The controversy over the future of director nominee compensation, a central feature of the 2013 proxy battle between JANA Partners LLC and Agrium Inc., may be boiling down to a disclosure issue.
corJANA, a U.S. activist hedge fund represented by Berl Nadler of Davies Ward Phillips & Vineberg LLP’s Toronto office, sought to elect five of its nominees to potash giant Agrium’s 12-person board. JANA’s intention was to influence what it saw as a poor corporate strategy. Most significantly, JANA objected to the retention of Agrium’s retail and wholesale divisions under the same corporate umbrella. It argued the company’s share price didn’t adequately reflect the value of the retail business.
Accordingly, JANA wanted Agrium to sell the retail division but worried the board lacked the necessary retail experience. As such, JANA recruited three nominees with the perceived experience and two other high-profile candidates. By way of inducement, JANA offered an upfront cash payment to cover their time and efforts. JANA also offered further compensation based on a percentage of the net profits it might earn on the sale of its Agrium shares. If JANA didn’t sell the shares within three years, it would pay the percentage compensation as if it had done so.
Agrium objected to the payments, labelling them a “golden leash” that made it impossible for JANA’s nominees to be independent as they were effectively its employees.
“We believed and still believe that nominee compensation is inappropriate,” says Walied Soliman, a partner at Norton Rose Fulbright Canada LLP’s Toronto office who acted for Agrium.
“It’s particularly inappropriate if the payments are aimed at achieving a stakeholder’s objective while the nominees, if elected, will be exercising their duties in a fiduciary capacity.”
Still, Soliman concedes it would be difficult to convince a court that such payments were illegal.
“I don’t think a court would give you that up front,” he says. “But I do think that courts would be more open to questioning subsequent board decisions where a golden leash is in place.”
However that may be, Agrium’s position garnered considerable support in the institutional and government community. But Nadler says it was the structured nature of the compensation rather than the argument about the lack of independence that attracted the support.
“What resonated was the argument that the nominees had personal incentives to take short-term action rather than acting in the long-term best interests of the company,” he says.
“Had JANA’s nominees received shares instead of cash, that perception might not have been as intense.”
As it turns out, Glass Lewis & Co. and Institutional Shareholder Services Inc., the leading shareholder advisory firms, didn’t see eye-to-eye on the issue. Glass Lewis saw the payments as compromising the nominees’ independence and as giving rise to a potential conflict because the arrangements were short-term. Institutional Shareholder Services saw no adverse impact on independence, didn’t comment on the conflict issues, and endorsed two JANA nominees.
The short-term versus long-term debate is hardly new. On one side are those who argue directors, as the corporation’s stewards, must take the long view, especially in the face of opportunistic unsolicited bids or shareholder efforts to focus on short-term returns. Others argue shareholders have the right to deal with their shares as they please, including standing up to boards that encumber these rights by invoking fiduciary duties.
Still, at least 25 American companies have adopted the so-called Lipton bylaw that disqualifies director nominees who receive compensation from any source but the company.
But Nadler maintains the Lipton bylaw goes too far.
“Most criticism of golden-leash arrangements has focused on the terms of the compensation, not the principle of compensating shareholder nominees,” he says.
“And recent experience suggests that efforts by boards to prohibit the practice entirely are likely to meet resistance.”
Indeed, after Provident Financial Holdings Inc., a U.S.-based bank holding company, passed what was essentially a Lipton bylaw, Institutional Shareholder Services recommended shareholders at the November 2013 annual meeting withhold votes from three directors who had approved the provision.
Institutional Shareholder Services’ reasons for opposing the bylaw include concerns about the virtually absolute prohibition on compensation; its deterrent effect on efforts to seek board representation by way of a proxy contest; the possibility of excluding highly qualified individuals as nominees, something that serves to entrench the existing board; and the absence of a shareholder vote.
The Provident board survived the uncontested vote. But following the meeting, Provident disclosed that more than 30 per cent of the votes cast were withheld from the three directors.
“The withhold vote was far in excess of that seen in prior Provident shareholder votes,” says Nadler.
Despite the criticism of nominee compensation, Nadler believes the Provident case provides a cautionary note.
“Any efforts by boards to prohibit the practice outright could reasonably be expected to be resisted by both proxy advisers and shareholders and to result in votes withheld in respect of the election of incumbent directors who support such measures,” he says.
For his part, Soliman doesn’t expect to see many more forays by activists into the golden-leash arena.
“The institutional shareholder community came out pretty strongly against JANA on this point,” he says.
Nadler agrees that JANA’s failure to elect any directors to Agrium’s board may have a “chilling effect” but believes disclosure rules for compensated nominees would help deal with the problem.
“Shareholders should be given the opportunity to decide who they want as directors,” he says. “So a bylaw prohibiting compensation is a bad idea, but requiring disclosure is a good one.”