US Corporate Governance Requirements: Independent Directors and Audit Committee Composition

The SEC’s Division of Corporation Finance issued a flurry of Staff Legal Bulletins in late 2024 and early 2025, tightening the interpretive framework around director independence and audit committee composition for foreign private issuers (FPIs) listing on the NYSE and NASDAQ. For Hong Kong-headquartered companies—particularly those structured as Cayman Islands or Bermuda holding companies with PRC operating subsidiaries—the convergence of US exchange listing standards with the Hong Kong Stock Exchange’s own Listing Rules creates a compliance matrix that is materially more complex than either jurisdiction alone. A company that satisfies HKEX Rule 3.13’s independence criteria may still fail a NASDAQ independence assessment under Rule 5605(a)(2), especially when evaluating consulting fees paid to a director’s affiliated firm or the materiality thresholds for cross-border related-party transactions. With the SEC’s 2025 enforcement data showing 23 actions against FPIs for governance disclosure deficiencies—up from 14 in 2023—the cost of misclassification is no longer theoretical. This article maps the specific independent director and audit committee requirements for US-listed FPIs, cross-references them against HKEX equivalences, and provides a compliance framework for issuers navigating both regimes simultaneously.

The Three-Tier Independence Framework for FPIs

The independence determination for a director of a US-listed FPI is not a single test but a layered assessment involving exchange listing standards, SEC Rule 10A-3, and the issuer’s own disclosed governance standards. For Hong Kong companies, the analysis must also account for the HKEX’s own independence criteria under Listing Rules Chapter 3, which in some respects are more prescriptive than their US counterparts.

NASDAQ Rule 5605(a)(2) and the Objective Thresholds

NASDAQ’s independence standard under Rule 5605(a)(2) requires the board to affirmatively determine that a director has no material relationship with the listed company. The exchange provides a set of bright-line exclusions: a director is not independent if, within the past three years, they received more than USD 120,000 in direct compensation from the company, excluding board and committee fees and certain retirement benefits. This is a stricter numeric threshold than the HKEX’s equivalent under Rule 3.13(3), which disqualifies a director who received more than HKD 1,000,000 (approximately USD 128,000) in the preceding year. While the absolute figures are similar, the look-back period differs—three years for NASDAQ versus one year for HKEX—meaning a director who was a consultant in 2022 may be independent under HKEX rules but disqualified under NASDAQ rules through 2025.

The NYSE takes a less formulaic approach. Listed Company Manual Section 303A.02 requires the board to consider all relevant facts and circumstances, with no fixed compensation cap. The exchange’s guidance, however, notes that annual compensation exceeding USD 120,000 from the company will generally preclude independence, creating de facto convergence with the NASDAQ standard in practice.

The HKEX Cross-Reference Problem

A structural challenge for dual-listed companies or those considering a secondary US listing is that HKEX Rule 3.13 requires the board to assess independence against a checklist of 10 enumerated factors, including whether the director is a partner or employee of the company’s external auditor (factor 1), whether the director has a material interest in any group company (factor 4), and whether the director has been a director for more than nine years (factor 10). The nine-year tenure limit is unique to Hong Kong—neither NASDAQ nor NYSE imposes a fixed tenure-based disqualification. A director who has served for 10 years on the board of a Cayman-incorporated, Hong Kong-headquartered company would be deemed not independent for HKEX purposes under Rule 3.13(10), yet could still be classified as independent for NASDAQ purposes if no other material relationship exists. This discrepancy forces issuers to maintain separate independence determinations for each listing venue, a practice the SEC observed in its 2024 review of FPI filings as a common source of inadvertent disclosure error.

Audit Committee Composition Under Rule 10A-3

The audit committee is the most heavily regulated board committee under US federal securities law, with requirements that override exchange listing standards where they conflict. For FPIs, the interplay between SEC Rule 10A-3 and home-country exemptions creates both relief and traps.

The Three-Member Minimum and the Financial Expert Requirement

SEC Rule 10A-3(b)(1) requires that each listed issuer have an audit committee composed of at least three members, each of whom is independent under the definition in the rule. This is stricter than the HKEX’s requirement under Rule 3.21, which mandates a minimum of three members but allows one member to be a non-executive director who does not meet the independence criteria if the board determines it is not reasonably practicable to fill the seat with an independent director. No such carve-out exists under US federal law. For a Hong Kong company with a single non-independent audit committee member, a US listing would require either a board restructuring or reliance on the FPI exemption under Rule 10A-3(c)(3), which permits the issuer to follow home-country governance practices if it discloses the differences and explains why compliance with the US rule is not required.

