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Executive compensation and related public disclosure are among the most high-profile topics in corporate governance today. Recent Securities and Exchange Commission settlements with General Electric [FOOTNOTE 1] and Tyson Foods [FOOTNOTE 2] and the recent Delaware lawsuit involving Abercrombie & Fitch [FOOTNOTE 3] have drawn public attention to the details of executive compensation and the quality and significance of company disclosure. This article highlights some of the lessons to be learned from recent examples and offers suggestions to directors for best practices going forward. RECENT CASES Examples of executive compensation-related controversies, lawsuits and settlements are, unfortunately, all too numerous at the moment. Three recent, highly-publicized situations offer cautionary tales for boards of directors and senior management. General Electric: Pursuant to former General Electric Chief Executive Officer Jack Welch’s retirement agreement, he was given permanent access to many perquisites and benefits that he had enjoyed as chief executive. The publicly filed agreement did not detail these items, and the proxy statement disclosure made only the general statement that Welch would be entitled to “continued lifetime access to Company facilities and services comparable to those that are currently made available to him by the company.” [FOOTNOTE 4] Proxy statements issued during Welch’s tenure did not disclose some of the more expensive benefits he received, such as personal use of company aircraft and limousines. These perquisites came to light in the course of Welch’s divorce proceeding. In September 2004, the SEC stated in the settlement of its enforcement action against GE that the company’s disclosure had not fully and accurately described Welch’s retirement benefits. [FOOTNOTE 5] Tyson Foods: In March 2004, the SEC began an inquiry into allegedly excessive and undisclosed benefits involving former Tyson Foods Chairman Don Tyson. Only a few months later, during negotiations with the SEC regarding the company’s failure to disclose Tyson’s bonuses, the directors approved a contract with Tyson that in exchange for up to 20 hours of consulting per week — and over and above his existing retirement benefits — awarded him $1.2 million annually and access to expensive perquisites such as extensive use of the company jet. [FOOTNOTE 6] The matter finally settled in April 2005, with the SEC finding that Tyson Foods made misleading disclosures of perquisites and personal benefits provided to Tyson both before and after his retirement as chairman. The SEC also found that, due to failures of internal controls, many of the more substantial perquisites were not known to or authorized by the board of directors or compensation committee. [FOOTNOTE 7] Though the 2004 consulting contract was not mentioned in the SEC settlement, it contributed to the public impression of excess and waste in executive compensation and benefits. Abercrombie & Fitch: A derivative suit was brought in February 2005 by a shareholder who claimed that the Abercrombie & Fitch board breached its duties of good faith, loyalty and candor by awarding a “grossly excessive and wasteful” pay package to Chief Executive Officer Michael Jeffries. [FOOTNOTE 8] The suit also charged directors with waste of corporate assets by approving the payment of excessive compensation and the unjust enrichment of the chief executive. [FOOTNOTE 9] The derivative complaint contrasted language from the company’s proxy statement indicating that the Abercrombie & Fitch compensation committee’s mandate was to pay bonuses that were commensurate with industry standards and the company’s financial performance with a Bloomberg article stating that Jeffries’ salary was higher than those of 11 chief executives of comparable companies and that Abercrombie & Fitch’s returns over the relevant period were low compared to peer retailers. In the April 2005 settlement, the company agreed to reduce by half a potential $12 million “stay” bonus to Jeffries, tie Jeffries’ bonus to specific earnings targets and eliminate new stock options for Jeffries for two years. [FOOTNOTE 10] INTERNAL CONTROLS The GE and Tyson settlements with the SEC illustrate the importance of board attention to all material aspects of executive compensation. GE failed to ensure that the details of Welch’s retirement pay were properly disclosed, which potentially raises questions regarding the GE board’s oversight. The Tyson Foods board was unaware that Don Tyson was receiving significant perquisites from the company and accordingly could not supervise appropriate disclosure. Moreover, when faced with an SEC investigation into compensation matters, the Tyson Foods board continued to approve benefits that could be viewed as disproportionate to the