The purpose of this post is to explain why the Board of Directors (the “Board”) of a publicly-traded corporation should consider having the issuer’s stockholders approve all or a portion of the compensation paid to its non-employee directors.
- Favorable Business Judgement Rule Defense. Generally, an action by the Board will be afforded deferential treatment by the courts, and the Board’s action will be upheld, if the action relates to a rational business purpose to which the directors were informed (i.e., the “business judgement rule” defense). The business judgement rule is favorable to directors because the defense makes it more likely that the issuer will prevail against a plaintiff on a summary judgement motion.
- Entire Fairness Standard. The entire fairness standard applies when the Board takes action with respect to its own compensation (i.e., the business judgement rule cannot apply because the Board’s action with respect to its own compensation is an interested transaction). If the entire fairness standard applies, then the directors have to prove that their compensatory action was fair (in both dealing and price) to the issuer. As a result, it is less likely the issuer will prevail on a summary judgment motion.
- Stockholder Ratification Defense. An action by the Board will be afforded deferential treatment by the courts if the compensatory decision by the Board is ratified by the issuer’s stockholders. The stockholder ratification defense is similar in outcome to the business judgement rule discussed above.
Recent Court Opinions
- Meaningful Equity Plan Sub-Limits. With respect to a Board’s decision to grant equity to itself, the courts have concluded that the stockholder ratification defense would apply only if the equity plan had non-employee director sub-limits that were both “meaningful” and approved by the issuer’s stockholders. See Seinfeld v. Slager and Calma v. Templeton. To determine whether an equity plan sub-limit is meaningful, the issuer would need to hire an outside compensation adviser to conduct a benchmarking analysis against the issuer’s peer group (i.e., benchmarking to determine that the equity award is fair to the stockholders in amount, form, vesting, etc.).
- Possible Heightened Standard. Subsequent to Seinfeld and Calma, the court in In re Investors Bancorp, Inc. Stockholder Litigation (December 2017) held that the stockholder ratification rule would apply only if the issuer’s stockholders approved the specific equity awards in question or if such awards were granted pursuant to a self-executing (i.e., non-discretionary) equity plan that was previously approved by the stockholders (e.g., an RSU covering 100 shares of stock granted on the day that immediately follows the annual stockholders’ meeting). Keep in mind that the compensation paid to the non-employee directors in In re Investors Bancorp was unique in amount, and therefore, it is too early to know with certainty whether a In re Investors Bancorp stands for a new heightened standard or whether the court was merely reacting to the facts of that case.
Actions to Consider
- Implement the Teachings of Seinfeld and Calma. On an annual basis, the Board should review existing compensatory arrangements for its non-employee directors, including the processes and practices for determining such compensation. As part of this review, the Board should hire outside compensation advisers to determine “meaningful” per director and annual sub-limits within the equity incentive plan. And if the issuer has not done so already, such per director and annual sub-limits should be presented to the issuer’s stockholders for their ratification.
- Create a Separate Non-Employee Director Compensation Plan. The concept of seeking stockholder ratification is likely easier when the compensatory arrangement for the non-employee directors is separate from the omnibus equity incentive plan otherwise applicable to the issuer’s employees. And too, having a separate non-employee director compensation plan is more simple and straightforward when seeking stockholder approval.
- Consider Seeking Robust Protection. Issuers seeking more robust protection should consider adopting the teachings of In re Investors Bancorp by having its stockholders specifically approve: (i) retainers and meeting fees, (ii) any irregular and larger compensatory awards, and/or (iii) formulaic or self-executing cash/equity awards. And too, the Board could retain small amounts of discretion with respect to the foregoing to allow for small upward or downward adjustments from what the stockholders otherwise approved (e.g. the amount involved could be too small for a plaintiff to bring a legal action if, for example, the Board retains discretion to move a stockholder-approved $75,000 retainer fee to $80,000 in order to compensate the director for extra efforts not otherwise anticipated when the stockholders first approved the $75,000 retainer fees).
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