The financial expert requirement under Sarbanes-Oxley Act Section 407 adds another layer. The audit committee must include at least one member who is an “audit committee financial expert” as defined by Item 407(d) of Regulation S-K. The SEC’s 2023 guidance clarified that the expert must have an understanding of generally accepted accounting principles and financial statements, the ability to assess the application of such principles, experience preparing or auditing financial statements, an understanding of internal controls, and an understanding of audit committee functions. For FPIs using IFRS as issued by the IASB, the SEC has confirmed that IFRS expertise satisfies the requirement. However, for a PRC-based company using PRC GAAP in its domestic reporting but IFRS for the US filing, the audit committee financial expert must demonstrate competence in both frameworks. The 2024 SEC enforcement action against a Cayman-incorporated, Shanghai-headquartered issuer for misrepresenting its audit committee chair’s IFRS experience—settled for USD 1.5 million—underscores the scrutiny applied to this disclosure.

The FPI Exemption and Its Limits

Rule 10A-3(c)(3) provides a blanket exemption for FPIs from the audit committee independence requirements, provided the issuer (i) discloses in its annual report the reasons it does not have an independent audit committee, and (ii) complies with home-country governance standards that require an audit committee. This exemption is widely used by Hong Kong companies listing on the NYSE or NASDAQ, but it has two critical limitations that issuers frequently overlook.

First, the exemption only applies to the independence requirements of Rule 10A-3(b)(1). It does not exempt the issuer from the requirement under Rule 10A-3(b)(2) that the audit committee have the authority to engage independent counsel and other advisors, nor from the requirement under Rule 10A-3(b)(4) that the issuer provide appropriate funding for the committee. Second, the exemption does not apply if the issuer is a “controlled company” as defined by the exchange—generally, a company where more than 50% of voting power is held by an individual, group, or another company. For a Hong Kong family-controlled enterprise listing via a SPAC merger, the controlled company exemption from exchange-level audit committee requirements under NASDAQ Rule 5615(c)(2) does not extend to Rule 10A-3. The issuer must still comply with the federal rule, even if it qualifies for the exchange-level controlled company carve-out.

The independence determination hinges critically on the materiality of relationships between directors and the company. For Hong Kong companies with complex group structures—often involving BVI intermediate holding companies, PRC operating subsidiaries under VIE arrangements, and Hong Kong listing vehicles—the related-party transaction analysis requires mapping relationships across multiple legal entities.

The USD 120,000 Bright Line and Its Gaps

Both NASDAQ and the NYSE use USD 120,000 as the threshold for direct compensation that presumptively disqualifies independence. The SEC’s 2025 Staff Legal Bulletin No. 14J clarified that this threshold applies to compensation from the listed issuer and its subsidiaries, but not from the issuer’s parent company or affiliates that are not consolidated subsidiaries. For a VIE-structured company, the PRC operating entity is typically a consolidated variable interest entity, not a subsidiary in the legal sense. The SEC staff took the position that compensation from the VIE is attributable to the listed issuer for independence purposes, because the VIE’s financial results are consolidated in the issuer’s financial statements. This means a director who serves on the board of the PRC VIE and receives compensation from that entity must count that compensation against the USD 120,000 threshold, even though the director has no contractual relationship with the Cayman-listed company.

The HKEX approach under Rule 3.13(3) is narrower, considering only compensation from the listed issuer and its subsidiaries, defined as entities in which the listed issuer holds a majority of voting power or control. For VIE structures, HKEX does not automatically treat the VIE as a subsidiary for independence purposes, because the listed issuer does not hold equity in the VIE. This creates a scenario where a director receiving RMB 500,000 annually from the PRC VIE would be independent under HKEX rules but not under NASDAQ or NYSE rules.

The HKEX Connected Transaction Regime as a Proxy

For Hong Kong companies that have already complied with HKEX’s connected transaction rules under Chapter 14A, the US independence analysis can leverage existing documentation but cannot rely on it exclusively. HKEX Rule 14A.07 defines a “connected person” broadly to include directors, chief executives, and substantial shareholders, as well as their associates. Transactions with connected persons exceeding certain de minimis thresholds—0.1% of the company’s market capitalization or HKD 1 million, whichever is higher—require shareholder approval and disclosure. The US framework under Item 404 of Regulation S-K requires disclosure of related-party transactions exceeding USD 120,000, but does not require shareholder approval. The materiality thresholds are different, and the definition of “related party” under US GAAP (ASC 850) is broader than HKEX’s “connected person” definition, encompassing any entity that controls, is controlled by, or is under common control with the issuer.

