Executive Compensation

by Joseph E. Bachelder

This article is reprinted with permission from the
December 20, 2010
edition of the
New York Law Journal.
© 2010 NLP IP Company.


Mark Hurd Separation From Hewlett-Packard

On Aug. 6, 2010, Mark Hurd stepped down as chairman, president and chief executive officer of Hewlett-Packard Company. His resignation was at HP's request. He was provided, among other things, a severance payment of approximately $12 million. Today's column considers whether the severance payment, given the circumstances involved in Mr. Hurd's departure, can be reconciled with the HP Severance Plan for Executive Officers pursuant to which it was paid. Specifically, the question is whether the separation qualified as one "not for cause," a condition to payment under that plan.

A severance of another HP CEO, Carly Fiorina, involving entirely different circumstances, was the subject of this column on March 24, 2005.

The Background

On April 1, 2005, Mr. Hurd became CEO of HP. Between that date and June 30, 2010, the market value of HP rose approximately $38 billion. This, together with dividends, represents a total shareholder return (TSR) of approximately 105 percent for the period between April 1, 2005, and June 30, 2010 (compared with a median TSR over the same period of 24 percent for the HP comparator group (55 percent for the 75th percentile)).1 For this purpose, HP comparator group means the comparator group as identified in the current HP proxy statement.

In late June of this year, Mr. Hurd received a letter alleging he had sexually harassed Jodie Fisher, a consultant to HP. He is reported to have promptly furnished the letter to the general counsel of HP. Ms. Fisher had been hired by the office of the CEO in late 2007 or early 2008 to assist in the hosting of certain HP meetings. It appears these included meetings that provided customers and prospective customers with an opportunity to meet and talk directly with Mr. Hurd. The letter, it has been reported, alleged that Mr. Hurd met with Ms. Fisher on numerous occasions and at different locations within and outside the United States and that a number of these meetings were not business-related.

Reports also have indicated that Mr. Hurd and Ms. Fisher were reimbursed for expenses in connection with their meetings and that at least some of their meetings were not business-related. Mr. Hurd is reported to have offered to pay HP back any erroneous reimbursements for his meetings with Ms. Fisher. During July and into the first week of August, Mr. Hurd apparently engaged in discussions with members of the HP Board of Directors regarding what happened in the Fisher matter. There appears to have been a growing concern on the part of at least some members of the board as to whether they were getting a complete picture from Mr. Hurd of what actually had occurred.2

The board retained an outside law firm to investigate the Fisher matter. The firm reported to the board at a meeting which took place in late July (apparently the meeting began on July 28 and continued into July 29). According to a Nov. 6, 2010, article in The Wall Street Journal:

• After its July meeting, the board "waited for a mediation session they had scheduled for a week later with Ms. Fisher's lawyer."

• On Aug. 5, lawyers for Mr. Hurd and Ms. Fisher settled the dispute raised by her letter.

• Also on Aug. 5, lawyers for HP were told of the settlement.

On Aug. 6, Mr. Hurd stepped down.3 Concurrently, he and HP entered into a Separation Agreement and Release.4

The Separation Agreement

Following are certain of the economic benefits provided Mr. Hurd in connection with his separation:

(a) Mr. Hurd received a severance payment of $12,224,693.

(b) Mr. Hurd was permitted to exercise those options that were already vested and exercisable during a window period commencing Aug. 23, 2010, and ending Sept. 7, 2010. The spread in the options on the date of Mr. Hurd's termination was approximately $9.5 million. Between Mr. Hurd's date of termination and the window period, the HP stock value declined significantly.

(c) He was allowed to continue to hold certain performance-based restricted stock units, subject to applicable conditions, following termination; these stock units had a value at the time of termination of approximately $15.3 million.

