Corporate Governance

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Independent ChairmanAre the CEO and the Chairman of the Board the same executive at your company?  While there can be very good reasons to have these positions held by the same person, the separation of these posts continues to be a hotly debated topic.  Since the early 1980s, much attention has been paid to corporate boards of directors and how their structures improve (or undermine) organizational performance. In the wake of the recent financial crisis, public corporations have come under scrutiny from activist shareholders, institutional investors, advisory firms and regulators alike.  So naturally, this is the source of the debate over the separation of the CEO and Chairman positions. 

According to the ISS Governance Exchange, in 2012, investors filed 49 independent chair proposals, with more than three-quarters coming to a vote, including three that received majority support.  As of February 1, 2013, this year’s volume of filings now exceeds last year’s total with 53 firms targeted by shareholders seeking a split of the top posts, with additional filings likely at companies meeting later in the year.  Notably, the record for such proposals was set in 2010, with a total of 66. 

Proponents of CEO and Chair independence base their view on the inherent system of checks and balances that the Board, and particularly the Board’s Chairman, is supposed to impose on management.  Essentially, a firm’s Board and Chairman of the Board serves to hire, fire, evaluate and compensate management (including the CEO) based on performance.  Clearly then, these proponents argue, a single CEO and Chairman cannot perform these tasks apart from his or her personal interests, making it more difficult for the Board to perform its critical functions, if and when the CEO is its Chairman.  Accordingly, separation of the Chairman and CEO roles, can lead to better management and oversight because an independent Chairman is able to ensure that the board is fully engaged with strategy and to evaluate how well that strategy is being implemented by management. Importantly, appointment of an independent Chairman can also signal to all stakeholders that the CEO is accountable to a unified Board with a visible leader. 

But while largely helpful from a corporate governance standpoint, one must note that the separation of CEO and Chair positions can impose several costs on a firm.  First, while appointing an outside Chairman can reduce the agency costs of controlling a CEO’s behavior, such an appointment introduces
Continue Reading Separating the positions of CEO and Chairman: The debate rages on

Is ISS claiming pledging is the same as bribery?The answer: when ISS is evaluating a public company’s corporate governance under its revised policies for the 2013 proxy season. We previously blogged about the potential insider trading issues that could theoretically arise when insiders pledge company stock to secure loans. Now, with the implementation of the revised ISS governance standards, there are additional reasons for publicly traded companies to implement antipledging and antihedging policies.

ISS specifically addressed hedging and pledging activity in its 2013 U.S. corporate governance policy updates, which were posted in November of last year.  In these updates, ISS included a footnote to its policy on voting for director nominees in uncontested elections in circumstances where there are perceived corporate governance failures. Under the new policy, ISS will recommend “against” or “withhold” votes for directors (individually, committee members, or, in extreme cases, the entire board) due to “[m]aterial failures of governance, stewardship, risk oversight, or fiduciary responsibilities at the company”. The new footnote cites hedging and significant pledging of company stock as examples of activities that will be considered failures of risk oversight. Other cited examples of risk oversight failures include bribery, large or serial fines or sanctions from regulatory bodies, and significant adverse legal judgments or settlements. 

The rationale behind this new update seems to be based on ISS’s belief that pledging any amount of company stock by insiders for a loan is
Continue Reading When does hedging or pledging of company stock by insiders equate to bribery?

Resolutions by in-house counsel for 2013As we start 2013, I thought it would be fun to ask in-house counsel what their New Year’s resolutions were.  I wasn’t looking for the usual “go to the gym more/ lose weight/ get organized” type answers, but rather what corporate secretaries/ securities counsel would want to improve upon in 2013 in their professional lives.  I heard back from a variety of in-house counsel, some of whom wish to remain anonymous.  Many had similar types of goals for this year.  I want to thank Bob Lamm, Assistant General Counsel and Assistant Secretary at Pfizer Inc., and Stacey Geer, Senior Vice President and Associate General Counsel at Primerica, Inc., both of whom were especially helpful in coming up with this list.  Here are the top resolutions submitted by in-house counsel:

Refresh the board and committee self-evaluation process.  Now is a good time to refresh the board and committee self-evaluation process.  If your board and committees are like most, they may be “bored” with the process by now.  By asking the same questions every year, eventually the process becomes stale and the answers become predictable.  Rather than have the directors complete the same survey consider changing the questions, or better yet, having a third party facilitate the evaluation process.  Remember to set aside some time to discuss the evaluation because the discussion of the evaluation is the most important part of the process. 