A practical consequence: a director who is a partner at a law firm that provides HKD 800,000 in legal services annually to the listed company would be a connected person under HKEX Rule 14A.07(4) if the firm is an “associate” of the director. The transaction would require disclosure under HKEX rules but may not require shareholder approval if it falls below the 0.1% threshold. Under US standards, the same transaction would trigger Item 404 disclosure if the director is an immediate family member of an executive officer or if the director’s firm is considered a related party. The audit committee must review the transaction under NASDAQ Rule 5630(b)(1), which requires all related-party transactions to be reviewed and approved by the audit committee or another independent body. The HKEX’s exemption for transactions on normal commercial terms does not apply in the US context.

Disclosure Obligations and the Annual Report Reconciliation

The annual report on Form 20-F is the primary disclosure vehicle for FPIs, and the governance section requires a detailed reconciliation between US standards and home-country practices.

Item 16G and the Significant Differences Disclosure

Form 20-F Item 16G requires the FPI to disclose the significant differences between its corporate governance practices and those required by US exchange listing standards. For a Hong Kong company listed on NASDAQ, this disclosure must identify each specific NYSE or NASDAQ requirement that differs from the issuer’s home-country practice, and describe the home-country practice in detail. The SEC’s 2024 review of 50 FPI filings found that 34% of issuers provided generic disclosures that did not identify specific differences, and 12% failed to mention the audit committee independence requirements at all.

The most common omission relates to the requirement under NASDAQ Rule 5605(c)(2) that independent directors hold regularly scheduled executive sessions without management. HKEX does not explicitly require such sessions, although HKEX Corporate Governance Code provision C.2.7 recommends that the board chairman hold meetings with the non-executive directors without the presence of executive directors at least annually. The difference between a mandatory requirement and a recommended code provision must be disclosed as a significant difference. A 2025 SEC comment letter to a Hong Kong biotech issuer specifically requested that the issuer explain why its compliance with HKEX’s code provision was not equivalent to NASDAQ’s mandatory requirement, and whether the issuer’s practice of holding executive sessions only semi-annually rather than quarterly constituted a material difference.

The Audit Committee Charter Requirement

Under NASDAQ Rule 5605(c)(1) and NYSE Section 303A.07, the audit committee must have a formal written charter that addresses the committee’s purpose, duties, and annual performance evaluation. The charter must specifically state that the audit committee is responsible for the appointment, compensation, retention, and oversight of the independent auditor. HKEX Rule 3.22 requires the audit committee to have written terms of reference that include the committee’s duties and powers, but does not explicitly require the terms of reference to address auditor compensation or retention. For a dual-listed company, the terms of reference must satisfy the stricter US standard. The HKEX’s 2023 consultation paper on corporate governance reform proposed aligning the terms of reference requirements with international standards, but as of May 2025, the amendments have not been enacted. Issuers should therefore adopt terms of reference that meet both HKEX Rule 3.22 and NASDAQ Rule 5605(c)(1) simultaneously, rather than maintaining separate documents.

Actionable Takeaways for Issuers and Advisors

Conduct a director-by-director independence assessment under NASDAQ Rule 5605(a)(2) and NYSE Section 303A.02 using the USD 120,000 three-year look-back, and reconcile the results against HKEX Rule 3.13’s 10-factor checklist, documenting any discrepancies in the board minutes.
Restructure the audit committee to include three independent members who satisfy both SEC Rule 10A-3(b)(1) and HKEX Rule 3.21, and ensure at least one member holds demonstrable IFRS expertise if the issuer uses IFRS in its US filings.
Map all compensation flows from consolidated VIEs and PRC operating subsidiaries to directors, counting such compensation against the USD 120,000 threshold for US independence purposes, even if the director has no contractual relationship with the Cayman-listed entity.
Disclose in the Form 20-F Item 16G reconciliation every specific difference between HKEX and NASDAQ governance requirements, including the absence of a mandatory independent director executive session requirement under HKEX rules, and explain the issuer’s actual practice in detail.
Adopt a single set of audit committee terms of reference that satisfies both HKEX Rule 3.22 and NASDAQ Rule 5605(c)(1), explicitly addressing auditor appointment, compensation, retention, and oversight, and include a provision for annual performance evaluation.