Golden leashes
Photo by Don Urban

The compensation disclosure rules contained in Regulation S-K are intended to provide meaningful disclosure regarding an issuer’s executive and director compensation practices such that the investing public is provided with full and fair disclosure of material information on which to base informed investment and voting decisions. However, as we pointed out in a blog from last year, not all compensation is covered by these rules, including compensation paid to directors by third parties (e.g., by a private fund or activist investors). These arrangements are commonly known as “golden leashes.”  The two examples I discussed previously related to proxy fights involving Hess Corporation and Agrium, Inc. In each case, hedge funds had proposed to pay bonuses to the director nominees if they were ultimately elected to the board of directors in their respective proxy contests. Additionally, in the Agrium, Inc. case, the director nominees would have received 2.6% of the hedge fund’s net profit based on the increase in the issuer’s stock price from a prior measurement date. The amounts at issue could have been significant considering this particular hedge fund’s investment in Agrium, Inc. exceeded $1 billion, but none of the nominees were ultimately elected to the Agrium, Inc. board.

Considering the large personal gains these director nominees could potentially realize under these types of arrangements, it could pose a problem from a corporate governance standpoint as it is a long-standing principal of corporate law that directors are not permitted to use their position of trust and confidence to further their private interests. Recognizing this potential problem, the Council of Institutional Investors (“CII”), a nonprofit association of pension funds, other employee benefit funds, endowments and foundations with combined assets that exceed $3 trillion, recently wrote the SEC asking for a review of existing proxy rules “for ways to ensure complete information is provided to investors about such arrangements.”

In its letter, the CII points out that existing disclosure rules do not “specifically require disclosure of compensatory arrangements between a board nominee and the group that nominated such nominee.” The CII believes that disclosure related to these types of third party director compensation arrangements are material to investors due to the potential conflict of interest they present and further points to the SEC staff’s recent comments on proxy solicitations alluding to the importance of these types of disclosures to provide investors with information on how to vote in contested proxy solicitations. The CII encouraged the SEC, through amendments to existing rules or through the issuance of interpretive guidance, to require additional disclosure on these types of compensation arrangements. Specifically, the CII believe that contestants in a proxy contest should, at a minimum, be required to disclose the following to enhance shareholder protection:

  • the existence of any compensatory arrangements between a board nominee and a nominating shareholder relating to the nominee’s candidacy or board service;
  • the specific components of any compensatory arrangements between a board nominee and a nominating shareholder relating to the nominee’s candidacy or board service, including:
    • any cash compensation, including salary, non-equity incentive and bonus to be paid to the nominee;
    • any equity compensation to be paid to the nominee;
    • any terms of the compensation, including performance criteria, payout formulas, any peer group companies used, measurement periods and vesting provisions;
    • the range of total compensation that may be paid under various performance scenarios;
  • the goals and objectives of such compensation arrangements, including whether the arrangements relate to the nominee’s willingness to be a nominee for the board or for his or her service on the board once elected;
  • any indemnification and similar arrangements between the nominee and the nominating shareholder;
  • disclosure regarding any conflicts of interest presented by such compensation arrangements; and
  • any other material features of the compensation arrangements.

CII’s position has gained some notable support, including that of Trevor Norwitz of Wachtell, Lipton, Rosen & Katz, who noted in a recent blog post the troubling inconsistency between “the extensive proxy disclosures and analysis required of publicly traded companies concerning compensation, including director pay, and the minimal disclosures required of shareholders waging a proxy contest.”

One might expect that proxy advisory firms could, in the interim, step in to address potential problems associated with these types of third party compensation arrangements and provide some level of transparency or investor protection in proxy contests. However, considering ISS’s recent policy position to recommend withhold votes on restrictive director qualification bylaws designed to prohibit such arrangements without submitting them to a shareholder vote, such action seems unlikely. For the time being, we’ll have to leave the protection efforts to the plaintiffs’ bar as this area seems ripe for potential breach of duty and similar lawsuits.