September 29, 2011
Another Say on Pay Update
Posted by Lisa Fairfax

As David notes, one of the fallouts of a negative say on pay vote have been shareholder lawsuits.  The lawsuits allege, among other things, that the negative say on pay vote is an indication not only that the board breached its duty of loyalty, but also that the board should not be given the presumption of the business judgment rule for demand futility purposes--and hence that such suits should be allowed to survive a motion to dismiss.  This semester I am writing an article on the feasibility of these say on pay lawsuits, and hence I was surprised when earlier last week a U.S. District Court in Ohio allowed shareholders say on pay lawsuit against Cincinnati Bell to survive a motion to dismiss in an order that relied on the negative say on pay vote.

Shareholders brought suit against the directors of Cincinnati Bell after 66% of shareholders voted against the 2010 executive compensation at its May 2011 annual meeting.  The order framed the issue in this way, "This civil lawsuit presents the question, among others, 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."  To be sure, with such a framing it seemed pretty clear where the court was headed. . .

In its order, the court stated that shareholders' allegations "raise a plausible claim that the multi-million dollar bonuses approved by the directors in a time of the company's declining financial performance violated Cincinnati Bell's pay-for-performance policy and were not in the best interest of Cincinnati Bell's shareholders.  In so stating, the court specifically noted shareholders' assertions that the negative say on pay vote provides "direct and probative" evidence that the compensation awards were not in the best interests of the shareholders.  This finding is of course precisely what shareholders hoped to achieve with say on pay litigation.  Indeed, each of the lawsuits makes a similar claim that the say on pay vote reflects shareholders' independent assessment that the challenged compensation awards were not in their best interests, and as a result, such negative votes should be used to rebut any presumption that directors' action ofapproving executive compensation awards were in the shareholders' best interests.  Moreover, the suits often rely on corporate disclosure in their proxy statement and other public documents that expresses a commitment to pay for performance to demonstrate that the challenged award conflicts with the company's own pay policies.  The Cincinnati Bell order suggest that relying on corporate disclosure in this way is effective.  In that regard, it also may prompt corporations to alter their disclosure to avoid such reliance.

Importantly for purposes of shareholders being able to get their day in court, the order agrees with shareholders' contention that they were excused from making any presuit demand.  In the court's view, the fact that directors had approved the compensation award, recommended that shareholders approve the award, and suffered a negative shareholder vote, demonstrated that demand would be futile on such directors.    This is interesting.  On the one hand, you can imagine directors contending that they only did what federal law now requires them to do.  Moreover, Dodd-Frank has a provision specifically stating that the say on pay vote is advisory and should not be construed as overruling directors' decisions, or changing or adding additional fiduciary duties for directors, and many commentators have argued that such a provision indicates that say on pay votes should not be used to somehow alter the law in this area, including the law with respect to demand rules.  On the other hand, some commentators have noted that Dodd-Frank does not prevent such votes from being used to support a finding of a fiduciary duty breach.  The Cincinnati Bell court cites this latter commentary.

Of course, just because a suit survives a motion to dismiss does not mean that shareholders will win at trial (see e.g., Disney!).  Then too, Cincinnati Bell is an Ohio corporation--though the court did cite Delaware law in its demand futility discussion.  However, a decision like this certainly prolongs these say on pay lawsuits.  Such a decision also suggests that these say on pay votes may impact, and even change, fiduciary duty law regarding compensation.

Corporate Governance, Current Affairs, Fiduciary Law, Securities | Bookmark

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