services provided by the former chairman. [FOOTNOTE 11] In addition, the SEC’s conclusion that Tyson Foods failed to maintain adequate internal controls over Don Tyson’s personal use of company assets raises important issues that would need to be considered in a Sarbanes-Oxley 404 review. It is clear that the SEC expects public companies to have compensation-related internal controls in place and that this would require both compensation committee and audit committee oversight. It would also appear to be an appropriate matter for public companies’ internal audit functions to review to ensure that adequate internal controls exist and are effective. The Abercrombie & Fitch settlement highlights the importance of board attention to company disclosure, but even more important, it may indicate a new development in the evolution of shareholder litigation alleging violations by directors of their duties under Delaware law. The plaintiff argued that the directors breached their fiduciary duties under Delaware law by failing to ensure that proxy disclosure accurately represented the company’s policies regarding executive compensation. Though the lawsuit was not adjudicated, the threshold for liability in Delaware for disclosure violations under the so-called “duty of candor” may be lower than that under federal securities laws. [FOOTNOTE 12] Delaware Vice Chancellor Leo Strine recently rejected as inadequate a proposed settlement agreement in a derivative action involving The Fairchild Corporation. The complaint alleged breaches of fiduciary duty, corporate waste and unjust enrichment in challenging compensation paid to and other arrangements for the chairman and chief executive officer and his son, the chief operating officer and president. [FOOTNOTE 13] Vice Chancellor Strine apparently indicated that, if the allegations in the complaint were true, the proposed settlement would not have provided adequate protection to shareholders from “a grotesque lack of controls in a company that also has no profits.” [FOOTNOTE 14] The Delaware courts continue to be focused on executive compensation matters and board oversight. The lessons to be drawn from these examples is clear: Directors would be well-advised to obtain all relevant information regarding executive compensation prior to taking any action, to give careful consideration to approving appropriate compensation arrangements (including perquisites), and to pay close attention to the resulting disclosure to ensure that it is accurate, complete and transparent. ENHANCED RESPONSIBILITY Historically, boards of directors and compensation committees generally have been content to approve the broad strokes of executive compensation: salary, bonus, retirement pay and perhaps severance and change-in-control arrangements. In some cases, perquisites appear to have been treated as “business expenses” that flew below the radar of the board of directors and were never addressed by the compensation committee. This approach, even if it was typical of past practices, no longer appears to be sufficient. In the current environment, it is important for boards of directors and compensation committees in particular to be proactive in requesting detailed information about executive compensation packages before approving them. To assure themselves the protection of the business judgment rule, directors should take affirmative steps to make sure that they are fully informed on all compensation-related matters involving the key executives of the company. Directors should review and discuss, both in executive session and with the chief executive officer, the material components of the compensation package, including annual salary, incentive and performance-related pay, perquisites, retirement benefits, deferred compensation, tax gross-ups, supplemental executive retirement plans, severance payments and change-in-control agreements. Directors should consider how each aspect of executive compensation fits into the general picture of the company’s compensation arrangements as well as the smaller picture of that executive’s package. In order to ascertain that compensation packages are appropriate and reasonable, directors should fully understand the costs and benefits of potential components of compensation. In this regard, directors are entitled to rely on the advice of experts. [FOOTNOTE 15] However, care should be taken in selecting these experts, and to the extent that compensation consultants are retained to advise the directors, prudence would dictate that these experts be retained by the compensation committee and not by management. It also would be beneficial for directors to review and discuss compensation policies to ensure that the compensation arrangements of the top executives are consistent with those policies as well as the corporation’s goals generally. FOCUS ON