(d) He became entitled to the settlement of certain time-vested restricted stock units on Dec. 11, 2010; these shares had a value at the time of termination of approximately $700,000.5

Mr. Hurd Joins Oracle

On Sept. 6, 2010, Oracle Corporation announced that Mr. Hurd had joined Oracle as president and a member of its Board of Directors. Oracle is a direct competitor of HP.6

On Sept. 7, 2010, HP sued Mr. Hurd (and 25 "Does") in the Superior Court of California for damages and injunctive relief as a result of his appointment at Oracle.7 It claimed that he possessed highly confidential information regarding HP, that he was under obligation not to disclose such confidential information, that by joining Oracle he was putting himself in a position of inevitably disclosing such information and that "HP has been injured and faces irreparable injury." On Sept. 20, HP filed a Form 8-K announcing that it had settled the lawsuit. In that filing, HP states that Mr. Hurd agreed, among other things, that he would forfeit his performance-based and time-vested restricted stock units noted above. Mr. Hurd apparently retained his severance payment and his gains from exercise of stock options.

Issues Raised

Was there cause to terminate Mr. Hurd?

The Form 8-K filed by HP on Aug. 6 states that Mr. Hurd received "a severance payment of $12,224,693 under the HP Severance Plan for Executive Officers." The separation agreement provides that the payment (less applicable withholdings) is "in full satisfaction of the Company's obligations under the Severance Plan."

The severance plan specifically provides that severance under it is limited to an involuntary termination without cause.8 Cause is defined by the plan to mean a participant's

• "Material neglect (other than as a result of illness or disability) of his or her duties or responsibilities to HP; or

• "Conduct (including action or failure to act) that is not in the best interest of, or is injurious to, HP."9

The severance plan provides that cause shall not be deemed to exist unless determined by a majority vote of the members of HP's board or an "independent committee thereof." It is not known whether a vote was taken by the board or by an independent committee of the board. By approving the payment of severance, at least a majority of the board (or a committee of independent members) presumably concluded that the circumstances did not warrant a finding of cause.10

Comments by HP executives and directors made on or after Aug. 6 are difficult to reconcile with a conclusion that conduct of the sort covered by "cause" for purposes of the severance plan was not involved.

Ray Lane (non-executive chairman of HP, appointed after the resignation of Mr. Hurd) in a letter to the editor for The New York Times, on Oct. 11, 2010, as set forth in "All Things Digital" (Oct. 11, 2010) and "Business Insider" (Oct. 12, 2010) wrote: "The bottom line is: Mr. Hurd violated the trust of the Board by repeatedly lying to them in the course of an investigation into his conduct. He violated numerous elements of HP's Standards of Business Conduct and he demonstrated a serious lack of integrity and judgment."

Cathie Lesjak (CFO of HP; Interim CEO following Mr. Hurd's resignation) wrote in an e-mail to HP employees on Aug 6: "Based on the [board's] investigation it was determined that…[Ms. Fisher's] claim of sexual harassment was not supported by the facts… The investigation did reveal, however, that [Mr. Hurd] had engaged in other inappropriate conduct. Specifically, based on the facts that were gathered it was found that [Mr. Hurd] had failed to disclose a close personal relationship he had with the contractor that constituted a conflict of interest, failed to maintain accurate expense reports, and misused company assets. Each of these constituted a violation of HP's Standards of Business Conduct, and together they demonstrated a profound lack of judgment that significantly undermined [Mr. Hurd's] credibility and his ability to effectively lead HP."

According to the transcript of an HP conference call with analysts on Aug. 6, Mike Holston (EVP and general counsel of HP) said: "The findings of the [Board's] investigation were as follows. [Mr. Hurd] had a close personal relationship with an HP contractor who was hired by the office of the CEO and [Mr. Hurd] never disclosed that relationship to the Board of Directors. The investigation revealed numerous instances where the contractor received compensation and/or expense reimbursement where there was not a legitimate business purpose. And the investigation found numerous instances where inaccurate expense reports were submitted by [Mr. Hurd] or on his behalf that [sic] intended to or had the effect of concealing [Mr. Hurd's] personal relationship with the contractor…. [The] Board concluded, and [Mr. Hurd] agreed, it would be impossible for him to be an effective leader moving forward and that he had to step down."11

In the same conference call, Marc Andreessen (director of HP) said: "[Mr. Hurd's] conduct undermined the standards we expect of our employees, not to mention the standards to which the CEO must be held…."

In an HP press release on Aug. 6, Mr. Hurd said: "As the investigation progressed, I realized there were instances in which I did not live up to the standards and principles of trust, respect and integrity that I have espoused at HP and which have guided me throughout my career."

