The Advisors' Blog

– Broc Romanek, CompensationStandards.com

Here’s something that Steven Seelig and Russ Hall of Towers Watson recently blogged:

A recent Delaware Chancery Court case (Seinfeld v. Slager) may provide the impetus for companies to refine the process by which independent directors set their own compensation. At issue in the case was whether the directors were protected under the “business judgment rule” from a potential self-dealing transaction in approving their own pay in accordance with a shareholder-approved stock plan that set upper limits on their compensation. The court recently refused to dismiss the plaintiff’s claim, finding that the shareholder-approved plan set compensation limits at such a high level that they were tantamount to the board being free to use its own discretion. Because no evidence was presented that the directors considered the grants entirely fair under the circumstances, the court permitted the case to move forward to determine whether the pay decision was in violation of the board’s fiduciary duties and constituted corporate waste.

The problem for the court was that, although the stock plan was approved by shareholders in accordance with Section 162(m), the plan put few, if any, limits on the board’s ability to set its own stock awards. The plan provided that the committee has the sole discretion to set compensation for the directors. Like many equity compensation plans, this plan provided upper limits on the number of shares granted to an eligible individual, but made no distinction between employees, officers or directors in applying these limits. Under the plan’s individual limits, theoretically each director could have been awarded restricted stock or stock units worth approximately $21.7 million each year. Even though the actual stock grant for the year was around $750,000 for each director, the court refused to dismiss the plaintiff’s claim, ruling that the stock plan lacked sufficient definition to afford protection under the business judgment rule due to the absence of a “meaningful limit” imposed by the shareholders.

Issues to Ponder

The court’s ruling did not provide any details on how the compensation committee arrived at its decision regarding its grant levels. This raises questions about whether the committee was advised by a compensation consultant who presented relevant market data to support the decision-making process or whether the committee documented any rationale for its decision in the minutes. Although there was no mention of such issues in the ruling, it’s possible they were not proffered simply because the defendant directors believed the case would be dismissed out of hand, as are many Delaware compensation-related claims. We will be interested to see whether the court’s ultimate ruling provides more information on these issues because prior Delaware cases have tended to set the bar fairly low for protection under the business judgment rule, typically holding that compensation committees need merely to have a rational basis for their pay decisions. We would hope that having a qualified expert advise the compensation committee on appropriate director pay levels would help meet this standard.

But would such actions have been enough in this case, given a rather open-ended, shareholder-approved plan? That’s not clear. The court was unwilling at this stage to describe any bright-line standard, noting that the sufficiency of plan provisions to provide potential protection under the business judgment rule “exists on a continuum.”

Among the questions this case raises are the following:

– Should companies consider drafting equity plans that set a separate “meaningful” maximum for director compensation levels when having their stock plan approved by shareholders?
– Should companies be more restrictive and provide for director compensation to be based on specific guidelines or criteria?
– Would the addition of a plan provision stating that the form and amount of director compensation should be set with respect to relevant market norms and/or appropriate for the time and energy required of directors be helpful in defending similar suits?
– Are any of these plan restrictions necessary if the board obtains and follows the advice of compensation advisers?

Assuming the Seinfeld case is not settled before the court renders its decision on the merits, the ruling could provide additional guidance on such issues. We’ll keep you posted on the litigation’s progress.