Tuesday, September 27, 2011
Shareholder's Challenge to Executive Compensation Survives MTD Because of Negative Say-on-Pay Vote
A recent opinion suggests that a negative shareholder vote on a "say-on-pay" resolution will improve shareholders' chances in surviving a motion to dismiss a derivative suit alleging excessive executive compensation. In NECA-IBEW Pension Fund v. Cox (S.D.Ohio 09/20/11), involving Cincinnati Bell, Judge Timothy Black framed the question:
Whether a shareholder of a public company may sue its directors for breach of the duty of loyalty when the directors grant $4 million dollars in bonuses, on top of $4.5 million dollars in salary and other compensation, to the chief executive officer in the same year the company incurs a $61.3 million dollar decline in net income, a drop in earnings per share from $0.37 to $0.09, a reduction in share price from $3.45 to $2.80, and a negative 18.8% annual shareholder return.
In answering that question in the affirmative, the judge emphasized that at the motion to dismiss stage, plaintiff only needs to state a plausible claim and that the business judgment rule imposes a burden of proof, not a burden of pleading. The factual allegations raise a plausible claim that the bonuses approved by the directors in a time of the company's declining financial performance violated Cincinnati Bell's pay-for-performance compensation policy and thus constituted an abuse of discretion or bad faith. In particular, the opinion references the fact that 66% of voting shares voted against the say-on-pay resolution; Cincinnati Bell was one of only 1.6% of public companies that received negative shareholder recommendations on their say-on-pay resolutions (as of the end of June 2011).
In addition, plaintiff was excused from the requirement of pre-suit demand because of futility, because it pled specific facts to give reason to doubt that the directors could make unbiased, independent business judgments about whether to sue:
Given that the director defendants devised the challenged compensation, approved the compensation, recommended shareholder approval of the compensation, and suffered a negative shareholder vote on the compensation, plaintiff has demonstrated suficient facts to show that there is reason to doubt these same directors could exercise the independent business judgment over whether to bring suit against themselves for breach of fiduciary duty....
Perhaps the nonbinding advisory vote will prove to have more teeth than anticipated!