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Director Compensation: The Case for a Say on Director Pay Vote

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As many who work in the area of executive and director compensation are aware, the landscape for director compensation has been undergoing some changes as a result of some recent court cases. The most recent came out in December 2017, In re Investor Bancorp.

Prior court cases (Seinfeld v. Slager and Calma v. Templeton) had held that shareholder approval of “meaningful limits” could constitute shareholder ratification that allowed directors actions in setting their own compensation to be reviewed under the business judgment rule. But, in In re Investor Bancorp, the Delaware Supreme Court held that when shareholders properly allege that directors breached their fiduciary duties when exercising discretion when setting their own compensation after shareholders have approved the general parameters of the compensation plan, the burden of proof shifts to the directs to show that their self-interested actions were entirely fair to the company (the “entire fairness” standard of review).

So, the prior court cases caused many companies to add a “meaningful” limit to total director compensation to their equity compensation plans that were put to shareholders for approval.  The limits were typically in the range of $500,000 to $1,000,000 in total compensation per director per year, depending on the size of the company. In re Investors Bancorp threw some uncertainty into that practice and had caused some commentators to wonder whether the Delaware court will uphold these types of limits. While I believe that is a valid concern, I see no way for a company to gain certainty about the courts upholding action undertaken pursuant to general limits established in a compensation plan barring a court ruling.

But, companies might be able to gain some certainty if they have an equity plan that states a “reasonable” limit for annual director compensation, and also put forth on the proxy statement a “Say on Director Pay” vote concerning the next year’s director compensation. Directors’ terms typically run from annual meeting to a subsequent (usually next) annual meeting, so having shareholders approve the directors’ compensation program for the next year period should work. The Say on Director Pay (SODP) vote would create a powerful presumption that shareholders approved the directors’ compensation (assuming directors only receive compensation that was detailed in the approval), which should enable the company to shut down any nuisance suits concerning director compensation.

Of course, care would need to be taken in drafting the SODP. The SODP should apply for the next year period or until shareholders are asked to approve a different compensation program for directors.  In this way, companies would only need to present a SODP on their proxy statements when director pay changes. For some companies, this might mean it becomes an annual item in the proxy. But for other companies, it could be a less frequent item on the proxy. In either event, by having shareholders approve the actual director compensation program, it would address many of the lingering issues after In re Investors Bancorp and its finding that the “entire fairness” standard of review applied and not the business judgment rule for review when directors set their own compensation under a compensation plan with “meaningful limits” on director compensation. While some companies might not want to “set a precedent” by asking shareholders to approve director compensation, others might view this as an appropriate corporate governance response to the situation that helps ensure that shareholder approval is obtained before director compensation is awarded, which dramatically lessens the potential for arguments of self-dealing by plaintiffs’ attorneys.

Indeed, at least one company has already agreed to hold a SODP vote. In June 2018, OvaScience filed a proposed settlement of its director compensation lawsuit (Fulton v. Dipp) which included a SODP vote every three years. So perhaps the SODP will start to catch on.  Likely would be eventually be viewed as a “routine” proposal and provides some protection against the plaintiffs’ bar which appears to have focused on director compensation issues.