LEGAL Director Independence: Setting the Standard

Boards of listed companies will be required to have minimum of two independent directors, from the later of 29 October 2004 or 12 months from the issuer’s 2003 annual meeting. If eight or more directors sit on the board, the minimum requirement increases to three or one-third of the total number of directors (rounded down?), whichever is greater. These minimum numbers differ from similar regimes in the United States, the United Kingdom and Australia which either recommend or require that at least half, or majority of directors of an issuer, be independent.
Boards of listed issuers are required to identify the directors the board considers to be independent and must advise the market. These decisions must be made after the listed company’s annual general meeting, following board appointments and prior to the publication of the annual report (and included in the annual report).
An “independent director” is someone who is not an executive of the issuer and who has no “Disqualifying Relationship”. The key term, “Disqualifying Relationship”, is defined broadly and conceptually as being “any direct or indirect interest or relationship which could reasonably influence, in material way, the director’s decisions in relation to the issuer”. The NZX Listing Rules provide some guidance by noting that the listed company should consider all circumstances, including the history of the relationship and any plans for the relationship on an ongoing basis.
Certain relationships are deemed “Disqualifying Relationships”. These are where:
*the director holds more than five percent of the voting securities of the issuer (ie, he or she is “substantial security holder”) or the director is an “associated person” of substantial security holder; or
*the director or an “associated person” of the director is likely to derive substantial portion of his, her or its annual revenue (in the listed company’s current financial year) by virtue of relationship with the issuer or one of its substantial security holders. As general benchmark, the NZX has stated that 10 percent of the director’s or the associated person’s revenue is considered “substantial portion”.
Persons “associated” with directors comprise potentially broad category of persons, and are those who, as consequence of an arrangement or relationship with the director, could influence the director or be influenced by the director in making decision or exercising power affecting listed company.
But these deemed “Disqualifying Relationships” are by no means an exhaustive list. The concept is wide, and might extend to variety of circumstances. For instance, could director whose firm provides legal or accounting services to the listed company be regarded as independent? Could one-off transaction between director and the listed company result in “Disqualifying Relationship”? How recently must the interest or relationship have come into existence for it to be (or not be) “Disqualifying Relationship”?
The fundamental driver for director independence is the pursuit of sound governance. The rules endeavour to ensure that there are persons on board with open minds who can effectively complement the skills and thinking of others more closely associated with the company’s operations. Independent directors are also often best placed to raise the hard questions and set off any necessary warning bells. In this light, many of our larger listed corporates already have embraced the independence requirements, adopting them (to the extent not already in place), and notifying the market, well before the signalled start date.
Looking at sample of these, some significant benchmarks for practice in this area in New Zealand have been set. Key principles under the spotlight include the following:
*Number of Independent Directors
Notwithstanding the minimum numbers set by the rules, various of our key corporates have set higher standard than that imposed by the NZX, requiring the majority of their boards to be independent. In many instances, this may be function of (or at least influenced by) international requirements or recommendations in other jurisdictions in which these corporates operate.
•Term of Appointment
Tenure is often considered. Some corporates require that an independent director must not serve on board for period which could reasonably be perceived to interfere with the director’s ability to act in the best interests of the company. This follows corporate governance developments in Australia. There are notable exceptions – one issuer in particular adopting policy that director should not cease to be independent merely because of length of service on the board. The focus instead is on the closeness of the relationship to management and how that may compromise independence.
•Assessing Independence
In further assessing whether director is independent, many corporates have listed factors and relationships which require particular consideration. In addition to those factors and relationships which are required by the NZX Listing Rules to be considered (as deemed “Disqualifying Relationships” – see above), many issuers have incorporated the principles recommended by the Australian regulators for assessing director independence. For instance:
•Independence will be under question in circumstances where there is any relationship that could materially interfere with, or could be perceived to materially interfere with, the exercise of the director’s unfettered and independent judgement.
•Regard is given to whether or not the director has previously been engaged with the company. One issuer casts the net most widely and precisely in this respect. It notes that it will have regard to many circumstances under which the director (or, with some variation, an immediate family member of the director) has or may have derived financial benefit from that issuer in certain previous years. This prior benefit may include (for instance) direct compensation over certain threshold amounts from company in the issuer’s group of companies; affiliation with (or, if family member, employment in professional capacity by) the issuer’s current auditors; employment as an executive officer by company which has one of the issuer’s executives on its remuneration committee; or employment (or, if family member, employment as an executive officer) by another company that makes significant payments to, or receives significant payments from, the issuer.
•Relationships between the director and material professional advisers or consultants to the issuer, material customers or suppliers of the issuer, and substantial security holders (or an associate of substantial security holders) of the issuer also will be considered.
In practice, this has in some cases meant that directors who are associated with or represent material supplier to the issuer have not been regarded as independent (notwithstanding that the director may have no influence within the issuer in respect of the supplier), because of the perception of lack of independence. However, in other cases directors who have certain relationships with suppliers to the issuer, and have had no involvement with the actual supply of services to the issuer in recent years, have been regarded as independent. distinction could perhaps be drawn between persons involved with supplier in profit-sharing capacity (or who will otherwise effectively benefit for services supplied to the issuer, regardless of any involvement in the supply), and those who will not and who are not otherwise compromised by involvement in providing the service.
So, the early indications from our larger listed issuers suggest that there may be some limitations when it comes to picking your independent directors. Directors whose other firms or businesses provide services to the issuer will need careful consideration, particularly where those services represent significant arrangement – from either the issuer’s or the provider’s perspectiv