If the Shareholders Say "Nay-on-Pay", Get Ready for "Sue-on-Pay"
(The following post originally appeared on ONSecurities, a top Minnesota legal blog founded by Martin Rosenbaum to address securities, governance and compensation issues facing public companies.)
June 27, 2011
A number of public companies this year have received a majority of negative votes in their shareholder advisory votes on executive pay (Say-on-Pay), required under the Dodd-Frank Act – see this prior post. In his Proxy Disclosure Blog on CompensationStandards.com (subscription site), Mark Borges reported yesterday that at least 36 companies have experienced “Nay-on-Pay” votes.
In a Reuters article, “Hercules execs sued over failed ‘say on pay’ vote,” Tom Hals reported recently that Hercules Offshore, Inc. became the sixth company to face shareholder derivative lawsuits based on a negative Say-on-Pay vote. The others are, in reverse chronological order, Umpqua Holdings Corporation, Beazer Homes USA, Inc., Jacobs Engineering Group, Inc., Occidental Petroleum Corporation and KeyCorp. There are generally multiple lawsuits involving each company in various state and federal courts. These “Sue-on-Pay” lawsuits have caused a great deal of consternation in boardrooms, partly out of fear that every negative Say-on-Pay vote has the potential to lead to expensive and distracting litigation.
My colleagues and I have taken a preliminary look at the cases and have some observations:
Timing. The KeyCorp and Occidental Petroleum lawsuits were filed in mid-2010, after the advisory votes at those companies’ 2010 annual meetings. Both of those cases have been settled. The KeyCorp settlement is discussed below. A blog post from the Davis Polk law firm reported that Oxy Pete settled one case and got two others dismissed. The lawsuits involving the other four companies have all been brought in 2011, based on failed Say-on-Pay votes at the companies’ 2011 annual meetings.
The Law Firms. A couple of plaintiffs’ firms each show up in several of these cases. In the KeyCorp, Oxy Pete and Jacobs Engineering cases, the Weiser Law Group in the Philadelphia area is listed as one of the plaintiffs’ law firms, and Weiser was lead counsel in the KeyCorp settlement. The Robbins Geller firm in San Diego is listed as counsel in the Oxy Pete, Beazer, Umpqua and Hercules cases. Other firms show up as well, but these two firms seem to be common threads. Both are well known plaintiffs’ firms.
The Claims. The lawsuits are all derivative claims, meaning the plaintiff/shareholders are bringing claims against the individual directors on behalf of the corporation. Not surprisingly, the claims in the various cases are very similar: the directors allegedly (i) breached their duty of loyalty by deliberately diverting corporate assets to the executives at the expense of the shareholders and aided and abetted each other in these actions; (ii) committed corporate waste and caused unjust enrichment; and (iii) breached their duty of candor and full disclosure by stating in the proxy statement that pay was based on performance, concealing the overpayments. Many of the complaints include lovely charts showing that compensation increased significantly in the preceding year, while shareholder return decreased significantly. The claims in these cases are based on both the board’s original approval of the preceding year’s compensation and the failure to make immediate changes to the compensation programs following the Say-on-Pay vote. Plaintiffs also generally claim that the negative Say-on-Pay vote rebuts the presumption in favor of the boards’ actions under the business judgment rule.
One interesting side note for compensation consultants: in every one of the six lawsuits, the consultants were named as defendants, on the theory that they aided and abetted the directors’ bad actions and breached their contracts with the company by allegedly giving lousy advice. PricewaterhouseCoopers and Frederic W. Cook & Co. are each named in two lawsuits, with Mercer and Pearl Meyer & Partners each named in one. This development cannot be welcome news in the executive compensation consulting world.
The Merits and Procedural Considerations. Strictly on the merits, there should be meritorious defenses to these claims. The board, not the shareholders, is charged under state law with making compensation decisions, and the presumptions in favor of the directors’ actions should not shift based on a non-binding advisory vote. This is especially true in light of Section 951(c) of the Dodd-Frank Act (848-page PDF), which specifically provides that “ . . . the shareholder vote . . . may not be construed . . . to create or imply any change to the fiduciary duties of such issuer or board of directors . . . [or] any additional fiduciary duties for such issuer or board of directors. . . .”
However, procedurally, getting a final determination on the merits of any case still takes time, at least a matter of months, and the Sue-on-Pay cases are scattered in a variety of state and federal courts. In the meantime, as plaintiffs get some settlements, this could embolden these same law firms or other plaintiffs’ firms to bring more claims.
The KeyCorp Settlement. In March 2011, KeyCorp reported that it had entered into a comprehensive settlement agreement for the legal actions based on its 2010 Say-on-Pay vote. Note that the Dodd-Frank Act requirement was not yet in effect for this vote, but KeyCorp held its vote under a similar requirement for TARP recipients, which includes language on fiduciary duties that is very similar to the Dodd-Frank language – i.e., the advisory vote does not change fiduciary duties. See Section 7001 of the American Recovery and Reinvestment Act of 2009 (PDF). Nonetheless, after months of wrangling, KeyCorp settled the case on terms that are pretty typical for derivative settlements. KeyCorp agreed to make numerous changes in its compensation practices and procedures, and also agreed to pay $1.75 million in fees to the plaintiffs’ law firms.
In one of my favorite provisions of the settlement agreement, the plaintiffs’ firms boldly stated that they intended to ask the court to approve the payment of cash fees to the named shareholder plaintiffs. These fees would be paid in recognition of these shareholders’ service to the company and all of its shareholders, and the amount of said fees, if approved, would be deducted from the plaintiffs’ firms’ fees. The aggregate amount of said fees to be requested: $5,000.
Comment. Regardless of the merits of these lawsuits, any company in danger of losing a Say-on-Pay vote should be prepared for a Sue-on-Pay action. Until courts in a number of jurisdictions rule on motions to dismiss (and any appeals from dismissals are decided), the plaintiffs’ law firms are likely to be emboldened by settlements like the KeyCorp agreement. Advisors should prepare the board members for the prospect of being named individually, and public companies should be prepared for the potential expense and distraction of a lawsuit.
In this litigious atmosphere, corporate counsel should be especially attuned to keeping appropriate records of the process followed in connection with any compensation decisions. Even if a company received an overwhelming vote of support this year, the shareholders may not be so generous next year if the stock takes a dive but reported compensation keeps flying high. Also, if the company is not confident in the result of an upcoming Say-on-Pay vote, it will be very important to react quickly to a failed vote. Does the compensation committee want to make immediate changes, if those changes are possible? Does the company want to announce changes right away? In light of the settlement by Key, preparation will be key.