Director fiduciary dutiesA recent case out of the Delaware Court of Chancery could result in heightened scrutiny of equity award grants to non-employee directors. Although this decision was rendered at the procedural stage of the case and the merits of the claims have yet to be fully analyzed, this case potentially affects directors of Delaware companies and those advising them on compensation-related matters.

In this case, a stockholder of Citrix, Inc. (“Citrix”) brought a derivative lawsuit against the Citrix board of directors alleging a number of things, including breach of fiduciary duty by the board of directors in awarding significant equity compensation awards. Specifically, the plaintiff alleged that restricted stock units (“RSUs”) granted to non-employee directors (who constituted eight of the nine Citrix board members) under the Citrix equity incentive plan, were excessive.

Because the non-employee directors who received the RSU grants in question constituted eight of the nine members of the Citrix board of directors, the plaintiff was successfully able to rebut the business judgement rule presumption and the defendants bear the burden of proving to the court’s satisfaction that the RSU grants were the product of both fair dealing and fair price (i.e., the “entire fairness” standard of review).

The defendants argued that Continue Reading Chancery Court Holds Board to Heightened Fiduciary Duty Standard in Connection with Equity Awards

It shouldn’t come as a surprise to anyone nerdy enough to be reading this blog that the Dodd-Frank Act mandated SEC rulemaking in four areas relating to the disclosure of executive compensation:

  • pay ratio,
  • hedging,
  • clawbacks, and
  • pay-for performance.

These items have been variously referred to as the “four horsemen” (as in apocalypse) or the “gang of four” (as in Chairman Mao’s evil wife and her evil friends).

Up until now, the SEC has been moving at a rather leisurely pace to get the horsemen – er, rules – out. In fact, the SEC’s failure to adopt final pay ratio disclosure rules has generated some criticism (see my recent UpTick). Perhaps for that reason, the SEC seems to be moving forward to propose the remaining rules at a somewhat faster pace. Just about 10 weeks ago, the SEC proposed rules on hedging.

And now the SEC has scheduled an open meeting on April 29 at which it will consider proposing rules for pay-for-performance disclosure. You can find the SEC’s Sunshine Act notice of this meeting here. It’s anyone’s guess what the proposed rules will look like, but the proposals will definitely generate lots of interest. So, for the time being, all I can suggest is “watch this space.” We’ll let you know once we have a chance to see what emerges from the open meeting.

On Sunday, April 12, the Business section of the New York Times led with an article by Gretchen Morgenson taking the SEC to task for not having adopted rules requiring disclosure of CEO pay ratios. This follows similar complaints by members of Congress, most recently in the form of a March letter by 58 Democratic congressmen to Chair White. And going further back – specifically, to Chair White’s Senate confirmation hearing in March 2013 – Senator Warren told Chair-Designate White that SEC action on this rule “should be near the top of your list.”

Really?

I’ve given this a great deal of thought since Congress mandated pay ratio disclosure in the Dodd-Frank Act, and I’ve yet to figure out why – aside from political considerations – so many people think this disclosure is so important or what it will achieve. In fact, when I coordinated a comment letter on the rule proposal as Chair of the Securities Law Committee of the Society of Corporate Secretaries and Governance Professionals, I told a number of people that it was the hardest comment letter I’d ever worked on, and I believe that was the case because it was hard to comment on a proposal that struck and continues to strike me as ill-advised and unnecessary in its entirety.

Ms. Morgenson’s article proves my point. It provides pay ratio data for a number of companies, as determined by a Washington think tank. But at the end of the article, all the data demonstrate is that the CEOs of the companies in question make a ton of money. The ratios don’t tell us anything more than that; Disney had the highest ratio, but does anyone need a ratio to know that its CEO makes lots of money? Ditto Oracle, Starbucks and the others – in all cases, the ratio is far less informative than the dollar amounts, which of course are and have for many years been disclosable.

The ratios might – but only might – be more meaningful if we knew what the underlying facts are; for example, what is the mix of US to non-US employees? To what extent are the employees part-time or seasonal? But of course the article doesn’t reveal this information, and neither would the proposed SEC rules. And the SEC Staff has indicated the final rules are not likely to allow companies to exclude non-US, part-time or seasonal employees. In other words, we won’t be able to distinguish between two companies with the same pay ratios regardless of the fact that one may have vast numbers of employees in the third world while the other’s employees are located in major industrialized countries.

Continue Reading CEO pay ratios: ineffective disclosure on steroids

Britney Spears has nothing on Institutional Shareholder Services, better known as ISS.  ISS is rolling out proposed new voting policies for the 2015 proxy season.  ISS often uses more words to tout how transparent it is than to explain its voting policies clearly, and the draft policies being considered for 2015 are no different.

One new proposed policy addresses voting on shareholder proposals on independent board chairs.  ISS proposes to expand the list of factors that will be considered in developing a voting recommendation and to look at these factors in a more “holistic” manner.  (The current policy is to support the proposals unless the company meets all of the criteria.)  So this seems like a good thing.  However, ISS indicates that the new policy is not expected to change the percentage of independent chair proposals that it will support.  The obvious question is, then, how will the new policy really work?  Your guess is as good as mine (which frankly isn’t very good).

