Houston-based energy company Dynegy, and Columbus, Ohio-based bank Huntington Bancshares don’t have much in common.
Except for maybe one thing—they both agreed to settle shareholder litigation by agreeing to governance changes they probably wouldn’t have dreamed of just a few years ago.
Two weeks ago, Dynegy said it would pay $468 million as part of an agreement to settle a class action lawsuit stemming from its accounting treatment and disclosures associated with a 2001 structured natural gas transaction known as "Project Alpha."
Under the agreement, the company also agreed to elect two new board members from a list of candidates supplied by the regents of the University of California, which represented the class.
As we have chronicled over the past year, just a handful of companies—including Ashland and Hanover Compressor—have recently agreed to allow certain shareholders to nominate directors as part of larger settlements of class action lawsuits.
Meanwhile, Huntington said last week that as part of its proposed settlement with the Securities and Exchange Commission over certain financial accounting matters, its chief executive officer, Thomas Hoaglin, former Chief Financial Officer Michael McMennamin and former Controller John Van Fleet will give up previously received bonuses.
The bank is the latest among a growing number of companies that have agreed to return earlier bonuses "earned" based on what turned out to be erroneous financials.
Although both trends are drastic and still relatively rare, each time they occur they underscore how much shareholders have become empowered in recent years and strengthen the resolve of plaintiffs in other lawsuits to extract similar concessions.
“Shareholders are a lot more emboldened to seek governance changes,” asserts Mark Brossman, a partner at Schulte Roth & Zabel.
“This does show new interest in corporate governance among lead plaintiffs,” adds Columbia University law professor John Coffee.
The easy explanation is to point to Sarbanes-Oxley. But, Coffee explains, “Sarbanes-Oxley has done little to change litigation.”
Indeed, Steven Hecht, a member of the Litigation Department and the Securities Litigation and Enforcement Practice Group at Lowenstein Sandler notes, “These [the Dynegy and Huntington settlements] aren’t court or Congressional-driven things.”
Sure, Section 304 of SOX states: “If an issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws, the chief executive officer and chief financial officer” must return bonuses and profits realized from the sale of securities during the 12-month period following the public issuance or filing of the restatement.
But, this language is open to interpretation. “You can have a restatement without the CEO and CFO being at fault,” Coffee explains. So, where is the misconduct and who committed it, he asks?
And, even if the CEO and CFO were deemed to be involved, there is nothing shareholders could do about it. “It does not provide express ride of action,” insists one lawyer. “There is no ability for the corporation to enforce it. The SEC must say so.”
The '95 Act
Lawyers, therefore, say the recent governance-related settlement provisions can be more traced to the Private Securities Litigation Reform Act of 1995, which, incidentally, President Clinton vetoed. This legislation essentially said that the shareholder with “the largest financial interest” will serve as the lead plaintiff to represent the interests of class members.
This was a significant development. Before then, each shareholder raced to the courthouse because whoever was first to file a lawsuit served as the lead plaintiff, no matter how few shares they held. So, the suits became all about money, especially among the smaller investors.
“In the past, the [plaintiff] bar knew their fee was some percentage of the cash settlement,” Coffee explains. “They didn’t push hard for corporate governance reform.”
But, under the 1995 Act, the lead plaintiffs are now typically large institutions who are more interested in obtaining longer-term changes through corporate governance reforms. “We will see this in more of these cases as public pension funds serve as lead plaintiffs,” Coffee predicts.
Indeed, this is what happened earlier this year when New York State Comptroller Alan Hevesi, the sole trustee of the New York State Common Retirement Fund and Court-appointed Lead Plaintiff in the lawsuit against WorldCom, was able to get 12 former directors to pay nearly $25 million out of their own pockets as part of a much larger settlement.
When Ashland earlier this year agreed to solicit director candidates from major shareholders as part of a shareholder settlement, the lead plaintiff was the Central Laborers’ Pension Fund, represented by Lerach Coughlin Stoia Geller Rudman & Robbins.
Incidentally, they were the same law firm behind similar, earlier settlements with Hanover Compressor, Broadcom and Microtune.
The Hanover securities action was led by five institutional and individual lead plaintiffs.
Fad Or Anomalies?
Meanwhile, the Wayne County (Mich.) Employees’ Retirement System, has asked a federal judge to stop multi-million dollar payouts to Federal National Mortgage Association’s former CEO and CFO who left the company in connection with a massive accounting scandal at Fannie Mae. Their law firm too is Lerach Coughlin.
“Pension funds realize they are now the fiduciary overseeing an investment of tens of millions of dollar,” explains Darren Robbins, a partner with Lerach Coughlin. “They are now exercising that right. When you are holding a portfolio [the size that] Hevesi holds, you will make a difference and the whole world reads about it.”
Other major institutions seeking governance changes as part of their litigation strategy include CalPERS and the Amalgamated Bank. “Institutions are much more concerned with corporate governance changes, and the last effect on corporate behavior than a financial settlement,” Brossman explains.
Is this just a fad or a handful of anomalies? Will the pendulum start to swing the other way soon? No, insist lawyers. Or, at least not for awhile.
“We will see this more,” insists Coffee. “Institutional investors want corporate governance reforms.”
“Plaintiffs will continually ask for corporate governance revisions,” agrees Brossman.
Even the SEC is catching the fever. The latest example: Last week the Commission settled charges against Tyson Foods and its former chairman and chief executive officer, Donald Tyson, stemming from $3 million in perquisites and personal benefits paid out to Tyson and other family members.
Under the deal, Tyson Foods will pay a $1.5 million penalty and Donald Tyson will pay a $700,000 penalty.
Remember, last September the SEC settled charges that General Electric failed to fully describe the substantial benefits it had agreed to provide its former chairman and CEO John "Jack" Welch, Jr., under an "employment and post-retirement consulting agreement." The Commission found that in proxy statements and annual reports filed with the Commission from 1997-2002, GE failed to fully and accurately describe the retirement benefits Welch was entitled to receive from the company.
"Shareholders have a clear interest in knowing how public companies compensate their top executives," said Paul Berger, associate director of the SEC's Division of Enforcement. "Compliance with SEC disclosure rules ensures that shareholders are provided a full and accurate understanding of senior executives' compensation arrangements."
How long will this last? Will the pendulum change directions? Not for awhile, say experts.
“This is the farthest the pendulum has swung in shareholder initiatives,” Brossman concedes.
Like any trend, this one won’t last forever. The pendulum will one day swing the other way. But, this may not occur for awhile.
Despite grumbling about the onerous demands of certain provisions of SOX, such as Section 404, there is no grass roots effort to overturn the landmark legislation.
Meanwhile, the institutions seem more emboldened than ever to press for governance change. Says Hecht: “The pendulum will swing back when executives say they can’t get anyone to serve on their boards unless they get $15 million in D&O insurance.”