VOLUME 4, ISSUE 5 MARCH 26, 2013 Meridian Client Update Delaware Federal Court Dismisses Say on Pay Case The Courts continue to strike down lawsuits arising from failed say on pay votes. The latest defeat occurred on March 14, 2013 in the U.S. District Court for the District of Delaware which dismissed such a suit against Hercules Offshore Inc. In the Hercules case, plaintiff made the typical claims asserted in failed say on pay lawsuits: (i) Hercules Board breached its fiduciary duties by increasing executive compensation despite the Company s poor financial and share performance which violated Hercules proxy-disclosed pay-for-performance philosophy and rendered the Company s compensation disclosures misleading and (ii) Hercules negative say on pay vote rebutted the presumption that the Board s decision on the disputed executive compensation was protected under the business judgment rule. Also, as in nearly all other failed say on pay lawsuits, the plaintiff claimed it was excused from the requirement to make a pre-suit demand on Hercules Board to file a suit on behalf of shareholders because to do so would be futile. In evaluating the plaintiff s claims, the court found that: The Dodd-Frank Act explicitly prohibits construing a negative say on pay vote as overruling a Board s compensation decision or altering the directors fiduciary duties (i.e., business judgment protection is not rebutted); Plaintiff s selective characterization of the company s compensation philosophy as pay for performance excluded other goals discussed in the company s proxy statement; and Plaintiff failed to demonstrate that making a pre-suit demand on Hercules Board would be futile. Based on these findings, the Court dismissed the case holding that plaintiff (i) had not pleaded facts sufficient to state a claim upon which relief could be granted and (ii) was not excused from making a presuit demand on Hercules Board to bring a lawsuit on the company s behalf. Meridian comment. This case reinforces the well-established view by courts that the protection afforded directors under the business judgment rule when making decisions on executive compensation is not negated due to a failed management say on pay proposal. The case also highlights the importance for proxy disclosures to include a comprehensive compensation philosophy that supports director decisions to approve executive compensation that is not solely performance-based. Meridian Compensation Partners, LLC PAGE 1 VOLUME 4, ISSUE 5 MARCH 26, 2013
Symantec Scores Important Victory in Say on Pay Disclosure Litigation An offspring of the failed say on pay lawsuits are so-called say on pay disclosure cases under which plaintiffs seek to stop shareholder voting on say on pay proposals due to allegedly defective proxy disclosures (similar lawsuits have been filed seeking to stop shareholder voting on equity plan proposals). In only one case has a court sustained a shareholder s motion to stop a shareholder vote (that case involved an equity plan proposal). All other similar lawsuits have been settled or thrown out. Continuing this trend, in late February a California state court dismissed a say on pay disclosure suit against Symantec Corporation. In the Symantec case, plaintiffs claimed that Symantec Corporation allegedly disseminated materially misleading and incomplete materials in its August 2012 proxy statement. The plaintiffs sought to enjoin Symantec from holding its shareholder say on pay vote unless Symantec provided adequate disclosure to shareholders. In addition, plaintiffs sought a declaratory judgment that Symantec s officers and directors breached their fiduciary duties by issuing a defective proxy and that Symantec aided and abetted the officers and directors in this breach. On October 17, 2012, the motion to enjoin the shareholder meeting was denied. Symantec shareholders voted on and approved management s say on pay proposal on October 23, 2012. On February 22, 2013, the California Superior Court ruled on the merits of plaintiffs claims and found that, under Delaware law, plaintiff failed to state a claim upon which relief may be granted, thereby, holding in favor of Symantec. Specifically, the Court found that plaintiffs failed to adequately plead a sufficient claim that Symantec s proxy disclosure was misleading and omitted material information ( disclosure claim ). The Court set forth the following standard for omitted facts to be considered material: there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable stockholder as having significantly altered the total mix of information made available in a company s proxy statement or other filings. Based on the foregoing standard, the Court dismissed each of plaintiffs disclosure claims The Court made clear that disclosure claims must meet a relatively high bar for relief to be granted. Equally important, the Court also noted that the determination of whether items should be included or omitted from a proxy statement falls within the area of management s judgment; provided that the proxy statement, viewed in its entirety, sufficiently discloses the matter to be voted upon. Meridian comment. The Symantec case is good news for public companies. Although the Symantec decision is non-binding outside of California, it does provide persuasive precedent to other jurisdictions. The influence of the Symantec case may also be elevated due to the Court s application of Delaware law to arrive at its decision. The case also provides some degree of assurance that typical CD&As contain sufficient disclosures to preclude plaintiffs from stopping shareholder say on pay votes and from requiring companies to make additional disclosures. This may discourage other plaintiffs from filing say on pay disclosure lawsuits. However, the Symantec case is unlikely to stop plaintiff suits based on defective disclosures concerning equity plan proposals. We continue to recommend that companies enhance the disclosures contained in equity plan proposals to avoid or mitigate the potential of such suits. Meridian Compensation Partners, LLC PAGE 2 VOLUME 4, ISSUE 5 MARCH 26, 2013
