On July 1, 2016, the SEC approved NASDAQ’s new rule requiring listed companies to publicly disclose compensation or other payments by third parties to members of or nominees to the board of directors. The new rule, which went into effect in early August, is being dubbed the “Golden Leash Disclosure Rule.”
The Golden Leash Disclosure Rule
New NASDAQ Rule 5250(b)(3) requires each listed company to publicly disclose the material terms of all agreements or other arrangements between any director or director nominee and any other person or entity relating to compensation or any other payment in connection with the person’s position as director or candidacy as director. The disclosure does not include regular compensation from the company itself for director services. The disclosure must be included in any proxy or information statement issued under Regulation 14C or 14A for a shareholder’s meeting at which directors will be elected. A company can also include the disclosure on its website.
There are a few exemptions from the disclosure requirement, such as arrangements that (i) relate to the reimbursement of expenses in connection with a person’s candidacy as a director; (ii) existed prior to the nominee’s candidacy and the candidate’s relationship with the third party is disclosed in the proxy statements (such as existing employment). I note that in reading the entire rule, I would think expense reimbursement in relation to a candidate’s campaign for election could be material where the candidate is being funded by an activist shareholder and the candidate is objected to by current management.
The Golden Leash disclosure must be made at least annually, and updated if there are material changes that would otherwise require an update of the information. A company has an obligation to conduct a reasonable inquiry to determine any information that is required to be disclosed under the new Rule. Moreover, if information is discovered that should have been disclosed, but was not done so previously, an 8-K must be filed. As long as a company satisfies its obligation to conduct due diligence and remediates any omissions with a prompt 8-K, it will be considered in compliance with the Rule.
NASDAQ also amended Rule 5615, which allows foreign companies to follow their home country practice in certain circumstances, even when such practice differs from U.S. rules. New Rule 5250(b)(3) is included in Rule 5615 such that a foreign company would not have to make the Golden Leash disclosure as long as it is abiding by its home country rule and that it discloses in its annual filings that the home country rule is different and explains the difference.
The Golden Leash Disclosure Rule appears to be a response to the increase in shareholder activism over the past few years. I’ve yet to write a full blog on shareholder activism, though it is on my very long list of future topics. However, this quote from a JP Morgan article published in January 2015 sums it up: “[N]o recent development has influenced firms’ strategic and financial decision-making as profoundly as the surge in shareholder activism following the global financial crisis. From a few activist funds managing less than a total of $12 billion in 2003, the activist asset class has ballooned to more than $112 billion in assets under management for activist hedge funds with most of that growth occurring since 2009.”
NASDAQ actually submitted its first iteration of the Rule to the SEC in March 2016, amended it on May 18, 2016, then withdrew that amendment and filed Amendment 2 on June 30, 2016, which was fast-tracked and approved by the SEC. The SEC received eight comment letters on the Rule.
Whether in support of the Rule or opposed, almost all the comment letters supported the disclosure. One comment letter in favor of the Rule stated, “the ability to keep both arrangement and the terms thereof secret provides ‘raiders’ and other types of activists an unfair tactical advantage over the incumbent board members,” and that “if an insurgent candidate is elected to the board, secrecy around that board member’s outside compensation can inhibit the effective functioning of the board of directors.”
Those opposed generally opposed on the grounds that the information may already be required by other rules and, as such, was duplicative. For example, Item 401(a) of Regulation S-K requires disclosure of any “arrangement or understanding between [the director] and any other person(s)” related to the selection or nomination as a director. Similarly, Item 402(k) requires disclosure of director compensation.
As with any proposed rule by an Exchange, the SEC must make a determination that the Exchange’s rules “be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to remove impediments to and perfect the mechanism of a free and open market and a national market system, and in general, to protect investors and the public interest.”
The SEC continues with an acknowledgment of the critical importance of initial and continued listing standards for exchanges such that only qualifying companies are listed. These qualitative and quantitative standards help ensure fair and orderly markets.
The SEC sees the Golden Leash Disclosure Rule as a corporate governance-related rule providing “greater transparency into the governance processes of listed issuers and enhance investor confidence in the securities markets.”
The SEC acknowledged the potential for duplicative disclosure, which I note was just the topic of a sweeping proposed rule change to eliminate duplication, among other things (see my blog HERE). However, the SEC notes that the Golden Leash Rule is a NASDAQ rule and not an SEC rule and that exchanges often have duplicative rules. The SEC supports such exchange reinforcement, stating, “[T]hese and other disclosure-related listing standards help to ensure that listed companies maintain compliance with the disclosure requirements under the federal securities laws…” Likewise, the SEC notes, “we believe that it is within the purview of a national securities exchange to impose heightened governance requirements…”
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