CEO Influence over Board Membership: In re: Affiliated Computer Services, Inc. Shareholders Litigation
There are many many problems with the Delaware model of corporate governance. We have noted that Delaware applies the business judgment rule to duty of loyalty decisions (read executive compensation) when the board consists of a majority of independent directors. The approach entirely ignores the fact that this allows the interested influence to remain in the decision making process. Moreover, as we have noted time and time again, the Delaware courts use a number of devices to pre-terminate the exploration of director independence, often not letting the allegations get past a motion to dismiss. For a more complete discussion of these issues, read Disloyalty Without Limits: 'Independent' Directors and the Elimination of the Duty of Loyalty. The result is that independent boards are often not independent at all.
We have likewise noted that directors have an economic incentive to do what the CEO wants. Sitting on the board of a public company can be an incredibly lucrative proposition. In 2007, the directors of Goldman Sachs received around $700,000 in total compensation. The Delaware courts, however, have an almost categorical rule that fees are not taken into account in determining whether directors are independent. Because fees can clearly be material, the only analytically defensible basis for the approach is that the CEO has no ability to terminate the material income stream. (The Delaware Courts use less definsible justifications including the argument that applying the materiality analysis would result in the elimination of "regular folk" from the board).
While legally true (only shareholders can fire directors), in fact it is practically incorrect. The best way to lose the comfortable sinecure of a board seat is to not be renominated. The best way to not be renominated is to irritate the CEO.
With that in mind, we turn to In re: Affiliated Computer Services, Inc. Shareholder Litigation, 2009 Del. Ch. LEXIS 35 (Del. Ch. Feb. 6, 2009). The case is a relatively straightforward demand excusal case where, as usual, shareholders had their case dismissed for failing to make demand. The Chancery Court concluded that the board in fact contained a majority of independent directors.
The more interesting thing is the facts. It seems that the outside directors irritated the CEO. The consequence? He insisted that they all resign. As the opinion noted: "That same day, Deason (by letter from a New York lawyer purporting to act as counsel to ACS, but delivered through Deason's personal counsel) demanded the immediate resignation of all of the outside directors of ACS, whom the letter accused of various breaches of fiduciary duty, and named four candidates to replace them." Two days later, the board held a special meeting. What did the directors do? Resign, conditioned upon reviewing the candidates proposed by the CEO.
On November 1, 2007, at another special meeting of the Board of Directors, the independent directors informed Deason and the management directors that, because of Deason's and management's conduct, they felt compelled to resign from the Board and not to stand for re-election. However, to ensure that their successors were truly independent and to protect the Company's minority shareholders, the independent directors also stated during the November 1 special meeting that they were prepared, prior to their resignation, to immediately begin the process of reviewing Deason's suggested nominees and any additional nominees proposed by the Company's shareholders.
Whatever the significance of the assorted allegations of misconduct and breach of fiduciary duty, one thing was clear. The CEO wanted the directors out and they left. It is a rare public example of what happens to independent directors when they no longer have the confidence of the CEO.
While the public nature of this fracas is unusual, the takeaway is widely understood. The CEO can effectively terminate a director, albeit at the next meeting when he or she is not reelected. As a result, the CEO can terminate the fees. Fees, therefore, ought to be tested under the same materiality test as any other income stream received from the company. But this being Delaware, fees are simply ignored in the determination of independence.