If there was not cause, what was the basis for Mr. Hurd's abrupt termination on Aug. 6? The board may have been very upset by the Fisher matter, including Mr. Hurd's discussions with board members during the board's investigation into that matter. Nonetheless, it may have concluded the circumstances involved something less than cause. But if the board concluded it lacked a basis for cause, how could Mr. Hurd's employment have been so abruptly terminated considering the positive accomplishments under his leadership at HP? The abrupt action by the board is at least difficult to reconcile with a conclusion that there was not cause within the meaning of the severance plan.

Shareholder Lawsuits

Since the announcement of Mr. Hurd's departure and the separation agreement, there have been a number of shareholder lawsuits directed at the termination arrangements with Mr. Hurd.12

Under the circumstances surrounding Mr. Hurd's termination, why was there such a prompt payment of severance?

HP could have provided that the severance payment would be made over a longer period than the 30 days following Mr. Hurd's termination date. In that event, it could have conditioned the payments on Mr. Hurd's not doing something during such longer period that would be inimical to the interests of HP, as it asserted in the complaint in its lawsuit, Hewlett-Packard Company v. Mark V. Hurd, et al., noted above.

If such a provision had been included, HP presumably would have caused the remaining portion of his severance payments to be forfeited when Mr. Hurd accepted the position of president at Oracle. HP would have been in a strong position to defend against any legal challenge to the forfeiture by Mr. Hurd. In addition to such forfeiture provision, HP might have provided in the separation agreement for a "clawback" of any severance payments already made to Mr. Hurd if he did something contrary to the interests of HP, as just noted.

Conclusion

Five years ago this column discussed discrepancies between the HP severance plan and the separation payments made to Carly Fiorina. (As noted at the outset of the column, the circumstances were entirely different from those in Mr. Hurd's case.) Accurate reporting to shareholders of plan provisions, such as the severance plan, and taking actions consistent with those provisions is a very important part of good corporate governance.

Judgment of governance in actual practice must allow some latitude for the realities of time and business pressures within which corporate actions are taken. But it certainly seems to this author that, for the second time in about five years, HP has pushed the limits of good corporate governance in its handling of separation arrangements with its CEO.


FOOTNOTES

1. Mr. Hurd was named "CEO of the Year" by the San Francisco Chronicle in 2008. This was based on a survey of the 200 largest companies (measured by revenue) in the San Francisco Bay Area. Mr. Hurd also was ranked as one of the top 25 CEOs for 2009 by Brendan Wood International, based on a review of 317 U.S. companies by 2,500 asset managers. This was reported in Forbes.com June 23, 2009.

2. According to news reports, Ms. Fisher had a film career that included a role in at least one so-called "adult" film. Apparently, a question arose over when Mr. Hurd learned of Ms. Fisher's film background. Also reported as being a concern to the board was the extent to which Mr. Hurd may have had conversations with Ms. Fisher that included discussion of confidential HP business information. The author is not aware of any direct evidence on this point. A report on both these matters appeared in an article in The Wall Street Journal, Nov. 6, 2010, p. A1.

3. In its announcement on Aug. 6, the HP board stated that "[t]he investigation determined that there was no violation of HP's sexual harassment policy, but did find violations of HP's Standards of Business Conduct."

4. As of March 29, 2005, effective April 1, 2005, HP and Mr. Hurd entered into an employment agreement. Statements contained in the current proxy statement, filed in connection with the March 17, 2010, annual meeting of HP stockholders, refers in several places to Mr. Hurd's employment agreement, suggesting that, at least as of the filing of the proxy statement in early 2010, the employment agreement continued in effect. The Separation Agreement and Release, entered into by HP and Mr. Hurd on Aug. 6, 2010, refers in Section 15 to "your prior employment agreement dated March 29, 2005." Thus, it appears that the 2005 employment agreement continued in effect for a period into 2010 but may have expired, or have been terminated, prior to Aug. 6.

