Out of Sight, Out of Mind: The Case for Improving Director Independence Disclosure.

• Author: Nili, Yaron

1. INTRODUCTION II. DIRECTOR INDEPENDENCE--WHAT'S AT STAKE A. The Board of Directors' Role in the Governance of the Corporation B. The Move Towards Independent Boards III.THE CURRENT REGULATORY FRAMEWORK A. State Law B. Stock Exchange Listing Rules 1. The Sarbanes-Oxley Act 2. Dodd-Frank and the Expansion of Director Independence 3. The Definition of an Independent Director IV. THE EMPTY NATURE OF THE CURRENT DIRECTOR INDEPENDENCE FRAMEWORK A. Too Much: Companies Have Too Much Discretion 1. A Hand in the Cookie Jar? 2. Behavioral Bias a. Social Ties & Structural Bias b. Groupthink, Confirmation Bias, Social Conformity & Status Quo Bias 3. Director Tenure 4. The Result: Companies Blur the Lines B. Too Little: Information is Lacking 1. Current Disclosure Requirements are Too Narrow and Lack Important Context 2. In Light of the General Emphasis on Disclosure--Director Independence Has Fallen Behind C. Too Late: Director Independence is Indeed a Context Based Issue but it is Not Enough to Address It Ex-Post D. Too Soft: Lack of Effective Enforcement V. DIRECTOR INDEPENDENCE DISCLOSURES--EMPIRICAL SURVEY A. Lack of Transparency B. Companies Providing Useful Information Are the Minority C. Companies That Have Regressed VI. FIXING DIRECTOR INDEPENDENCE A. Augmenting the Current Designation System with Stronger Disclosures B. Independent Verification of Director Independence Determinations C. Adjusting the "Bright-Line" Rules and Disclosure Requirements D. Potential Objections 1. Unnecessarily Deterring Investors 2. Over-inclusiveness 3. Chilling Effect? 4. Questionable "Independent Directors" Will Persist 5. Increased Costs VII. CONCLUSION I. INTRODUCTION

   In July 2016, a coalition of 13 CEOs and heads of major investment firms--which included names like J.P. Morgan Chase CEO Jamie Dimon, Berkshire Hathaway CEO Warren Buffett, General Motors CEO Mary Barra, and BlackRock CEO Larry Fink, released the Commonsense Principles of Corporate Governance. (1) These principles emphasize the critical role of director independence in corporate America, stating that: "[t]ruly independent corporate boards are vital to effective governance, so no board should be beholden to the CEO or management" (2) and that "[directors should be strong and steadfast, independent of mind and willing to challenge [management] constructively...." (3) Indeed, this recent statement echoes the importance and emphasis that academics, investors, regulators, and companies alike, have placed on director independence.

   Two months later, on September 7, 2016, Apple and Nike announced a new collaboration with one another regarding the Apple Watch. Within their announcement, the companies declared their new Apple Watch Nike+ to be "the latest result of a long-standing partnership" between the world-renowned brands. (4) Significantly, the announced initiative came on the heels of Nike appointing Mr. Tim Cook, Apple's CEO, as Nike's lead independent director. (5) Despite the new collaboration and its clear potential to impair Mr. Cook's ability to remain truly "independent," the companies did not refer to any potential conflicts of interest or to Mr. Cook's status as lead independent director within their press release. (6)

   Mr. Cook's ability to continue serving as a lead independent director (7)--the most powerful independent director role on the board--despite Apple's business dealings with Nike, and without proper disclosure to shareholders, is not an outlier. It is one of many instances in which the ability of "independent directors" to act independently could be questioned, due to business, personal, or other ties with the companies, and the executives of the companies, in which they serve. These concerns are particularly heightened due to the lack of effective disclosure by companies to their investors regarding these connections and the potential impact they may have on the independence of these directors.

