SEC Approves NASDAQ Golden Leash Disclosure

In the past couple of years, a relatively hot area of the sometimes rather lackluster world of bylaws amendments has centered on requiring candidates for election to a board of directors to disclose any compensation arrangements with third parties that relate to such board service. In their most egregious form, issuers fear that such ‘golden leash’ arrangements incentivize board candidates – almost certainly those nominated by activist investor funds – to advocate positions that would otherwise not be in the long term interests of stockholders, instead focusing on short term increases in results.

When this issue first gained prominence in 2013-2014, some issuers attempted an outright ban on such third party arrangements. In the face of howling (though largely private) opposition from activists and, more importantly and publicly, proxy advisory firms, most companies fell back to a position of simply requiring disclosure rather than an outright ban. Accordingly, numerous bylaws have been amended to require disclosure of such arrangements. Disclosure (only) is increasingly viewed as the simple norm.

More recently, the NASDAQ – home to most technology companies, a sector which only in the past few years has firmly become a prime target of the activist community – proposed and, as of July, now has received SEC approval for, a listing rule that requires disclosure of all golden leash arrangements.

Interestingly, the NYSE – at least publicly as of now – is not contemplating such a move, nor is the SEC pushing wider regulation. One could posit that the disclosure laws are already sufficiently broad to permit the SEC to require such disclosure through relatively simple rulemaking (or even just comment letters to strengthen interpretations). Such potential regulation would appear prudent, particularly for the ‘pink sheet’ OTC micro-cap stocks where this could also be an issue but such companies would not be subject to larger exchange regulation. However, the Staff – whether overburdened by thousands of pages of bureaucratic complexity stemming from initiatives such as Dodd Frank, or simply timid given their mixed success in regulation with respect to director elections (e.g. proxy access) – has declined to do so. Such declination arguably is an abdication of responsibility, though perhaps not a surprising one given the poisoned political atmosphere currently involved in merely having commissioners confirmed to serve.

Golden leash arrangements in and of themselves need not be  anathema to long term stockholder value. The pros and cons of the arguments are boiled down to:

Pro: To attract truly high quality board candidates – particularly to ‘normal’ activist situations which involve companies facing various challenge and usually whose stock as a result underperforms rather than outperforms – requires super-compensatory arrangements well beyond what has become the vanilla director benchmarked compensation rate for the standard 8 days a year (and a few teleconferences).

Pro: If tailored correctly, a separate compensation arrangement does not in and of itself need create disparate incentives on the board. Activists have begun arrangements that involve significant remuneration – but as a condition, such money must be invested exclusively in company stock, thereby aligning the particular board candidate with the stockholders as a whole.

Con: No matter how putatively aligned such compensatory arrangements may be, an arrangement may disproportionately affect a director when compared to holdings of a large institutional investor who may have more patience and fortitude to have a long term time horizon. Even if a director invests in company stock, he or she may still be looking for (or simply more susceptible to) the ‘quick pop’ from a year or two of board service and selling the company for a modest premium – even if the growth prospects for 5 or 10 years could be reasonably expected to eclipse the present value of a short term sale price.

Con: Disparate compensatory arrangements can create disparate power perceptions in the boardroom because of the different labor markets from which such director pools are drawn. This can create a situation where a new ‘superstar’ director is able to have outsized influence on management and de facto potentially intimidate other board members to be more susceptible to ‘short-termism.”

Obviously disclosure only requirements – including NASDAQ’s new rule – do not normatively weigh-in on the merits of the arguments listed above; that is left to the stockholders through the exercise of their franchise in director elections. The NASDAQ rule does, however, fortify the accepted norm of such disclosure.

Finally, NASDAQ’s rule also presents the odd optic that a self-regulator – who is in heated competition to retain listings against the NYSE – is unilaterally imposing the obligation as its own rule, inviting issuers to view this a stock exchange regulatory arbitrage. It remains entirely unclear whether this portends a future pattern of competition among exchanges based on perceived enhanced governance standards – ones that go beyond prior accepted norms such as director independence and delve into relatively technical and more disputed areas.