NASDAQ Proposes Golden Leash Disclosure Rule
Originally appeared in Kaye Scholer's Spring 2016 M&A and Corporate Governance Newsletter.
—by Michael Isaacs
The debate over “golden leash” arrangements—payment agreements made between stockholders and their director nominees, often in connection with shareholder activism—recently ramped up when NASDAQ proposed a change to its Listing Rules. The proposed change, published on January 28, 2016, would require NASDAQ-listed companies to publicly disclose golden leash arrangements (the Proposed Disclosure Rule).
Golden leash arrangements provide compensation in exchange for a director’s service on, or candidacy for, a company’s board of directors. In a typical arrangement, this compensation would be paid directly by a sponsor activist and would be tied to the company’s stock performance.
Activist stockholders claim that these arrangements are necessary to recruit qualified candidates for board service and to provide appropriate compensation for director nominees. Conversely, companies argue that any incentive compensation directly from a stockholder may lead to conflicts of interest among directors through the establishment of a two-tiered compensation structure for the board. While some directors would be compensated with the typical retainer and expense reimbursement, others would have incentive-based compensation tied to the company’s stock performance. Additionally, companies argue that the fostering of any continued allegiances between directors and sponsoring activist stockholders casts doubt on the fulfilment of directors’ fiduciary duties. For example, the arrangement may engender a short-term focus, consistent with the activist’s goals, at the expense of long-term value creation for all stockholders.
Companies initially tried addressing golden leash arrangements through bylaw amendments, which prohibited individuals from serving as directors if the individuals received compensation related to candidacy or service from third parties. ISS viewed this type of bylaw as a governance failure, and recommended that shareholders withhold their votes from some companies that had adopted them. Similarly, Glass Lewis recommended that shareholders vote against members of the corporate governance committees of such companies. In light of this backlash, some companies adopted a weaker form of bylaw amendment, which required disclosure of such golden leash compensation arrangements as part of the director-qualification process. ISS will consider these bylaws on a case-by-case basis, but generally does not view them as a governance failure.
The Proposed Disclosure Rule
The Proposed Disclosure Rule would require the disclosure, subject to exceptions, of “all agreements and arrangements between:
(i) any director or nominee for director, and
(ii) any person or entity other than the Company, which provide for compensation or other payment in connection with such person’s candidacy or service as a director of
the Company.” A company will not be considered to have violated this rule if it has undertaken reasonable efforts to identify all such agreements or arrangements.
Based on publicly available statements from NASDAQ, the Securities and Exchange Commission (SEC) rejected the Proposed Disclosure Rule on technical grounds. NASDAQ intends to submit a new proposed rule that is substantively similar to the Proposed Disclosure Rule, but which remedies the technical deficiencies. Assuming that the technical deficiencies are remedied, the new proposed rule will be published in the Federal Register. Comments will be solicited for some period of time following publication, and the SEC will approve, disapprove or institute proceedings within 45 days of publication of the new proposed rule, subject to certain exceptions for longer periods.
With the backdrop of the Proposed Disclosure Rule, on February 18, 2016, NASDAQ distributed a survey questionnaire (closes March 18, 2016) seeking opinions on whether it would be appropriate for further restrictions on directors with golden leash arrangements. The first question of the survey is foreboding: “[Should NASDAQ] adopt a listing standard to prohibit directors from serving on boards if they receive compensation from third parties for board service.” In the unlikely event such a rule was adopted, it would have a significantly greater impact on golden leash arrangements than the Proposed Disclosure Rule. Other questions appear to fall somewhere in the middle by postulating a situation where directors who receive third-party payments would not be considered independent directors.
While it is too early to draw conclusions about the ultimate terms of any final rule, the Proposed Disclosure Rule and NASDAQ’s survey provide some important insights into NASDAQ’s current thinking about golden leash arrangements.