On July 1, 2016, the Securities and Exchange Commission (the “SEC”) approved, on an accelerated basis, proposed amendments to the listing rules of The Nasdaq Stock Market LLC (“Nasdaq”) to require Nasdaq-listed companies to disclose annually any “compensation” or “other payment” provided by third parties to directors or director-nominees in connection with their candidacy or service on the company’s board of directors. These arrangements are referred to as “golden leash” arrangements and commonly occur when an activist stockholder compensates its nominee for service on the company’s board of directors based on achieving certain criteria that are important to the activist stockholder. The new rule, Nasdaq Rule 5250(b)(3) (the “Rule”), became effective July 31, 2016.
What is the Purpose of the Rule?
Although the SEC acknowledged that there may be overlap between the Rule and existing compensation disclosure requirements, the purpose of the Rule is to provide further transparency on director compensation and reveal potential conflicts of interest on the board from golden leash arrangements that may encourage a director to value short-term results at the expense of long-term value creation. Some of these arrangements would not otherwise be captured by existing compensation disclosure requirements.
For example, Item 402(k) of Regulation S-K (“Item 402(k)”) only requires disclosure of compensation paid to a director for “services rendered” to the company. If a golden leash arrangement provides that a director will be paid upon the achievement of certain company or stock performance criteria, that is not necessarily “services rendered” to the company and may not be compensation that is required to be disclosed under Item 402(k). The Rule, however, requires disclosure of all such compensation agreements and arrangements, regardless of whether it is for “services rendered” or for any other purpose. Furthermore, whereas Item 402 of Regulation S-K (“Item 402”) only requires disclosure of compensation that is actually paid during the fiscal year, the Rule requires the annual disclosure of the material terms of any compensation agreements and arrangements, regardless of whether or not such compensation is actually paid to the directors or director nominees during the particular year. The Rule requires disclosure of the mere existence of these golden leash arrangements.
When is the Disclosure Required?
The Rule requires initial disclosure in annual meeting proxy materials filed with the SEC after July 31, 2016. Thereafter, in the event any disclosure is included in such proxy materials, the disclosure must be made annually until the resignation of the applicable director or one year following the termination of the golden leash arrangement, whichever occurs first.
Which Companies are subject to the Rule?
All Nasdaq-listed companies must disclose the material terms of all golden leash arrangements, subject to a few exceptions described below, on or though the company’s website (which must be continuously available) or in the definitive proxy statement or information statement filed by the company with the SEC. Alternatively, if a company does not file a proxy statement or information statement, the disclosure should be made in its Form 10-K or 20-F.
It is important to note that Nasdaq broadly defines “compensation” and “other payment” to include cash compensation as well as non-cash compensation and other payment obligations or incentives, such as health insurance premiums or indemnification, that are provided to the director in connection with his or her candidacy or service on the company’s board of directors. This broad definition could pick up many types of compensation received by directors and director nominees which are not currently disclosable under Item 402. For example, disclosure under the Rule might be required for a private equity sponsor which provides indemnification to its partners and employees who serve on the boards of its Nasdaq-listed portfolio companies.
Are there any Exceptions to the Rule?
Yes, the Rule does not require disclosure of the following types of agreements and arrangements:
- Those that that relate only to reimbursement of expenses in connection with candidacy as a director (whether or not such reimbursement has been previously disclosed);
- Those that existed prior to the director-nominee’s candidacy (including as an employee of the person or entity providing the compensation) if that director-nominee’s relationship with the third party has been publicly disclosed in a definitive proxy statement or annual report (i.e., if the director-nominee was an employee of the third party and such information is included in the director-nominee’s biography); or
- Those that have been disclosed in the current fiscal year under Item 5(b) of Schedule 14A of the Securities Exchange Act of 1934 (relating to proxy contests) or those entered into in the current fiscal year that have been disclosed under Item 5.02 of Form 8-K in the current fiscal year, which requires a brief description of any arrangement or understanding between the new director and any other person, pursuant to which such director was selected as a director. Notwithstanding the foregoing exception under this item 3, such agreements or arrangements would be subject to the continuous disclosure requirements on an annual basis until the earlier of the resignation of the director or one year following the termination of the agreement or arrangement.
Furthermore, a foreign private issuer may abide by its home country practice with respect to disclosing third party payments to directors, subject to satisfying certain conditions under Nasdaq Rule 5615(a). To meet the conditions of Nasdaq Rule 5615, among other things, a foreign private issuer would be required to submit to Nasdaq a written statement from an independent counsel in its home country certifying that the company’s practices are not prohibited by the home country’s laws.
Is it Possible to Remediate Deficiencies?
The Rule leaves some room for unintentional error. If the company discovers a golden leash agreement or arrangement that should have been disclosed, it must make the required disclosure by promptly filing a Form 8-K or Form 6-K (where required by the SEC rules) or issuing a press release. The company is not permitted to remediate the deficiency through its website. However, this is a remedial disclosure and the company must still satisfy its annual disclosure requirements in the future to remain compliant with the Rule.
The Rule also provides that a company will not be considered deficient if it has taken “reasonable efforts” to identify all relevant agreements and arrangements, including by asking each director or director-nominee in a manner designed to allow timely disclosure, and promptly making the required remedial disclosure if an undisclosed arrangement or agreement is discovered in the process. Therefore, companies should be sure to ask its directors and director nominees if any such arrangements exist on at least an annual basis. Please see below for potential questions to add to D&O questionnaires and/or which may be used as a D&O questionnaire supplement in the event D&O questionnaires for the next proxy statement have already been completed by directors.
If Nasdaq considers a company deficient in its compliance with the Rule, the company will have 45 calendar days to submit a remedial plan to the satisfaction of Nasdaq in order to regain compliance. If the company does not do so, Nasdaq could issue a delisting determination.
What Do I Need To Do Now?
Nasdaq-listed companies and their advisors should begin gathering the relevant information from directors and director-nominees in order to satisfy the Rule.
Below are some potential questions that companies may consider including in their D&O questionnaires (or in a supplement to previously completed D&O questionnaires) for each of their directors and director-nominees:
- Are there any agreements or arrangements (whether written or oral) between you and any person, company or other entity (other than the company) relating to compensation or other payment (including non-cash payment, such as health insurance premiums, indemnification agreements, etc. but not including expense reimbursement) in connection with your candidacy or service on the company’s board of directors?
- If yes, please identify the person, company or other entity and describe all material terms of the agreement or arrangement.