New Brand of "Sue-on-Pay" Litigation Targets Annual Meetings

Call it “Sue-on-Pay – The Sequel.” 

In 2011, several public companies faced lawsuits after losing their Say-on-Pay shareholder advisory votes on executive compensation mandated by the Dodd-Frank Act. As reported in this prior post, a few of these first generation “Sue-on-Pay” lawsuits resulted in settlements, while many since that time have been dismissed. However, in early 2012, a new round of compensation-related lawsuits began, and these lawsuits use a new tactic that presents real dangers. Companies need to use caution in preparing proxy materials for annual meetings, especially in certain cases as described below.

The plaintiffs in this new round of cases have sued over 20 companies prior to their annual meeting, seeking to enjoin shareholder votes based on purported incomplete or misleading disclosures. See “‘Say on Pay’ and Executive Compensation Litigation: Plaintiffs’ New Racket”, posted on the D&O Diary blog by securities litigation attorneys Bruce Vanyo, Richard Zelichov and Christina Costley of the Katten firm. The cases focus on two types of shareholder vote: (1) the Say-on-Pay vote and also, very often, (2) a separate shareholder vote to increase the share authorization of an equity plan (a “share authorization vote”). The attempt to delay vital corporate activities through litigation is similar to the tactic that has been used successfully over the past several years by plaintiffs’ lawyers in merger and acquisition-related litigation. If the litigation threatens the timing of the important events, the defendant company will often be willing to agree to a settlement to end the litigation so life can go on. For a new comprehensive discussion of the impact of the M&A litigation, see “The Trial Lawyers’ New Merger Tax” (download) issued by the U.S. Chamber Institute for Legal Reform.

Vanyo, et al. report that several companies have settled the compensation-related cases in 2012, notably Brocade Communications Systems, Inc. In that case brought in California state court, plaintiffs claimed various disclosure deficiencies in the proxy statement, including failure to include projections of future stock grants under the plan and planned share repurchases, as well as the failure to include the board’s peer group analysis of share usage under the plan. The court issued an order enjoining the share authorization vote. In the ensuing settlement, the company had to delay for a week the portion of the annual meeting involving the share authorization vote. The company was forced to file a supplemental proxy statement in which it disclosed, among other things, the board’s internal projections regarding future stock grants. As is often the case in these types of settlements, the only cash payment was up to $625,000 in fees to plaintiffs’ counsel.

Comment. Reportedly, some of these second-generation Sue-on-Pay lawsuits have been brought solely in connection with the disclosure in the Say-on-Pay advisory vote. However, in Brocade and the other cases where plaintiffs have reportedly been successful in obtaining injunctions and/or achieving settlements, the common denominator is that the company was also seeking an increased share authorization for an equity plan. Although I don’t have access to the courts’ rulings or the settlement documents in all of these cases, I believe plaintiffs can present these share authorization vote cases in a more compelling way:

  • For many companies’ proxy statements in the past few years, the share authorization vote disclosures have been given less thought and scrutiny than the compensation discussion and analysis section that sets the stage for the Say-on-Pay vote. Often, the share authorization disclosure describes the equity plan in detail but gives little or no background on how the requested amount of the share authorization was chosen, the company’s share usage or the board’s intentions in connection with share usage going forward. Therefore, it is fairly straightforward for plaintiffs to pick apart these disclosures and point out alleged deficiencies.
  • The applicable SEC disclosure rule for share authorization votes (Item 10 of Schedule 14A) includes disclosure requirements that relate to some of the deficiencies claimed by counsel in Brocade. (In contrast, the rules for Say-on-Pay votes themselves include no substantive disclosure requirements, but rather refer to the other compensation disclosures, which are usually more polished.) For example, Schedule 14A requires that the proxy statement disclose the number of options to be received under the plan, “if determinable,” by executive officers as a group and other specified persons and groups. In practice, companies generally don’t include these disclosures, because the amounts are not considered to be determinable prior to the compensation committees’ actual decisions to make the awards. Even though the Brocade plaintiffs apparently did not base their argument on this point, a future plaintiff might be able to convince a court that the proxy disclosure rules were not followed adequately.

