Shareholder Derivative Litigation
- challenges to Director Compensation
2018.09.20 Beware "Entire Fairness": It Sets a High Bar for Decisions about Director and Officer Compensation. In contrast to the fizzle that followed failed say on pay litigation, shareholder derivative claims of excessive compensation have legs - and momentum. Within past weeks, one pharma company settled such litigation, and another was sued based on fairly typical allegations (namely: above-market compensation and below-market corporate performance). A sense of those cases appears in the bullet points below.
More importantly, excessive compensation claims should provide a wake-up call for boards of directors. In a nutshell, the business judgement rule has long provided corporate decision-makers with a near iron-clad defense against being second-guessed for their executive compensation decisions. That protection can disappear when boards make decisions about their own compensation, as well as CEO compensation if that is not determined by disinterested directors.
Absent shareholder approval for self-interested compensation, "entire fairness" becomes the judicial standard that boards need to meet. This requires a showing not only that such compensation decisions are fair on a peer group basis, but also that they resulted from a fair diligence process. Overall, smart boards will act either within shareholder-approved boundaries, or will act based on a corporate record designed to satisfy judicial review under an entire fairness test.
Given the risks to board members, independent counsel for compensation committees is worth considering -- because there can be significant protections, at modest company cost.
2018.09.04 Director Compensation: $300K Price-tag to Settle. It cost OvaSciences more than $300,000 of attorneys' fees to settle shareholder derivative litigation alleging that its directors paid themselves excessive compensation. The company also had to agree both to cap the annual cash and stock compensation of its outside directors, and to pay them according to a shareholder-approved plan that is binding for at least three years. See Meridien Update (also covering a similar settlement to litigation against Clovis Oncology). For precautions that boards should consider, see Director Compensation Homepage.
2017.12.22 Directors Lose Stock Award in Settlement. In Williams v. Sorrento Therapeutics, a DE Chancery Court accepted the settlement of shareholder derivative litigation "alleging that the Individual Defendants breached their fiduciary duties by granting to themselves a series of options and warrants in Sorrento’s subsidiaries, either shortly before or shortly after they had caused Sorrento to transfer valuable assets to the subsidiaries."
2017.12.19 From Delaware's Supreme Court: Dramatic Change in Shareholder Approval Rule. Gone is Delaware precedent under which the business judgement rule protected directors who made equity awards to themselves within "meaningful limits" that stockholders had previously approved. Delaware's Supreme Court enunciated the following new standard in deciding In re Investors Bancorp:
Overall, only shareholder approval of exact awards will insulate directors from shareholder derivative litigation. Here are steps that are recommended for corporate directors to follow when making decisions about their own compensation:
Overall, directors risk costly litigation if they lose business judgment protection because courts will then apply an entire fairness standard (discussed in several of the cases below) when evaluating shareholder claims alleging director compensation is excessive.
2016.09.09 Settlement of Citrix Director Compensation Litigation. Law360 reports that a Delaware Chancery Judge approved the settlement of shareholder derivative litigation under which Citrix agreed to limit annual stock awards to directors to $795,000 (roughly two times the highest past levels), to submit that limit to a shareholder vote next year, to make enhanced proxy statement disclosures about the determination of director compensation, and to use an independent consultant to assist with peer data and the annual determination of proper cash and equity-based compensation.
2015.Sept.24 Director Compensation - What to Limit to Defuse Litigation?
In a well-publicized Citrix decision earlier in 2015, Delaware's Chancery Court comprehensively reviewed past shareholder derivative litigation alleging excessive compensation for directors. That decision, Calma v Templeton (4/30/2015), focused on the circumstances under which shareholder approval would either secure highly deferential court review under the business judgement rule, or result in review under an "entire fairness" standard that generally enables such litigation to survive a motion to dismiss. In the wake of the Citrix decision, it has become common for public companies to consider receiving shareholder approval of some director compensation limit when they seek approval for new or amended stock plans. Should approval relate to total compensation, or focus on equity awards.
The safest course involves seeking shareholder approval of a reasonable limit on total compensation - cash plus equity. Any such provision needs careful drafting to avoid precluding a board member from, for example, later collecting special compensation for extraordinary services. A reasonable shareholder-approved limit imposed solely on equity compensation has one notable drawback: any cash compensation could arguably be contested a having made overall compensation excessive. Although the caselaw is nuanced, the message is clear: seek shareholder approval of reasonable limits on director compensation because there is case law momentum that is sure to fuel more shareholder derivative actions. Note we suggested this defensive action almost three years ago, in our Cannons Article reviewing U.S. executive compensation litigation risks.
2014.Jun.26 Delaware Chancery Again Requires "Entire Fairness" . . . in order to justify director compensation. See Cambridge Ret. Sys. v. Bosnjak, 2014 Del. Ch. LEXIS 107 (Del. Ch. June 26, 2014). Law360 reported as follows:
2014.June.9 Director Compensation - FaceBook Struck with Shareholder Litigation.
A Facebook shareholder has launched derivative litigation in Delaware Chancery Court, seeking to recover "unfair excessive compensation" being paid to directors (quoting from this Bloomberg article). The lawsuit alleges corporate waste, breach of fiduciary duties, and unjust enrichment.
2013.Nov.13 Mere Eligibility for Future Stock Awards does not Make Directors "Interested"
An amended complaint in a shareholder derivative action was dismissed with prejudice after revised allegations failed to excuse demand on the board. The court explained in Abrams v Wainscott (D.DE, 11/13/13):
2013.Oct.11 "Spring-loading" of Director Compensation, alleged by Shareholders
The appearance of grant-making based on inside information has fueled past shareholder derivative lawsuits, as well as the adoption of corporate guidelines for the timing of stock option and other awards (and SEC rules requiring their disclosure). Boards should not let their guard down however. Law360 reports that Peregrine Pharma's directors have been sued in a shareholder derivative suit asserting claims that they awarded themselves excessive compensation, quoting from the article:
2012.Jul.09 Delaware Court Permits Claims to Proceed re Director Equity Awards
The typical omnibus stock plan includes non-employee directors among the list of those eligible to receive discretionary stock awards. Shareholder approval of those plans will not alone insulate directors from claims that they have awarded themselves excessive compensation, based on refusal to dismiss such a claim in Seinfeld v. Slager, DE Ch, 6/29/2012.
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