Diversity & Inclusion
As the 2013 proxy season is now underway, companies should be aware of the recent wave of lawsuits alleging breaches of fiduciary duties by management and directors in connection with compensation-related decisions. These suits allege deficient disclosure with respect to compensation-related proxy proposals and seek to enjoin the company’s annual meeting until supplemental disclosures are made. They primarily target proposals to increase the amount of shares reserved for equity compensation plans and advisory votes on executive compensation (say-on-pay). There also have been a handful of suits relating to proposals seeking to amend certificates of incorporation to increase the total number of authorized shares.
More than 20 such cases were filed in 2012, and the plaintiffs’ law firm predominantly initiating these suits has announced that it is investigating nearly 40 additional companies. These cases are typically filed shortly after a company files its definitive proxy statement and make generic accusations of inadequate disclosure. Some companies concerned about potential disruption to their annual meetings have been willing to settle these claims. There have been at least six reported settlements, all involving proposals to increase the number of shares authorized under equity plans. These settlements have generally involved supplemental disclosure and payment of up to $625,000 of plaintiffs’ attorneys’ fees. Other companies have settled prior to the filing of a formal lawsuit. Although a preliminary injunction has been granted in only one of these cases, Knee v. Brocade Communications Systems, Inc., many cases in which preliminary injunctions were denied are still pending resolution regarding other relief requested by the plaintiffs, such as damages. An analysis of the claims made in filed cases to date may help companies decide whether to increase disclosure in their 2013 annual meeting proxy statements.
These cases are generally brought as class actions in the state court in which the company’s principal place of business is located. The demands for additional disclosures are not based on allegations of deficient disclosure under SEC rules, but rather on the theory that a director may breach his or her state-law fiduciary duties by failing to disclose material information in connection with a request for shareholder action. Plaintiffs claim that a litany of additional information is necessary for shareholders to make an informed vote.
In Boxer v. Accuray, the defendant argued that the advisory say-on-pay vote, imposed under the federal Dodd-Frank Act, should be litigated under federal law and had the case removed to federal court. The U.S. District Court judge, however, remanded the case to California Superior Court, holding that Accuray had made “no showing that a violation of the Dodd-Frank Act with respect to disclosures in a proxy statement is a necessary prerequisite to [sic] finding of materiality — or a board member’s breach of fiduciary duty.”1 The judge also noted that disclosure related to proposals to increase the number of authorized shares is a state law issue. Based on this holding, companies should be prepared to defend these types of lawsuits, particularly those involving increasing the number of shares available under an equity plan or the total number of authorized shares under a company’s certificate of incorporation, on state-law materiality standards.
Alleged Deficiencies in Disclosures Related to Advisory Votes on Executive Compensation
1. General Pay Practices:
2. Peer Company Benchmarking and Survey Data:
3. Compensation Consultants:
In reality, no amount of disclosure will fully protect a company from these types of suits. Nonetheless, clients should consider enhancing disclosure relating to the areas that have been most susceptible to plaintiffs’ attacks. In particular, companies including proposals to increase the number of shares authorized under their equity plans may want to address the dilutive effect of the plan on shareholders. Companies should also pay particular attention to the requirements of Items 402 and 407 of Regulation S-K and Item 10 of Schedule 14A to ensure full compliance with these rules. While there is no panacea that will eliminate the chances of being sued, careful drafting and attention to the issues raised in these cases will improve the likelihood that a company will avoid, or at least be successful in, such litigation.
1 Boxer v. Accuray, No. 12-cv-05722-SBA (N.D. Cal. Oakland Div.).
This memorandum is provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum is considered advertising under applicable state laws.