Usha Rodriques reports that:
From yesterday's Deal Professor comes Steven Davidoff on the "newest trend in activist investing": hedge funds incentivizing their directors by paying them extra if they win a seat and the company takes off. For example, Elliott Management has nominated 5 directors for the Hess Corporation. If any win a seat and Hess stock outperforms a peer group, the directors could make $9 million over 3 years. Jana Partners is offering its nominees a similar deal for serving on Agrium's board, again for a potential of millions if it profits. Plus both funds offer a $50,000 retainer, over and above whatever the directors collect from the companies themselves, likely a six-figure director fee.
Usha doesn't address how taking such third party payments could possibly be consistent with the directors' fiduciary duties to the corporation on whose board they serve. Davidoff thinks that "as long as the arrangement is disclosed and the hedge funds don’t exert any future control over the nominees, it is unlikely that this violates any state or federal law." Clearly, as discussed below, such third party payments create a serious conflict of interest for the directors in question. Maybe you can argue that the shareholder vote electing them to the board cures that conflict (at least if the directors in question receive the affirmative vote of a majority of the disinterested shares,as to which see Portnoy v. Cryo-Cell Intern., Inc. 940 A.2d 43 (Del.Ch.2008) (holding that, under Delaware's corporate election law, ratification has to be accomplished by a vote of the disinterested shares; that is, even if one assumes that the election of the nominee on the management slate by the electorate is a ratification of that nominee's placement on that slate by way of the agreement under challenge, the nominee would have to win a majority of the shares not subject to the agreement)).
But I'm not convinced a generic vote to elect directors ratifies this sort of conflict of interest. Delaware law on conflicted interest transactions, after all, talks about disinterested shareholder approval of "a transaction," which I would understand to mean a specific vote on the specific conflicted transaction. Cf. Restatement (Third) of Agency sec. 8.06, which provides in pertinent part that "the principal's consent concerns either a specific act or transaction, or acts or transactions of a specified type that could reasonably be expected to occur in the ordinary course of the agency relationship." To be sure, directors are not agents, but their fiduciary duties are quite similar.
Finally, given that:
Corporate officers and directors are not permitted to use their position of trust and confidence to further their private interests. While technically not trustees, they stand in a fiduciary relation to the corporation and its stockholders. A public policy, existing through the years, and derived from a profound knowledge of human characteristics and motives, has established a rule that demands of a corporate officer or director, peremptorily and inexorably, the most scrupulous observance of his duty .... The rule that requires an undivided and unselfish loyalty to the corporation demands that there shall be no conflict between duty and self-interest. [Guth v. Loft, Inc., 5 A.2d 503, 510 (Del. Ch. 1939)]
It seems to me that the burden ought to be on proponents of such arrangements to come up with a clear and convincing explanaton of why they're legal.
Even if these arrangements are legally valid, I thinkthey are a terrible idea. Davidoff notes two common arguments made against them:
The first is that the hedge fund directors are not independent. Because the directors are being paid by the hedge fund, they will be loyal to the hedge fund, rather than the company.
The second is that by paying these directors large sums over three years, the hedge fund nominees will aim for short-term performance and not care what happens to the company in the longer term.
They both strike me as eminently sensible. In addition, as he also notes:
There is no doubt that this kind of pay arrangement sets up two classes of directors doing the same job but being paid very different amounts. It could not only create resentment, but disagreement over the path of the company. And it also has the potential to begin a second arms race in director compensation, something probably best avoided.
If this nonsense is not illegal, it ought to be.