Tweak your director orientation program.  A good director orientation program allows new board
Continue Reading Starting the New Year off right: In-house counsel disclose their New Year’s resolutions

Proxy advisory firms' influence over proxy votingAs we say “goodbye” to 2012 we say “hello” to another proxy season full of angst caused by the self-appointed czars of corporate governance, the proxy advisory firms.  Although ISS and Glass Lewis have been making voting recommendations for more than a decade, over the past two years their power over voting outcomes has increased.  When the Dodd-Frank Act was enacted in 2010 Congress was very clear that the Say-on-Pay votes were merely advisory and that directors would not be subjected to increased liability over a company’s executive compensation practice; however, the unintended consequence of Dodd-Frank was to strengthen the unregulated proxy advisory firm industry by allowing these firms to be the near-final arbiters of whether executive compensation should be approved by shareholders.  Failure to comply with the arbitrary guidelines of ISS or the often unknowable guidelines of Glass Lewis can cause a company the potential embarrassment of a “failed” Say-on-Pay vote regardless of whether the independent directors at the company, who painstakingly analyzed various metrics in deciding what to pay the executive officers, determined the compensation to be in the best interests of the company and its shareholders.  In fact, Matteo Tonello of the Conference Board suggests there is substantial evidence demonstrating that the proxy advisory firms have significant influence over the design of executive compensation programs, but no evidence that they have contributed at all to improved governance quality or increased shareholder value.

The SEC clairvoyantly expected a growing conflict between issuers and the proxy advisory firms when it
Continue Reading Are investors’ interests served by proxy advisory firms?

Penn State Freeh reportMr. Lamm is Assistant General Counsel and Assistant Secretary at Pfizer Inc. and a Gunster alumnus.  The views expressed in this posting are Mr. Lamm’s personal views and should not be attributed to Pfizer Inc. or to Gunster.

While nothing good has come out of the Jerry Sandusky sexual abuse scandal at Penn State, I am not aware of anyone who has focused on the lessons learned, particularly the link between corporate governance and the scandal.  However, in my view, anyone who professes to be interested in corporate governance (or compliance) should read the report prepared by former FBI Director Louis Freeh and give it some thought.  It is comprehensive, well organized, well written and thoughtful; in short, it is an important document, notwithstanding the sordid subject matter and the massive human tragedy involved.

Of course, Penn State is an educational institution rather than a publicly traded company, and the facts of the Sandusky scandal are arguably not likely to be replicated in a public company setting.  However, many of the issues outlined in the Freeh Report apply equally to public companies – or to almost any form of organization – as much as to educational institutions, including the following (just to cover a few):

  • Boards of directors (or trustees, governors, etc.) tend to be blamed when bad things happen, even if they are not given the information they should be given and have no way of knowing that information.  Penn State’s trustees were excoriated in the press and other media for not dealing with the matter early on, despite the fact that they hadn’t been informed about the matter, didn’t even know of its existence and had no reason to know of its existence.  It’s really no different in the corporate world; the media tend to ask “where was the board?” even when the board could not possibly have known what was going on.  For example, was it really the board’s responsibility to review specific derivative trades that resulted in losses to financial institutions – particularly when the managements of the institutions provided information about the trades and assured their boards that the risks were minimal? If – as most corporate practitioners agree – the proper function of the board is to oversee management (rather than to supplant it), why should the board be blamed?
  • Of course, good directors understand that they have an obligation to ask questions, including tough questions, to test what they are being told and to ferret out more than what they’re being told.  Reading the Freeh Report, one gets the impression that
    Continue Reading GUEST BLOGGER: Lessons learned in corporate governance from the Jerry Sandusky tragedy

compensation committeesIssuers listed on the NYSE or Nasdaq should pay close attention to the rules proposed by the exchanges last week because the proposed rules will impact compensation committees; however, the impact may be a “tale of two exchanges” because the impact is more significant to Nasdaq-listed companies.  As you may recall, Congress included several provisions in the Dodd-Frank Act to combat perceived public concerns over excessive executive compensation.  One provision, say-on-pay, has been implemented, but other more controversial provisions such as executive compensation clawbacks and executive compensation pay ratios have not been implemented.  Last week, the exchanges proposed rules to implement the independence requirements for compensation committees required under Dodd-Frank. 

As we have mentioned before, Section 952 of the Dodd-Frank Act does not infringe on traditional state corporation law by requiring an issuer to have a compensation committee or to have a compensation committee actually approve executive compensation.  Instead, it directs the exchanges to design and implement their interpretations of corporate governance best practices based on the parameters of Section 952.  The NYSE and Nasdaq proposed rules are different, and I highlight some of the most important aspects of each of the set of rules below.  In general, NYSE-listed companies are impacted significantly less than Nasdaq-listed companies.  

Director Independence  

The SEC rules implementing Section 952 require that the exchanges’ definition of independence consider relevant factors such as (i) the source of the director’s compensation, including any consulting, advisory, or other compensatory fees paid by the listed company and (ii) whether the director has an affiliate relationship with the company.  The two exchanges interpreted the SEC’s rules vastly different.  

