Outside Director Lessons #6: Insist on Total Independence!

When Livedoor was delisted in the spring of 2006, its shareholder composition suddenly became a big issue. Why? Because the majority of its stock were held by a large group of foreign funds (mainly hedge funds) who never imagined that their stock would be so quickly delisted by the TSE and become unsalable “private equity” shares. They were very angry. Another large portion of outstanding stock was held by a combination of ordinary Japanese institutional investors and a corporation or two. The rest was held by large number of individuals, many of whom had spent large amounts of their limited savings on the stock because the company had done so many stock splits that its low price had made it easy to buy, and made it look cheap, at the same time.

The company was in immense turmoil because its corporate brand name and social “license to operate” had become worthless, and all shareholders were extremely angry, because they suddenly saw no credible path to getting their money back. Some of the hedge funds were not high quality global funds, and many of them knew nothing about Japan. They met many times among themselves and tried to come to an agreement as to if, how and when the company should be liquidated, but could never agree on details as to how to sell assets or which fund should be able to appoint its employees to the board. Moreover, they were used to making demands on companies with regard to major issues (individually or as a group), and this was proving difficult to do in Livedoor’s case. The one thing they all agreed about, was that they were unhappy with the performance of the replacement CEO who had been brought in, because he had little experience in M&A transactions.

Finally, a perceptive lawyer at one of the smartest of the funds suggested that they should stop haggling, and should look for truly independent directors who would make up an overwhelming majority of the board. I was contacted as part of the search process that followed, and was asked if I would be willing to serve as a director. Because I felt strongly about the need to improve governance in Japan and thought this might be a learning experience (!), I replied that I might be, but I had three conditions: 1) my compensation would have to be fixed in advance; 2) there would have to be D&O insurance (directors and officers liability insurance) in place; and 3) the funds must understand that I would act as a completely independent director, representing all shareholders, not just them. I set forth these conditions very clearly on my “interview” call, and later on put them in writing in a followup email.

I was also introduced in person to one of the investors by a fund manager at one of the hedge funds. This turned out to be a short interview, so I had coffee with the fund manager afterwards. He told me, “you know it’s been agreed that Livedoor will sell XYZ asset to that investor, don’t you?” To this I replied, “no I have never heard that, and do not necessarily agree with it. In my view all large assets should be sold by way of competitive auction, to obtain the highest price.” This provoked an argument.

A month and a half later I got an email asking if I was still interested. I replied that I was. Since there was no immediate response, I thought the matter was over. A few weeks later, I was notified that the proxy materials had been published, stating that I had been nominated by the company to become an outside director.

I inquired about my compensation, and was told to meet with the “outside director who was in charge of compensation”. Someone did visit me at my office, but what I thought would be a discussion about compensation, instead turned into an hour of loud brow-beating of me, with no mention of compensation whatever. The brow-beating occurred because I was asked to promise to immediately vote to fire the current CEO after I was elected, but I refused to make any such promise. I just kept replying that as an independent director, I would have to decide whether that was necessary or not after I had joined the board and would be in a position to responsibly ascertain the full circumstances of the company and the CEO’s performance. (At that point it was too late to “reverse” my nomination anyway, because my name was already listed in the proxy materials (the convocation notice).)

By sticking to my primary condition of complete independence despite this discussion and various other threats, I was able to remain flexible and able to make the right decisions later on. But it was clear that this company was in total chaos. I told the aforementioned smart lawyer at the fund manager who had originally interviewed me, that my conditions still had to be fulfilled, or I would not join this board.

That is when things got even more chaotic….

Nicholas Benes
(writing in his personal capacity and not representing any organization).

Note: I can write about what happened on Livedoor’s board only because the company no longer exists. Normally as a director, one owes a “duty of confidentiality” to the company, and this duty continues until one dies. But since Livedoor no longer exists, there is no longer any corporation to which I owe a duty.