Corporate Governance Weekly

How Much Latitude Do Directors Have In Setting Executive Compensation?

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Executive compensation decisions are core functions of a board of directors and, absent unusual circumstances, are protected by the business judgment rule.  As Delaware courts have repeatedly recognized, the size and structure of executive compensation are inherently matters of business judgment, and so, appropriately, directors have broad discretion in their executive compensation decisions.  In light of the broad deference given to directors’ executive compensation decisions, courts rarely second-guess those decisions.  That is particularly so when the board or committee setting executive compensation retains and relies on the advice of an independent compensation consultant.

Nevertheless, despite the high hurdle to challenging compensation packages, shareholder plaintiffs continue to aggressively challenge executive compensation decisions, in particular at companies that have performed poorly and received negative or low say-on-pay advisory votes. READ MORE →

The Auditor’s Report: Is “Pass/Fail’” Enough?

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In August, the Public Company Accounting Oversight Board (“PCAOB”) issued a proposal that calls for enhanced communication from Auditors—in addition to the traditional Pass/Fail opinion—in Audit Reports (PCAOB Release No. 2013-005).  If this proposal is approved, it would be the first significant change to the audit report in more than 70 years, according to PCAOB Chairman James Doty.  The proposed changes are based on the premise that investors and financial statement users want more information from auditors, and these changes would represent a huge landscape change for the audit profession.

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When Are Directors Liable for Failing to Exercise Proper Oversight?

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Recently we discussed whether directors of public companies face potential liability for not preventing cyber attacks.  As we discussed, the answer is generally no, because absent allegations to show a director had a “conscious disregard” for her responsibilities, directors do not breach their fiduciary duties by failing to properly manage and oversee the company.

That well-established rule was again affirmed last week by the Delaware Court of Chancery in In re China Automotive Systems Inc. Derivative Litigation,  a case that concerned an accounting restatement by a Chinese automotive parts company.  Plaintiffs there alleged that the company’s directors breached their fiduciary duties by failing to manage and oversee the company’s accounting practices and the company’s auditors, who improperly accounted for certain convertible notes from 2009 to 2012.  When the error was uncovered, the company restated its financials for two years and its stock price dropped by 15%. READ MORE →

Shareholder Books and Records Requests to Become More Frequent, and More Potent

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As we previously detailed, a shareholder’s request for corporate books and records can raise competing concerns for the company and its directors.  On the one hand, shareholders have a legal right under Section 220 to seek company records, and have been repeatedly encouraged by Delaware courts to exercise that right. On the other hand, because Section 220 requests are often a precursor to litigation – and because even innocuous documents can sometimes be used to bolster an otherwise baseless lawsuit – fiduciaries must ensure their response protects shareholder interests as a whole.

A string of recent Delaware decisions have added a new layer of complexity to these concerns.  Going forward, Section 220 requests will likely become more common, and will potentially carry a larger downside for companies that fail to properly respond.

First, Delaware courts are increasingly insistent that shareholders seek corporate records before filing suit.  In fact, the Delaware Court of Chancery recently went so far as to hold that if a shareholder fails to seek books and records before filing a derivative complaint, the court can assume that shareholder is unable to “provide adequate representation for the corporation.”  That decision was later overturned by the Delaware Supreme Court, but by acknowledging “the trial court’s concerns,” the Supreme Court yet again reiterated its expectation that shareholders should request company records as a matter of first course. READ MORE →

Does A Board Need To Put A “For Sale” Sign On The Company When Considering A Change-of-Control Transaction?

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When a board of directors decides to enter the company into a change-of-control transaction, the board is charged with the duty to act reasonably to secure the best value reasonably attainable for its shareholders. As the Delaware Supreme Court put it in its seminal decision in Revlon, Inc. v. MacAndrews & Forbes Holdings, in the change-of-control context, the directors’ role changes “from defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company.”

But is an “auction” of the company always necessary to comply with this duty? No – there is no bright-line rule that directors must conduct a pre-agreement market check or shop the company. Delaware courts have repeatedly emphasized that there is no single “blueprint” that a board must follow to fulfill its duties in connection with a change-of-control transaction and, in fact, a board may pursue a single-bidder sales process so long as it has reliable evidence with which to evaluate the fairness of the transaction without an active survey of the market and retains flexibility to consider potential topping bids after the merger agreement is signed.

That is not say that a single-bidder approach will always pass judicial muster, as demonstrated in Koehler v. NetSpend Holdings, Inc., a recent case in which the Delaware Court of Chancery found that NetSpend’s directors acted unreasonably by not engaging in a market check before agreeing to sell the company. The court in NetSpend acknowledged that a single-bidder process is not unreasonable per se, and found that the board’s initial decision to adopt a “not-for-sale” strategy that sought to maximize value by inducing the sole bidder to bid against itself was reasonable. According to the court, however, the board’s approach to the transaction was not reasonable. In support of this finding, the court pointed to a “weak” fairness opinion, as well as acquiescence to potentially preclusive deal protection provisions, including a “No-Shop” clause and “Don’t Ask-Don’t Waive” provisions that precluded NetSpend from waiving any standstill agreement without the buyer’s consent. These factors precluded an effective post-agreement market check to assess the fairness of the deal price. READ MORE →

How Corporate Charters Can Protect Directors from Money Damages for Acts of Negligence

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Several weeks ago we asked whether directors of public companies face potential liability for not preventing cyber attacks. But what about liability for other acts of oversight? Can directors be held personally liable for money damages when they have done nothing affirmatively wrong?

