Shareholder Lawsuits Push for More Pay Disclosure

Investors are pushing for more executive compensation disclosure at some companies, and they are taking a novel approach to getting it.

Shareholders have filed a wave of lawsuits, leveraging the Dodd-Frank Act's requirement that they get an advisory vote on executive compensation, to demand even greater disclosures and are threatening to enjoin annual meetings if they don't get it. The lawsuits claim that some companies aren't providing enough compensation information—or that it is inaccurate—for investors to make sound judgments during “say-on-pay” votes.

So far, investors have filed approximately 20 such lawsuits on the grounds that companies are breaching their fiduciary duty by failing to provide more complete and accurate compensation data. And more are likely on the way. The majority of the cases, although filed in the state of California, are using Delaware law as their basis.

Even when cases are settled and dropped, as nearly all of them have been, the plaintiffs' lawyers are extracting hefty fees. An injunction stopping a shareholder vote by Brocade Communications Systems on increasing the number of shares available under an equity incentive plan ended up requiring attorneys' fees of $625,000 as part of its settlement.

H&R Block, Martha Stewart Living Omnimedia, and WebMD have all settled similar suits. A case against Microsoft was dropped in November after the California State Teachers' Retirement System threw its support behind the company.

Some see the tactic as no more than an attempt by plaintiffs' firms to extract settlement fees from companies. “The law firms bringing most of these lawsuits appear to be putting virtually no time into researching the merits of their claims before filing,” asserts Michael Melbinger, a partner at the law firm Winston & Strawn and chair of its employee benefits and executive compensation practice. “In fact, one lawsuit had the name of a different company—one sued previously—in the complaint. They seem to be using the search and replace feature and running these off.”

Melbinger expects the number of cases to multiply during March, April, and May, as calendar-year companies begin to file their proxy statements and schedule annual meetings. New York law firm Faruqi & Faruqi, which has filed approximately 15 compensation disclosure lawsuits and has put investigative feelers out on roughly 50 other companies to find willing shareholder plaintiffs, did not respond to a request for comment on the practice.

The most common defense of such lawsuits is to show that companies are providing all the executive compensation disclosures required by law or that are commonly released by similar companies. In Gordon v. Symantec Corp., for example, the company produced expert testimony that the information allegedly omitted from its proxy was also not disclosed by other companies, notably those in its compensation peer group. 

“Symantec had prepared for the possibility of this type of lawsuit and was ready to respond quickly when it was filed,” Melbinger explains. “However, even in victory, the company incurred legal expenses that it wishes it could have avoided.”

Many companies are now taking preliminary steps to review the executive compensation disclosures required in their proxy statement, with an eye toward the potential for litigation. “Because the plaintiffs' lawyers have alleged many of the same disclosure deficiencies in many of their lawsuits, it is wise to keep them in that mind when drafting compensation disclosures,” Melbinger says.

“The law firms bringing most of these lawsuits appear to be putting virtually no time into researching the merits of their claims before filing.”

—Michael Melbinger,

Partner,

Winston & Strawn

While some companies will look for a pre-emptive strike by filing supplemental proxy materials just prior to the annual meeting, others may just bite the bullet. Ed Batts, a partner at law firm DLA Piper, suspects that future cases may focus on smaller companies, “where their disclosures are a little more boiler plate than they really should be.” Many of these companies may decide that paying $50,000 to $100,000 to make a nuisance lawsuit go away is worth it, especially given the added costs of cancelling an annual meeting at the last minute.

How Much Is Enough?

According to Steve Seelig, a senior executive compensation consultant at Towers Watson, SEC disclosure regulations are somewhat “amorphous,” with companies left on their own to decide what is, or isn't, material to shareholders. He describes the underlying question of how much disclosure is enough as nearly a “metaphysical” one. 

Seelig reluctantly calls the lawsuits “inspired genius.” “If you are a plaintiff's lawyer and you sue in the area of employee benefits, or executive compensation, you are usually suing on issues that have to do with matters of judgment,” he says. “What better matter of judgment would there be than trying to get a court of law to actually entertain figuring out what is enough when it comes to disclosure. There is a sort of brilliance in suing with those terms.”

SOP VOTES: PAY DECISIONS

Below is an excerpt from “Changing Your Proxy Disclosures May Not Be the Right Way to Fend Off Annual Meeting Litigation,” by Steve Seelig.

Our basic view is that companies should continue to follow the strategy they have established over the past several years, balancing their SEC counsel's concerns with their desire to provide clarity for shareholders. This approach reflects that the determination of what ought to be disclosed is in the eye of the beholder as to whether it's “material.” Yet, these cases do provide an opportunity to reconsider approaches that will provide some more clarity to shareholders, an exercise we recommend our clients undertake periodically as a matter of course. Following is a summary of the kinds of additional disclosures sought by the plaintiffs in these suits—they vary from complaint to complaint—along with our reactions.

