The NASPP Blog

Does your company issue grants to outside directors out of the same plan that you issue grants to executives and other employees?  If do you, does the plan expressly limit the number of shares that can be granted to directors over a specified period of time?

If it doesn’t, you aren’t alone.  According to the NASPP/Deloitte Consulting 2014 Domestic Stock Plan Administration Survey, 77% of respondents’ plans don’t include a limit on grants to outside directors. But a recent spate of litigation, including a lawsuit that Facebook recently agreed to settle, suggest that maybe companies should rethink this practice.

What Litigation?

The lawsuits cover a range of issues related to stock and executive compensation. Some suits allege excessive compensation and some allege deficiencies over stock plan disclosures or proxy disclosures. In addition to Facebook, companies that have been targeted in these suits include Republic Services, Citrix Systems, Goldman Sachs, Cheniere Energy, and Unilife.  One common denominator in all of these suits, however, is that the plaintiffs allege that because the company’s outside directors can receive unlimited awards under the plans, they aren’t disinterested administrators of the plan.

Why Is Disinterested Administration Important to these Lawsuits?

These lawsuits are all “derivative” actions (which are lawsuits brought by a shareholder on behalf of the corporation, usually alleging that management is doing something that is to the detriment of the corporation).  In a derivative lawsuit, the plaintiff has to meet a “demand” requirement for the suit to proceed.  Demand means that the plaintiff asked the company to investigate the matter and the company either refused to investigate or the shareholder doesn’t agree with the outcome of the investigation.  In a lot of cases, these suits never get past the demand stage.

But, there is an exception to the demand requirement in lawsuits over stock compensation plans. Can you guess what it is?  Yep, that’s right, the demand requirement is excused if a majority of the directors administering the plan lack independence. Plaintiffs are claiming that directors who can receive unlimited awards under a plan aren’t disinterested.

What Happened with Facebook?

Well, first of all, once a suit gets past the demand stage, it gets expensive. So the first thing is that Facebook had to spend a bunch of money on their own lawyers.  That, in and of itself, is reason enough to want to keep any of these suits from getting past the demand stage.

The settlement Facebook agreed to includes the following provisions:

1. Corporate governance reforms, including (A) an annual review of all compensation (cash and equity) paid to outside directors, (B) engage a compensation consultant to advise the company on this review and on future compensation to be paid to outside directors, and (C) use the results of the review to make recommendations to the board on future compensation to outside directors.
2. Submit the 2013 grants to outside directors to shareholder vote (these grants were the subject of the lawsuit). Hopefully the shareholders approve them–I’m not sure what happens if they don’t (but I’m pretty sure it would make a good blog entry).
3. Submit an annual compensation program for directors to shareholders for approval. The program has to include specific amounts for equity grants and has to delineate annual retainer fees. As far as I can tell, this is a one-time requirement, for Facebook’s 2016 meeting; if I understand the settlement correctly, the board is allowed to make changes to the program in the future, commensurate with the results of the annual review required under #1 above.
4. Pay an award of attorneys’ fees and expenses to plaintiff’s counsel not to exceed $525,000 (this is, of course, in addition to whatever Facebook has paid to its own counsel).

A Simple Fix

The simple fix to avoid all of this is to have a limit on the awards that can be issued to outside directors in your plan.  If your company is submitting a stock plan to shareholder vote this year, it is worth considering adding a limit like this to your plan.

Thanks to Mike Melbinger of Winston & Strawn for providing a handy summary of the Facebook settlement, as well as a number of the other lawsuits, in his blog on CompensationStandards.com (see “Follow-Up on Facebook Litigation Settlement,” January 29, 2016).

– Barbara