Quoting both a nearly 70-year-old decision and a nearly 30-year-old SNL skit, the Delaware Court of Chancery, in Stein v. Blankfein et al, reaffirmed that in most circumstances decisions of directors awarding director compensation are subject to review under the entire fairness standard. The Court also addressed the possibility of stockholder waiver of application of that standard to future director actions, but did not conclude as to whether such a waiver was even possible. The litigation addressed compensation of Goldman Sachs’ directors– primarily the stock incentive plans, or SIPs, approved by Goldman Sachs stockholders in 2013 and 2015. Ruling on a motion to dismiss, the Court rejected director defendants’ arguments that:
- the stockholder-approved SIPs absolved, in advance, the director’s breaches of duty in self-dealing, absent a demonstration of bad faith. Since the argument was rejected the director decisions were subject to review under the entire fairness standard because the plans provided the directors discretion to determine their own awards; and
- the plaintiff failed to adequately allege that the self-awarded director compensation was not entirely fair.
The following courses of action remain available to public company boards in approving director compensation:
- have specific awards or self-executing guidelines approved by stockholders in advance; or
- knowing that the entire fairness standard will apply, limit discretion with specific and meaningful limits on awards and approve director compensation with a fully developed record, including where appropriate, incorporating the advice of legal counsel and that of compensation consultants.
It may also be possible to obtain a waiver from stockholders of the right to challenge future self-interested awards made under a compensation plan using the entire fairness standard. To do so, stockholders would have to approve a plan that provides for a standard of review other than entire fairness, such as a good faith standard. In addition stockholders would have to be clearly informed in the proxy statement that director compensation is contemplated to be a self-interested transaction that is ordinarily subject to entire fairness, and that a vote in favor of the plan amounts to a waiver of the right to challenge such transactions, even if unfair, absent bad faith. Note that the Court did not conclude, because it was not required to do so, that such a waiver was even possible.
Entire Fairness Applies
Section 141(h) of the of the Delaware General Corporation Law, or DGCL, gives a corporation’s board of directors the power to fix director compensation. Consistent with precedent, the Court noted where a challenge is raised to a director decision on director compensation, Section 141 is the beginning, not the end, of the inquiry. The DGCL provision means that the actions of the directors are not ultra vires, but it says nothing about whether those actions are consistent with the directors’ fiduciary duties.
The Court noted that existing jurisprudence indicates directors’ self-interested decisions on executive compensation are inherently likely to be based on conflicted motives and therefore disloyal. As a result, directors’ decisions on director compensation are subject to review under the standard of entire fairness, and the burden to demonstrate fair price and process is on the directors, not the plaintiff.
However, in this case the SIPs provided that “no member of the Board . . . shall have any liability to any person . . . for any action taken or omitted to be taken or any determination made in good faith with respect to the [SIPs] or any Award.” Based on stockholders’ approving the SIPs that included this language, the defendants argued that any action taken by the Goldman Sachs board under the SIPs—self-interested or otherwise—was reviewable only under a good faith standard. The defendants argued this was dispositive, since the plaintiff did not plead that the defendants did not act in good faith.
The Court rejected the defendants’ argument. If the directors wanted to obtain a waiver from stockholders of the right to redress for the directors’ future unfair and self-dealing transactions (assuming such a waiver is even possible), the related proxy statement would have had to have informed stockholders that the SIPs contemplated self-interested transactions subject to entire fairness, and that a vote in favor amounted to a waiver of the right to redress for such transactions, even if unfair, absent bad faith.
Allegations that Compensation was Not Entirely Fair
The Court noted applicable Delaware precedent was set forth in In re Investors Bancorp, Inc. Stockholder Litigation. In that case, a corporation’s stockholders approved an equity incentive plan that allowed the directors to later award themselves compensation, on terms set at the discretion of the directors. Even though the stockholders approved the equity incentive plan, which included specific limits on director awards, because the directors were able to later determine their own compensation under the plan, the Delaware Supreme Court held that entire fairness was the applicable standard.
The Goldman Sachs SIPs set no specific limit on non-employee director compensation, and permitted directors to use their discretion to set that compensation. In other words, the stockholders were not informed about the specifics of the compensation package itself; that is to say, as in Investors Bancorp, the stockholders did not “know precisely what they [were] approving,” triggering application of the entire fairness standard.
Given the result in Investors Bancorp, the defendants argued, and the Court agreed, that plaintiff’s complaint must meet a pleading burden: plaintiff must assert facts that, if true, make it reasonably conceivable that the transaction is not entirely fair to the corporation. Such a burden in the self-compensation area cannot be simply conclusory, in light of the power the DGCL confers on directors to self-compensate.
The plaintiff alleged that the directors were paid nearly twice as much as their counterparts at companies identified as peers by Goldman Sachs, and attended fewer board meetings than the directors of the peer companies—that is, the Goldman Sachs directors awarded themselves more pay for the same or less work. The plaintiff did not allege that the process used to determine compensation was unfair.
Although the Court noted the allegations of excessive compensation were not particularly strong, it found that the plaintiff met the low pleading burden regarding director compensation: to point to “some facts” implying lack of entire fairness. The Court observed the foregoing allegations were more than conclusory.