The NYSE merely maintains its current definition of “independence” and requires the issuer to consider the two additional factors set out by the SEC.  In practice, it would be highly unlikely that the two additional factors set out by the SEC would impact a board’s assessment of a particular director’s independence.  

Nasdaq’s current definition of “independent director” remains in effect; however, Nasdaq has elected to overlay a separate independence
Continue Reading Proposed compensation committee independence rules will impact some issuers more than others

Imagine the following scenario. Your company is publicly traded. As such, senior management is keenly aware of the potential for executives and employees trading in the company’s securities on the basis of material nonpublic information in violation of Section 10(b) of the Exchange Act and the infamous Rule 10b-5 promulgated thereunder. To prevent improper trading, the company has instituted an insider trading policy which, among other things, requires certain high-level executives to pre-clear trades internally, prohibits directors and officers from trading during “blackout periods” (i.e., the period immediately prior to fiscal quarter and year ends), and requires periodic training for all employees on the scope of insider trading laws. As model corporate citizens, all of the company’s directors, officers, and employees follow the company’s policies precisely. No one would dare to take the risk of attempting to gain illicit profits by trading the company’s stock while in possession of material nonpublic information.

One day, just before the end of a quarter (and therefore during a blackout period), analysts covering your company reduce their estimates for the company’s quarterly results which in turn, causes the company’s share price to decline. The company’s officers know that the analysts’ revised estimates are accurate and that the company will report sub-par earnings results the following week but none of those officers initiated any trades to improperly take advantage of this material nonpublic information. However, as a result of the decline in share price alone, one of the company’s executive officers unknowingly violated Section 10(b) and Rule 10b-5 and both he and the company are now potentially on the hook for insider trading liability. 

How can this be if none of the officers executed any trades you ask? The problem arises from the fact that company policy does not prohibit margining company securities. When the share price declined, the value of the securities in the executive’s margin account dropped sufficiently to trigger a margin call requiring the executive to deposit additional collateral to make up the shortfall or risk having the broker sell a portion of the pledged securities (this is similar to what happened to the founder and chairman of Green Mountain Coffee Roasters, Inc. earlier this year). Regardless of which route is taken, the executive is in a problematic situation. 

If the executive does nothing and allows the broker to sell company stock, he’d be violating company policy by trading during the blackout
Continue Reading Margin calls: The insider trading trap

It is a basic tenant of corporate law that directors of a corporation are not liable for business decisions as long as the directors acted with a reasonable level of care in making these decisions. This is referred to as “the business judgment rule.” Because directors are not guarantors of corporate success, the business judgment rule specifies that a court will not review the business decisions of directors who performed their duties (1) in good faith; (2) with the care that an ordinarily prudent person in a like position would exercise under similar circumstances; and (3) in a manner the directors reasonably believe to be in the best interests of the corporation. As part of their duty of care, directors have a duty not to waste corporate assets by overpaying for property (e.g., 100% of the stock of a target company in an acquisition) or employment services. The business judgment rule is very difficult to overcome and courts will not disregard it absent, among other things, a showing of fraud or misappropriation of corporate funds.

One of the landmark cases in this area of law was Smith v. Van Gorkam, which was decided by the Delaware Supreme Court in 1985. In that case, the board of directors of TransUnion approved a merger with Marmon Group without consulting outside experts as to the fairness of the price to be paid to TransUnion shareholders, rather, the board relied on the recommendations company’s CEO and CFO, neither of whom made any substantive attempt to determine the actual value of TransUnion. Additionally, the board did not inquire as to the process used by the CEO and CFO in determining the merger consideration. As a result, the Delaware Supreme Court found that the directors of TransUnion were grossly negligent in carrying out their fiduciary duties to the company. Because of this, the board was found not to have satisfied their duty of care and were therefore not entitled to the presumptions and protections of the business judgment rule. Ultimately, the TransUnion board agreed to pay $23.5 million in damages resulting from their fiduciary duty breaches.

The facts of Facebook’s recently announced acquisition of Instagram (as reported by the Wall Street Journal) are strikingly similar to the Van Gorkam case. Allegedly, Facebook’s CEO Mark Zuckerberg and Instagram’s CEO Kevin Systrom worked out the details of the acquisition privately over the course of 3 days at Mr. Zuckerberg’s home. Once the details were finalized for the $1 billion acquisition, the deal was presented, without notice, to the Facebook board of directors who approved the deal, likely without outside expert advice as to the fairness of the transaction. According to several reports, the board vote was largely symbolic because Zuckerberg has control of 57% of the voting power of the company. Facebook directors were likely put in a precarious
Continue Reading Could directors be personally liable if Facebook paid too much for Instagram?

One of the most well-known and popular Internet companies, Groupon, Inc., has again encountered significant accounting problems. These problems appear to be potentially severe. This situation is very negative for Groupon, but it also has troubling ramifications for the entire technology industry and especially for technology companies that have recently gone public. There is…