ABA Section of Business Law

Calling those with fortitude

So you need a dissident director

Seiden is president of Seiden Krieger Associates, an executive search firm in New York City.

America is well past the dawn of shareholder activism and has reached high noon of maximizing shareholder value. Indeed, corporate governance has traveled light years since the landmark Smith v. Van Gorkom case, in which corporate directors were put on notice that they could no longer rubber stamp the decisions of management.

Corporate governance concepts that were once espoused by those on the fringe have now become mainstream thinking. Joining the ranks of activists are investors from a variety of constituencies. Institutions like the California Public Employees' Retirement System (Calpers) are leveraging their investment dollars by prodding directors of portfolio companies to be more responsive to shareholder value. In fact, a recent announcement from Calpers discloses that they may indeed nominate their own representatives to become directors of companies whose boards resist the kinds of changes that they deem necessary.

And then in late May 1998, a watershed event occurred. Teachers Insurance and Annuity Association (TIAA), the largest U.S. pension fund, succeeded in removing the entire nine-member board of Furr's /Bishop's, a foundering cafeteria company — and replacing it with seven TIAA-nominated directors — at the company's annual meeting.

Apart from institutions like Calpers and TIAA, another sector heard from with increasing frequency is the growing number and size of limited partnerships whose stated intention is replacing entrenched directors/management as a means of enhancing shareholder value. Those once called "raiders" have earned the respect of shareholders by forcing change on underperforming companies as well as on those resisting legitimate takeover bids.

The traditional modus operandi of an activist investor in such situations was to take an initial position in the target company and, failing other efforts to bring about the desired changes, call a special meeting of shareholders for the purpose of nominating a slate of directors usually well known to the investor. If he prevailed, the activist would supposedly "guarantee" a vote in favor of his proposals. While possibly benefiting shareholders, such dissident director nominees aren't independently representing them.

In the spirit of acting solely in the best interests of shareholders, only independent directors with no connection to the activist ought to be nominated by him. Corporate governance guru Ira Millstein, senior partner of Weil Gotshal & Manges LLP, properly prefers the term "shareholder slate director" rather than "dissident director." How does the investor, with his own well-intentioned agenda for maximizing shareholder value, proceed to recruit an independent slate of director nominees whose efforts will serve his best interests as well as those of other shareholders?

On the surface, this task is not as straightforward as initially might be perceived. True, there are many individuals eager to serve on boards — both those already on one or two as well as those who are eager to do so but without such experience.

Serving as a dissident or shareholder director requires someone who is or has been on a corporate board. The need to deal immediately with the kinds of thorny issues confronting a newly elected director in the aftermath of a hard-fought proxy contest are too weighty and complex for the corporate governance novice. Moreover, such directors need to be unfettered by any financial, family or close personal ties to the activist or to the other directors. In short, there can be no conflicts of interest. That includes potential influence from directors or executives of other companies on whose boards or management teams she may serve. Indeed there still exists an "old school tie" mentality with some directors. "I'll never be invited to serve on another board if I go against management," sadly proclaimed one potential director. "It's heresy!" she exclaimed.

The notion that directors should align themselves with management or even with the activist investor seeking to promote beneficial change is contrary to the fiduciary responsibility that every board member accepts. Regardless who has nominated her, a director's allegiance should be solely to the shareholders. Just as directors must hold management accountable, so must stockholders hold directors accountable for enhancing shareholder value.

When an activist or corporate acquisitor nominates a dissident or shareholder director, his cause needs to be in the best interests of the shareholders. Director nominees in such contested situations serve as a validation of the activist/acquisitor's motivation, which should be "on the side of the angels."

It follows that activists need to recruit director nominees who are willing if not eager to stand up and be counted and who, under the pressures to which they will surely be subjected, will not succumb to any course of action that does not singularly benefit the shareholders. This calls for an individual with true resolve and leadership qualities, particularly if the activist is unable to replace the entire board. In that instance, the conceivably lone or in-the-minority dissident shareholder director may need to produce a sea change on the board in order to reverse the course of the corporation. Such directors will need to demonstrate faultless logic and be persuasive advocates of their positions.

