Better Late Than Never – Nasdaq Proposes to Clean Up 2002 Revisions to Rule 5605

The Nasdaq Stock Market (“Nasdaq”) filed with the SEC a proposed rule change on June 12, 2019 that would clean up the wording of its 2002 revisions to Rule 5605 addressing standards for independent directors. The proposed rule would make a very focused change; specifically, that sons and daughters-in-law, but not stepchildren, should be considered along with the parent director when determining the existence of relationships that would preclude a director from being ‘independent’. The peculiar thing about this change is that it took Nasdaq 17 years to realize the inadvertent impact of its 2002 revisions.

Rule 5605 sets forth a list of relationships that preclude a director from being determined to be “independent” for purposes of meeting board and board committee independence requirements. The relationships, which are not proposed to be changed in any respect by the revised rule, include being compensated or employed by the listed company, owning or holding positions in a company that does certain amounts of business with the listed company, certain compensation committee overlaps and being a partner of the listed company’s outside auditors.

The proposed changes deal with which children of a director should be considered as potentially precluding the parent director from being qualified as independent. In 2002, as part of a broad package of corporate governance reforms, Nasdaq changed the definition of covered family members in Rule 5605 from “sons and daughters-in-law” to “children by marriage”. Nasdaq apparently now realizes that this change caused stepchildren to be covered, since they are children by the marriage of the parent, when they were not covered before as sons or daughters-in-law (which are children by the marriage of the child)  Nasdaq now claims that the 2002 revisions were never intended to make this substantive change.

The NYSE standard in this area was and has been that sons and daughters-in-law are covered (and not stepchildren), so since 2002 issuers have been forced to apply different standards of director independence when they move from one exchange to the other. Nasdaq now concludes that it is unduly burdensome for issuers in such circumstance to have to apply both standards, and since this burden was never intended anyway, it now proposes to change its rule to eliminate the difference. 

Is this change by Nasdaq really worth it, particularly after all these years? It does not seem intuitive that a stepchild’s prohibited relation would have any less influence on their stepparent than would the same prohibited relation of a son or daughter-in-law. It clearly could go either way, depending on the circumstances. Nasdaq supports its proposed revision by noting that relationships of adult stepchildren from a later-in-life marriage would not be likely to influence the director stepparent. But that scenario is no more likely than a stepchild raised from an early age as the director’s own.

Nasdaq appears focused on streamlining the listing process by conforming the standards of the major exchanges – which is of course a laudable goal that we would like to see applied to areas where even more significant discrepancies currently exist. The lingering question is if this inadvertent discrepancy has been a significant burden, how did it take Nasdaq 17 years to realize it?

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