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:
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.
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).
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.
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).
Today I have a grab bag of short topics for you, each worth mentioning but none are really long enough for their own blog.
The Most Ridiculous Section 162(m) Lawsuit Ever Last year, a Delaware federal court ruled in favor of a company that was the subject of lawsuit alleging that their incentive plan had not been properly approved by shareholders for Section 162(m) purposes. The plaintiff argued that because Section 162(m) requires the plan to be approved by the company’s shareholders, all shareholders–even those holding non-voting shares–should have been allowed to vote on it. Shareholder votes are governed by state law but the plaintiff attorney argued that the tax code preempted state law on this matter. Luckily the judge did not agree.
The plaintiff also argued that the company’s board violated their fiduciary duties because they used discretion to reduce the payments made pursuant to awards allowed under the plan. The plaintiff stipulated that this violates the Section 162(m) requirement that payments be based solely on objective factors. In a suit like this, the plaintiff attorney represents a shareholder of the company; it seems surprising that a shareholder would be upset about award payments being reduced–go figure. In any event, it’s fairly well established that negative discretion is permissible under Section 162(m) and the judge dismissed this claim.
Glass Lewis Policy Update Glass Lewis has posted their updated policy for 2014. For US companies, the policy was updated to discuss hedging by execs (spoiler alert: Glass Lewis doesn’t like it) and pledging (they could go either way on this). With respect to pledging, Glass Lewis identifies 12–count ’em, that’s 12–different factors they will consider when evaluating pledging by execs.
The policy was also updated to discuss the SEC’s new rules related to director independence and how the new rules impact Glass Lewis’s analysis in this area. Although we now have three perfectly good standards for director independence (Section 16, Section 162(m), and the NYSE/NASDAQ listing standards), Glass Lewis has developed their own standards and they’re sticking to ’em. I’m sure I’ve asked this before, but really, how many different standards for independence do we need? I’m not sure director independence is the problem here.
Should Your Plan Limit Awards to Directors? As you are getting this year’s stock plan proposal ready for a shareholder vote, one thing to consider is whether to include a limit on awards to directors. In 2012, a court refused to dismiss one of the plaintiff’s claims in Seinfeld v. Slager because the plan did not place sufficient limits on the grants directors could make to themselves and, thus, were not disinterested in administration of the plan, at least with respect to their own grants.
A little blurb in the Wall Street Journal blog caught my eye this week. As it turned out, daily deal website Groupon had to rescind a portion of a restricted stock unit award to its Chief Operating Officer because the award exceeded a plan limit on share issuances to an individual – by 200,000 shares. I’ll cover the topic and the associated lesson that we need to reconcile, reconcile, reconcile awards and grants against all of the limits established in a plan.
What Happened?
In January 2013, Groupon’s COO was granted 1.2 million shares under a restricted stock unit award. From their own account in an 8-K filed with the SEC, the award exceeded a then-in-place 1 million share calendar year per person limit on awards – meaning the COO’s award exceeded that limit by 200,000 shares. It appears the error was not detected until a deep dive into the plans was done in conjunction with shareholder litigation. As a result of the discovery, Groupon rescinded the portion of the grant that exceeded the limit – 200,000 shares. This occurred just days before a portion of the award was scheduled to vest.
The Good News
The good news is that the error was detected in advance of shares vesting/sold. Had the shares vested and subsequently been sold, this would have made the situation more complicated to rectify. Even if not sold, had taxes been collected and the error gone unnoticed, the correction of the tax withholding could have gotten very complicated. Aside from the fact that the error was caught in advance of the vesting date, I can’t really think of any more “good news” in this situation.
The Bad News
This leaves me wondering how the error – for such a sizable, high profile grant – was not detected earlier. It seems to have gone unnoticed during quarter close and other periods where reconciliation seems to be likely. In fact, it appears that nearly a year went by without a blip on the stock plan radar. In addition, the correction involved public disclosure – another negative in this situation.
What Did We Learn?
Anytime there’s a negative involving errors and public announcements, I think it’s a prime opportunity for us to seek the lesson to be learned. In this case, this is a solid reminder that reconciliations need to extend beyond overall plan balances. It’s not enough to stop your analysis at the overall outstanding plan balance at the end of the quarter (which usually reflects beginning balance, plus any shares returned to the plan and minus any issuances). If your plan has internal limits on share types, maximum shares per award, or overall grants within a period of time, these parameters must be audited regularly. Examples of common limits within stock plans may include:
Limit on shares granted per award type: for example, no more than 3 million shares may be granted as restricted stock awards/units.
Limit on shares granted per option/award: for example, a grant to any individual cannot exceed 1 million shares.
Limit on shares granted within a specific window of time: for example, no more than 2 million shares in a calendar year.
If you have any of these types of share limits within your plans, you’ll want to ensure you are comparing grant and award activity to these limits. Ideally, this should initially be done at grant, and then double checked during the monthly or quarterly reconciliation process that follows. Year-to-date reconciliations should always be performed with each reconciliation process – in addition to the current month or quarter’s activity.
Groupon is probably not thrilled to publicly correct an award. However, the silver lining is the message in this for all of us – that monitoring plan share limits regularly and consistently is important. If you haven’t performed these reconciliations for 2013, you may want to do so now. Correcting errors that cross calendar years can often be tricky – or sometimes impossible, especially if a disposition of the shares is involved.