Shareholders Need Robust Disclosure to Exercise Their Voting Rights as Investors and Owners SEC Commissioner Luis Aguilar In a recent speech, Commissioner Luis Aguilar of the Securities and Exchange Commission (SEC) emphasized the need for public companies to make robust proxy disclosures so that investors may make informed voting and investment decisions. Mr. Aguilar voiced his appreciation of the many public companies that have made a good effort to enhance the quality of their proxy statements However, the Commissioner took to task those companies that continue to fall short of providing the robust, clear, and useful disclosure required by law. Mr. Aguilar pointed to several areas in which proxy disclosures could be substantially improved including disclosures on compensation risks and on leadership structure. Compensation Risks The proxy rules require a narrative disclosure on a company s compensation policies and practices relating to risk management only if the risk arising from such policies and practices is reasonably likely to have a material adverse effect on the company. Otherwise no disclosure is required. Consistent with SEC comments on major public companies proxy filings over the past several years, Commissioner Aguilar believes that it would be prudent and appropriate for all issuers to discuss the role of compensation in risk management in the proxy statements. In support of this position, Commissioner Aguilar notes that how a company assesses and manages compensation-related risks is inherently material to investors. Beyond urging companies to make volitional disclosures on management of compensation risk, Commissioner Aguilar also noted that the following compensation practices could impact a company s risks: Pay differentials between classes of employees, such as the ratio between CEO compensation and median employee pay. Commissioner Aguilar observed that pay differentials may create risks to a company, including the risk of employee, customer, and shareholder discontent. According to Commissioner Aguilar, companies should consider whether additional disclosure is necessary to enable shareholders to assess such risks and the manner in which any such risks may be affected by a company s compensation policies and practices. Policies and practices that reward poor performance, or that result in a poor correlation between pay and performance. Commissioner Aguilar noted that a disconnect between pay and performance may adversely affect risk management by sending the wrong signals to a company s executives and by impeding the board s ability to exercise proper risk oversight. To permit investors to adequately assess this risk, Commissioner Aguilar urges companies to consider enhanced disclosure regarding the relationship between executive compensation actually paid and a company s long-term performance. Board Leadership Structure Commissioner Aguilar noted that many issuers provide only minimal discussion in response to the board leadership disclosure requirement. This discussion, he observed, has devolved into uninformative boilerplate narrative. For example, where the same person serves as both principal executive officer and chairman of the board, the reason given is often simply efficiency, streamlined decision-making, or depth of knowledge or where the CEO and chairman positions are separated, the rationale often provided is that the separated roles permit the CEO to concentrate on day-to-day business, while allowing the chairman to lead the board in providing independent oversight. These disclosures, Commissioner Aguilar opined, do not satisfy the required disclosure of why a company has determined Meridian Compensation Partners, LLC PAGE 3 VOLUME 4, ISSUE 5 MARCH 26, 2013
that its leadership structure is appropriate given the specific characteristics or circumstances of the company. Meridian comment. Commissioner Aguilar s remarks represent his opinions and do not necessarily represent the views of the SEC. Nonetheless, the Commissioner s remarks are significant as they could influence the SEC staffs interpretation of the proxy rules and assessment of proxy disclosures. Additionally, the remarks may influence future rule-making in areas that touch upon Commissioner Aguilar s comments such as the disclosure on CEO pay ratio, mandatory recoupment policies and pay for performance disclosure. In his speech, Commissioner Aguilar provided detailed guidance regarding the application of the proxy rules in each of the four areas discussed above. The Commissioner identifies areas where mandated disclosures are lagging as well as areas where volitional disclosures would be material to shareholders. In addition, the Commissioner suggests a number of surprising disclosures that appear to stretch the limits of the proxy rules. The latter situation is most evident when the Commissioner waded into disclosures on compensation-related risk. The Commissioner acknowledges that the proxy rules only require a disclosure on compensation-related risk if the risk is reasonably likely to have a material adverse effect on a company. Nonetheless, the Commissioner believes that all issuers should discuss the role of compensation in risk management. We have, in fact, seen many large and mid-cap companies make various types of volitional disclosures around compensation-related risk often at the urging of the SEC. If, as the Commissioner claims, disclosures on compensation-related risk are inherently material to investors, then a compelling case would exist to make such volitional disclosures. Although we may have moved past the point of discussing the merits of making such disclosures, it remains important to point out that neither the SEC nor any other governmental agency (including the Federal Reserve) has provided any analysis or any evidence that demonstrates that compensation programs and policies may give rise to risks so great that they may have a material adverse effect on a company (at least for those companies outside the financial services industry). Commissioner Aguilar claims that additional risk disclosures may be required in certain cases of pay differentials between classes of employees and disconnects between pay for performance. Given the lack of any empirical or analytical basis supporting the need for compensation-related risk disclosures, the Commissioner s claim that additional disclosures on risk may be desirable is simply an opinion. It is also curious that Commissioner Aguilar would specifically identify these areas for disclosure since the SEC is required to issue rules under Dodd-Frank that will mandate the disclosure of CEO pay relative to median pay (i.e., CEO pay ratio) and the relationship between executive pay and company performance. Commissioner Aguilar does raise valid observations regarding disclosures on board leadership structure and risk oversight. We agree with the Commissioner that many companies should provide more robust, meaningful disclosures on board leadership structure to more directly address why the chosen structure is best suited for the company. With regard to risk oversight, the Commissioner s recommended disclosures are largely consistent with SEC comments in its release of disclosure rules on risk oversight. We believe companies would be well-served by following the Commissioner s suggested disclosures on risk oversight. * * * * * Meridian Compensation Partners, LLC PAGE 4 VOLUME 4, ISSUE 5 MARCH 26, 2013
The Client Update is prepared by Meridian Compensation Partners Technical Team led by Donald Kalfen. Questions regarding this Client Update or executive compensation technical issues may be directed to Donald Kalfen at 847-235-3605 or dkalfen@meridiancp.com. This report is a publication of Meridian Compensation Partners, LLC, provides general information for reference purposes only, and should not be construed as legal or accounting advice or a legal or accounting opinion on any specific fact or circumstances. The information provided herein should be reviewed with appropriate advisers concerning your own situation and issues. www.meridiancp.com Meridian Compensation Partners, LLC PAGE 5 VOLUME 4, ISSUE 5 MARCH 26, 2013