DISCLOSURE The settlements described above illustrate the paramount importance of disclosure. Compensation committees should update their proxy disclosure annually instead of relying on generalized boilerplate from prior years. The Abercrombie & Fitch compensation committee likely never imagined that the broad description of their compensation goals set forth in the company proxy statement could form the basis of a lawsuit alleging misrepresentation. In this environment, proxy and other executive compensation disclosures should be carefully scrutinized for accuracy and completeness. Directors should consider reviewing the actual disclosure and discussing it with the counsel that prepared it prior to its submission to the SEC. The compensation committee report currently is not considered “filed” under the Securities Exchange Act of 1934; however, the Abercrombie & Fitch settlement indicates the importance of treating the disclosure in the report as seriously as if it were legally part of a publicly filed document. Alan Beller, director of the Division of Corporation Finance at the SEC, noted in a widely-cited speech last October that the SEC may consider eliminating this “special treatment” for compensation committee reports unless companies and their advisors reciprocate with transparent disclosure. [FOOTNOTE 16] Beller advocated for disclosure that focused on presenting complete descriptions of compensation arrangements in a clear and concise manner rather than on revealing the minimum amount of information that is required. For example, to the extent that it may be argued that certain elements of compensation may not be required to be disclosed under the line-item disclosure requirements, consideration should be given to making disclosure if it could be argued that shareholders will lack a complete understanding of an executive’s compensation if these elements are not disclosed. [FOOTNOTE 17] Moreover, to the extent that management makes decisions on what does and does not need to be disclosed, compensation committee members may wish to be informed as to these decisions so that their impact may be more fully considered before disclosure is made, rather than in hindsight. Increasingly, boards of directors are hiring separate outside counsel for the board and for certain of its committees. Though companies should support the use of advisors and experts by boards and their committees (and should consider specifically delegating the power to retain such persons directly to board committees), boards should take care not to promote competing advisors or to bifurcate advice such that the board as a whole could be disadvantaged. It would make sense for the team that advises a compensation committee and assists in the drafting of its disclosure also to be involved in the drafting of any related board-level disclosure. Advisors will be more effective in drafting and reviewing company disclosure if they have been present at the deliberations and discussions held at both the board and committee levels. If, however, committees employ their own counsel, it is quite possible that the committee may receive different disclosure advice than the board (or management). In most cases, there is no need to retain separate committee counsel. CONCLUSION Two years ago, SEC Chairman William Donaldson famously alluded to a “disconnect between executive compensation and performance.” [FOOTNOTE 18] Increasing public disillusionment with executive compensation clearly relates to widespread concern that the compensation-related interests of executives are not aligned with those of shareholders. Beller recently identified a second, related concern: that inadequate or confusing disclosure is raising suspicions in the minds of shareholders that they are not receiving the full story. [FOOTNOTE 19] Boards of directors should be vigilant in focusing on compensation and disclosure matters and taking steps to address these concerns in a proactive fashion. Public company boards of directors should continue to work toward implementing best practices in the highly sensitive area of executive compensation. At a minimum, directors should ensure that they are fully informed as to the details and operation of executive compensation arrangements. Institutional investors continue to clamor for executive compensation to be tied to long-term corporate performance and increases in shareholder value. In addition, directors now need to consider whether perquisites provided to key executives would be viewed as reasonable; certainly, there should be a clear demarcation between business and personal expenses. Internal controls for compensation matters should be in place and actively used. Finally, directors and their advisors should take a fresh look at all disclosure regarding executive compensation matters and philosophy to ensure that it