A good example of this is the case of Armstrong World Corp. The company was a real underperformer at the time the Belzberg interests targeted it. In a proxy contest, Belzberg had acquired only sufficient stock to nominate and elect one director. Fortunately for the company, he was Michael Jensen, the well-known Harvard Business School professor. The sole dissident on the board, he was sufficiently influential to bring about long-needed reforms. Without being officially designated as such, he became the "lead director."

Jensen persuaded the board to replace the management team. With his quite appropriate and effective coaching from the sidelines, he was in no small way responsible for what was ultimately a dramatic reversal of Armstrong's fortunes. The stock price soared as a result. However, the irony of this successful Jensen-engineered turnaround was that the Belzbergs, who nominated him to the board, sold their position early on in the process, never reaping the rewards of the longer-term shareholders. The dissident shareholder director must be prepared and indeed qualified to serve in a leadership role.

Where and how to find such stalwart independent director candidates? Though tempting, it is strategically imperative that activists do not recruit such nominees from among their business associates, paid consultants (lawyers, accountants, etc.) or social acquaintances. In a proxy contest, that merely invites management and the entrenched board to accuse the activist of the very same cronyism of which she may strategically need to accuse them.

The National Association of Corporate Directors, in Washington, offers a service that can provide the names of potentially available member directors. Corporate lawyers and investment bankers frequently keep lists of directors willing to serve as nominees in contested situations. In most cases, it is wise to select director nominees who have had experience in that industry, especially where issues of valuation or management performance are involved.

Though a group of extant directors may be less interested in creating shareholder value than pleasing management, their estimation (even if flawed) of that company's worth in the marketplace as well as the industry knowledge that they bring to the table strongly suggests that their replacements need be industry-specific.

That strategy proved to be decisive in the proxy contest between activist investors Guy Wyser-Pratte/Spear, Leeds & Kellogg and the Rexene Corp., a Texas-based chemical company. The Rexene board had used the "just say no" defense to refuse a $15 per share bid from Huntsman Corp., also a chemical company. Rexene's stock was trading at only $10! Wyser-Pratte wisely reasoned that to nominate either his own associates or others lacking chemical knowledge would not sufficiently impress Rexene's shareholders to vote to call a special meeting.

Instead, Wyser-Pratte recruited a blue-ribbon slate of four nominees, three of whom had prior experience as senior executives at some of the nation's most respected chemical companies and knew about what Rexene was worth. In no small way, that strategic move caused the shareholders to vote in favor of the special meeting, in the face of which the Rexene board acceded to a sweetened ($16 per share) Huntsman bid. The Wyser-Pratte nominees were never called on to serve.

What inducements are required to recruit such dissident/shareholder directors? There is, of course, the issue of compensation. If the director nominees are actually elected, then the matter of compensation is straightforward. They receive the prescribed directors' fees. Of course, it is the prerogative of such new directors to increase their fees (albeit in accordance with the company's bylaws) if their service through a difficult transition period warrants the raise.

However, if the nominees do not actually serve as directors, either because the activist or acquisitor loses the proxy contest or because the desired corporate changes are made without a new board having to be voted in, then the nominees will, in fairness, expect to be compensated nonetheless. This is certainly reasonable. Indeed the mere stature, reputation and experience of the nominee may not be totally irrelevant during the post-nomination/pre-election period.

A case in point is the Rexene proxy contest above. Each nominee was a recognized figure in the field three former chemical industry executive officers and one corporate law professor. They justly expected to be compensated for the use and value of their names as well as for their time in the event they never served and therefore didn't receive directors' fees from Rexene. Wyser-Pratte/Spear Leeds thus entered into a written agreement with each nominee, which provided a fee of between $10,000 and $15,000 in the event that the individual did not become a Rexene director.

