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‘A New World:’ Fears Mount Over Board Pay

By Amanda Gerut

As more settlements are struck in lawsuits alleging that directors have been paying themselves excessively, legal advisors are warning boards that it may be time to consider adopting a separate director compensation policy that includes hardwired cash and equity grants, and securing shareholders’ approval by voluntarily holding a say-on-director-pay vote.

The idea of say on director pay was once thought to be an intriguing hypothetical thought exercise, but recent court rulings have pushed the idea further into the mainstream. In the past three weeks, two boards have settled director pay lawsuits, agreeing to pay plaintiffs’ attorneys fees, hold binding shareholder votes on board compensation plans and adopt a raft of corporate governance reforms. And last week, a new amended complaint was filed in a case alleging excessive compensation at Ophthotech Corporation.

“I never saw cases like this in 35 years of practice and now they are the norm,” says Mike Melbinger, a partner with law firm Winston & Strawn. “Guess what? We’re in a new world now.”

Melbinger blogged about the new settlements last week, cautioning that “every public company in America needs to review its non-employee director compensation process or risk facing a lawsuit.”

At issue is that for the past several years, boards have been adopting “meaningful limits” on the amount of equity or total compensation directors could earn in a calendar year. The limits were adopted as a deterrent to lawsuits alleging excessive director compensation. However, it was never very clear how to determine whether a limit on the amount of pay a director could earn was “meaningful.” Still, the limits were thought to serve as a barrier against potential legal challenges.

But a case decided last December considerably altered the landscape.

In the case, which alleged that the directors of Investors Bancorp had breached their fiduciary duties regarding their own compensation, the board had pay limits in place that had been approved by shareholders.  However, directors paid themselves an average of $2.1 million per director, which was well above the peer group mean of $175,817, the complaint stated. The case was initially dismissed because of the limits the board had adopted, but the ruling was later reversed by the Delaware Supreme Court. The court ruled that shareholders should be able to expect that boards will exercise discretion to pay themselves in a manner consistent with their fiduciary duties.

The case was a shot across the bow for boards, which have long enjoyed discretion in how much they pay themselves, and some companies opted to preemptively take the most conservative course of action, which essentially minimizes any discretion directors have to ratchet up the amounts paid to board members, in the unlikely event a board would do so. 

JPMorgan Chase & Co. adopted formulaic grants in its 2018 proxy. The grants were included in the company’s equity plan and dictate that directors will earn $350,000 per year in cash and equity. The plan gives directors a modicum of discretion to increase the retainer by $25,000, but otherwise the director comp plan was hardwired in when investors approved the equity plan at the company’s annual meeting last month.  According to the results, 95.4% of votes were in favor the plan.

Peer Groups

A hardwired comp plan was previously thought to be the most conservative approach and only for the most risk-averse boards, but it has become increasingly likely that it may be the best way for directors to avoid the risk of a demand letter from a plaintiff if pay is anywhere above the company’s peer group median.

“If you’re above the peer group substantially, you’re at risk,” says Jim Barrall, senior fellow at the UCLA School of Law and retired partner and former head of the executive compensation practice at Latham & Watkins.

For example, last week, a case alleging that the directors on the board of OvaScience, a biotech company that develops fertility treatments for women, was settled in exchange for a $300,000 attorneys’ fee and a raft of corporate governance reforms.

According to the settlement and the company’s proxy, OvaScience directors must adopt a director compensation policy and present it to shareholders for a binding vote. The policy includes a $300,000 limit on annual compensation and specifies an annual cash retainer of $35,000 and an equity grant with an option to purchase 12,000 shares. Pay for committee chairs, members and new directors is also fully spelled out in the compensation policy, and directors are now subject to a mandatory hold-until-retirement policy for all new equity awards, net of taxes. The policy is to remain in place until 2021. 

Shareholders will vote on the binding proposal at the annual general meeting on June 26. 

Currently, compensation on the OvaScience board ranges from $52,395 to $182,895, according to the company’s 2018 proxy. In 2017, compensation ranged from $102,363 to $230,363. In 2016, pay ranged from $303,430 to $522,069. The pay differences are largely due to the board’s use of options in the directors’ pay plan. However, the complaint focused in part on the fact that the board’s pay was above the median of the company’s peer group.

The OvaScience board denies all wrongdoing, according to the settlement.

Days before the OvaScience settlement was announced, another settlement, involving the board of Clovis Oncology, was approved by the Court of Chancery.

The Clovis board agreed to pay attorneys’ fees of $395,000 and included in the company’s 2018 proxy a proposal for shareholders to approve and ratify the board’s compensation policy, which the board adopted in April.  Investors voted on the policy last Thursday and the policy was not approved.

The policy specifies an annual $50,000 cash retainer and $350,000 in stock options as well as retainers for committee members and chairs. Board pay can’t change without shareholder approval until 2021. The board must also adopt mandatory stock ownership guidelines, and the settlement requires that the board must consider peer group benchmarks annually and be guided by “best practices” in determining directors’ pay.

Pay for the Clovis directors ranges from $492,079 to $533,329, according to the 2018 proxy. The board’s pay plan also includes an option grant valued in the director compensation table at $439,579.

The agreement does not constitute an admission, the settlement states.

Both cases involve the use of options, which is a rare practice among large-cap companies, but is more common among newly IPO’d companies and those in the tech and biotech industries. Additionally, the focus in the cases on peer group medians underscores concerns for boards that are being paid above their industry medians, attorneys say.

Melbinger notes that while the recent cases have included “bad facts,” he also adds that “apparently there are a lot of bad facts out there,” among micro- and small-cap companies that are less thoroughly advised.

Stephen Jacobson, an executive compensation partner at Vinson & Elkins, says the cases emphasize the importance of process and peer benchmarking in board considerations of director pay.

In addition, Jacobson suggests boards use benchmarking in determining the meaningful limit to be used in board pay plans. He agrees that it’s worthwhile for boards to consider whether it makes sense to adopt a director compensation policy and possibly seek shareholder approval.

“Have a process and follow your process,” Jacobson says.

Uncharted Territory

Still, lawyers say boards are in uncharted territory following Investors Bancorp and should include the issue on upcoming agendas for review and discussion.

Jeffrey Norton, a partner with law firm Newman Ferrara LLP, which has filed a number of cases and sent letters to boards about their pay policies and practices, says the Investors Bancorp ruling has impacted negotiating settlements since the case was decided last December.

Prior to Investors Bancorp, director pay lawsuit settlements typically involved putting outer limits on overall compensation, and they were likely much higher than boards would ever pay their directors, he says.

Then Investors Bancorp came around and ruled that these outer limits still left boards with too much discretion, such that those limits weren’t all that meaningful, Norton says.

He adds that director compensation hasn’t been scrutinized nearly as much as executive pay, and some practices among micro-cap, small-cap and mid-cap boards are wide-ranging.

“There are boards of micro-caps paying non-employee directors two and three times as much as Fortune 50 companies,” Norton says.