Opinion

Alison Frankel

Federal judge gives shareholders green light for say-on-pay suit

By Alison Frankel
September 21, 2011

One of the verdant new fields the Dodd-Frank act has opened for litigators involves the Securities and Exchange Commission’s say-on-pay rule, which requires public companies to put executive compensation up for an advisory shareholder vote every two years. The rule went into effect in January. By May, Dena Aubin of Reuters was already reporting on a surge in shareholder derivative suits claiming boards breached their fiduciary duty by pushing through pay packages that shareholders voted down.

Darren Robbins of Robbins Geller Rudman & Dowd, whose firm has led the shareholder say-on-pay litigation, said there have been about a dozen derivative suits filed in state and federal courts. At least two have settled, according to a July 2011 report from Drinker Biddle & Reath (one settlement included $1.75 million in legal fees). But the say-on-pay rule — and ensuing litigation — is so new that plaintiffs lawyers didn’t really know whether it would provide a reliable income stream.

That prospect looks a little more likely after a ruling Tuesday by Judge Timothy Black of Cincinnati federal court. In a tart 12-page ruling, Judge Black noted shareholders’ “overwhelming rejection” of a multimillion-dollar pay package for three officers of Cincinnati Bell, even as the company’s earnings and share price slid. “Normally, a board of directors is protected by the ‘business judgment rule’ when making decisions about executive compensation,” the judge wrote. But shareholder lawyers from Robbins Geller, he said, had adequately alleged that the Cincinnati Bell board isn’t entitled to that protection.

“The complaint provides factual allegations and not simply conclusory allegations,” Judge Black wrote, in language you’re going to see quoted by plaintiffs firms across the land. “These factual allegations raise a plausible claim that the multimillion dollar 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 were not in the best interests of Cincinnati Bell’s shareholders and therefore constituted an abuse of discretion and/or bad faith.”

The judge also rejected the directors’ argument that shareholders didn’t serve a demand on the board. “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,” he wrote, “plaintiff has demonstrated sufficient facts to show that there is reason to doubt these same directors could exercise their independent business judgment over whether to bring suit against themselves for breach of fiduciary duty.”

Judge Black said the board could argue its business judgment and demand futility defenses in a summary judgment motion or at trial. (Here’s the board’s motion to dismiss; Grant Cowan of Frost Brown Todd declined comment.)

Shareholder counsel Robbins of Robbins Geller told me the ruling is good news for plaintiffs lawyers. “Ohio is a fairly conservative jurisdiction, and the Cincinnati Bell board raised substantive and procedural arguments that were rejected by the judge,” he said. “That tells you judges — as well as shareholders — find it distasteful for boards to ignore the will of shareholders.”

I should note that Judge Black’s ruling is contrary to the decision of a state court judge in Georgia, who dismissed a shareholder derivative suit against the board members of Beazer Home in a say-on-pay suit. The Georgia judge ruled from the bench; here’s the transcript of arguments in that case, which also featured Robbins Geller as plaintiffs counsel.

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