Recent Court Decision in Cincinnati Bell Sue-on-Pay Case Is a Game-Changer
(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.)
September 26, 2011
A federal district court in Ohio recently denied the defendants’ motion to dismiss in a “Sue-on-Pay” derivative lawsuit against the officers and directors of Cincinnati Bell. This decision is a game-changer that will further embolden potential plaintiffs and plaintiffs’ attorneys in Sue-on-Pay cases and make directors and officers more likely to settle these cases.
The Cincinnati Bell lawsuit claimed that the directors had violated their duty of loyalty by approving compensation that was not in the best interests of the shareholders, based in large part on a 66% negative Say-on-Pay vote against approval of its 2010 executive compensation. Last week, the judge ruled that the plaintiff had pleaded a “plausible” claim featuring factual allegations that would, if proven, overcome the business judgment rule. He cites the plaintiff’s assertion that the negative shareholder vote provides “direct and probative evidence” that the 2010 compensation was not in the shareholders’ best interests.
I respectfully disagree with the judge’s ruling, which seems to ignore the language of Section 951(c) of the Dodd-Frank Act of 2010. As discussed in this prior post, Section 951(c) states that the Say-on-Pay votes “may not be construed . . . to create or imply” any change in directors’ fiduciary duties or any additional fiduciary duties. In fact, the judge mentions this statutory language in a footnote but dismisses its relevance with little analysis or discussion.
However, it doesn’t matter whether I agree with the judge, or even whether the Cincinnati Bell decision will ultimately be reversed on appeal. The decision is very significant in practical terms, even though the only other reported decision to date in a Sue-on-Pay case favors the defendants. Alison Frankel reports in her On The Case Blog on Reuters that a state court judge in Georgia recently dismissed a Sue-on-Pay lawsuit against the Beazer Homes board. But looking at these first two court decisions together, now there is a “1-1 tie” up on the scoreboard. Given the slow pace of litigation, that score may stay up on the board for a while, which is not encouraging for corporate boards. A procedural loss in one of the first decisions sends a clear message that many of these lawsuits will be messy and expensive, making settlements more likely.
As Broc Romanek advised in his recent post in TheCorporateCounsel.net Blog, a variety of factors may lead to more failed Say-on-Pay votes in 2012 – for example, “ . . . a rapidly declining economy and stock market – compared with all boats rising earlier this year.” It will be increasingly important next year for companies to focus on their proxy statement language and shareholder engagement, to maximize the chances for a positive vote and to mitigate the consequences of a negative vote. See this prior post, which includes some proxy statement advice from Towers Watson. I will be providing more tips as we approach the end of the year.