• Dissident Shareholder Nominee Compensatory Arrangements; Bylaw Amendments
  • May 31, 2013
  • Law Firm: Jones Walker LLP - New Orleans Office
  • The recent rise in shareholder activism has created unique and potentially conflicting compensatory arrangements between dissident shareholders and their board nominees. As hedge funds and other third parties seek greater returns for investors, they are, in some cases, dangling compensation packages before their opposition nominees, promising to pay director candidates retainer fees and performance bonuses upon achievement of certain objectives by a company. These objectives may include the sale of a company at a specific price or increased profitability. For example, activists grant nominees an option to buy stock at a certain price in the event of a change in control of a company, i.e, a sale. Other schemes include a base retainer fee in exchange for agreeing to serve as a nominee, in addition to bonuses tied to a company's financial performance. In one case, a fund paid each of its nominees an initial retainer fee of $50,000, plus 2.6 percent of the fund’s net profit resulting from the company’s stock price increase if the director was elected and 1.8 percent even if he was not elected.

    Incumbent boards argue that dissident director-nominees would, with respect to at least certain board decisions, be conflicted, and place the hedge fund's or his or her personal interests ahead of a company's. With respect to financial institutions, the Office of the Comptroller of the Currency has stated that "a conflict of interest can also exist if a director or officer has such a substantial interest outside of the bank that it could reasonably affect his or her judgment with respect to the bank's business. Such a conflict of interest may arise out of one's personal business interests and/or in connection with transactions that benefit friends, relatives or business associates."

    Companies argue further that such arrangements encourage hedge fund nominees to favor short-term performance relative to their personal compensation goals at the expense of balanced, long-term growth alternatives. Activist funds argue that, once a nominee is elected, the funds will no longer exert control over nominees' day to day decision-making, and that special pay incentives align activist nominees' interests with company performance.

    In response to these pay packages, noted commentators and practitioners have proposed bylaw amendments prohibiting activists from compensating director nominees. The form of bylaw proposal goes to director qualifications that would prevent a nominee from serving on the board if he or she is a party to a compensatory arrangement, except an arrangement with a company, in connection with board candidacy or service, other than indemnification and reimbursement for out-of-pocket expenses or as part of any pre-existing employment agreement a candidate has with his or her employer.