Design Board Independence Standard

---
name: design-board-independence-standard
description: Use when composing or evaluating a public or pre-IPO company's board of directors — determining what fraction of the board must be independent directors, applying the specific criteria that disqualify a director from independent status, and structuring the independence-review process, rather than treating board composition as a purely informal or founder-controlled decision.
source: NYSE Listed Company Manual Section 303A; Nasdaq Listing Rule 5605; OECD Principles of Corporate Governance (2023 edition)
tags: [law, corporate, board-independence, corporate-governance, listing-standards, director-qualification]
related: [design-corporate-governance-structure, design-audit-committee-charter, audit-board-effectiveness]
---

# Design Board Independence Standard

Determine what fraction of a company's board must be independent directors, apply the specific criteria that disqualify a director from independent status, and structure the independence-review process — rather than treating board composition as a purely informal or founder-controlled decision.

## Why This Is Best Practice

**Adopted by:** The NYSE Listed Company Manual (Section 303A) and Nasdaq Listing Rule 5605 both require listed companies to maintain a majority-independent board and disclose the specific basis for each independence determination, and the OECD Principles of Corporate Governance recommend a sufficient number of independent, non-executive board members as a core governance standard adopted across G20 jurisdictions.
**Impact:** Boards lacking a genuine independent majority are documented to exhibit weaker oversight of executive compensation, related-party transactions, and financial reporting — precisely the failures independent directors are structurally positioned to catch, since they lack the financial or personal ties to management that could otherwise compromise objective judgment on these matters.
**Why best:** A board composed primarily of directors with financial ties to the company or personal relationships with management can still function, but it structurally lacks the objective check independent directors are specifically designed to provide — a majority-independent board with clearly applied, disclosed independence criteria is what separates governance oversight from management self-review.

Sources: NYSE Listed Company Manual, Section 303A (Corporate Governance Standards); Nasdaq Listing Rule 5605 (Board Independence); OECD Principles of Corporate Governance (2023)

## Steps

### Step 1: Determine the required independence threshold

Determine the minimum fraction of the board that must be independent under the applicable listing standard — a majority of the full board under both NYSE and Nasdaq standards — and confirm whether any transition period or controlled-company exemption applies (e.g., a company where a single shareholder or group holds more than 50% of voting power may qualify for reduced independence requirements).

### Step 2: Apply the specific independence disqualification criteria

Evaluate each director candidate against the specific criteria that disqualify independent status — a material business relationship with the company (as an executive, consultant, or significant customer/supplier) within the look-back period, family relationships with executive officers, or compensation from the company beyond director fees — rather than relying on a general sense of the director's objectivity.

### Step 3: Document the basis for each independence determination

Document, in writing, the specific basis for determining each independent director's independence — the absence of each disqualifying relationship — since both NYSE and Nasdaq require disclosure of this determination, and an undocumented determination cannot be verified or defended if later challenged.

### Step 4: Structure the independence-review process to recur, not just occur at appointment

Establish a recurring (at least annual) review process re-confirming each independent director's continued independence, since relationships that didn't exist at appointment (a new consulting arrangement, a new family connection to a new executive hire) can develop over a director's tenure and change their independence status.

### Step 5: Escalate any independence gap below the required threshold

If the board's independent fraction falls below the required threshold — due to a departure, an acquisition bringing in new insider directors, or a relationship change — treat this as requiring prompt remediation (recruiting an additional independent director) rather than an acceptable temporary state, consistent with listing-standard cure periods.

## Rules

- Apply the specific listing-standard disqualification criteria to each director, not a general subjective sense of objectivity.
- Document the basis for each independence determination in writing — an undocumented determination isn't verifiable or defensible.
- Re-confirm independence at least annually, not only at initial appointment — relationships can change over a director's tenure.
- Treat a fall below the required independent-majority threshold as requiring prompt remediation, not an acceptable ongoing state.

## Examples

**Independence review catching a developing conflict:** An annual independence re-review reveals that a previously independent director has, over the past year, begun a paid consulting relationship with the company's largest customer — a relationship not present at the director's original appointment. The board reclassifies the director as non-independent and confirms the remaining independent directors still satisfy the majority threshold.

**Documented, disclosed independence determination:** A company's board documents, for each independent director, the specific absence of disqualifying relationships (no employment, no material business relationship, no disqualifying family ties) as part of its annual proxy disclosure — providing a clear, defensible record rather than an assumed or informal determination.

## Common Mistakes

- **Relying on a general sense of director objectivity rather than the specific listing-standard criteria** — independence determinations must be evaluated against defined, disclosed criteria, not subjective impression.
- **Determining independence once at appointment and never re-confirming it** — relationships that develop during a director's tenure can compromise independence that existed at appointment.
- **Leaving independence determinations undocumented** — an undocumented determination cannot be verified or defended if later challenged by regulators or shareholders.
- **Treating a temporary fall below the independent-majority threshold as acceptable** — listing standards provide cure periods specifically because this gap is expected to be remediated promptly, not tolerated indefinitely.

## When NOT to Use

- For a "controlled company" under NYSE/Nasdaq rules (a single shareholder or group holds more than 50% of voting power) — controlled companies qualify for reduced independence requirements, and applying the full standard may be unnecessary, though many still choose to for governance credibility.
- For a private company with no current plans to list on a public exchange — listing-standard independence requirements don't apply, though the underlying principle (avoiding board capture by management-tied directors) may still be worth adopting voluntarily.
- As a substitute for assessing a director's actual expertise and engagement — independence addresses a specific conflict-of-interest risk, not the separate question of whether a director brings genuinely valuable expertise to board deliberations.

> **Legal disclaimer:** This skill encodes professional best practices for educational purposes. It is not legal advice. Board composition and independence determinations carry securities-law and listing-standard implications that vary by exchange and jurisdiction — consult licensed securities counsel before finalizing board composition decisions.