JW Verret has been considering whether state law-based defenses could be erected that would minimize the effect of the likely adoption by the SEC of a proxy access rule. In one post, he observed that:
Proxy access was one of the major corporate governance reforms included in the Dodd-Frank Act, and we can expect that Boards of Directors will be anxious to implement defenses against insurgent shareholder campaigns as a result. This paper considers what defenses would be strategically useful, and then analyzes whether they will survive review in Delaware, federal courts, the SEC and the stock exchanges. It follows my previous academic work and testimony on proxy access.
In my first post on this topic I mentioned the possibility of using lower poison pill triggers to prevent shareholders from obtaining a sufficient ownership stake to meet the minimum holding requirements to actually nominate candidates onto the corporate proxy. A second defense I want to mention could be even more powerful and is more likely to survive review in both Delaware and the federal courts.
The Delaware General Corporation Law gives the board and the shareholders the co-extensive authority to adopt bylaws setting the qualification requirements necessary to become a director. There is very little case law interpreting this provision, other than the general rule from Schnell v. Chris-Craft that powers granted to the corporation may not be used in an inequitable manner. Qualification requirements based on experience, education, and other background-like variables would likely survive scrutiny, particularly where they are adopted well in advance of a threatened proxy fight.
The key element in such a bylaw would be that the Board would serve as the ultimate interpreter of the provisions. For example, a qualification provision could require directors to have 20 years of experience at a comparable company in the same line of business.
I have a slightly different proposal, albeit one also based on board qualifications.
My friend Charles Elson has long advocated that directors should be paid in stock rather than cash. he has also advocated board qualification rules requiring that directors own a very substantial amount of stock in the corporation on whose board they serve. In a 2004 Wake Forest law review article, for example, Elson wrote that:
Commitment to the organization by a director is demonstrated in two respects-- time and ownership. The time requirement is obvious. The more time effectively devoted to one's directorship, the more complete a job one will do. Ownership, though, is particularly critical. The Council urged meaningful equity ownership by independent directors both in the form of direct stock purchases by directors and equity-based compensation. While director independence promotes objectivity, a requirement that board members maintain equity ownership in the corporation gives the directors an incentive to exercise their objectivity effectively. When management appoints the board of directors, and these directors have no stake in the corporate enterprise other than their board seats, the directors simply have no pecuniary incentive to actively monitor management. When directors shirk their duty to monitor management, stockholder interests are left unprotected. The most effective incentive for directors to address their responsibilities to the shareholders is to make them stockholders as well. By becoming equity holders, the outside directors assume a personal stake in the success or failure of the enterprise.
An ISS report further notes that Elson proposes a minimum of $100,000 stock ownership, while others support a similar figure:
How much director ownership is enough? The majority of director ownership requirements are expressed as a multiple of annual retainer, typically five times retainer to be acquired within five years of election to the board, though some guidelines may be expressed as a number of shares or a dollar amount of stock.[12] Among companies using the latter, median ownership requirements are 3,500 shares (where expressed as a number of shares) or $180,000 (where expressed as a dollar value). For Elson, the amount should be personally meaningful. "It ought to be enough so that if you lose it you get sick." His own rule is to buy $100,000 of company stock when he joins a board. Directors should also be discouraged from selling stock while on the board, which sends a bad signal to shareholders. Few companies, however, have stock retention policies for directors.
Requiring directors to invest, say, $250,000 in the company would shrink the pool of candidates able and willing to make use of the proxy access machinery. It also would align the interests of those who do get nominated and elected via proxy access with those of the shareholders as a whole.
