Skadden – Rethinking Director Nomination Requirements and Conduct in an Era of Shareholder Activism

”This memorandum identifies and discusses a number of steps public companies may wish to consider regarding director nomination requirements and conduct in light of the heightened potential for arrival on the board of
activist shareholder-nominated directors.

Increased Incidence of Nomination Proposals: Based on publicly reported information published by Activist Insight,1 during 2012 activist shareholders threatened to initiate or initiated 58 director election proposals, and in 45 of them succeeded in electing at least one director either in an election contest or by agreement with the target’s board. During the first quarter of 2013, activist shareholders are reported by Activist Insight2 to have threatened to initiate or initiated 36 director election proposals and in an election contest or by agreement in 13 of them succeeded in electing at least one director. By way of comparison, in the first quarter of 2012, activist shareholders threatened to initiate or initiated only 18 director election proposals.

Reaction of Investment Community: Moreover, the activist call for shareholder-sponsored directors, typically less than a majority, to public company boards is receiving increasing support in the investment community.

Need for Proactive Board Assessment: With short slate election contests by activist shareholders becoming an increasing risk and reality for public companies,incumbent boards should be taking a proactive approach to assessing the implications of this development and to determining what steps, if any, would be appropriate to take in response.

Legitimate Subject for Board Consideration; Timing: To be clear, this suggestionis not motivated by a knee-jerk bunker mentality that shareholder-sponsored directors are an automatic threat. Of course that is not the case. However, it would be equally incorrect to conclude that the arrival of an activist shareholdersponsored director is an inherently positive event. The fact is that dealing with the phenomenon of activist shareholder director nominations is a perfectly legitimate subject for sitting boards to consider. As the body ultimately responsible for overseeing a company’s business and affairs, the board of directors should be interested in mitigating the risk of dysfunction that often results from directors representing specific interests rather than shareholders as a whole, that can lead to, among other things, a loss of confidentiality with respect to company information, including discussions among and views expressed by directors. The optimal time to focus on mitigating this risk is “on a clear day,” without the pressures and confusion about motives surrounding a threatened or pending election contest.

Exercise Thoughtful Judgment: Before addressing various issues, one point should be underscored — any nomination requirement or conduct rule to be applied to a proposed new director sponsored by an activist shareholder should be tested against the following question: Would we, the incumbent board, be prepared to apply the requirement or rule to ourselves and to new nominees proposed in the future by us? This is not to say that a “one size fits all” approach to director nomination requirements and conduct is mandatory. However, if there is to be a difference in application, the board should be prepared to articulate a legitimate basis for it, grounded in proper corporate interests — and should be comfortable that the differentiation does not overstep the bounds of public policy that in Delaware protects the exercise by shareholders of their voting rights and imposes some limits on directors constraining other directors.

Full memo: (click at lower right to download)

The Board Director Training Institute (BDTI) is a "public interest" nonprofit in Japan dedicated to training about directorship, corporate governance, and related management techniques. It is certified by the Japanese government to conduct these activities as a regulated nonprofit. Read a summary about BDTI here, and see a menu of its services for both corporations and investors here.

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