The Readers' Guide to Annual Meeting Lawsuits

As an increasing number of companies have been hit (or threatened) by shareholder derivative lawsuits prior to their annual meeting, the number of articles, posts and other materials discussing these cases has also increased. A few of these articles, discussed below, should be on the reading list for anyone who might be faced with defending one of these actions.

The annual meeting lawsuits are filed after the mailing of the proxy statement, seeking to enjoin the shareholder vote or votes based on purported incomplete or misleading disclosures and claimed breaches of the directors’ fiduciary duties. I have called these cases the second generation of “Sue-on-Pay” lawsuits, because they focus mainly on the Say-on-Pay vote and, often, a separate shareholder vote to increase the share authorization of an equity plan. [A third type of claim, not compensation-related, sometimes relates to a shareholder vote to increase the share authorization under the corporation’s charter.]

Most of these lawsuits have been filed by the Faruqi & Faruqi law firm; a review of that firm’s web site shows that since the beginning of 2013, they have announced investigations relating to at least 20 companies’ annual meetings, a step often followed by the commencement of a derivative lawsuit. These cases have become more widely known as a result of a recent Wall Street Journal article, “Anxiety Stalks Proxy Season” by Emily Chasan.

A recent post by David Katz of the Wachtell, Lipton law firm, “The New Wave of Proxy Disclosure Litigation,” offers some very specific and helpful tips on advance preparation for the possibility of an annual meeting lawsuit. Katz first focuses on crafting proxy disclosures that are more likely to withstand challenge, and on advising the board of directors on the possible risk of litigation. Then he provides some tactical advice about steps that might help the company move quickly in the event of litigation:

Companies that are sued in this context and decide to vigorously contest the allegations frequently have been successful. One tactic that has been helpful in some cases is to procure affidavits from significant institutional shareholders to counter the allegations. Such an affidavit can be very persuasive to a court; moreover, in our experience, institutional shareholders generally are not supportive of this type of litigation. Having an institutional shareholder submit a declaration gives the lawyer defending the company the ability to draw a sharp contrast between the interests of shareholders and the interests of plaintiffs’ lawyers who file these lawsuits on behalf of small individual shareholders who often serve that function in multiple cases. Companies that engage regularly with their significant institutional shareholders are more likely to be able to leverage these relationships to procure support when confronted with these lawsuits. Companies have also successfully engaged experts in areas such as disclosure practices to effectively resist preliminary injunction motions. Prior planning is important to be able to marshal the resources necessary to defend against these lawsuits.

Another good post counsels that companies in the process of drafting their proxy statements should be cautious before trying to tailor their disclosures to avoid litigation. In “Changing Your Proxy Disclosures May Not Be the Right Way to Fend Off Annual Meeting Litigation”, Steve Seelig of Towers Watson goes through a laundry list of the types of proxy statement disclosures frequently sought by plaintiffs in these cases and analyzes in very specific terms whether it makes sense to address them in advance. For example:

Equity Plan and Share Authorization Votes . . . [W]e view the request for information on dilutive impact and estimates of run rates to be reasonable and relatively easy to fulfill.  With this information, shareholders can see the current state and forecasts of future dilution, but we would only disclose forecasts based on historical patterns. . . . We are less enthusiastic about providing share usage projections developed for the compensation committee as these often contain hypotheticals that do not come to pass. . . .

Finally, the Society of Corporate Secretaries & Governance Professionals has made available the materials from a January webinar on “Protecting Your Company from Proxy Disclosure Litigation” (PDF). A panel of in-house counsel, outside counsel and a Society representative present a laundry list of steps that can serve as a checklist for a public company that wants to be as prepared as possible.

Or, if you don’t want to do advance planning, you can just file your proxy statement and collectively try to look invisible – maybe look into this company’s claims that it has created an invisibility cloak using its “Quantum Stealth” technology. Hey, buddy, does that cloak come in size “Corporate”?

The Cheat Sheet is Back!

We have posted the latest version of the ON Securities Cheat Sheet (PDF), including the updated status of all of the governance and compensation developments under the Dodd-Frank Act. After several months with very few changes, in January the SEC approved the changes in the listing standards of Nasdaq and the New York Stock Exchange relating to compensation committees and their independence. The Cheat Sheet covers, in one place, the specific requirements of the new listing requirements, the effective dates, and which new provisions cover smaller reporting companies. Check it out.

Thanks to my colleagues Alan Gilbert and Leah Fleck for their help in bringing the Cheat Sheet up to date.


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!

Say-on-Pay Update: How Does 2012 Compare With 2011?

