Corporate Governance

The Need for Reform of the Director Nomination Process

By J Robert Brown Jr.

The system for electing directors in the United States is skewed against shareholders.  Its bad enough that shareholders have no real say in board membership.  Most slates are nominated by the existing board and almost always run unopposed.  Majority vote provisions are a myth, giving authority not to shareholders but to the board. 

The board's fiduciary obligations, at least theoretically, require that the board examine nominees each year to determine whether they are qualified to serve on the board.  In at least one case, however, the right to sit on the board has become contractual. 

According to the proxy statement filed by FBR Capital noted that its former CEO (he stepped down on January 1, 2009, would nonetheless have a contractual right to be nominated to the board for three years.  As the proxy statement notes:

• It is expected that Mr. Billings will continue to have active involvement in crucial business development and relationship management aspects of our company's business, and will help to grow and strengthen our company's current and future client relationships. In consideration of these efforts and to incentivize these actions, our company has entered into the Director Agreement, which provides that for three years (i) our company will nominate Mr. Billings to serve as a Board member, (ii) Mr. Billings will receive an annual Chairman's fee of $400,000, at the same time and in the same form as the fees paid to other Board members generally, no later than March 15 of each year following the calendar year in which Mr. Billings earned this fee and (iii) Mr. Billings will be eligible to receive an annual bonus. 

In general, contractual provisions cannot override fiduciary duties.  If a board decides that it is not in the best interests of the company to renominate a particular director, they will usually have a legal duty not to do so, irrespective of contractual obligations.  The director who is not nominated may, however, have a claim for damages as a result of breach of the contract. 

Nonetheless, it is a bad practice to put the company in a position of having to breach a contract if its fiduciary duties so require.  Better to decide on the qualification of nominees on an annual basis, without any contractual obligations. 

Full post as published by The Race to the Bottom on May 31, 2010 (boomark / email).