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On December 13, 2017, the Delaware Supreme Court issued In re Investors Bancorp, Inc. Stockholder Litigation, Case No. 169. The holding of this case could be particularly impactful to Delaware corporations because of its weakening of the “stockholder ratification” defense. This defense allows compensation decisions by a company’s board of directors to avoid “entire fairness” review if the company’s stockholders have previously approved the discretionary plan and such plan provides meaningful limits on awards directors make to themselves. Investors Bancorp held that the discretionary plan approved by stockholders failed to provide meaningful limits. The Court held that when it is properly alleged that directors inequitably exercised their discretion in granting themselves compensation, they are required to demonstrate that the compensation was entirely fair to the company regardless of whether stockholders have previously approved the discretionary plan.1 This requirement established by the Court increases the likelihood that a plaintiff challenging a compensation decision can overcome a motion to dismiss and entangle a company in costly litigation unless the company takes certain measures to support its board’s compensation decisions. This holding raises many issues; what is a proper allegation of an inequitable exercise of director discretion; what are meaningful limits on discretionary plans; and what reliance may a Board awarding itself stock benefits from a discretionary pool place on outside attorneys and compensation advisors?
The particular equity incentive plan challenged in Investors Bancorp permitted up to 30% of the total share pool to be awarded to non-employee directors. Soon after the stockholders approved the plan, the compensation committee of the Board met with company counsel on four separate occasions in June of 2015. Counsel presented the committee its analysis of companies based on size of their recent stock offerings, the companies and their equity plans. The complaint alleged that the first two exercises were arbitrary and the third a “textbook example of results driven by a self-selection bias.” Based on its counsel’s and consultant’s advice, the directors awarded themselves the entire 30% pool and created compensation levels that surpassed both the company’s historical compensation levels and competitor/peer group compensation levels. The non-employee director awards totaled $21,594,000 and averaged $2,159,400 individually, with an alleged total fair value of $51,653,997 for all directors. These benefits were in addition to significant annual director cash fees and stock benefits granted in an earlier offering. The Court noted the allegation in the complaint that the compensation to each non-employee director of more than $2,100,000 in 2015, “eclipsed” director pay at every wall street firm, citing a Bloomberg article.
In its opinion, the Delaware Supreme Court reaffirmed that the stockholder ratification defense would still be effective in instances where a company’s stockholders have approved a specific director compensation award or a formulaic award under a self-executing plan that does not require director discretion. However, in the instance where stockholders have approved a plan “that gives the directors discretion to grant themselves awards within general parameters”, the Court held that the stockholder ratification defense would be unavailable and could not be used to dismiss the complaint.2 Quoting an earlier Court of Chancery decision, the Court stated that “director action is twice tested first for legal authorization and second by equity.” The Court stated that the board is imputed with knowledge that it must exercise its general discretion “consistently with equitable principles of fiduciary duty”. Whether there could be stockholder approved compensation limits or “general parameters” which allow director discretion but do not reach the level of director discretion at issue in Investors Bancorp is a judgment that requires more diligence than was employed by Investor’s counsel, consultant and Board. Clearly, the Court was swayed by the sheer magnitude of the numbers and the unfavorable comparisons made by the complainant.
Investors Bancorp was a bank holding company with approximately $20 billion in assets at year-end 2015 which had converted in the prior year from a Mutual Holding Company with minority stockholders. As such its transformation to a public company is fairly unique and unusual for a Court accustomed to more conventional situations. Nonetheless, the size of the awards granted to non-employee and employee directors alike and the absence of compelling comparables influenced the Court’s decision. Regardless of its actual reach, this particular holding from Delaware’s highest court likely creates more litigation risk for Delaware corporations when they are developing discretionary director compensation plans regardless of stockholder ratification. Indeed, it exposes fiduciaries to stockholder challenge when they are most vulnerable, at the moment they determine their own compensation. This decision also calls into question the efficacy of the standard practice of obtaining prior stockholder approval of future awards from discretionary director stock benefit plans. Do Boards disclose the specific awards in advance of stockholder approval even though such disclosure would be expensive and cumbersome if done annually as part of a stockholder ratification?
We advise our clients to be especially diligent in making a record of the reasonableness of individual awards under a discretionary plan and avoid any appearance of results driven self-selection bias by advisors and the board. Discretionary director equity plan award analysis should be reasonable in light of the current marketplace and industry standards. A comprehensive review of compensation plan awards, that give directors any discretion in determining their own compensation, mitigates against stockholder derivative litigation challenging the compensation awards as unfairly excessive.