In light of the fact that dissident director nominees are the potential targets of lawsuits, Wyser-Pratte/Spear Leeds indemnified them and additionally agreed to reimburse certain expenses incurred during the period of service as director nominees. Once elected, such indemnity would logically cease, owing to coverage under Rexene's D&O insurance policy.

In another well-publicized proxy contest, which ensued when U.S. Surgical Corp. sought to take over a smaller competitor, Circon Corp., on an unsolicited basis, U.S. Surgical paid each of its two nominees a fee of $100,000, payable in 6.963 Circon shares, for merely agreeing to stand for election to the Circon board. That was in addition to fees received from Circon for actual director service. The two nominees were Charles Elson, a Stetson University law professor noted for his expertise in corporate governance, and Victor Krulak, a retired U.S. Marine general. U.S. Surgical also agreed to indemnify and reimburse certain related out-of-pocket expenses for both nominees.

Another example was Contran Corp., controlled by takeover specialist Harold Simmons. It sought to acquire Lockheed Corp. and offered to both Raymond Troubh, a professional director who today sits on 11 public boards, and then-Admiral Elmo Zumwalt an amount equivalent to a year's worth of Lockheed directors' fees for agreeing to be nominees.

The preceding are all examples of compensation and other consideration provided to directors at large.

What follows are several examples of financial packages offered by activists to dissident director nominees who were expected to play a more pivotal role.

Dickstein Partners Inc., in connection with its efforts to effect a sale of Hill Stores, sought to elect its own slate of dissident directors, including two experienced retailing executives who were not partners of Dickstein. One such nominee was Chaim Edelstein, the former chairman of retailer Abraham & Strauss, whom Dickstein also retained as a strategically important consultant in the Hills matter. Dickstein agreed to pay Edelstein a consulting fee of $50,000 and a contingent fee equal to 1.5 percent of net profits in respect of Dickstein's investment in Hills. Moreover, Dickstein was prepared to install Edelstein as Hills' interim CEO if the extant senior management exercised its rights to resign.

Michael Jensen, mentioned earlier, deservedly received from the Belzberg interests options on 100,000 shares of Armstrong World Corp. Carl Icahn, in his second proxy contest to force a spin-off of RJR Nabisco's food businesses, retained Thomas Ratigan, former Heileman Brewing executive, to head his (Ichan's) dissident slate, which included a total of 10.

Reportedly, Ratigan had a six-month contract, which called for $2 million in salary plus an additional 5 percent of Icahn's profit, net of proxy expenses, should he prevail and the RJR stock subsequently increased in value.

While I advocate total independence for dissident nominees, I recognize that any payment by an activist may appear to fetter that director-in-waiting. Likewise it could be maintained that even directors of companies where no control issues exist are paid by those very companies. (Indeed their directors' fees are paid by a check signed by the CFO, who serves at the pleasure of the chairman.) I submit that director independence is a matter of how a particular director views his or her fiduciary responsibility. Therefore, it is incumbent on the nominator, whether activist or the extant board nominating committee chair, to select potential directors whose reputations and track records bespeak total independence regardless of who pays their fees.

Corporate activists are becoming more numerous, and their war chests are being filled by institutional investors with increasingly greater funding capabilities.

Drawing to a close are the days when such activists enlisted their cronies to serve as nominees. To convince shareholders that they are "on the side of the angels," these activists will need to garner the support of sophisticated, industry-specific, indeed hard-to-find nominees, who will command competitive fees (including equity participation) for the value they contribute.

Perhaps the term "dissident director," will yield to Ira Millstein's preferred term, "shareholder slate director," reflecting a more enlightened activist community of the future. As Charles Elson put it, "As the power and activity level of institutional shareholders grows, so will the nomination and election of the dissident slate of directors. The various challenges such individuals will face will have a profound impact on the development of both the corporate practice and the corporate law."