The other new proposed policy provides additional information regarding the “scorecard” that ISS will use to evaluate equity plans.  Like the independent chair policy above, some more criteria are laid out, but it’s impossible to tell how the factors – or, indeed, the new scorecard, will be weighed or will work – thus assuring that companies seeking shareholder approval of equity plans will have to continue to use ISS’s consulting service to find out whether a new plan will pass muster.

I could just as easily have referred to Yogi Berra as to Britney Spears, because if this isn’t déjá vu all over again, I don’t know what is.

Your thoughts?

Regulations continue to be burden on public companiesAlthough you may have missed the fireworks and the parade, we celebrated the one year anniversary of the JOBS Act on April 5th.  Of course you wouldn’t have been alone if you missed the big celebration because, unfortunately, despite the initial hype surrounding the JOBS Act, not much has happened.  The media has chastised the JOBS Act for not fulfilling its early promise.  Most of the innovative provisions of the JOBS Act remain unimplemented by the SEC such as the relaxation of the ban on general solicitation on private offerings, crowd funding, and the improvement to Regulation A.  But even Title I (generally referred to as the “IPO on Ramp”), which was effective over a year ago, hasn’t had much effect.  In fact, IPOs, according to Jay Ritter at the University of Florida, have actually decreased for the so-called emerging growth companies.

How can this be?  While there can be numerous factors for why IPOs continue to remain elusive (costs of regulation and a poor economy are the top factors), other factors such as a rising stock market and pent up demand for IPOs should be compelling companies to go public.  Or is it possible that the cost of regulation that has been piled on since the fall of Enron trump everything else?

When Congress passed Title I of the JOBS Act, Congress recognized that public companies have been facing increased burdens for being public.  Although the causal relationship was suspect at best, Congress determined that over regulation was responsible for the severe drop off in IPOs from the 1990s through the 2000s.  While I might suggest that the dotcom bubble bursting may have played a part in the decrease in IPOs, I would agree that the unrelenting regulation that has come out of Congress over the past decade (Sarbanes-Oxley, Dodd-Frank) as well as rulemaking from the SEC itself (executive compensation disclosures) must have had some effect.

As a reminder, Title I of the JOBS Act, among other things, reduces executive compensation disclosures.  Specifically, emerging growth companies (companies with less than $1 billion in revenues) are exempt from holding “Say-on-Pay” and “Say-on-Golden Parachutes” votes, disclosing the two controversial executive compensation pay ratios required under Dodd-Frank, and providing a Compensation Discussion and Analysis (CD&A). Other executive compensation disclosure is also shortened by reducing the number of named executive officers, reducing disclosure from three to two years, and eliminating certain compensation tables.  In other words, Title I of the JOBS Act was designed to address over regulation of executive compensation for public companies.

While this was a great start by Congress, companies haven’t taken advantage of Title I because Continue Reading Executive compensation disclosure is too great a burden for issuers

Director Pay Practices

Since 2007, executive compensation practices of public companies have been at the forefront of activist shareholders’ and shareholder rights groups’ agendas. Mandatory say-on-pay proposals, enhanced executive compensation disclosure, compensation committee and compensation consultant independence rules are just a few of the recent significant changes to the laws and regulations applicable to public companies in the U.S. Moreover, as we reported in prior blogs, some countries have gone as far as making say-on-pay proposals binding on public companies. In fact, just this year, Switzerland amended its constitution to require binding shareholder say-on-pay votes and other executive compensation limitations for its public companies (also check out Broc Romanek’s blog for a collection of articles related to this topic). However, while public company executives have been in the crosshairs, little attention, if any, has been given to compensation of public company directors.

But that may change as a result of certain director pay practices highlighted by a recent NY Times Deal Book article by Steven Davidoff. The article focuses on two current proxy fights involving hedge funds attempting to get their proposed nominees elected to the boards of Hess Corporation and Agrium Inc. In the first case, the nominating hedge fund is proposing to pay a $30,000 bonus to any of its nominees who ultimately win a seat on the Hess board. Additionally, each such nominee would be eligible to earn a performance bonus based on share performance relative to its peer group. Based on the performance award formula, the maximum potential payout could be as much as $9 million if Hess outperforms its peer group by 300% over a three-year measuring period.

The second case is potentially even more lucrative for the director nominees. In addition to a $50,000 bonus each nominee would receive if elected,  they would also receive 2.6% of Jana Partners’ net profit based on the stock closing price on September 27, 2012. Director nominees not elected would still receive 1.8% of the net profit during that same period. Considering Jana’s total investment in Agrium is over $1 billion, the earning potential could be significant. However, based on the results of the Agrium annual meeting held on April 9, it appears that none of these Jana nominees were elected to the Agrium board this time around.

These arrangements pose some interesting questions from a corporate governance standpoint. Historically, directors Continue Reading Will director compensation be the next target?