It’s June, and the crush of annual meetings is, for the most part, finished. For most companies, this has been the second year in which a Say-on-Pay vote – an advisory shareholder vote on the company’s executive compensation – has been required under the Dodd-Frank Act. This is a good time to look at the shareholder votes to see if there has been a major change from 2011.

Semler Brossy’s latest Say-on-Pay Results report (PDF) reveals that not much has changed from last year. For the vast majority of companies, Say-on-Pay has passed with a significant margin of victory. Like last year, most companies have received greater than 90% approval.

It does appear that there will be more failed Say-on-Pay votes this year than last year. Mark Borges, in his Proxy Disclosure Blog on (subscription site) reports that 40 companies have failed to achieve a majority of affirmative votes this year, about the same number as all last year. Therefore, there will almost certainly be more negative votes in 2012 – but it’s unlikely that there will be a huge difference.

Of course, for some companies the results will be much different this year. For example, as reported in this previous post, Citigroup failed to get a majority positive vote this year, even though it won by a large margin last year. And Chiquita Brands International slipped on a banana peel this year – Borges reported that Chiquita got less than 20% Say-on-Pay support this year, compared to an 86% positive vote last year.

The 2012 proxy season so far teaches these lessons:

Don’t get cocky. As Citigroup’s experience demonstrates, a company can take nothing for granted, even if it did great on the vote in the previous year.

Supplemental proxies don’t seem to have a major impact. According to Semler Brossy, company responses to an “against” recommendation from ISS, filed in the form of supplemental proxy statements, do not appear to have a material impact on vote results. [On the other hand, they can’t hurt.]

Sue-on-Pay is still alive. As reported in this previous post, Citigroup was sued shortly after the negative Say-on-Pay was defeated, with claims based on the negative vote. 

Engage, engage, engage. Continue to engage with major shareholders and proxy advisory firms about executive compensation issues before, during and after proxy season. The day after the 2012 annual meeting, it’s not to early to start planning for 2013.

Perspectives on Citigroup's Negative Say-on-Pay Vote

As the 2012 proxy season kicks into high gear, Citigroup’s negative Say-on-Pay vote a couple of weeks ago remains the big story. Because of Citigroup’s size and prominence, the vote received a lot of commentary in newspapers and blogs. As Mark Borges pointed out in the Proxy Disclosure Blog on (subscription site):

This turns out to be Citigroup's fourth "Say on Pay" vote since 2009 - the first two were as a participant in the Troubled Asset Relief Program. I took a look at the support for the company's executive compensation program over this entire period, which went from 82% in 2009, 89% in 2010, and 93% in 2011 to just 45% in 2012. So it appears that there was a fairly consistent level of support for the program, which spiked in 2011 (the second consecutive year in which the company's CEO received essentially nominal compensation - $1 in 2010 and $128,000 in 2009) before the bottom fell out.

One lesson to be learned from the Citigroup experience: take nothing for granted. Because the vote was so positive the past several years, the company might have been blindsided by a wave negative shareholder reaction this year. As Borges pointed out, Citigroup’s CD&A disclosure this year matter-of-factly explained that the compensation committee viewed last year’s 93% support as an endorsement of its existing approach: “The committee considered the outcome of the most recent say-on-pay vote and stockholder perspectives [from stockholder engagement efforts] generally as factors in the 2011 compensation process. . . .”

In hindsight, maybe Citigroup should have anticipated tough sledding. Unlike 2009 and 2010, when the CEO, Vikram Pandit, had received compensation of $1 per year, in 2011 the story was very different, as Steven Davidoff pointed out in a DealBook post:

Last year, the Citigroup board paid Mr. Pandit almost $15 million, plus one-time retention awards with a potential value of $34 million, as calculated by I.S.S. The proxy advisory firm recommended against Mr. Pandit’s package because parts of his awarded pay were not based on Citigroup’s financial performance, Citigroup stock had declined by more than 90 percent in the last five years and Mr. Pandit’s pay package was not in alignment with that of his peers. . . . Citigroup in part defended this pay package by arguing that Mr. Pandit had not received a meaningful salary for the three previous years, being paid only a dollar a year. This was nice of Mr. Pandit, but it must be put against the fact that Citigroup paid about $800 million to acquire Mr. Pandit’s hedge fund, Old Lane, an investment that Citigroup subsequently wrote off completely. And Mr. Pandit received an $80 million payment from Citigroup last year as part of the Old Lane buyout. He’s not about to become part of the 99 percent anytime soon.

When ISS recommended a vote against Citigroup’s executive pay, the company could have filed and mailed supplemental proxy materials to tell management’s side of the story. As Semler Brossy points out in its latest weekly Say-on-Pay update (PDF), many companies, perhaps most, have responded to a negative ISS recommendation with supplemental proxy materials. Although Semler Brossy does question whether such supplemental materials have a material impact on the ultimate results of the vote, the practice does give the company an additional chance to tell its story.

