A third wave of shareholder lawsuits over companies’ executive-compensation programs has come ashore.
In the past six months, the boards or officers of 10 companies have been targeted by derivative shareholder lawsuits alleging that executives were awarded stock-based compensation in excess of the amounts specified in approved stock plans, and thus the companies filed false and misleading proxy statements. (Under derivative shareholder lawsuits, investors sue board members or officers, technically on behalf of companies whose shares they own.)
It’s too soon to tell how the cases will be resolved, according to a client alert from law firm Pillsbury Winthrop Shaw Pittman (usually known simply as Pillsbury, the firm has been monitoring compensation-related investor litigation since the 2010 passage of the Dodd-Frank Act). But where the allegations prove to be true, “these suits stand a higher probability of success than the two prior litigation waves,” the firm wrote.
Provisions of Dodd-Frank forced companies to make new executive-compensation disclosures in proxy statements and authorized shareholders to hold nonbinding advisory (or “say on pay”) votes on the proposed pay packages of five executives: the chief executive officer, the CFO, and the three other most highly paid officers.
Unlike the lawsuits filed in the first two waves of shareholder litigation, which began in 2010 and 2012, the new ones have nothing to do directly with say on pay. But they are another attempt to take companies to task over executive compensation.
In the first wave of litigation (also composed of derivative shareholder suits),the board members of 22 companies whose shareholders had voted down executive-compensation plans were sued by individual investors or investor groups alleging the boards breached their fiduciary duties by approving the plans anyway. Courts have dismissed 11 of those cases, 1 was voluntarily withdrawn, 6 are still pending, and only 4 were settled, though in 3 of those, plaintiffs were compensated for attorneys’ fees of $1 million or more.
The second wave of suits — so far, 24 class actions brought by individual investors on behalf of all investors, aimed at companies directly, as well as their board members — peaked last fall. They claimed that proxies did not provide enough disclosure of executive compensation for shareholders to make an informed say on pay vote.
Those suits, filed in advance of companies’ annual meetings, sought to postpone the meetings until additional disclosures were made. With companies understandably anxious for the meetings to take place as planned, nine of the suits have been settled, with the companies agreeing to either make supplemental disclosures, pay plaintiffs’ attorney fees, or both. The attorney fees in the settled cases have been lower in the second wave, topping out at $625,000 for a single case.
Companies sued in the second wave — which is still alive, though new lawsuit filings have waned somewhat in recent months — have included such well-known names as Brocade Communications, Cisco, Clorox, H&R Block, Martha Stewart Living Omnimedia, Microsoft, Symantec, and WebMD.
The settled cases tended to be the earlier-filed ones. After a while, companies began to defend the cases more aggressively, and the suits’ success rates declined. In eight cases, plaintiffs’ requests for preliminary injunctions to postpone annual meetings were denied, though five of those eight cases are still pending. And plaintiffs have voluntarily dropped eight cases.
“Settling these cases only incentivizes plaintiffs to continue filing such suits,” says Ana Damonte, a Pillsbury attorney. “Companies that settle could put targets on their backs. Maybe they’d get sued again next year.”
Further, Pillsbury wrote in its February 21 client alert, “No amount of additional disclosure in proxy statements will prevent companies from being sued. Rather, plaintiffs’ counsel will poke holes and allege that additional disclosure is required no matter what is contained in the proxy.” Still, “It goes without saying that strong disclosures will put companies in a better position to defeat these actions.”
Towers Watson compensation consultant Steve Seelig says some of the disclosure requests made in the lawsuits are in line with what compensation consultants have been counseling clients to disclose, “but others are really overreaching.” In fact, he takes a dim view of the litigation overall.
In a recent blog post, Seelig wrote, “These lawsuits have been brought under various state laws in search of a favorable forum. Their overarching goal seems to be to find a sympathetic judge who sees merit in becoming the arbiter of what is ‘enough’ disclosure and is willing to enjoin a company from proceeding with its annual meeting until that determination is made. Our hope is that state courts are wise to the game.”
Notably, all but one of the second-wave lawsuits (against Abaxis, a provider of portable blood-analysis systems for human and veterinary clinics) have been brought on plaintiffs’ behalf by a single law firm, New York–based Faruqi & Faruqi. The firm did not respond to a request for comment on this article, nor did the two major shareholder-advocacy firms, Institutional Shareholder Services and Glass Lewis.
In an interview with CFO, Seelig suggested that CFOs may be interested in the potential for shareholder litigation for reasons other than the specter of paying plaintiffs’ attorney fees. “Should CFOs be policing the disclosures?” he asked. “There’s the school of thought that says these suits will come regardless of the quality of disclosures. But another school says, ‘maybe we need to do a better job of describing some of the things that are pursuant to these allegations that are out there.’”
As to the third wave of shareholder suits over executive compensation, the cases are in the very early stages. At least two companies — drug wholesaler Amerisource Bergen and satellite-services provider Echostar — find themselves having to defend two of the suits.
Unlike the lawsuits that typified the first and second waves of litigation, those of the third wave are “entirely preventable,” Pillsbury wrote in its client alert, merely requiring compensation committees and their counsel to ensure that all stock grants and executive-compensation proposals are in compliance with companies’ stock plans.
At least two CFOs, James O’Leary of Beazer Homes and Gary Wojtaszek of Cincinnati Bell, were named as individual defendants in the first wave of cases. But finance chiefs have generally been spared shareholders’ legal wrath.
That’s not a given, though, points out Lynne McCauley, managing director of The Spofford Group, a broker of directors’ and officers’ (D&O) liability insurance and other types of liability insurance. “Besides caring about the impact defending these suits has on financial performance, CFOs should care about these suits on a personal level,” McCauley says. She notes that while D&O policies typically do not specifically exclude coverage for liability related to say on pay, wrongful acts involving personal profit or advantage are excluded.
“CFOs should make sure they have the narrowest ‘personal profit and advantage’ exclusion possible so that defense costs are covered,” says McCauley. “These suits are frequently not indemnifiable by the company, so CFOs are on their own if they don’t have broad D&O coverage.”