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By Mary Hughes
March 5 — Keeping on the right side of the business judgment rule means that compensation committee members take into consideration all the facts with respect to a company's executive pay plans and make appropriate decisions, Charles M. Elson, director of the University of Delaware's John L. Weinberg Center for Corporate Governance, said in a webcast.
The business judgment rule gets down to a question of whether directors were informed, had a rational basis for their decision and were acting in good faith, Elson said. The concept of good faith has “to do with notions of director independence,” he said during the March 3 program.
Compensation committee members involved in interpreting a shareholder-approved plan won't get into trouble unless they “steer away from the plan” and do something clearly in violation of the shareholder-approved plan terms, Elson said.
“That is, from a Delaware perspective, clearly problematic,” and “there is case law that says you can't do it,” he said. However, the “fuzzy area is interpretation and this notion of independence” of the committee and compensation consultant, and how the committee documents an informed process in which it made the decision, Elson said.
Elson spoke as part of a webcast titled “Delaware Law Primer: Documenting Compensation Decisions and Compensation Committee Hot Topics.” The program, hosted by Cleary Gottlieb Steen & Hamilton LLP, was based on ideas developed by Delaware Supreme Court Chief Justice Leo E. Strine Jr. in a soon-to-be-published paper titled “Documenting the Deal: How Quality Control and Candor Can Improve Boardroom Decision-Making and Reduce the Litigation Target Zone.”
Arthur H. Kohn, a New York-based Cleary Gottlieb partner, discussed several cases in the Delaware Chancery Court involving ambiguous plan terms and their interpretation by the boards of the companies involved.
The cases ranged from a ruling against a compensation committee's actions to one backing a committee's judgment.
The court came down the hardest on a committee in the 1999 Sanders v. Wang case, in which Myron T. Steele, then vice chancellor of the court, “had some very harsh words to say about the judgment of the board,” Kohn said.
On the other end of the spectrum is Friedman v. Khosrowshahi, a case in which the court in 2014 upheld a compensation committee decision as a valid exercise of the rule.
In the middle of the spectrum, Kohn said, is Pfeiffer v. Leedle, a case involving stock option grants to an executive that exceeded the number of shares that could be granted under the plan. The “documentation oversight” in Pfeiffer sank the defendants, he said.
In avoiding the kinds of errors highlighted in the cases, Steven Hall, managing director of Steven Hall & Partners in New York, said process is important throughout the committee deliberations.
Part of that process includes document retention, such as meeting minutes. Companies often prepare minutes that are too short, Kohn said. Minutes should provide some explanation about the meeting participants' deliberations, he said. “I'm in favor of a little bit more documentation,” he said.
On the question of whether to give compensation committee members the underlying plan documents, which can be lengthy and opaque, Elson said that members should be given the documents, but also a summary. That way, if they wish to refer to the underlying documents, they can do so even if the summary is adequate, he said.
“But not giving the plan documents is a mistake. How can you approve something you have never seen?” he asked.
The panelists agreed that providing a version of the documents that track changes is helpful.
Referring to Institutional Shareholder Services Inc. as the “elephant in the room,” Hall said it may appear that compensation committees sometimes make decisions in an effort to please ISS. After the ISS report on the company comes out, a consultant can do a postmortem and deliver it to the committee with any recommended changes, he said. This isn't “pleasing ISS,” but it is documenting that you have considered its views as well as those of other shareholders, he said.
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The Strine paper is available at http://papers.ssrn.com/sol3/papers. cfm?abstract_id=2514520.
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