Not that the Citigroup proxy statement was inadequate. It certainly seemed to follow many of the best practices of compensation disclosure, including a robust summary at the beginning of its CD&A disclosure. On the other hand, there’s a lot of information to digest in the summary, and they certainly did not follow the practices of some companies that are making effective use of graphics to make their point. Compare the proxy statement filed by Coca-Cola this year, which uses charts, tables and color captions really effectively to tell their story. Maybe graphics would not have been enough to save Citigroup’s Say-on-Pay vote, but they probably wouldn’t have hurt.

Future Trends in Proxy Materials as PR Pieces

Coca-Cola obviously put a huge amount of effort into its proxy filing, and I think that’s a trend that will continue in the future, fueled by examples of negative votes like Citigroup’s. I can envision public relations and graphics firms getting more involved, and proxy statements and supplemental materials will look more and more like political campaign mailings. For another example, see the graphics in this very impressive glossy supplemental piece, filed by Exxon Mobil as a companion to their proxy statement for the second year in a row.

Sue-on-Pay Is Still With Us

As has been widely reported, Citigroup was sued in federal court almost immediately after the negative Say-on-Pay vote. Mark Borges reported that this is the 11th “sue-on-pay” case based on a failed shareholder advisory vote. The sheer size of this case is likely to ensure that it will capture public attention.

"Sue-on-Pay" Litigation Update: The Good News and the Bad for Boards

In recent weeks, there have been several important developments in litigation against companies that have experienced negative Say-on-Pay votes – what I refer to as “Sue-on-Pay” cases. It’s a good time to put these events into perspective. For public companies concerned about the adverse consequences of a failed Say-on-Pay vote, the recent litigation developments present a classic “good news - bad news” situation.

The good news for corporate boards is that two Sue-on-Pay cases have been dismissed in recent weeks:

  • The U.S. District Court for the Southern District of California granted defendants’ motion to dismiss in a Say-on-Pay lawsuit involving Pico Holding, Inc. As Mike Melbinger pointed out in the Melbinger Disclosure Blog on (subscription site), the court dismissed the plaintiffs’ case for failure to state a claim. The court relied on the language in Section 952(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. . . .”
  • In early January, the U.S. District Court for the District of Oregon also dismissed the Say-on-Pay lawsuit involving Umpqua Holdings, Inc. Similar to the Pico case, the court relied in part on the language in 952(c). As reported in Blog, the court did not follow the reasoning of the U.S. District Court for the Southern District of Ohio, which declined to dismiss the federal Sue on Pay lawsuit involving Cincinnati Bell. The federal Cincinnati Bell decision was discussed in this prior post. [Note: After posting, I became aware that the Umpqua court dismissed the case without prejudice, meaning that the case may be revived.]

On the other hand, there was bad news recently for companies that may lose Say-on-Pay votes in the future. In December 2011, Cincinnati Bell announced that it has agreed to settle the shareholder derivative lawsuit in state court related to its negative Say-on-Pay vote (as opposed to the federal court case discussed above). The settlement in the state court case appears to be similar to that in the KeyCorp litigation, announced in March 2011. In these settlements, the defendants agree to make various changes in governance practices, and the company agrees to pay the legal fees of the plaintiffs’ law firms. In the KeyCorp case, the legal fees were $1.75 million. The fees in the Cincinnati Bell state case are still subject to negotiation and final approval (probably in April 2012), but presumably they will be substantial.

It is encouraging that the California federal judge in the Pico Holding case and the Oregon Federal judge in the Umpqua Holdings case followed the lead of a Georgia state court in the case involving Beazer Homes in August 2011, as reported in this blog post. These courts promptly dismissed the stockholder claims that resulted from the failed Say-on-Pay vote. More courts appear to be reading Section 952(c) of the Dodd-Frank Act as meaning what it says – the Say-on-Pay vote does not “create or imply any change” to the fiduciary duties of the company or the board. Therefore, the vote cannot be used to rebut the business judgment rule or to provide evidence that the directors breached their duties. Assuming the vast majority of courts reach this result eventually, then plaintiffs’ counsel will be discouraged from bringing such claims.

However, the settlement in the Cincinnati Bell state court litigation is likely to have the opposite effect. The announcement of the second settlement of such a case less than a year after the KeyCorp settlement, probably involving another large award of attorneys fees, is likely to encourage further litigation in the short term. This factor raises the stakes further for the 2012 Say-on-Pay vote, making it even more important for the management and boards of directors of public companies to engage with their shareholders, carefully draft their proxy statement disclosures and document their compensation decisions, and minimize the chances of a failed Say-on-Pay vote.