Publications & Resources

October/November 2007
Focus: Directors Issues

Corporate Governance Update for 2007

By Dave Muchnikoff and Craig M. Scheer

The conqueror, Frederick the Great, an outstanding military strategist, said “It is pardonable to be defeated, but never to be surprised.” This wisdom applies equally well in today's business world. Being a director or an executive officer of a public company has never been more challenging or time-consuming; however, by keeping on top of the latest developments in corporate governance, you can avoid serious missteps while navigating the minefield created by post-Sarbanes-Oxley reform initiatives. Here are some key practices to consider:

Equity Grant Procedures: Don’t invite scrutiny

With the recent stock option backdating scandals, there probably isn’t any other area currently receiving greater scrutiny than equity award grant practices. Suggestions to minimize the risk of improper grant dating or allegations of improper grant timing include:

If equity awards are made annually (or at some other regular intervals), consider specifying that awards will only be made on fixed, pre-set dates on which the board or compensation committee is already scheduled to meet. For new hire grants, also consider limiting these to set dates, such as the last business day of each month or each quarter. If grants are not typically made at any particular time of the year, consider limiting grant dates to open trading periods under the company’s insider trading policy.
Designate a compliance person to oversee the documentation, accounting and reporting of all equity grants.
If the compensation committee wishes to delegate its grant authority (e.g., to the CEO, for grants to new hires), do not permit grants under this delegation of authority to be made to directors or Section 16 officers (i.e., Form 4 filers). Make sure the delegation of authority is permitted under state law and the terms of the plan document.
Grants by the board or compensation committee should be made at meetings (in person or by telephone) and not by unanimous written consent. If a unanimous written consent must be used, it should be dated the date(s) on which the directors actually sign, not “as of” a particular date. “As of” dating tends to generate suspicions of backdating.

Majority Voting in Director Elections: Look before you leap

Most companies use a plurality standard; whoever receives the most votes is elected. Thus, if the board’s nominees are unopposed, they can be elected with just one vote. Critics say this makes director elections meaningless, absent a proxy contest. Under a majority standard, directors are not elected unless the number of votes cast for exceeds the number of votes withheld (or votes against). If not elected under a majority vote system, a director typically must offer his or her resignation to the board.

While an increasing number of companies (especially larger ones) have moved to a majority vote system, doing so has the potential to land you in a legal and practical mess. There are questions regarding the legality of the required resignations of directors who do not receive the requisite majority vote, although Delaware law was recently amended to permit resignations. The board may believe it would be in the company’s best interests for these individuals to remain on the board, but declining to accept their resignations and allowing them to stay on would likely anger shareholders. If these individuals are independent directors, their departure from the board could result in non-compliance with stock exchange listing standards.

The possibility of directors not being elected under a majority vote standard could become much greater if the proposed elimination (effective January 1, 2008) of broker voting discretion in uncontested director elections is approved by the SEC. Traditionally, brokers have voted discretionary shares overwhelmingly in favor of the board’s nominees in uncontested elections. The absence of this large favorable voting block could result in directors having a difficult time getting elected under a majority vote standard.

Under the SEC’s new e-proxy rules, companies and shareholders are now able to deliver proxy materials by posting them on a website and sending shareholders notice of the availability of the materials. This is expected to make it much easier and less expensive to run a proxy contest. This, coupled with recently proposed SEC rules that could require companies to include shareholders’ nominees in the company’s proxy statement, cuts against the notion that a majority vote standard is the only way to make director elections meaningful.

Board Self-Evaluations: Consider doing them even if not required

Even if your board is not required to perform a self-evaluation (they are only required for NYSE-listed companies), it should consider doing so. The basic idea is to assess how the board has actually been functioning compared to how it should be functioning, with the goal of enhancing the board’s future effectiveness. The biggest risk and most oft-stated reason for not performing a board self-evaluation is the possibility that damaging documents generated in the process will be discovered in litigation. Although real, this risk can be mitigated by limiting the retention of documents pursuant to a board-approved policy. If the evaluation process leads to significant improvements in the board’s performance, directors’ liability risk may actually decrease as a result.

CEO Succession Planning: Do it!

Even where the CEO is relatively young and retirement is not expected to occur until the distant future, the company needs to prepare itself for the possibility of a change in its top executive position, whether sudden or planned, by adopting a written policy. Investors often react negatively to news of a CEO’s departure, and the longer it takes for the board to find a suitable replacement the greater the level of uncertainty that will likely exist in the minds of shareholders and employees. Depending on the circumstances, a CEO’s departure can be an extremely distracting event for senior management and rank and file employees.

While not a cure-all for the many challenges you face, the above suggestions may help you avoid missteps in the current, post-Sarbanes environment.

Dave Muchnikoff and Craig M. Scheer are partners at Silver, Freedman & Taff, LLP in Washington, D.C. They specialize in securities and corporate transactions for financial institutions. They may be reached at 202-295-4500 or dmm@sftlaw.com and cscheer@sftlaw.com, respectively.