SEC Approves Nasdaq Proposal for Golden Leash Disclosure

This post comes to us from Cooley LLP. It has been authored by Cydney S Posner. Another version of this post was published here.

In July, the SEC approved a Nasdaq proposal requiring listed companies to disclose ‘golden leash’ arrangements — arrangements under which third parties provide compensation to directors in connection with their candidacy for or service on company boards.  These arrangements are most common in connection with board nominations (either through negotiation or proxy contest) by hedge fund activists. The new rule will become effective on August 1, 2016.

The proposal arose out of Nasdaq’s concern that third-party compensation of directors may not always be publicly disclosed. While there is no set format for these arrangements, they may include compensation conditioned on achievement of specified benchmarks, such as an increase in share price over a fixed term. Nasdaq fears that these arrangements ‘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. Nasdaq further believes that the proposed disclosure would not create meaningful burdens on directors or those making these payments nor on the companies required to make the disclosure’.

Rule 5250(b)(3) will require each listed company to disclose, by the date the company files its definitive proxy statement for its next annual meeting, the parties to and material terms of all arrangements between any director or nominee and any person or entity other than the company relating to compensation or other payment in connection with that person’s candidacy or service as a director. A company must make the required 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 accompanying interpretive material indicates that the terms ‘compensation’ and ‘other payment’ as used in the rule are intended to be construed broadly: the disclosure requirement encompasses non-cash compensation and other forms of payment obligation, such as indemnification or health insurance premiums. Note that the rule does not separately require the initial disclosure of newly entered arrangements so long as disclosure is made under the rule for the next annual meeting.  The information must be disclosed either on or through the company’s website (in which case it must be continuously accessible) or in its definitive proxy statement. Nasdaq also explicitly states that, if a company provides disclosure in a definitive proxy or information statement, including to satisfy the SEC’s proxy disclosure requirements, sufficient to comply with the proposed rule, the company’s obligation to satisfy the rule is fulfilled regardless of the reason that the disclosure was made.

No disclosure will be required for arrangements that:

• relate only to reimbursement of expenses in connection with candidacy as a director;
• existed prior to the nominee’s candidacy (including as an employee of the other person or entity) and the nominee’s relationship with the third party has been publicly disclosed in a definitive proxy or annual report (such as in the director or nominee’s biography); or
• have been disclosed under Item 5(b) of the proxy rules (interests of certain persons in connection with a proxy contest) or Item 5.02(d)(2) of Form 8-K (description of arrangements in connection with election of a new director) in the current fiscal year. (However, this disclosure would not obviate the need for the company to comply with its annual disclosure obligations under the rule).

As an example of an agreement or arrangement falling under the exception for arrangements that existed prior to the nominee's candidacy, Nasdaq cites the employment of a director or a nominee by a private equity or venture capital firm or a related fund, ‘where employees are expected to and routinely serve on the boards of the fund’s portfolio companies and their remuneration is not materially affected by such service. If such a director or a nominee’s remuneration is materially increased in connection with such person’s candidacy or service as a director of the company, only the difference between the new and the previous level of compensation needs to be disclosed under the proposed rule.

So long as a company has undertaken reasonable efforts to identify all arrangements — including asking each director or nominee in a manner designed to allow timely disclosure — if the company then discovers an agreement or arrangement that should have been disclosed but was not, the company can remedy the inadvertent failure to disclose by prompt disclosure after discovery of the error by filing a Form 8-K, where required by SEC rules, or by issuing a press release; in that event, the company will not be considered deficient with respect to the rule. However, remedial disclosure, regardless of its timing, would not satisfy the annual disclosure requirements. In all other cases, the company must submit a plan showing that the company has adopted processes and procedures designed to identify and disclose relevant agreements or arrangements, subject to approval by Nasdaq.

Nasdaq is also amending Rule 5615 to provide that the required disclosure of third-party payments to directors will be among the provisions allowing a foreign private issuer, upon satisfying specified conditions, to follow home country practice.

Interestingly, the National Venture Capital Association submitted a comment letter on the Nasdaq proposal raising a complication that might arise out of the rule, stating that NVCA’s aim was to ensure that Nasdaq was fully informed as it considered whether to move forward with the proposed rule change. The letter observed that VCs who sit on boards can often have complex arrangements with their funds and recommended that ‘Nasdaq clarify the conditions of the exemption in the rule for pre-existing relationships as well as the degree of detail needed in disclosures required by the proposed rule’. Nasdaq advised the SEC that it had fully considered and addressed comments on the proposal, specifically calling out the concerns raised in the NVCA Letter around board service by venture capital board members. The NVCA letter also noted that potential restrictions on the ability of individuals who receive compensation to serve as directors could adversely affect VC funds due to the structure of the funds. The SEC responded by noting that this point is ‘not within the scope of the Nasdaq proposed rule change’. Presumably the comment was intended to address a footnote in the Nasdaq rule change submission indicating that Nasdaq is considering whether to propose additional requirements regarding third-party payments to directors and candidates, including whether these directors should be prohibited from being considered independent under Nasdaq rules or prohibited from serving on boards altogether. The footnote added that a proposal on this topic, if any, would be made in a separate rule filing.