Why doesn’t the plaintiffs’ bar believe Congress means what it says? The Dodd-Frank Act could not have been more clear that the outcome of the mandatory say-on-pay advisory vote for public companies does not create or imply any change to the fiduciary duties of board members. However, as we have discussed in previous blog posts, this fact hasn’t stopped lawsuits in the wake of failed say-on-pay votes that allege, among other things, breaches of fiduciary duty by the boards of directors and management of public companies related to such failed votes. The vast majority of these cases have been dismissed at the early stages of proceedings, usually for failing to make a proper demand on the board of directors as required by most state corporate law statutes, but this has only lead to a shift in strategies.
As the old saying goes, if you fail, try and try again. That is exactly what the plaintiffs’ bar is doing. The current tactic du jour seems to involve filing suits to enjoin the annual meeting. Most of these complaints seeking an injunction have typically alleged that directors and/or management breached their respective fiduciary duties by not providing adequate disclosure in the annual proxy statement to enable shareholders to make informed voting decisions, usually as it relates to proposals seeking to approve (i) executive compensation, (ii) a new or amended compensation plan, or (iii) an amendment to the charter to increase the number of authorize shares. Some of the most common allegations include:
- “The Proxy fails to disclose the fair summary of any expert’s analysis or any opinion obtain[ed] in connection with the [equity incentive plan]”;
- “The Proxy fails to disclose the criteria” used by the compensation committee “to implement the [stock purchase plan] and why the [equity incentive plan] would be in the best interest of shareholders”;
- “The Proxy fails to disclose the dilutive impact that issuing additional shares may have on existing shareholders”; and
- “The Proxy fails to disclose how the Board determined the number of additional shares requested to be authorized.”
The timing of these lawsuits is less than ideal for companies as many are only a few weeks away from their scheduled meeting. This, of course, creates increased pressure to settle rather than face the uncertainty and expense of litigation and a postponed meeting.
There have been some recent indications that courts are hesitant to support the plaintiffs’ claims in this new line of cases. In Noble v. AAR Corp., a federal case out of the Northern District of Illinois, and Gordon v. Symantec Corp., a California superior court case, the courts in both instances denied granting injunctive relief to plaintiffs on the grounds that they had failed to establish that the law required more information to be disclosed in the proxy statement than what had been supplied.
However, the recent Delaware Court of Chancery decision in Seinfeld v. Slager, the court highlighted a potential fiduciary duty issue related to equity awards to non-employee directors. In denying defendants’ motion to dismiss a breach of fiduciary duty claim in that case, the court indicated that the presumptive benefits of the business judgment rule may not apply where directors have relatively unbounded discretion in determining the equity amounts they award themselves. The plan at issue gave directors the ability to award themselves 1.25 million shares per director per year, potentially more than $21.7 million (grant date value) each. The court stated that “there must be some meaningful limit imposed by the stockholders on the Board for the plan to receive . . . the blessing of the business judgment rule.” The court contrasted another Delaware Court of Chancery case, In re 3COM Corp. Shareholders Litigation, where the option plan at issue had “sufficiently defined terms” and therefore the defendant directors were entitled to business judgment rule protection.
Similarly, in Knee v. Brocade Communications Systems, Inc., the court granted plaintiffs’ motion for a preliminary injunction, holding that plaintiffs demonstrated a reasonable likelihood of prevailing on the claim that the defendant’s proxy statement amounted to a breach of fiduciary duty because of deficient disclosures. In this case the plaintiffs had alleged that Brocade’s proxy statement, which included a proposal to increase the company’s equity incentive plan reserves by 35 million shares, did not fully and accurately describe the proposal or its purported dilutive impact. Brocade subsequently settled the claim, agreeing to supplement its proxy statements and to reimburse plaintiffs’ counsel up to $625,000.
Although the Dodd-Frank Act expressly provided that the mandatory say-on-pay votes imposed upon public companies was advisory and directors could not be held liable for a breach of fiduciary duty based on the outcome of such vote, the plaintiff’s bar has taken some ingenious and opportunistic approaches to pursue executive compensation related claims nonetheless. Even though no level of disclosure can completely protect companies from the risks associate with these types of claims, companies can potentially reduce the litigation risk in a number of ways such as:
- carefully reviewing proxy disclosures, especially if compensation related proposals are included;
- comparing disclosures with those of their peers;
- reviewing “best practices” and updating disclosure appropriately;
- carefully documenting board and committee meetings related to compensation as well as the compensation process, including recommendations and analyses from consultants; and
- preparing in advance to defend disclosure claims, particularly claims seeking to enjoin an annual meeting.
We believe that most of these compensation related lawsuits seeking injunctive relief are likely meritless and should be dismissed at the pleading stages. Notwithstanding this fact, and as John Olson of Gibson, Dunn & Crutcher LLP recommends, “companies should be prepared in advance to defend their disclosures in litigation and in the context of requests for expedited preliminary injunctive relief. Having a litigation team and potential strategy in place before filing the proxy statement may be the most important step a company can take to minimize the disruptive impact of any litigation.”