NASDAQ Listing Rule 5605 plays a central role in ensuring strong corporate governance among companies listed on the NASDAQ Stock Market. One of its key provisions is the definition of “independence” for directors—a critical standard that promotes accountability, investor trust, and the integrity of corporate boards.
This article explores the meaning, criteria, and implications of director independence under NASDAQ Rule 5605, particularly as it relates to independent directors serving on boards and key committees such as audit, compensation, and nominating/governance.
What Is NASDAQ Rule 5605?
Rule 5605 outlines the corporate governance requirements applicable to NASDAQ-listed companies. It mandates that listed companies maintain a board of directors with a majority of independent directors, and that key board committees—audit, compensation, and nominating/governance—be composed entirely of independent directors (with limited exceptions for controlled companies or certain smaller reporting issuers).
Definition of “Independent Director”
Under NASDAQ Rule 5605(a)(2), an “independent director” is a person who:
“Is not an executive officer or employee of the company and does not have a relationship which, in the opinion of the board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.”
This definition is both principles-based and rule-based, giving the board some discretion while also requiring compliance with specific disqualifying conditions.
Objective Criteria That Preclude Independence
A director cannot be considered independent if any of the following applies:
- Employment Relationship
- The director is, or has been within the last three years, an employee of the company or one of its subsidiaries.
- Immediate family members of the director are, or have been within the last three years, an executive officer of the company.
- The director is, or has been within the last three years, an employee of the company or one of its subsidiaries.
- Compensation
- The director, or an immediate family member, has received more than $120,000 in direct compensation from the company (other than director fees or pension benefits) in any 12-month period in the last three years.
- The director, or an immediate family member, has received more than $120,000 in direct compensation from the company (other than director fees or pension benefits) in any 12-month period in the last three years.
- Audit Firm Affiliation
- The director is, or was within the last three years, affiliated with or employed by a company’s independent auditor, or has an immediate family member who was a partner or employee in such a firm and worked on the company’s audit.
- The director is, or was within the last three years, affiliated with or employed by a company’s independent auditor, or has an immediate family member who was a partner or employee in such a firm and worked on the company’s audit.
- Interlocking Directorships
- The director, or a family member, is or was within the last three years an executive officer of another company where any of the NASDAQ company’s executive officers served on that company’s compensation committee.
- The director, or a family member, is or was within the last three years an executive officer of another company where any of the NASDAQ company’s executive officers served on that company’s compensation committee.
- Business Relationships
- The director is a partner, controlling shareholder, or executive of a company that has made or received payments from the listed company exceeding 5% of the recipient’s gross revenues or $200,000 (whichever is greater) in the last year.
- The director is a partner, controlling shareholder, or executive of a company that has made or received payments from the listed company exceeding 5% of the recipient’s gross revenues or $200,000 (whichever is greater) in the last year.
Role of the Board in Determining Independence
Beyond the objective rules, the company’s board must make a subjective determination that the director has no material relationship—either directly or as a partner, shareholder, or officer of an organization—that would interfere with their ability to exercise independent judgment.
This gives boards some flexibility but also places the onus on them to disclose these determinations clearly in proxy statements or other SEC filings.
Committee-Specific Requirements
1. Audit Committee (Rule 5605(c))
- Members must meet stricter standards under Rule 10A-3 of the Securities Exchange Act of 1934, which bars any compensatory relationships beyond director fees and prohibits affiliated persons.
2. Compensation Committee (Rule 5605(d))
- Members must be independent under NASDAQ’s definition and must also consider factors such as affiliations and consulting relationships.
3. Nominating Committee (Rule 5605(e))
- Must be composed entirely of independent directors unless the company chooses to have independent directors select nominees directly.
Exceptions and Exemptions
Certain companies may qualify for exemptions or phase-ins, including:
- Controlled companies (where more than 50% of voting power is held by one entity or individual).
- Foreign private issuers, which may follow home country practices if properly disclosed.
- Smaller reporting companies, which have modified governance standards.
Why Independence Matters
Director independence helps ensure that decisions—particularly regarding oversight, financial reporting, and executive compensation—are made with objectivity and without undue influence from management. This contributes to:
- Enhanced investor confidence
- Better risk oversight
- Stronger ethical and fiduciary practices
Conclusion
NASDAQ Rule 5605 establishes rigorous but essential standards for director independence to promote transparent, effective, and ethical corporate governance. Companies must evaluate both the letter and the spirit of the rule when assessing their board composition and committee memberships.
By adhering to these independence standards, NASDAQ-listed companies signal to investors that they are committed to accountability, regulatory compliance, and long-term shareholder value.
For more information about Nasdaq Listing Requirements or to speak with a Securities Attorney assisting with your listing, please contact Brenda Hamilton at 200 E Palmetto Rd, Suite 103, Boca Raton, Florida, (561) 416-8956, or by email at info@securitieslawyer101.com.
Hamilton & Associates | Securities Attorneys
Brenda Hamilton, Securities Attorney
200 E Palmetto Rd, Suite 103
Boca Raton, Florida 33432
Telephone: (561) 416-8956
Facsimile: (561) 416-2855
www.SecuritiesLawyer101.com
