Cooley LLP

The SEC has granted accelerated approval of Nasdaq’s amended proposal, originally filed in May 2019, to modify the definition of a “family member” for purposes of determining director independence under Listing Rule 5605(a)(2).  As part of the new definition, Nasdaq excludes stepchildren from the definition of “family member,” but will ultimately leave to the board the determination of whether stepchildren who do not live at home with the director nevertheless have a relationship with the director that could interfere with the director’s exercise of independent judgment.  Calling Dr. Phil….

The amended definition of “family member” applies in the context of defining director independence and excludes from the definition stepchildren who do not live at home with the director and domestic employees who share the director’s home. Under the new definition, for purposes of Nasdaq Rule 5605(a)(2), “family member” means a person’s spouse, parents, children, siblings, mothers- and fathers-in-law, sons- and daughters-in-law, brothers- and sisters-in-law, and anyone (other than domestic employees) who shares the person’s home.

Under Nasdaq rules, the boards of listed companies are required to be majority independent (as defined by Nasdaq), and listed companies’ audit, compensation and nominating committees are required to be composed solely of independent directors. Rule 5605(a) identifies relationships that preclude a finding of director independence, including relationships involving a family member of the director.  Nasdaq Rule 5605(a)(2) defines an “independent director” to mean a person other than an executive officer or employee of the company or any other individual having a relationship which, in the opinion of the company’s board, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. Rule 5605(a)(2) also precludes a board finding of independence where a director or a director’s “family member” has (or has had), specified relationships with the listed company.

Prior to the amendment, “family member” referred to a person’s spouse, parents, children and siblings, whether by blood, marriage or adoption, or anyone residing in the person’s home. “Children by… marriage” includes stepchildren.  But that definition was not consistent with the NYSE’s. The new amendment, however, remedies that concern, making the two definitions correspond (and also making D&O questionnaires simpler).  Under the last amendment filed with the SEC, Nasdaq added an interpretation of the term “children” that excludes stepchildren. However, if a stepchild shares the same home with a director, the stepchild would still be considered a family member because the definition includes anyone (other than domestic employees) who shares the director’s home.

And here’s where boards will really need Dr. Phil….or maybe Dr. Melfi. As the reason for the change, Nasdaq explains that it believes the prior definition was over-inclusive.    Nasdaq’s view is that whether a director’s relationship with his or her stepchildren could interfere with the director’s exercise of independent judgment depends on the facts and circumstances. According to Nasdaq, if “a stepchild has been a dependent of a director or was part of the director’s household since being a minor, the director’s relationship with that stepchild is likely to be similar to a relationship with a biological child.”  But, “if the director married a person who has an adult child, the director never acted in any capacity as a parent of this stepchild, and the stepchild never shared the director’s household, then the director and stepchild are likely to have an attenuated relationship that is unlike the relationship of a parent and a child. Nasdaq has concluded, therefore, that a stepchild relationship should not preclude a director from being considered independent in all circumstances.”  Rather, Nasdaq continued, “a company’s Board is in the best position to determine whether a given relationship between a director and stepchild is likely to interfere with the director’s exercise of independent judgment in carrying out his or her responsibilities based on the facts and circumstances,” and, under Rule 5605(a)(2) and IM-5605, the board has the responsibility to affirmatively determine that no relationship exists that would interfere with such independent judgment.

The last amendment to the proposal also clarified that the change to Rule 5605(a)(2) does not affect the additional independence criteria for audit committee members in Rule 5605(c)(2), which criteria incorporate the independence requirements of Rule 10A-3 under the Exchange Act.  (Presumably, this issue could arise under the definition in Rule 10A-3 of the term indirect acceptance by a member of an audit committee of any consulting, advisory or other compensatory fee, which includes acceptance of the fee by a spouse, a minor child or stepchild or a child or stepchild sharing a home with the member.)

The rule change also excludes from the definition of “family member” domestic employees who share a director’s home, because those relationships are typically commercial, not familial, as intended by the definition.  However, this relationship will ultimately also need to be scrutinized by a company’s board under the general Nasdaq requirement that the board affirmatively determine that no relationship exists that would interfere with the exercise of independent judgment in carrying out the director’s responsibilities.

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