Therefore, it is reasonable to assume that plaintiffs will have better luck getting traction with cases that involve a share authorization vote than in cases that involve only a Say-on-Pay vote. In fact, there is some anecdotal evidence that lawsuits that relate solely to a Say-on-Pay vote may be defended more readily by the company with less likelihood of a delay in the annual meeting. For example, we have learned of two recent court cases involving annual meetings where there the only compensation-related item on the agenda was the Say-on-Pay vote - there was no share authorization vote. In both cases, plaintiffs’ motion for a TRO was denied by the court in time to hold the annual meeting as originally scheduled. This blog post by Cornerstone Research describes one of the cases, involving Symantec.

Recommendations. At least in the near future, it is likely that these lawsuits to enjoin shareholder votes will continue. Therefore, as other commentators have pointed out, companies should use caution and make sure their compensation disclosures are as complete and accurate as possible.

I would add that companies that intend to seek share increases in the share authorizations for their equity plans should be especially cautious. The proxy disclosures on this topic should be as complete as possible. If the board has considered analyses of share usage or projections of future grants, the company might consider including summaries of this information in the proxy statement. Further, practitioners should take a fresh look at Item 10 of Schedule 14A and err on the side of more disclosure.

For a company that is uncertain about whether to seek an increased share authorization in 2013, my advice would be to delay that vote until 2014 if possible. By that time, the litigation may have died down, or strategies to defeat such lawsuits may be clearer.  

A Few Enhancements on the Way!

I'm delighted to announce that two of my partners in Maslon’s Business & Securities Group, Alan Gilbert and Paul Chestovich, will join me to write some of the posts for ON Securities going forward. Alan and Paul have each written guest posts in the past. Maslon attorney Leah Fleck provided research for this post and will continue to provide editorial assistance. I will continue to be the Blog’s Editor.

In the near future, we will also seek feedback from readers about the Blog, including subject areas you would like to see covered. Also, if any readers would like to write a guest post or contribute to the Blog in some other way, please send me an e-mail.

As always, I would like to thank our readers for their support and feedback over the past three and a half years!

Program Provides Update on Dodd-Frank Act Requirements

This month, I participated in an executive compensation program for the Twin Cities Chapter of Financial Executives International (FEI). In “A Perspective on Executive Compensation After Dodd-Frank”, compensation consultant Eric Gonzaga of Grant Thornton LLP and I gave an update on Dodd-Frank Act requirements, including new and upcoming SEC rules, and Eric gave his perspective on the latest trends in performance-based compensation – see our presentation materials here (PDF).

Highlights of the Dodd-Frank Act update included the following:

General Update. I presented the latest version of the ON Securities Cheat Sheet, with updates on the latest compensation and governance regulations. The Cheat Sheet is always available at the right hand side of the home page of this blog. It no longer includes projected dates for proposal and adoption of the SEC rules, because (1) the SEC’s web page that lists upcoming rulemaking activities under Dodd-Frank no longer discloses projected dates and (2) the SEC kept missing/changing the dates anyway.

Say-on-Pay. There is not much new in connection with the non-binding shareholder advisory vote on executive compensation, and the vote on the frequency of the Say-on-Pay vote. The results in 2012 are very similar to those in 2011. Average shareholder support once again is over 90%, but a handful of companies continues to experience negative votes. ISS and other advisory firms continue to have significant influence, approximately 20% of the vote by some estimates.

Advisory Vote Requirements for Smaller Reporting Companies. One of the great things about speaking to the FEI gathering was that it forced me to look back at all of my Dodd-Frank materials from 2012. I realized that we are coming up on a major compliance date for Say-on-Pay and Say When on Pay: smaller reporting companies, after a two-year exemption, will finally become subject to these advisory vote requirements (PDF) for annual meetings starting on January 23, 2013. See the SEC's Small Entity Compliance Guide (PDF) for these rules. Smaller reporting companies have not previously been required to include a Compensation Discussion and Analysis (CD&A) section in their proxy statements, and this will not change as a result of Say-on-Pay. The advisory vote will cover whatever is actually disclosed in the proxy statement – generally, just the compensation tables and the description of severance benefits. Some smaller reporting companies already voluntarily include some form of CD&A in their proxy statements, including an explanation of the company’s compensation philosophy and the reasons for the levels and types of the executives’ compensation reported in the tables. Companies that are not making these disclosures should definitely consider adding some version of CD&A in 2013, as it will be helpful in achieving a positive Say-on-Pay vote.