Pitfalls issuing securities to employeesThis is the fourth part of our Securities Law 101 series.  Because capital raising is such a critical function for middle market companies, we designed this series to introduce their management teams to some of the fundamental concepts in securities law.  We hope that this series will prevent some of the most common mistakes management teams make.  We will periodically publish posts examining different aspects of securities law.

For startup companies, cash is almost always tight.  Despite the cash crunch, startups need to be able to attract qualified employees to get their business off the ground.  So, a question I get all the time from founders of startups is: Can’t I just give my employees some shares?  The answer, of course, is “yes, as long as there is an exemption from registration.”

So, what is this “exemption from registration”?

Well, as a reminder every time you issue securities the securities must be registered with the SEC and each state’s securities commission unless there is an exemption from registration.  When you are issuing securities to employees, the exemption that you would most likely rely on is “Rule 701.”  To be able to rely on Rule 701, you need to meet the following conditions:

Pitfalls issuing securities to employeesThis is the fourth part of our Securities Law 101 series.  Because capital raising is such a critical function for middle market companies, we designed this series to introduce their management teams to some of the fundamental concepts in securities law.  We hope that this series will prevent some of the most common mistakes management teams make.  We will periodically publish posts examining different aspects of securities law.

For startup companies, cash is almost always tight.  Despite the cash crunch, startups need to be able to attract qualified employees to get their business off the ground.  So, a question I get all the time from founders of startups is: Can’t I just give my employees some shares?  The answer, of course, is “yes, as long as there is an exemption from registration.”

So, what is this “exemption from registration”?

Well, as a reminder every time you issue securities the securities must be registered with the SEC and each state’s securities commission unless there is an exemption from registration.  When you are issuing securities to employees, the exemption that you would most likely rely on is “Rule 701.”  To be able to rely on Rule 701, you need to meet the following conditions:

Say-on-pay lawsuitsWhy doesn’t the plaintiffs’ bar believe Congress means what it says? The Dodd-Frank Act could not have been more clear that the outcome of the mandatory say-on-pay advisory vote for public companies does not create or imply any change to the fiduciary duties of board members. However, as we have discussed in previous blog posts, this fact hasn’t stopped lawsuits in the wake of failed say-on-pay votes that allege, among other things, breaches of fiduciary duty by the boards of directors and management of public companies related to such failed votes. The vast majority of these cases have been dismissed at the early stages of proceedings, usually for failing to make a proper demand on the board of directors as required by most state corporate law statutes, but this has only lead to a shift in strategies. 

As the old saying goes, if you fail, try and try again. That is exactly what the plaintiffs’ bar is doing. The current tactic du jour seems to involve filing suits to enjoin the annual meeting. Most of these complaints seeking an injunction have typically alleged that directors and/or management breached their respective fiduciary duties by not providing adequate disclosure in the annual proxy statement to enable shareholders to make informed voting decisions, usually as it relates to proposals seeking to approve (i) executive compensation, (ii) a new or amended compensation plan, or (iii) an amendment to the charter to increase the number of authorize shares. Some of the most common allegations include: 

  • “The Proxy fails to disclose the fair summary of any expert’s analysis or any opinion obtain[ed] in connection with the [equity incentive plan]”; 
  • “The Proxy fails to disclose the criteria” used by the compensation committee “to implement the [stock purchase plan] and why the [equity incentive plan] would be in the best interest of shareholders”; 
  • “The Proxy fails to disclose the dilutive impact that issuing additional shares may have on existing shareholders”; and 
  • “The Proxy fails to disclose how the Board determined the number of additional shares requested to be authorized.” 

The timing of these lawsuits is less than ideal for companies as many are only a few weeks away from their scheduled meeting. This, of course, creates increased pressure to Continue Reading Say-on-pay litigation: Round 2

Compensation committees remain on the hot seat.  Stemming from the Dodd-Frank Act, the SEC has adopted rules directing each national securities exchange to require companies with listed equity securities to comply with new compensation committee and compensation advisor requirements. Among other things, these new rules require national securities exchanges to implement listing standards that require :

  • each member of a listed company’s compensation committee to be an “independent” director;
  • the issuer to consider relevant factors (to be determined by the national securities exchange) including, but not limited to, the source of compensation of a member of the compensation committee member and whether a compensation committee member is “affiliated” with the issuer, subsidiary of the issuer, or an affiliate of the subsidiary;
  • an issuer’s compensation committee to have the authority and responsibility to retain compensation advisers and consider the independence of compensation advisers; and
  • require issuers to include specified disclosure about the use of compensation consultants and any related conflicts of interest in the proxy materials for their annual shareholders’ meetings.

As we noted when these rules were originally proposed, the SEC has not infringed on the traditional rights of states to define corporate law because these new rules do not require an issuer to have a compensation committee.  Rather, the new rules require that the independence rules be applied to committees performing functions typically performed by a compensation committee regardless of the name of the committee (compensation committee, human resource committee, etc.).  Under the final rules, the SEC has broadened the independence requirement to apply also to the members of the listed issuer’s board of directors who, in the absence of a compensation committee, oversee executive compensation matters.

The final definition of “independence” for a compensation committee will largely depend on the final rules of each national Continue Reading Are your compensation committee members independent?