Can Lobbyists Pass the Declaration of (Director) Independence to Sit On Corporate Boards?

Thursday, April 20th, 2017 at 2:04 pm, by Carly Goeman

Corporate boards employ independent directors to solve many corporate governance problems, including monitoring related-party or conflicted transactions, protecting minority shareholders against a dominant majority, setting the company’s executive pay, and auditing the company’s financial reports. From these responsibilities stems the typical definition for independent directors: “one who has no need or inclination to stay in the good graces of management, and who will be able to speak out, inside and outside the boardroom, in the face of management’s misdeeds in order to protect the interests of shareholders.” The NYSE notes that independent directors are meant to “increase the quality of board oversight and lessen the possibility of damaging conflicts of interest.” Different jurisdictions speak of these directors as “independent,” “disinterested,” or “outside.”

Yet, many companies now employ their own lobbyists to fill these independent seats—lobbyists whose lobbying fees are paid either by the company at which they hold an independent board seat or by an industry association created or run by that company’s CEO. In such a case, the “independent director” would both be paid by the company to serve in a director position designed to monitor management and by the lobbying firm paid by management to lobby on its behalf. These two roles seem at odds with one another, raising the issue of whether lobbyists affiliated with a company should be allowed to serve as independent directors on that company’s board.

What Role Do These Lobbyists Fill as Directors?

In many cases, these lobbyists fill seats that must be filled by independent, disinterested, or outside directors. For example, companies listed on the NYSE or NASDAQ must typically have a majority of independent directors on their boards and exclusively independent directors on their audit, corporate governance, nominating, and compensation committees.

Many companies use lobbyists to fill out their compensation committees, which set pay for CEOs and other top executives. Companies listed on the NYSE are required to create independent compensation committees, while NASDQ companies may either create an independent compensation committee or set compensation at the recommendation of a majority of the board’s independent directors. Most other exchanges either require formation of a compensation committee, like the NYSE, or require compensation decisions to be made by a majority of independent directors in the absence of an independent compensation committee, like NASDAQ. Thus, either way, the decisions or recommendations for executive pay begin with independent directors.

Similarly, under federal taxation rules, companies wishing to deduct CEO salary above $1 million must have that CEO’s compensation approved by a compensation committee consisting entirely of two or more “outside directors.”

Independent directors are also important under many state laws. In Delaware, for example, these individuals play crucial roles in approving interested transactions and making decisions about shareholder derivative actions. If a company decides not to pursue a derivative suit, they may be required to prove that the decision not to pursue the litigation was made by an independent committee comprised of disinterested directors.

What Does It Mean to Be an Independent, Disinterested, or Outside Director?

While jurisdictions and agencies define the independence requirement in different ways, the common thread appears to be a requirement that independent directors not directly or indirectly receive material financial compensation from the company in any capacity other than as a director:

  • NYSE Rules: A director is only independent if the board “affirmatively determines” that that person has “no material relationship” with the company. The board must consider all relevant factors that are material to the director’s ability to be independent, including the source of that director’s compensation (and “whether the director receives compensation from any person or entity that would impair his ability to make independent judgments”) and whether the director is affiliated with the listed company (and “whether the affiliate relationship places the director under the direct or indirect control of the listed company or senior management … of a nature that would impair his ability to make independent judgments.”).
  • NASDAQ Rules: A director is only independent if the board makes an “affirmative determination” that the director does not have a “relationship with the listed Company that would impair their independence.” Audit committee members, for example, “must not accept any consulting, advisory, or other compensatory fee from the Company other than for board service,” and the board must consider such fees in evaluating the independence of directors on compensation committees.
  • IRC/Tax Rules: In determining a company’s ability to deduct CEO pay over the amount of $1 Million, that compensation must be approved by a committee of “outside” directors who must not receive remuneration from the company, either directly or indirectly, in any capacity other than as a director.
  • Delaware Law: Director independence under Delaware law is highly fact-specific and nuanced, but financial ties should be considered. While Delaware courts have sometimes found directors to be independent despite compensation from the company that comprises only a modest portion of the director’s overall income, courts have also found independence lacking based on, among other things, a $75,000 consulting contract. Delaware courts will also consider personal relationships and current and past employment of the director.

If the source of director compensation appears to be important across all jurisdictions, how much leeway should be given in that analysis? The Corporate Executive advises companies to consider whether directors receive compensation from any persons or entities “that would impair their ability to make independent judgments.” Thus, while there are some bright line rules, a board’s determination of independence seems to involve a very qualitative judgment. With that in mind, boards must consider how lobbyists are incentivized and whether those incentives allow them to make truly independent judgments.

How Are Lobbyists Incentivized?

Lobbyists’ compensation may predispose them to side with management, undermining their independent status.

For example, LHC Group Inc.’s board compensation committee, which recently approved a 90% raise for its CEO and gave him personal use of the company plane, is comprised of three “independent directors” – two of which are paid lobbyists not just for LHC, but also for an industry group co-founded and chaired by LHC’s CEO. One of those lobbyists is reported to have been paid $210,000 by LHC for lobbying services while also serving on the company’s board. The other, as senior counsel for lobbying firm Squire Patton Boggs, earned his lobbying firm $1.25 million and secured a $20,000-a-month ongoing retainer from LHC while still serving on LHC’s board.

Similarly, Boeing’s lead independent director simultaneously runs his own lobbying group, which has been paid $5.6 million to lobby on behalf of an association of CEOs which Boeing’s CEO is part of and previously chaired.

Conclusion

It is difficult to imagine that individuals in these positions, deriving the majority of their income from a lobbying firm that is paid by the company, truly have no need to “stay in the good graces” of some of the very people paying their primary employer. If lobbyist compensation packages or promotions incorporate contract sales or renewals in any way, they could be further incentivized to appease the board in order to secure ongoing retainers or win business for the company’s new lobbying efforts.

Company boards – and regulators – should re-evaluate how independent board seats are filled in light of the compensation schemes and motivations of affiliated lobbyists. While these individuals should still be permitted to sit on company boards in non-independent positions, their ability to be truly independent in an “independent” board position is questionable at best.