Proxy Disclosure Trends. For larger companies that continue to be subject to Say-on-Pay votes, proxy statement disclosures have been focusing more and more on describing Pay for Performance (P4P). I pointed to the Coca-Cola proxy statement, with its color graphics, and the Exxon Mobil glossy mailing on executive compensation (with companion video) as examples of effective communication. Compensation disclosures are looking more and more like political campaign pieces.

Upcoming Disclosure Requirements. We’re still waiting for these new compensation disclosure requirements from the SEC:

  • Pay vs. performance chart: will require disclosure of executive pay compared to the company’s financial performance (likely measured by Total Shareholder Return).
  • Pay equity disclosure: will require a comparison of median annual compensation of employees vs. that of the CEO, a rule that will likely result in reporting burdens for public companies.

Clawbacks. We’re also waiting for proposed SEC rules on recoupment of compensation by companies listed on stock exchanges – clawbacks. As described in this prior post, the exchanges will be directed to adopt listing standards requiring a clawback policy for listed companies. The policy must require recovery of incentive compensation (including stock options) from current and former officers during the three years prior to a financial restatement, to the extent the compensation was based on erroneous financial data. I continue to believe that the clawback requirements will be the “sleeper” under Dodd-Frank, creating lots of interesting issues for listed public companies.

Why Am I Inspired By the Songs of Stephen Sondheim?

As I said in my last post, the theme of the Maslon Law Firm’s holiday project is “Inspiration – Pass It On”. My inspiration – “Studying the Songs of Sondheim.” So why am I inspired by the songs of Stephen Sondheim? And can he teach any lessons to those of us who draft disclosure and communication documents for a living?

I’ve been a fan of musical theater at least since high school, when I got a chance to play Tevye in Fiddler on the Roof. I still love the classic musicals, but I find the shows of Sondheim to be more funny, moving and ultimately challenging than those of any other composer. From the twisted fairy tales of Into the Woods to the revenge of the murderous barber, Sweeney Todd, to the life and art of painter George Seurat in Sunday in the Park With George, Sondheim brings rich characters to life through his songs.

Sondheim’s songs are complex and work on many levels, making them fascinating and satisfying to study. While his music is often beautiful or stirring, the lyrics are always paramount and feature some of the greatest rhymes ever. For example, from Company:

When a person’s personality is personable,
He shouldn’t oughta sit like a lump.
It’s harder than a matador coercin’ a bull
To try to get you off of your rump.

Or, from A Little Night Music (note the two rhymes per line):

DeMaupassant's candor would cause her dismay.
The Brontes are grander but not very gay.
Her taste is much blander, I'm sorry to say.
But is Hans Christian Andersen ever risque?

But rhymes are only one example of Sondheim’s amazing choices of words. Consider the line in “I’m Still Here” from Follies in which the character reminisces: “Then you career from career to career.” And sometimes the lyrics are literally inspiring, as in “Our Time” from Merrily We Roll Along: “It’s our time, breathe it in, Worlds to change and worlds to win.”

I heard Sondheim speak a few years ago, and it struck me how much he loves wordplay – the challenge of finding that perfect combination of words to communicate precisely and economically what is going on. In the Preface of his 2010 book of collected lyrics and commentary, “Finishing the Hat,” Sondheim articulates his three principles of lyric writing:

They were not immediately apparent to me when I started writing, but have come into focus via Oscar Hammerstein’s tutoring, Strunk and White’s huge little book The Elements of Style and my own sixty-some years of practicing the craft . . . . In no particular order, and to be inscribed in stone:

Content Dictates Form

Less is More

God is in the Details

all in the service of


without which nothing else matters.

Not to trivialize Sondheim’s art, but doesn’t the above describe the best principles for drafting disclosure documents? Don’t you wish the writers of more 10-Ks, press releases and proxy statements would think more about Sondheim’s principles? For example, as the Compensation Discussion and Analysis sections of many proxy statements approach (or exceed) 20 pages, wouldn’t it be great if the writers practiced “Less is More” and always had “Clarity” as their mantra?

Anyone Can Whistle

In addition to being inspired listening to Sondheim’s music and reading the lyrics, I am also “Studying the Songs of Sondheim” in my voice lessons. Thanks to the magic of karaoke background tracks, here is my rendition of one of my favorite Sondheim songs, “Anyone Can Whistle”.