is clear, concise and sufficiently detailed. David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz. Laura A. McIntosh is a consulting attorney for the firm. The views expressed are the authors’ own. ::::FOOTNOTES:::: FN1 In the Matter of General Electric Company, SEC Administrative Proceeding File No. 3-11677, Sept. 23, 2004 (“GE Settlement”). FN2 In the Matter of Tyson Foods, Inc. and Donald Tyson, SEC Administrative Proceeding File No. 3-11917, Apr. 28, 2005 (“Tyson Complaint”). FN3 Derivative Complaint, O’Malley ex rel. Abercrombie & Fitch Co. v. Jeffries, No. CA1077-N (Del. Ch. filed Feb. 8, 2005) (“Abercrombie Complaint”). FN4 See GE Settlement, supra note 1. FN5 See id. FN6 See Mark Jaffe, U.S. Intensifies Efforts To Determine CEOs’ Compensation, Bloomberg News Wire Services, The Record (Bergen County, NJ), Mar. 6, 2005. FN7 See Tyson Complaint, supra note 2. FN8See Abercrombie Complaint, supra note 3. FN9 See id. Similar allegations were made in a derivative complaint filed in November 2004 against the directors of The Fairchild Corporation in the Delaware Chancery Court. Derivative Complaint, Noto ex rel. Fairchild Corp. v. Steiner, No. CA871-N (Del. Ch. filed Nov. 18, 2004) (“Fairchild Complaint”). FN10 See Tiffany Kary, Abercrombie Settles Derivatives Suit on Compensation, Wall St. J., Apr. 12, 2005; Jeffrey Sheban, Investor Pressure Prompts Abercrombie & Fitch To Overhaul Executive Pay, Columbus Dispatch (Ohio), Apr. 12, 2005. FN11 See supra text accompanying note 6. FN12 See, e.g., Malone v. Brincat, 722 A.2d 5, 12, 14 (Del. 1998) (citations omitted):
An action for a breach of fiduciary duty arising out of disclosure violations in connection with a request for stockholder action does not include the elements of reliance, causation and actual quantifiable monetary damages. Instead, such actions require the challenged disclosure to have a connection to the request for shareholder action. The essential inquiry in such an action is whether the alleged omission or misrepresentation is material. …. Delaware law also protects shareholders who receive false communications from directors even in the absence of a request for shareholder action. When the directors are … deliberately misinforming shareholders about the business of the corporation, either directly or by a public statement, there is a violation of fiduciary duty. That violation may result in a derivative claim on behalf of the corporation or a cause of action for damages There may also be a basis for equitable relief to remedy the violation.

See also generally Lawrence A. Hamermesh, Calling off the Lynch Mob: The Corporate Director’s Fiduciary Disclosure Duty, 49 Vand. L. Rev. 1089 (1996). FN13 See Fairchild Complaint, supra note 9. FN14 See David S. Hilzenrath, Fairchild Executives’ Settlement Rejected, Wash. Post, May 19, 2005 at E1. Vice Chancellor Strine was also quoted as saying “”You’ve got a very poorly performing company over time that continually pays the CEO like he’s a top slugger.” Id. The total present value to the class of the rejected settlement was $2.9 million. The release in the rejected settlement covered a number of different claims because the original complaint was quite broad. In addition, the company had paid over $5 million to cover the Chairman’s costs for defending criminal charges brought against him in France for acts not taken in his official capacity at the company, including paying a criminal fine for him. The Vice Chancellor appeared to be troubled that, in exchange for modest benefits, sweeping claims were going to be released where the complaint was broad and articulated troubling facts at a company that had been sued twice before and settled compensation claims, that the company is controlled by the Chairman, and that the company pays its managers well even when the company has poor results. FN15 See, e.g., Delaware General Corporation Law Section 141(e). FN16 Remarks Before Conference of the National Association of Stock Plan Professionals, The Corporate Counsel and the Corporate Executive by Alan Beller, Director, Division of Corporation Finance, U.S. Securities and Exchange Commission, Oct. 20, 2004 (“Beller Speech”). FN17 One example that the SEC staff appears to be focusing upon is comprehensive, understandable and consistent disclosure of the use of corporate aircraft by company executives. FN18 Remarks Before the Economic Club of New York, by William H. Donaldson, Chairman, U.S. Securities and Exchange Commission, May 8, 2003. FN19 See Beller Speech, supra note 16. Beller stated: “Too much executive compensation disclosure has become an example of the kind of disclosure companies should disavow — disclosure that says as little as possible while seeking to avoid liability, rather than disclosure that seeks to inform.” Id.

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