By Howard Levitt
These two cases offer important lessons in executive compensation
Last Saturday, I looked at two cases involving issues of executive compensation. Here are two more, and some lessons for how boards of directors and executives can properly approach compensation issues.
I might add here that executives should never be on committees discussing or impacting their own compensation and companies should have conflict of interest policies to ensure that never occurs.
The board cancelled the SAR units and set up two pools, a SAR cancellation pool granting McGoey $600,000 and a bonus pool providing McGoey $1.2 million in bonuses. The shareholders revolted and removed the directors. McGoey resigned, taking the position he was terminated without cause. He had earlier negotiated a golden parachute clause of $9.5 million, with the only exception being a narrow definition of cause. McGoey sued for the $9.5 million, the SAR cancellation award and the bonus payment.
The court dismissed all of these claims saying that McGoey owed UBS fiduciary duties, which “included an obligation to act in good faith and in the best interests of the company. He had a specific obligation to scrupulously avoid conflicts of interest and not to abuse his position for personal gain.”
It found that McGoey’s actions in establishing the SAR cancellation award and bonus pool were “driven by self-interest, unsupported by any reasonable or objective criteria and contrary to the best interests of UBS.” He also could not rely on the golden parachute clause as the breach of fiduciary duty was serious misconduct (i.e. cause) depriving him of the benefit of the enhanced severance.
The court found that Berg had breached his fiduciary duties in the way he negotiated and presented the agreement and the board itself had failed to establish a reasonable process such that the contract was neither fair nor reasonable.
Simply declaring a conflict, contrary to the view of many lawyers and officers, is legally insufficient by itself.
As Justice Lax stated, “It can rarely be enough for a director to say, ‘I must remind you that I am interested’ and leave it at that. His declaration must make his colleagues ‘fully informed of the real state of things’…. If it is material to their judgment that they should know, not merely that he has an interest, but what it is and how far it goes, then he must see to it that they are informed.”
As the court put it, “Berg failed utterly in his duties to Repap. His own self-interest prevailed. His conduct was exactly opposite to the conduct that the law required of him as a fiduciary — disclosure, honesty, loyalty, candour, and the duty to favour Repap’s interest over his own.” The agreement was set aside.
So what are the conclusions for executives and their respective boards?
- Create a proper compensation committee. The people on it should not be the ones benefiting from it. It should be selected from the board and outside individuals with competence, integrity and objectivity so that they can provide proper oversight;
- Hire an outside consultant. Make sure you have a compensation expert who clarifies that the compensation provided is reasonable in all respects;
- Ensure that the compensation, including contractual termination payments, is objectively reasonable. As in the Zielinski case, it should seldom be the same amount regardless of the executive’s ultimate tenure;
- Give the committee enough time to make a proper decision. A rushed decision can be attacked for inadequate oversight and the improper weighing of different factors;
- When voting, board members must avoid any conflict. Any board member with a conflict must absent themselves from the discussion;
- Consider suing for disgorgement of funds if a past executive took advantage of the company;
- Contact counsel to ascertain whether there is a basis to either not pay or to recover monies already paid to an executive who might have breached their fiduciary duty.