Corporate Disclosure and the Role of Outside Directors: SEC v. Krantz (Stock Exchanges and the Definition of Independent Director) (Part 2)

We have noted often on this Blog that the definition of "independent" director used by the various stock exchanges is not robust enough to capture all of the relationships that can impair independence.  The definitions do not, for example, speak to friendship.  The problems with the definition are apparent from this case.

The issue of director independence came up in SEC v. Krantz.  The SEC asserted in the Complaint (the case has not settled or been tried, so these are only allegations) that the outside directors at DHB lacked sufficient "impartiality" to serve as independent directors on the audit committee.  As the complaint described:

• They were [the CEO's] longtime friends and neighbors, with personal relationships with [the CEO] that spanned decades. [A director] lived close to [the CEO], and he and his family went out to dinner with [the CEO] and the [the CEO's] family two or three times a month.  A director and his family had a social relationship with [the CEO] and the [the CEO's] family, and regularly attended [the CEO's] family social functions. [A director] had a relationship with [the CEO] starting in 1998 or 1999, and was [the CEO's] insurance agent before [the CEO] asked him to join [Company's] board.

In addition, the outside directors allegedly had various business dealings with the Company and/or the CEO. 

Yet the Company's proxy statement in 2004 represented that these directors met the applicable standard for independence.  See DHB Proxy Statement filed in 2005 states ("In 2004, each of these Committees was comprised of three directors, [the three outside directors], who are not officers of DHB and who are all independent directors as defined under Section 121(A) of the listing standards of the American Stock Exchange and under Rule 10A-3 under the Securities Exchange Act of 1934, as amended.").

There are two ways to interpret the characterization in the 2004 proxy statement.  First, the characterization was wrong and the directors were not independent under the stock exchange rule.  Second, the directors were in fact independent under the stock exchange rules.  In the former case, the problem is one of enforcement.  In the latter case, the problem is the stock exchange definition.   Either way, its suggests issues with director independence at the exchange level. 

For more detail, see the Litigation Release in SEC v. Krantz, Litigation Release No. 21867 (SD Fla Feb. 28, 2011) as well as the Complaint.