Say-on-Pay Votes: Pay Decisions1. Disclosure of comparable companies observed in the peer groups used by the compensation committee, and disclosure of compensation data for the named executive officers of the peer companies, including even the median, mean and range for the peer group data set

2. Disclosure of the base salary, annual incentive awards, long-term incentive (LTI) awards and total direct compensation data for each company in the company's peer groups

Reactions: Our advice to clients has been that they should reflect in their peer group discussion where their CEO's total compensation ranks compared to the company's peers because that provides material information of interest to shareholders. We also suggest that companies disclose the breakdown (percentages) of their pay mix between salary, bonus and LTI, as well as how that mix may deviate from that of their peers. However, we don't believe that including the additional data points listed above will provide added insight into the compensation committee's decision-making. Instead, it will only be confusing to shareholders.

3. Disclosure of the objective performance goals for each metric of the annual and LTI plan as they apply to each NEO and what information, if any, the compensation committee relies upon in creating such targets

4. Where directors review an array of measures before applying their judgment to determine named executive officers' (NEO) pay, disclosure of how much weight the listed factors have in determining NEO pay for the year

5. A discussion of the extent to which the compensation committee exercised discretion and the process it employed in using any discretion to change the payments available for any individual's bonus if different from the objective targets set forth

Reactions: This set of requests seems to have merit in that we believe each would provide material information to shareholders and it shouldn't be a hardship to provide as many companies already provide considerable detail on these issues. Certainly, disclosure of objective performance goals has become a prevalent practice and one that we feel should always be disclosed, except where it would cause competitive harm as that has been interpreted by the SEC.

The request for a discussion about the use of discretion by compensation committees, both in setting pay opportunity levels and paying incentives, is more problematic as the discretionary process is rarely subject to an easy description. We think most companies attempt to provide adequate disclosures regarding discretion, although this request suggests that more details on the factors most important to setting and paying compensation might be in order for some companies.

Source: Towers Watson.

That doesn't mean companies should ignore the lawsuits either, says Seelig. The items highlighted by them may give companies a blueprint for reviewing their disclosures and ensuring that shareholders have sufficient information, he says. “I think the SEC did it right by leaving it up to the companies,” he says. “But that's not to say there aren't some valid points being made in these lawsuits, and things that probably could be disclosed. There are points we might agree with, just not to the point where people need to be sued.”

One of those areas, Seelig says, may be annual targets and goals that trigger compensation increases. In his view, shareholders should get answers to such questions as: Why were they set the way they were? Were they met? Did they result in payouts? “Those appear to be something that is required by SEC rules for companies to disclose, and yet you sometimes have a tough time finding it within certain proxy disclosures,” he adds.

More difficult issues arise when compensation committees have the ability to exercise discretion in figuring out what they are going to pay executives. While they may have some objective goals, they also have discretionary goals.

“That can be one that is very difficult for companies to get their arms around in terms of precisely what made the decisions happen,” Seelig says. “It is art sometimes, not science. I can certainly understand shareholders being concerned that they are not getting full information about that decision, or how it was made. On the other hand, it is awfully difficult sometimes to really describe how business judgment was exercised to come up with those amounts.”

David Priebe, also a partner at DLA Piper, says that the legal challenges, built upon the Dodd-Frank Act and associated SEC rulemaking offer “an unusual situation” where they are trying to enforce, using state law, fiduciary duties that are now a matter of interpreting federal law. It would be far more difficult to challenge a proxy statement under federal law, because there is not “a generalized duty to disclose all material information,” he explains.

Because the lawsuits, no matter where they are filed, are built on Delaware law, Batts sees a simple way to put a stop to them.

“If a Delaware court came out and said, in a decision, ‘Here is what really is called for in a proxy, and here's what is not called for,' then its game over for the business model,” he adds “The problem is that nobody is going to sue in Delaware. They are just going to go to all these different states.”

Companies that decide to provide more compensation disclosure to fend off such lawsuits must proceed cautiously, since some disclosure, such as details on reports issued by an adviser to the compensation committee, could open them to other litigation. “There is a potential there that if you put more disclosure out there on this issue, you might actually be subjecting yourself to further litigation down the line,” Seelig says.

“Imagine if you were to disclose what this report said, and it said ‘X' and the compensation committee did ‘Y,' perhaps that creates a cause of action for not having followed the recommendation. Or, if they did the same, [litigants] might claim they exercised none of their independent judgment. You can be in a no-win position and whipsawed.”

Seelig also warns that companies that decide to release more information on compensation should be aware of the precedent they are setting. “You are not only buying into disclosing something for this year,” he says. “You are buying into disclosing things for forthcoming years. You really do need to come to a consensus among your advisers as to what the right approach is going to be. It may be that no good deed goes unpunished, and that no matter what it is you disclose the plaintiffs' bar might still say that is not going to be enough.”