GovernanceMetrics International

Classifying board members as executive or non-executive is usually straightforward. But just because someone is a non-executive director does not automatically mean he or she is free of other relationships with the company that might cloud his or her independence. As a result, classifying board members as independent or non-independent requires careful scrutiny.

GMI has reviewed independent director standards from a number of domestic and international regulatory and self-regulatory organizations, shareholder groups and corporations to develop our own guidelines. Stated most simply, an independent director is someone whose only connection to the company is his or her board seat. GMI uses the following guidelines to assess whether there are any relationships or significant transactions involving board members that might undermine their independence from company management. GMI analysts apply these guidelines to the full board and to members of the Audit, Compensation and Governance / Nominating committees.

A director will generally not be classified as independent by GMI if any of the following apply:

Company employee within the last five years. However, unless other criteria apply, we exclude interim CEOs (e.g., someone who stepped in as a result of a crisis) who were independent directors prior to becoming CEO and whose tenure was less than one year.
Ten percent (or greater) shareholders or shareholder groups or employees or other affiliates of such ten percent shareholders or shareholder groups who have business relationships with the company, are engaged in related-party transactions, or are represented within senior management, will be considered non-independent. Ten percent (or greater) shareholders or shareholder groups whose only interest in the company is as a financial investment will be considered independent, unless other criteria apply.
An employee or director of a subsidiary or an affiliated business in which the company controls at least 10 percent of the voting power. However, we exclude directors of holding companies who also serve as non-executive directors of wholly owned subsidiaries. Unless other criteria apply, these individuals will be classified as independent.
Within the last five years has been an employee of a predecessor company that represented more than 50 percent of the company's sales or assets when it became part of the company or an employee of a business acquired by the company.
Anyone providing personal/professional services to the company or to a member of the company's senior management for a fee of at least $120,000 per year.
Within the last three years has been an owner, partner, employee or paid adviser to a professional services firm (e.g., law firm, accounting firm, insurer, underwriting firm, commercial bank, information technology consultant, management consultant) that has provided services of at least $120,000 per year to the company or to a member of the company's senior management.
Owner, partner, employee, paid adviser or director of a firm that within the preceding or current fiscal year has sold goods or services to the corporation for a fee representing more than one percent of the sales of the supplier or the corporation. GMI will also look carefully at directors who are owner, partner, employee, director or paid adviser to a firm that purchases goods or services from the corporation, but these relationships are generally less of a concern than the former category.
Within the last three years has been an employee of a company at which an employee of the company in question also serves as a director ("interlocked directors").
Company founder(s), regardless of their current employment status with the company, current share ownership, and/or current economic interest in the company.
Within the last five years, has been an employee or other representative of a former parent company following a spin-off or divestment, regardless of the parent's current interest.
A director who is nominated by an entity whose voting interest in the company exceeds 5% or is represented within management. Directors nominated by 5% (or greater) shareholders or shareholder groups whose only interest in the company is as a financial investment will be considered independent, unless other criteria apply. Directors nominated or elected by a separate class of stock are considered non-independent when a majority of that class of stock is controlled by a person, entity, or group.
A non-executive chairman whose annual cash compensation is equal to or greater than 50% of the total cash compensation (salary plus bonus) of any of the named executive officers or is more than five times that of other non-executive directors (whichever is greater).
A director who is an employee of a company owned or run by a non-independent director or a member of management.
A relative of any individual described above.

GMI will look carefully at directors who are employees, directors or trustees (as opposed to general members) of a non-profit organization to which the company made charitable contributions of $100,000 or more in the last fiscal or calendar year. Depending on the situation, these individuals may be classified as independent or non-independent. E.g., a full-time professor who heads a university department where the company has made material contributions would be classified as non-independent.

Regarding directors who are nominated by a shareholder whose voting interest in the company exceeds 5%, GMI will look carefully at situations in which an agreement (or other understanding) exists between the director(s) and the company or management that has the potential to compromise the director's independence. For example, a director who is guaranteed a seat on the board for a number of years pursuant to an agreement or other understanding with the company could be classified as non-independent when looking at the overall nature of the agreement.

We also look carefully at situations not explicitly covered by the guidelines above and will use our best judgment to determine if a director's relationship with the company warrants being classified as non-independent.

If a company does not disclose sufficient information regarding its directors to properly judge independence (e.g. by not disclosing director biographies), GMI will rate such directors as non-independent due to insufficient disclosure.