Generally, the answer is no. Many states, like Delaware, allow corporate charters to include provisions that protect directors (and sometimes officers) from money damages for certain breaches of fiduciary duty. Acts that are not protected include breaches of the duty of loyalty, intentional misconduct, knowing violations of the law or receiving an improper personal benefit. But where plaintiffs seek money damages for breaches of the duty of care, exculpatory provisions in corporate charters typically provide directors a defense to the claims.

Practically speaking, these provisions protect directors against claims of negligence, and some courts have held the provisions even go so far as to protect against “reckless indifference.” The protection stops, however, when a director consciously disregards his or her duties. For example, and with reference to the earlier discussion on cyber attacks, an exculpatory provision might not shield a director from money damages where (i) a damaging cyber attack occurred, and (ii) it could be proven that the director exhibited a “sustained or systematic failure to exercise reasonable oversight” over the company’s cybersecurity, such that it evidenced the director’s conscious disregard of cybersecurity. READ MORE →

Do A Deal and You’re Sure to Get Sued; Now, at Least, You Can Get Sued in Just One Place

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These days almost every public company that announces an agreement to sell itself can expect to be the subject of multiple shareholder class actions challenging the transaction – even if shareholders will be receiving a blowout price for their shares under the terms of the agreement. Many of these cases are baseless, and are brought by plaintiffs hoping to leverage a quick settlement. Their strategy, in blunt terms, is to force a speedy payment by threatening to disrupt or stall the deal. Unfortunately, even if the litigation presents only a small risk of disrupting or delaying the deal, many companies feel obligated to settle rather than risk upsetting the deal.

It’s bad enough that target companies and their boards are forced to deal with these “worthless” “sue-on-every-deal cases,” as Delaware Vice Chancellor Travis Laster once described them, but they often have to deal with them in multiple jurisdictions. Indeed, rarely are shareholder class actions challenging a merger brought in a single forum. Instead, companies and their boards are forced to expend time and money defending against duplicative lawsuits in multiple fora around the country. READ MORE →

Do Directors Face Potential Liability for Not Preventing Cyber Attacks?

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In the past weeks, we’ve reported that while most companies are properly disclosing their exposure to cybersecurity threats, the increasing occurrence and severity of cyber attacks has the SEC considering even more stringent cybersecurity disclosure requirements. Now, another study reports that while 38% of Fortune 500 companies have disclosed that a potential cyber event would “adversely” impact their business, only six percent of those companies purchase cyber security insurance.

What of the other 94%? Should they be doing more to protect themselves against the growing cyber threat? Do their directors have a fiduciary obligation to do more?

In re Caremark International Inc. Derivative Litigation, a Delaware decision from 1996, sets forth a director’s obligations to monitor against threats such as cyber attacks. In short, as long as a director acts in good faith, as long as she exercises proper due care and does not exhibit gross negligence, she cannot be held liable for failing to anticipate or prevent a cyber attack. However, if a plaintiff can show that a director “failed to act in the face of a known duty to act, thereby demonstrating a conscious disregard for [her] responsibilities,” it could give rise to a claim for breach of fiduciary duty. READ MORE →

Do Trades Made Pursuant to 10b5-1 Plans Still Offer A Defense to Insider Trading?

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Rule 10b5-1, enacted in August 2000, codified the SEC’s position that trading while in possession of material non-public information is sufficient to establish liability for insider trading. The rule also provided an affirmative defense for individuals who could prove that the purchase or sale of stock was made pursuant to a pre-existing written plan executed before the individual became aware of the material non-public information. These so-called 10b5-1 plans have long been considered to be an efficient way to trade company stock without raising suspicion of insider trading or another improper motive.

However, recent news stories have reignited concerns that corporate insiders may be abusing 10b5-1 trading plans to trade on material non-public information. An April Wall Street Journal article reported that not only has the use of 10b5-1 plans by non-executive directors nearly doubled between 2006 and 2011, but a significant percentage of the plans were being used to unload all or a large percentage of the directors’ holdings in a short period of time. An earlier November 2012 Wall Street Journal article analyzing thousands of trades made by corporate executives found evidence that company insiders did statistically much better than expected in realizing trading profits. Together, these articles suggest that the lack of transparency and regulation of 10b5-1 trading plans has allowed them to be misused as vehicles to effectuate opportunistic trades.

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Going-Private Transaction With a Controlling Stockholder – What Standard of Review Applies?

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We previously discussed how important a special negotiating committee of independent directors can be when defending against stockholder challenges to change-of-control transactions – particularly for going private transactions with controlling stockholders, which usually require boards to be able to prove the “entire fairness” of the transaction. This week, in an important decision that may reach the Delaware Supreme Court, In re MFW Shareholders Litigation, the Delaware Court of Chancery again affirmed the importance of special committees in those circumstances, and offered a road map to companies and controlling stockholders on how to structure going private transactions.

Nearly two decades ago, in Kahn v. Lynch, the Delaware Supreme Court held that where (1) a special committee of independent directors or (2) a majority of the non-controlling stockholders approves a merger with a controlling stockholder, it shifts the burden of proving the entire fairness of the transaction from the defendants to the stockholder challenging the transaction. Last year, in Americas Mining Corp. v. Theriault, the Delaware Supreme Court reiterated that the use of a properly functioning special committee of independent directors is an integral part of the best practices that are used to establish the entire fairness of a merger with a controlling stockholder. READ MORE →