Why Icahn Now Wants to Boot Yahoo!'s Jerry Yang

Billionaire investor Carl Icahn says he will seek to remove Jerry Yang as chief executive of Yahoo! if he succeeds in a proxy battle against the company over its failure to reach a deal with Microsoft Corp., the Wall Street Journal reports. Icahn has proposed an alternate slate of directors for Yahoo's board, but has yet to directly target Yang, the paper says.

"It's no longer a mystery to me why Microsoft's offer isn't around," the Journal quoted Icahn as saying. "How can Yahoo keep saying they're willing to negotiate and sell the company on the one hand, while at the same time they're completely sabotaging the process without telling anyone?"

Icahn's frustration evidently stems from a nasty shareholder class action law suit that is buzzing through Silicon Valley. Yahoo! tried to keep this embarrassing law suit secret, but failed. It's a suit that could give more cannon fodder to corporate raider Icahn's attempt to unseat the company's board, as it purports to unmask what really went on behind the scenes at Yahoo! as it fought back Microsoft's unwanted advances.

A Delaware chancery court judge has unsealed details of this embarrassing lawsuit filed against Yahoo's (YHOO) directors, including chief executive Jerry Yang. The suit alleges they erected obstacles to thwart a takeover bid from Microsoft (MSFT).

The suit should make you rethink the "100-day" plan Jerry Yang promised when he assumed the chief executive position in June 2007, when former CEO Terry Semel left in the wake of a shareholder revolt. In that plan, Yang vowed "no sacred cows." Instead, the suit shows that Yang made all of his employees expensive "sacred cows" in a bid to thwart Microsoft.

The web site of the law firm Bernstein Litowitz Berger & Grossmann LLP, which represents the investors (the pension funds for the Detroit policemen and firemen as well as Detroit's city employees) have posted a copy of the complaint on its website, as well as a copy of the judge's letter explaining his decision to unseal the filing. See http://www.blbglaw.com/complaints/YahooFirstAmendedVerifiedComplaint-Unsealed-5.12.08.pdf

It's a suit I had told you about in a prior blog that Yahoo! had fought to keep sealed, as it was concerned it could damage the board's efforts to repel a challenge by activist investor Icahn, ("Why Yahoo! Can't Go it Alone," see also "Why Carl Icahn May Fail at Yahoo!", "Why Microsoft Should NOT Up its Bid for Yahoo!").

Microsoft initially offered $31 a share for Yahoo!, then later upped it to $33 per share, or $47.5b. It then withdrew its offer when Yang and his cohort held out for $37 per share. Legg Mason money manager Bill Miller, whose fund is one of Yahoo!'s largest shareholders, has publicly said he would have happily supported a Microsoft offer of $34 per share. Yahoo's shares closed yesterday at $26.40.

The shareholder suit, which has evidently gotten hold of Yahoo!'s internal emails and records of phone conversations and internal meetings, alleges Yahoo!'s board of directors breached their fiduciary duties and ought to be financially liable for rejecting the Microsoft bid and for deliberately enacting "roadblocks" to make a Yahoo! "acquisition less attractive" to Microsoft.

The roadblocks came in the form of an alleged costly employee-severance plan for 13,800 Yahoo! workers that Microsoft would have to pay in the event it bought Yahoo! The suit also alleges Yang "engineered an ingenious defense creating huge incentives for a massive employee walkout in the aftermath of a change in control."

The "rich" new compensation plan would purportedly have made it easier for Yahoo! employees to quit Microsoft en masse, and get Microsoft to pay them upwards of a total of $2.4b in severance benefits, depending on the deal's price, the suit says.

The plans would have given Yahoo!'s 13,800 employees anywhere from four months to two years of pay, depending on their employment level. Usually top executives get full severance pay in a deal, not all employees, as incoming management seeks to seat its own top guns.

In addition, the Yahoo! change in compensation would let employees easily walk out the door for any "good reason," by claiming "a substantial adverse alteration" in job duties or responsibilities. Moreover, employees could quit and get accelerated vesting of their stock and stock options after a change in control.

According to notes the plaintiffs' lawyers say they received in discovery, one Yahoo! vice president wrote that it is "a bizarre outcome if people who stick around make off worse financially than people who [are] laid off." The suit attaches an email from Yahoo!'s senior director of integration and corporate development, Jonathan Dillon, who wrote that the new plan "will make things increasingly expensive for msft [sic] though."

Yahoo!'s newly hired chief technology officer, Ari Balogh, allegedly objected to Yang's new plan, the suit says. The suit also alleges Yang "chose to keep from Yahoo!'s employees the details of Microsoft's own retention plans" secret by keeping Yahoo!'s senior human resource executives and advisors in the dark about it, and instead conducting closed door, "closed session" meetings with board compensation committee members.

The extra compensation costs would have made it prohibitively expensive for Microsoft to buy Yahoo!, who would have to foot that bill. Every $1.4b in severance cost theoretically would translate into about $1 per share less that Microsoft would have available to offer Yahoo shareholders.

Yahoo!'s new plan is the reason why Microsoft suddenly said it would earmark an extra $1.5b in retention pay to keep Yahoo! employees in the door in order to get the deal done, in addition to its then $45b offer. In an April 5, 2008 letter, Microsoft's Steve Ballmer criticized Yahoo!'s board for adopting the severance plan, which he said "made any change of control more costly."

Compensia, the outside compensation consultant Yahoo! hired to review the change, apparently wasn't having any of this, though. An email exchange dated February 5 that's attached as records to the suit shows Compensia principal Michael Benkowitz wrote "their [Yahoo!] latest proposal is to provide 100% equity acceleration for everyone," to which his colleague Tim Sparks emailed back, "That's nuts."

Yang insisted on a more expensive plan than his human resources executives originally wanted, the suit says, by also "providing full" 100% "acceleration of all equity-based compensation ever granted to all employees," with the blessing of Yahoo! president Susan Decker, the suit alleges. That would include accelerating their stock options and restricted stock rights.

The suit says Yahoo! estimated that Microsoft would have to pay severance benefits to all employees at a cost ranging from $2.1b (at the offer price of $31 a share) to $2.4b (at $35 a share) if they quit en masse, according to the unsealed court documents.

The outside compensation consultant hired to review the change, Compensia, was allegedly worried "about the breadth of the program," and wrote an email expressing "surprise," about the acceleration of stock-based grants, the suit says.

Footnote: The plaintiffs assert that in January 2007 Microsoft offered to buy Yahoo! for $40 a share, but that the proposal was rejected in a letter from then-CEO Terry Semel, who instead proposed "a commercial partnership arrangement."