Proxy Season Brings a Third Wave of “Gotcha” Shareholder Litigation

Since the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act on July 21, 2010 (“Dodd-Frank Act”), which requires a say-on-pay advisory vote on executive compensation, the plaintiffs’ securities bar has been busy filing lawsuits and issuing press releases “investigating” companies concerning say-on-pay votes and/or executive compensation matters. As discussed in our November 19, 2012 Client Alert, Plaintiffs’ Firms Gaining Steam in New Wave of Say-on-Pay Shareholder Suits?, there have been two distinct waves of shareholder litigation over the past couple of years. Now, there has been a third one consisting of derivative shareholder suits alleging that companies approved executive compensation in violation of stock plans.

First Wave Peaked in the Third Quarter of 2011: Derivative Shareholder Suits Following Failed Say-on-Pay Vote

After say-on-pay advisory votes became required, few companies have had shareholder votes that did not approve the proposed executive compensation arrangements. Specifically, only 57 out of 2215 companies (2.6%) had such failed say-on-pay votes in 2012.¹

Many of those companies approved the executive compensation subject to the failed say-on-pay vote and quite a few of those companies were targeted with derivative shareholder litigation. Shareholders have sued 22 companies with failed say-on-pay votes. Shareholders sued 15 of 43 companies (35%) with failed say-on-pay votes in 2011 and 4 out of 57 companies (7%) with failed say-on-pay votes in 2012. Those actions generally alleged that boards of directors breached their fiduciary duties by approving executive compensation arrangements that shareholders did not approve in their non-binding, advisory vote. They peaked in the third quarter of 2011 and none have been filed since a few stragglers were filed in the third quarter of 2012.

As indicated in the Appendices, courts have dismissed 50% of these cases on motions to dismiss for two primary reasons. First, these suits failed to plead that plaintiffs were excused from the pre-suit requirement of making a demand on the board of directors to bring suit. Second, courts recognized that a say-on-pay vote is purely advisory and non-binding on boards of directors. Several of those decisions are on appeal. In addition, 18.5% of the cases have settled with some resulting in very significant attorneys’ fees awards. 27% of the suits are still pending. These cases have been filed all over the United States, with California, Delaware and Texas courts being the most popular.

Second Wave Peaked in the Fourth Quarter of 2012: Putative Class Actions to Enjoin Annual Meetings

The plaintiffs’ central allegation is inadequate disclosure of executive compensation matters in proxy statements, which justifies enjoining the annual shareholder meeting. A significant part of the second wave included a blizzard of press releases targeting 73 companies by plaintiffs’ law firms which contended that they were “investigating” executive compensation matters. Of course, such press releases often are issued to dig up a shareholder of the target company who could serve as a figurehead plaintiff in a lawsuit and/or to terrorize the targeted company with imminent litigation to disrupt the timing of the annual meeting.

Only a small percentage of the companies targeted by “investigatory” press releases actually were sued. Of the 73 companies targeted, 14 companies eventually were sued and an additional 10 companies were the subject of litigation without the issuance of any “investigatory” press release. As indicated in the Appendices, 33.5% of the cases resulted in a denial of a motion for preliminary injunction and 17% of the cases were voluntarily dismissed. 33.5% of these cases have been settled prior to a ruling on a preliminary injunction motion, with settlements consisting of enhancements to disclosures in proxy statements coupled with cash payments of attorneys’ fees. Unsurprisingly, a large chunk of these cases, 32%, are pending – even after denial of plaintiffs’ preliminary injunction motions.

In those cases in which motions for preliminary injunction were defeated, courts found that there would be no irreparable injury should the annual meeting proceed as scheduled. A critical component appears to be an expert declaration from a Stanford professor in support of the company’s disclosures in the proxy statement. While the preliminary injunction may have been defeated and no disruption to the annual meeting schedule occurred, those cases have not yet been dismissed. There are a number of motions to dismiss pending in those cases, and it remains to be seen if those motions will be successful or if courts will require discovery to proceed.

As indicated in the Appendices, these cases have been filed all over the United States, with California and New York courts being the most popular.

Second Wave May Have Resulted in Non-Public, Individual Settlements Prior to the Initiation of Litigation

Press articles and statements from lawyers at other law firms indicate anecdotal evidence that some of the second wave suits may have been settled on an individual, rather than class-wide, basis prior to the filing of litigation. In order to evaluate the truth of these assertions, we evaluated whether the 59 companies targeted by an “investigatory” press release from the plaintiffs’ bar and which subsequently were not sued may have issued enhanced disclosures on executive compensation matters in their proxy statements prior to scheduled annual meetings. Our review indicated that there were 5 companies that did issue enhanced disclosures concerning executive compensation matters. This enhanced disclosure could have been in response to the issuance of the press release in an attempt to fend off actual litigation or it could have been consideration for an individual settlement or a response to a shareholder’s letter or demand to a company’s board of directors to investigate executive compensation matters.

If these augmented disclosures formed the basis for an individual, out-of-court settlement, such settlements likely would consist of those disclosures and a cash payment for attorneys’ fees. Such settlements, however, could not contain releases that would be binding on other shareholders of those companies because no court would have approved those settlements. While one law firm dominated in the initiation of the second wave of lawsuits, there are two other firms involved in initiating litigation or issuing press releases relating to this second wave. As a result, companies electing to settle such matters on an individual basis without court approval run the risk of settling with one law firm on behalf of one shareholder and then either having that same law firm represent a different shareholder in making a similar claim or having another law firm file suit for the same matters. In addition, companies electing to settle such matters on an individual basis may have a heightened risk of being targeted as easy marks by plaintiffs’ law firms every time proxy season rolls around or in future potential securities litigation about other matters. In the long run, not settling but instead litigating and winning will be less expensive than a one-time cheap settlement because it will deter future litigation.

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1. Semler Brossy, 2012 Say-On-Pay Results (12/31/12), available at http://www.semlerbrossy.com/wp-content/uploads/2013/01/SBCG-SOP-Year-End-Report.pdf