, board compo…