Home Depot Settlement: Corporate Governance Changes

Over the past two years Home Depot has faced multiple derivative lawsuits by stockholders. These suits allege that former and current officers and directors breached their fiduciary duties in multiple ways, including: backdating of stock-options, engaging in illicit return-to-vendor practices, and approving excessive compensation for its former CEO, Robert Nardelli. On March 28, 2008, the plaintiffs of these derivative suits and Home Depot stipulated the settlement terms. In exchange for the plaintiffs’ release of their claims, Home Depot has agreed to pay $14.5 million for the plaintiffs’ legal fees and to change many of its corporate governance practices for a term of four years. On April 3, 2008, Georgia’s Superior Court of Fulton County issued a preliminary approval of the proposed settlement.

The corporate governance changes in the proposed settlement are quite broad in scope, ranging from the board structure to annual meetings requirements. Some of the most significant provisions in the settlement relate to the make-up of the company’s board. The Audit, Nominating and Corporate Governance (“NC&G”) and Leadership Development and Compensation Committees will each be required to have a written charter. The directors on those committees must all be independent. Additionally, at least two-thirds of the board itself must be independent. The settlement also addressed director independence, as it set forth a more stringent standard than that of state law by noting several circumstances where a director is not independent. For example, employment with Home Depot in the last three years or jointly acquired investments with the company would destroy a director’s independence.

The settlement has also made significant changes to the director nomination and election processes. It requires the NC&G to consider all candidates recommended by any stockholder (or group of stockholders) who own at least 1% of Home Depot’s outstanding stock. The company is then required to use reasonable efforts to work with LENS Governance Advisors, a shareholder-friendly investment firm, in evaluating the stockholder candidates. When it comes to uncontested director elections, one can only be elected if they receive a majority of the votes cast. If a director fails to receive a majority of the votes in an uncontested election, that director must then resign from his or her position.

The settlement also addresses the awarding of compensation to both officers and directors. To help prevent the backdating of officer options the company must publicly disclose such grants within two days. The exercise price of these options cannot be lower than the closing price on the date of the grant. Additionally, any long-term incentive plan for an officer must be “constructed to ensure that the vesting and award of cash incentives are based on performance metrics and targets.” Directors’ options, on the other hand, must be granted on a pre-determined set date, eliminating the possibility of back-dating altogether. Furthermore, the settlement also ties director compensation to the performance of the company; at least two-thirds of a director’s annual retainer must be paid in stock, restricted stock, stock options, equity units, or other equity awards.

The corporate governance changes also sought to create more transparency by placing conditions on officers and directors at the annual meeting. One such provision mandates that all directors attend the meeting absent extraordinary circumstances. At the meetings, stockholders are given a right to ask questions and receive answers regarding all matters that are up for vote. Such questions can be directed at the CEO or any other appropriate officer who is at the meeting.

Although the court has issued a preliminary order approving the settlement, the corporate governance changes will not go into effect until the court’s final approval. The court scheduled a settlement hearing for June 10, 2008, to determine if the terms are fair, reasonable, adequate, and in the best interest of Home Depot and its stockholders. If the court approves the settlement, Home Depot’s corporate governance will be significantly altered for the next few years.

The primary materials for this post are available on the DU Corporate Governance website.