On February 14, NVCA offered comments to the Securities and Exchange Commission (SEC) on the most appropriate criteria for determining an audit committee director's independence from management under a new proposed rule mandated by the Sarbanes-Oxley Act.

Our recommendation, in sum, is that the SEC should base "independence" not just on a level of share ownership that indicates "control" under conventional "affiliate" analysis. Rather, it should either strike the right balance between the proven benefit of large shareholders as directors and the risk that a large shareholder will abuse its voting power, or allow the exchanges to determine this balance.

NVCA believes that, under the typical structure of a venture capital fund, a representative of that fund on the audit committee presents no material risk of abuse of control and, indeed, brings significant benefit to the company and its shareholders. We believe that a full review of the issues will lead the SEC to conclude that a representative of a venture capital fund is generally the type of financially savvy, independent board member that the Sarbanes-Oxley Act and the SEC seek. Accordingly, NVCA urges the SEC to adopt an interpretation of the terms "affiliate" and "control" that reflects the structure under which venture capital funds own large share positions following an IPO, and that takes into account the independent nature of directors who represent large fund shareholdings (e.g., a VCF director's fiduciary obligations to the venture capital fund it represents). NVCA believes that this can be achieved through the proposed rule's "facts and circumstances" approach in a way that weighs the risk of abuse of control against the benefits that large shareholders provide the investor interests in corporate performance.

Importantly, in its comments letter the NASDAQ argued, "the proposed safe harbor definition of 'affiliated person' should be changed to a bright-line test of 20% ownership or control. Such a threshold would cap the influence of very large shareholders, while allowing shareholders, such as venture capitalists, owning less than 20% of an issuer's securities to serve on the audit committees to the benefit of all investors." (link to NASDAQ Comment Letter)