   Apple itself has similarly straddled the line regarding the independence of its "independent" directors. Bob Iger, Disney's CEO, is one of Apple's five independent directors. This is despite the close and frequent business collaboration that Disney and Apple have with one another. Their collaboration dates back to 2006 when Steve Jobs, while serving as CEO for Apple and Pixar, sold Pixar to Disney for $7.4 billion. (8) More recently, the companies negotiated a potential collaboration for a video streaming service produced by Apple. (9) Despite these frequent interactions with one another, Apple does nothing more than disclose that "in the ordinary course of its business, Apple enters into commercial dealings with Disney that it considers arms-length." (10) In regards to Mr. Iger's independence, Apple has stated that it "does not believe that Mr. Iger has a material direct or indirect interest in any of such commercial dealings." (11)

   Indeed, in the current regulatory regime, public companies' boards self-designate their peer directors as "independent directors," and boards are only required to disclose very specific and very limited information regarding their designation of a director as an "independent director"--leaving shareholders with minimal knowledge regarding the true level of independence their elected directors actually have.

   Apple's short statement concerning Mr. Iger's independence is indicative of a larger practice taken by public firms. Many public companies can, and do, satisfy their stock exchange's disclosure requirements by simply declaring that "the Board of Directors has determined that all non-employee Directors who served during [the fiscal year] are 'independent' under the listing standards of the NYSE." (12) Investors receive very little value from these unsubstantiated statements.

   Giving self-interested boards the final say regarding their own independence, and the lack of full transparency regarding the designation of a director as independent, is particularly concerning considering two important trends. First, in recent years, effective disclosure has taken on an increasingly pivotal role in corporate law. The SEC has attempted to increase transparency for investors in many regulated areas and topics. Executive compensation, option grants, financial disclosures, and most recently share ownership and pay ratio have all seen continuous effort for effective disclosure. Reflective of that important role, in April 2016 the SEC chair stated that "[t]he SEC's disclosure regime is central to our mission to protect investors and the integrity of our capital markets ... [g]ood disclosure benefits everyone--investors, companies, and the markets generally. And everyone has a strong interest in it." (13)

   Second, the concept of director independence has also taken an increasingly central role in contemporary corporate America. Over the last few decades, the composition of U.S. public firms' boards of directors has seen a significant shift. (14) Boardrooms controlled by company executives have been replaced with boardrooms that are "independent," which in many cases consist of the CEO as the lone executive in the room. (15)

   This ongoing shift, which has been aimed at ensuring that shareholders' interests in the corporation are properly represented and protected, has accelerated during the last decade. (16) Academic discourse, the trend towards the shareholder franchise approach, and corporate scandals that brought about regulatory reforms have all led to this push toward more, so-called, independent boards. (17)

   If the purpose of independent boards is to ensure that directors are objective and free of conflicts that can impair their judgment when serving as monitors of management, then the definition and rules governing director independence must be properly crafted to achieve such goal. The example of Nike's designation of Tim Cook as lead independent director calls into question the efficacy of the current regulatory framework and whether all of the directors that companies designate as "independent" are in fact free of the conflicts that could cloud their ability to effectively and objectively serve as independent monitors of management. Moreover, it calls into question the ability of any definition of director independence that is not accompanied with a broad disclosure regime to successfully screen for all of the potential conflicts that might impede the independence of directors. This is particularly true in contemporary corporate America, where businesses and people are closely interconnected, often for the benefit of their shareholders.

   This Article contends that this potentially problematic result stems from the intersection of (1) deficiencies in the definitions of director independence that govern publicly traded corporations; (2) lack of effective enforcement of these independence standards by regulators; and (3) lack of sufficient and meaningful disclosures by companies to their shareholders regarding their directors and the designations they made regarding their independence.

   First, with respect to defining independence, Delaware law, federal regulations, and stock exchange rules have all tackled the issue of director independence with great variance. Delaware law, for instance, has treated the issue of independence as a factual issue to be determined on a case-by-case basis, after a challenge to the designation of independence has been made, examining "whether the director's decision is based on the corporate merits of the subject before the board, rather than extraneous considerations or influences." (18) The stock exchange rules following SOX and Dodd-Frank are widely perceived as "bright-line" rules. (19) They contain specific pre-requisites for independence--explicitly prohibiting some directors from being considered independent directors if they were employees of the company, received compensation that is not a director fee over a certain threshold, had ties to the company's auditor, or had business or...