The rise in shareholder activism has resulted in the addition of a significant number of new directors to public company boards who receive, in addition to the public company’s standard director compensation, additional compensation from the activist shareholder who sponsored their appointment to the board. In response to recent concerns relating to the potential conflicts presented by such compensation and the lack of relevant disclosure, Nasdaq recently implemented a new rule requiring disclosure of these “golden leash” arrangements for companies with securities listed on Nasdaq. Effective August 1, 2016, each Nasdaq-listed company is required by Rule 5250(b)(3) to disclose annually, in its proxy or information statement in connection with its next shareholders meeting at which directors are elected or on its website, all compensation or other payments by third parties to any nominee or director in connection with their candidacy for or service on the company’s board of directors.
Purpose of New Disclosure Requirement
Nasdaq believes that it has identified an area where investors may not have complete or timely information. Golden leash arrangements generally involve an activist shareholder and may include compensating directors based on achieving certain benchmarks, such as an increase in share price over a fixed term. Nasdaq states in an issuer alert that these undisclosed compensation arrangements potentially raise several concerns, including that they may lead to conflicts of interest among directors and call into question the directors’ ability to satisfy their fiduciary duties. These arrangements may also tend to promote a focus on short-term results at the expense of long-term value creation. Nasdaq believes that enhancing transparency around third party board compensation would help address these concerns and would benefit investors by making available information potentially relevant to investment and voting decisions.
As a condition of continued Nasdaq listing, the company must disclose, at a minimum, the names of the director or nominee and the third party, as well as the material terms of the compensation arrangement relating to the person’s candidacy or service as a director. The Nasdaq’s related interpretive material and SEC submissions indicate that the disclosure requirement is intended to be construed broadly to include agreements and arrangements that provide for non-cash compensation and other payment obligations, such as health insurance premiums or indemnification, made in connection with a person’s candidacy or service as a director. The disclosure requirements of the new rule, however, would not apply to agreements and arrangements that relate only to reimbursement of expenses incurred in connection with candidacy as a director, whether or not such reimbursement arrangement has been publicly disclosed.
Agreements or arrangements that existed before a nominee’s candidacy (such as in connection with their employment with the third party) need not be separately disclosed if the nominee’s relationship with the third party has been otherwise publicly disclosed, such as in the nominee’s biography in the proxy statement. But if the director’s or nominee’s remuneration is materially increased in connection with their candidacy or service, disclosure of the difference between the new and the previous level of compensation is required.
The disclosure requirement will not apply in any year in which disclosure of the agreement or arrangement is otherwise made in a proxy statement under Item 5(b) (relating to a contested election) or in Item 5.02(d) of a Form 8-K report disclosing a director’s addition to the board. Disclosure will be required in future years, however, as long as the agreement or arrangement remains in place and the director remains on the board.
Timing and Placement of the Disclosure
The required disclosure must be made no later than the date on which the company files or furnishes a proxy or information statement in connection with its next shareholders meeting at which directors are elected. The company must make this disclosure at least annually until the earlier of the resignation of the director or one year following the termination of the agreement or arrangement.
The company may include the disclosure in its proxy or information statement or may make this disclosure on its website or by hyperlinking to another website, which must be continuously accessible. If the linked website subsequently becomes inaccessible or the hyperlink becomes inoperable, the company must promptly restore it or disclose a plan to regain compliance. If the company does not file proxy or information statements, it may include the disclosure in its next Form 10-K or Form 20-F.
Relief for Certain Omissions
Recognizing that a company, despite reasonable efforts, may not be able to identify all such agreements and arrangements, the rule provides that a company will not be considered deficient if (i) it has undertaken reasonable efforts to identify all such agreements and arrangements, including by asking each director or nominee in a manner designed to allow timely disclosure, and (ii) upon discovery of a previously undisclosed arrangement, promptly makes the required disclosure by filing a Form 8-K or issuing a press release. In all other cases, if the company is deficient, it must submit a plan within 45 days that is sufficient to satisfy Nasdaq staff that the company has adopted processes and procedures designed to identify and disclose relevant agreements and arrangements in the future. If the company does not do so, Nasdaq could issue a delisting determination.
Additional Changes Ahead?
Footnote 12 of Nasdaq’s final amended rule notice indicates that Nasdaq is surveying interested parties as to whether it should propose additional requirements surrounding directors and candidates that receive third party payments, including whether such directors should be prohibited from being considered and “Independent Director” under Nasdaq rules or prohibited from serving on the board altogether. In this regard, Nasdaq noted that Rule 5605(a)(2) already excludes from the definition of Independent Director any “individual having a relationship which, in the opinion of the Company's board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.” If Nasdaq does determine to propose additional rules, any proposal would be subject to a separate rule filing. But the footnote seems to make clear that Nasdaq is seriously considering whether a director who is party to such an arrangement should be disqualified from independence under its listing standards.
What Should We Do Now?
Nasdaq-listed company boards should be apprised of the new disclosure requirement and alerted that the company will be asking directors for this information in connection with the next proxy or information statement for the election of directors. Companies should review their annual meeting director and officer questionnaire to ensure that it will elicit information with respect to such agreements or arrangements with third parties and modify the questionnaire as needed. Companies should also consider whether their advance notice bylaw and corporate governance guidelines should be modified to elicit the necessary information from nominees proposed by shareholders.
If a company determines that it must provide the new disclosures, it should consider whether it is preferable to include the disclosure in its proxy or information statement or to add the required information to its website. If the website option is chosen and the company elects to hyperlink to another website, it should periodically test the hyperlink to ensure it remains active and accessible.