A director counts as independent under US stock exchange rules only if two things are true. First, the person must clear a set of fixed “bright-line” tests, most of which look back three years at employment, pay, business dealings and family ties. Second, the board must decide that the director has no other relationship that would get in the way of independent judgment. Passing the numbers is necessary but is not enough on its own.
This page walks through the main criteria used by the New York Stock Exchange (NYSE) and Nasdaq, the extra standard for audit committees and how the two exchanges differ. It is general information. The exchanges publish the authoritative text and revise it, so check the current rulebook before relying on any detail.
Why exchanges define independence
Independent directors are meant to give shareholders a check on management. The page on what independent directors do covers the role itself. The exchange rules answer a narrower question: who is allowed to be called independent, and how a company proves it.
Both exchanges require listed companies to have a majority of independent directors on the board, and both require key committees, such as the audit committee, to be made up of independent members. The NYSE section that sets the test is 303A.02; Nasdaq’s is Rule 5605(a)(2).
Step one: the board’s own determination
Under the NYSE rule, no director qualifies as independent unless the board affirmatively determines that the director has no material relationship with the company, either directly or as a partner, shareholder or officer of an organization that has a relationship with it. Nasdaq’s rule likewise defines an independent director as someone who is not an executive officer or employee and has no relationship that the board believes would interfere with the exercise of independent judgment.
In practice this means a board needs a documented review. A director who trips none of the bright-line tests can still be found not independent if the facts suggest a conflict.
Step two: the bright-line tests
The tests below are summarized from the exchange rules and from law firm and regulatory summaries. Dollar figures and details have been amended before, so treat the table as a map and not as a legal checklist.
| Relationship | NYSE | Nasdaq |
|---|---|---|
| Employed by the company | Not independent until three years after the employment ends | Not independent if employed now or within the past three years |
| Family member is an executive officer | Same three-year look-back | Same three-year look-back |
| Pay from the company | More than $120,000 in direct compensation in any 12-month period, with a three-year look-back; director and committee fees and certain pension payments excluded | More than $120,000 in any 12 consecutive months within the past three years; board fees and certain other payments excluded |
| Business dealings | Payments with a company where the director is an employee or executive that exceed the greater of $1 million or 2% of that company’s gross revenues | Payments with an organization where the director is a partner, controlling shareholder or executive officer that exceed the greater of 5% of the recipient’s revenues or $200,000 |
| Auditor ties | Disqualifying if the director, or a family member, was a partner or employee of the auditor and worked on the company’s audit within three years | Disqualifying for a current partner of the auditor, or a past partner or employee who worked on the audit within three years |
| Compensation committee interlock | Disqualifying if the director or a family member was an executive officer elsewhere while a company executive sat on that firm’s compensation committee | Similar interlock test with a three-year look-back |
The NYSE business-dealings figures come from summaries of the NYSE rule used in public filings, so confirm them in the current manual.
What the tests are looking for
Each test targets a way that money or loyalty could tie a director to management. Employment and family ties suggest loyalty to insiders. Large payments, whether as pay or as business with the director’s own firm, suggest financial dependence. Auditor ties raise the question of who is really checking the numbers. Interlocks catch the case where two executives set each other’s pay.
Audit committee: a stricter layer
The audit committee faces an additional federal standard. Rule 10A-3 under the Securities Exchange Act, which both exchanges incorporate into their listing requirements, says that audit committee members may not accept, directly or indirectly, any consulting, advisory or other compensatory fee from the company or its subsidiaries, apart from board and committee pay. They also may not be an affiliated person of the company or a subsidiary. The text is available on Cornell’s Legal Information Institute.
So an audit committee member must meet the exchange’s general independence test and the federal one. A consultant who passes the dollar test under the exchange rule can still fail the audit committee rule, because the federal rule bars the fee whatever its size.
Where the exchanges differ
Reading the table above, three differences stand out. The business-dealings test uses different thresholds and measures revenue differently: the NYSE looks at the other company’s gross revenues and Nasdaq at the recipient’s. The NYSE works with “until three years after” wording while Nasdaq phrases the same idea as a look-back from the date of determination. And each exchange has its own definition of which relatives count as family. A company follows the rules of the exchange where it is listed.
What boards do in practice
Boards usually collect information through annual questionnaires from each director, review business dealings against the thresholds and record their conclusions in the proxy statement. They also revisit the decision when circumstances change, such as a director joining another company’s board or a family member taking a new job.
The advisory portfolio page lists the board and advisory topics described on this site, and the article on how airlines earn money beyond the ticket shows the kind of commercial dealings that a board has to weigh in a related industry.
Frequently asked questions
Can a former employee become an independent director?
Yes, but only after the look-back period has passed. Both exchanges use three years for employment. The NYSE, for example, does not disqualify a director for having served as an interim chairman or chief executive.
Does owning shares make a director non-independent?
Not by itself. Share ownership is one of the facts a board weighs, but the bright-line tests listed above do not disqualify a director only for holding stock.
Who decides whether a director is independent?
The board does. The exchange rules set the minimum tests, and the board makes the final determination and discloses it, normally in the annual proxy statement.
Do these rules apply to private companies?
No. They are listing requirements for companies on the NYSE or Nasdaq. Other organizations may adopt similar standards voluntarily.