By-laws counteracting “Golden Leash” arrangements: ISS speaks

On January 13, 2014, Institutional Shareholder Services Inc. (“ISS”) issued FAQs explaining its views on by-laws designed to prohibit so-called “Golden Leash” arrangements. As discussed in our post last month, such arrangements arise when a shareholder activist privately offers to compensate its nominee directors in connection with such nominees’ service as a director of the target corporation.

ISS’ view is that, absent a shareholder vote, a by-law precluding a nominee director from being compensated by a third party “may be considered a material failure of governance”. Consequently, in such circumstances, ISS may “recommend a vote against or withhold from director nominees for material failures of governance, stewardship, risk oversight, or fiduciary responsibilities.”

ISS takes no issue with a by-law precluding a director nominee for failing to disclose a third-party compensatory arrangement. ISS’ view is that such by-laws promote transparency and better-informed voting decisions.

ISS’ rationale appears to be that a by-law should not infringe on a shareholder’s fundamental right to vote for an otherwise qualified director without a compelling reason. Recently, after Provident Financial Holdings, Inc. (a U.S. bank holding company) enacted a by-law prohibiting nominee directors from receiving third-party compensation without seeking shareholder approval, ISS recommended that Provident’s shareholders withhold their vote for the incumbent directors that were up for election at Provident’s annual meeting (and who earlier in the year had approved the amendment to the Provident by-law prohibiting such third-party compensation).

Even where a by-law is put to a shareholder vote, ISS will apply a “case-by-case analytical framework”, taking into consideration the board’s rationale for adopting the by-law, whether the by-law materially impairs or improves shareholder rights, and “any market-specific practices or views on the underlying issue.”

ISS’ FAQ is also significant for what it does not say. ISS has not drawn a bright line on the appropriateness of third-party compensation for nominee directors provided such arrangements are disclosed. Therefore, in a proxy battle involving “Golden Leashes”, ISS will likely apply a “case-by-case analytical framework” to assess whether a third-party compensation arrangement poses any risk to “governance, stewardship, risk oversight, or fiduciary responsibilities.”

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