Delaware Court Provides Further Guidance on Stockholder Challenges to Director Compensation
June 4, 2019
On May 31, 2019, Vice Chancellor Sam Glasscock of the Delaware Court of Chancery issued a decision refusing to dismiss a stockholder's fiduciary duty claims challenging the compensation of Goldman Sachs' board of directors.1 The case highlights the type of claim potentially available to stockholders in challenging board (and sometimes executive) compensation, and it provides important guidance for boards when considering the possibility of such a challenge. The decision also reflects the relative uptick we have seen in demands and challenges from stockholders and plaintiffs' attorneys relating to board compensation.
The Goldman Sachs decision builds on the Delaware Supreme Court's 2017 ruling in Investors Bancorp, which concluded that director compensation involves an inherently conflicted decision on the part of a board and that, as a result, in a stockholder challenge to board compensation, a court may apply the entire fairness standard of judicial review, rather than the more deferential business judgment rule, absent adequate stockholder approval of the compensation at issue.2 Under the entire fairness standard of review, the court examines the fairness of the compensation itself as well as the company's processes relating to setting the compensation. Because the standard is fact-intensive and searching, it can result in protracted litigation that survives the pleadings stage. Importantly, Investors Bancorp further held that a stockholder vote approving director compensation can effectively preclude an entire fairness claim, but that the stockholder vote must approve specific amounts of compensation or self-effectuating formulas to be effective. This aspect of the ruling appeared to reverse several decisions from the Delaware Court of Chancery concluding that stockholder approval of director compensation within "meaningful limits" could eliminate entire fairness claims. Finally, the Investors Bancorp decision also permitted the plaintiff to challenge executive compensation paid to management members of the board where the board's deliberations and approvals relating to that compensation appeared sufficiently intertwined with its decisions about director compensation.
The Goldman Sachs decision reinforces various implications from Investors Bancorp and provides important additional data points. At the outset, the Court of Chancery reiterated that director compensation "involves the quintessence of director self-interest: self-compensation" and that, generally, the entire fairness standard of review can apply to directors' decisions about their own compensation, unless stockholders "approve a compensation plan that does not involve future director discretion in setting the amount of self-payment." Significantly, the Court noted that in bringing an entire fairness challenge, a stockholder must plead some facts showing that the compensation actually is unfair, beyond simply alleging director self-interest. This aspect of the Delaware case law allows for the possibility that where director compensation is sufficiently modest or comparable to a company's peers, a stockholder claim can be dismissed at the pleadings stage, as has occurred in some litigation. In the Goldman Sachs decision, however, the Court concluded that the plaintiff adequately alleged facts challenging the unfairness of the compensation. In particular, the Court noted that the Goldman Sachs board was paid $605,000 per outside director, per year—an amount above the average of the company's peer group (approximately $350,000)—and that the company's net revenue and net income were comparatively lower than its peers. Much of the directors' compensation was paid pursuant to a stock incentive plan that, as in Investors Bancorp, contained no limits on such payments. Thus, the stockholder's claim could go forward, although the Court also acknowledged that the company might ultimately be successful in defending its director compensation. Interestingly, the plaintiff's entire fairness challenge focused only on the amount of the director compensation—not the board's decision-making process, which involved, among other things, the use of a compensation consultant and accepting that consultant's recommendation.
In the course of its decision, the Court rejected an argument by Goldman Sachs that the company's stock incentive plan, which stockholders had approved, had effectively waived stockholders' right to seek entire fairness review of director compensation. In particular, the company argued that the plan provided that directors could not be held liable for actions taken in "good faith"—and that the directors had not acted in bad faith here. The Court expressed hesitation in general as to whether such a waiver would be enforceable under Delaware law and concluded that, in any event, in seeking such a waiver, the company would have needed to inform stockholders specifically that self-interested transactions were contemplated and that they would be waiving their right to seek redress, which had not occurred here.
This decision underscores that companies can come under scrutiny by plaintiffs' attorneys and stockholders for their director compensation practices, even if the upper limits for director compensation awards have been approved by stockholders. Although it is relatively unusual for public companies to seek the type of stockholder approval contemplated by recent Delaware case law, companies may wish to consider seeking stockholder approval of board compensation, recognizing that stockholders may have to approve concrete amounts or formulas in order to preclude entire fairness review of the compensation. In any event, in reviewing the possibility of an entire fairness challenge, a board will want to consider the fairness of its compensation: the terms and amount of the compensation that the board receives and the quality of the board's decision-making processes in setting compensation.
For more information on the implications of this decision or other litigation, please contact a member of the corporate governance, public company representation, securities and governance, and employee benefits and compensation practices at Wilson Sonsini Goodrich & Rosati.