5. Taking into account applicable plans and forms of awards that are available from SEC filings, following appear to be relevant provisions regarding the outstanding equity awards referred to in Sections 2(b), (c) and (d) of the text:

a. Stock options. Unvested awards are forfeited. Vested awards are forfeited if the termination is not one that qualifies under the plan (retirement, death or disability). However, the Board or a Committee of the Board may modify the option, including acceleration of its vesting and exercisability.

b. Performance-based restricted stock units. These would be forfeited upon a termination (other than retirement, death, disability or a "reduction in work force") but the Board or a Committee of the Board appears to have the authority to provide for accelerated vesting in the case of other terminations, such as a termination without Cause.

c. Restricted stock units. These would be forfeited upon a termination other than retirement, death or disability but the Board or a Committee of the Board appears to have the ability to provide for accelerated vesting in the case of other terminations, such as a termination without Cause.

6. Both corporations are headquartered in California. Mr. Hurd's Separation Agreement provides that it is subject to California law. Under the California Business and Professions Code Section 16600, no-compete agreements generally are unenforceable. Section 16600 states, "Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void." As discussed in the text, HP sought to avoid this restriction by claiming it would be damaged as a result of inevitable disclosure of confidential information by Mr. Hurd in his role as president and a director at Oracle.

7. Hewlett-Packard Company v. Mark V. Hurd, et al., 1-10-CV-181699 (Cal. Super. Ct., filed Sept. 7, 2010). The action appears to have been dismissed Sept. 28, 2010.

8. The Compensation Discussion and Analysis of executive compensation in the current HP proxy statement states that "[u]nder the HP Severance Plan for Executive Officers, participants who incur an involuntary termination, not for cause, and who execute a full release of claims following such termination, are eligible to receive severance benefits in an amount determined as a multiple of base pay and the average of the actual bonuses paid under the PfR Plan in the preceding three years." The CD&A also notes that the multiple is two in the case of the CEO.

9. A California Court of Appeals decision has held that, under California law, an employer can terminate an employee for cause, taking away benefits to which he might otherwise be entitled, under circumstances in which inappropriate behavior may jeopardize the employee's own reputation and be injurious to the employer. The case involved employment without a specific contract provision like that contained in the HP Severance Plan. See Waymire v. Placer Joint Union high School Dist., 29 Cal. Rptr. 459 (Cal. App. 3rd Dist. 1963).

10. As stated in its Aug. 6 announcement of Mr. Hurd's resignation (see footnote 3 above), the HP board took into account HP's Standards of Business Conduct. Those standards provide that, among other things, "we maintain accurate business records…[we] create business records that accurately reflect the truth of the underlying transaction or event." It also provides that "[we] cooperate with all internal investigations…" Cathie Lesjak, in her Aug. 6, 2010, e-mail to HP employees, excerpts from which are quoted in the text, stated that the board's investigation also revealed failure to disclose a close personal relationship with an independent contractor (Ms. Fisher) that constituted a conflict of interest, that the investigation also revealed a misuse of company assets and that these circumstances violated HP's Standards of Business Conduct.

11. The transcript can be found at http://h30261.www3.hp.com/ phoenix.zhtml?c=71087&p=irol-EventDetails&EventId=3282080.

12. Shareholder lawsuits have been filed in Delaware and California. These include:

In Delaware:

a. Espinoza v. Hewlett-Packard, CA 6000 (Del. Ch., filed Nov. 18, 2010)

b. Zucker v. Andreessen, et al., CA 6014 (Del. Ch., filed Nov. 24, 2010).

The complaints in both Delaware cases, as of the writing of this column, were under seal.

In California:

a. Brockton Contributory Retirement System v. Andreessen, et al., and Hewlett-Packard, 1-10-CV-179356 (Cal. Super. Ct., filed Aug. 10, 2010). This action was consolidated with two other state court actions into In re Hewlett-Packard Company, 1-10-CV-179356 (Cal. Super. Ct., consolidated Sept. 21, 2010).

b. Levine v. Andreessen, et al., 10-CV-03608 JW (U.S.D.C., N.D. Ca., filed Aug. 16, 2010). This action was consolidated with three other federal court actions into In re HP Derivative Litigation, 10-CV-03608 JW (U.S.D.C., N.D. Ca., consolidated Nov. 1, 2010).