Published November 30, 2012
NEW YORK – Since the Dodd-Frank law gave shareholders a say in executive pay in 2010, courts have routinely rebuffed efforts by shareholders to force companies to heed their voice.
Now, lawyers have found a new way to bring lawsuits over executive pay, resulting in a handful of legal settlements. But the settlements to date have produced no changes in executive compensation and no money for investors. In fact, the main financial beneficiary so far has been a small New York law firm that brought the bulk of the cases.
The law firm, Faruqi & Faruqi, said the settlements benefit shareholders by giving them the information they need to make investment decisions, but it declined to comment on monetary details.
The Dodd-Frank Wall Street Reform and Consumer Protection Act requires companies listed in the United States to hold shareholder votes at least every three years on the compensation of top executives. These "say-on-pay" votes are advisory and nonbinding.
While most of them pass, a few fail, sometimes resulting in shareholder lawsuits against company directors. Of the 12 such cases that have been decided by courts, 11 have been dismissed, according to a report by the law firm Pillsbury Winthrop Shaw Pittman.
The lawsuits filed by Faruqi & Faruqi, however, are brought before votes are even taken and do not challenge compensation packages directly. Instead, the lawsuits accuse companies of failing to give shareholders enough information on compensation plans to make informed votes.
This can either be executive compensation, which is subject to the advisory votes, or employee share plans, which require shareholder approval. In both cases, the lawsuits seek to prevent votes from going forward at annual shareholder meetings.
Some 20 public companies including Microsoft Corp, H&R Block Inc and Clorox Co have been hit with these lawsuits in the past year, according the report by Pillsbury and court records. Pillsbury usually represents companies that are defending themselves against shareholder lawsuits. It is not representing any defendants in the current wave of cases.
At least six of the new cases have resulted in settlements in which the companies have agreed to give shareholders more information on the pay of their executives or on the employee share plans. The settlements have also resulted in fees of up to $625,000 for the lawyers who brought the cases.
Juan Monteverde, the partner at Faruqi who is leading these lawsuits, said his firm was providing shareholders with information to protect their investments, even if there was no monetary award. "The settlements confer a benefit to shareholders by providing adequate disclosure necessary to make decisions on important issues," Monteverde said.
The extra information sought has included such things as the data the company reviewed in determining executive compensation and analyses showing the effect on shareholders of increasing the number of shares in a stock plan.
Lawyers from defense firms, however, have taken note that while settlements have provided additional disclosures and legal fees for Faruqi, they have netted no cash for shareholders.
"It's a shakedown for a quick buck," said Boris Feldman, a lawyer at Wilson Sonsini Goodrich & Rosati who is defending a case against cancer radiation company Accuray Inc.
Mark Chandler, the general counsel of Cisco Systems Inc, which faced a lawsuit that was later dropped, said the practice is a "new cottage industry for plaintiffs' lawyers." Cisco makes sure its proxy disclosures are thorough, he said.
Monteverde, the partner at Faruqi, declined to comment on the criticism.
The new strategy mirrors lawsuits in which shareholders have been able to delay mergers and acquisitions by bringing lawsuits accusing company directors of trying to sell companies at an unfair price. Settlements quickly follow and, as in the new say-on-pay lawsuits, the accords usually involve more disclosures from the company, no cash for the class and fees for the lawyers.
Many of the M&A lawsuits are brought in Delaware, a major venue for business litigation, where judges have become increasingly critical of settlements in which attorneys get paid but plaintiffs receive more information but no cash.
The compensation lawsuits, however, were filed not in Delaware but in the states where target companies are headquartered. Judges have given the cases a mixed reaction.
In an early victory for Faruqi, Superior Court Judge James Kleinberg in Santa Clara, California, on April 10 blocked a vote at networking equipment manufacturer Brocade Communications Systems Inc scheduled for two days later.
Brocade was seeking to increase the number of shares available under its stock plan. The plaintiff alleged the company failed to disclose details and misrepresented how the increase would dilute investors' holdings.
Kleinberg said the plaintiff had shown a "substantial likelihood" of success in establishing the company did not disclose material information about a proposed increase in shares granted under the incentive plan.
"Denial of the proposed injunction would forever preclude the Brocade shareholders from casting a fully-informed vote on a proposal that could have dilutive effects on their shares, and after-the-fact damages calculations would be speculative and ineffective," he wrote.
Instead of delaying the annual vote, Brocade reached a settlement on April 11 in which it disclosed more details about its stock incentive plan while paying $625,000 in fees to the plaintiffs' lawyers, which were led by Faruqi. John Noh, a spokesman for Brocade, declined to comment.
The plaintiffs in all of Faruqi's cases were individual investors. One plaintiff, Natalie Gordon, is named in three of the lawsuits. The lawsuits gave no details about Gordon or the other plaintiffs, except to say that they are investors in the companies. Gordon could not be located for comment.
The one case that was not brought by Faruqi was filed on behalf of an institutional investor, the St. Louis Police Retirement System, against blood analytics company Abaxis Inc. In that case, U.S. District Judge Yvonne Gonzalez Rogers on October 23 determined the plaintiff would likely succeed in establishing that the company failed to reference material information on its equity incentive plan in its proxy statement and blocked a shareholder meeting from going ahead.
"The law requires that when a board of directors seeks a shareholder vote, the board must fully and fairly disclose all material information regarding the matters on which votes are sought," said Eric Zagar, a lawyer at Kessler Topaz Meltzer & Check who represented the plaintiff.
A spokesman for Abaxis did not respond to a request for comment. The lawsuit is ongoing.
At least five companies have reached settlements rather than fight an injunction demand, according to Pillsbury's report. Most recently, WebMD Health Corp agreed on November 15 to a disclosure-only settlement that would pay investors nothing but award Faruqi at least $250,000.
As part of the settlement, WebMD provided supplemental disclosures to investors that detailed the "guiding philosophy" of the board's compensation committee and more details on why it had approved an increase in the number of shares available under a stock plan.
Representatives of WebMD and the other companies that settled - Martha Stewart Living Omnimedia Inc, NeoStem Inc and Applied Minerals Inc - did not respond to requests for comment.
Other companies, though, have fought on and recently some judges have sided with them. At least five times, judges have denied injunction requests, the Pillsbury report said.
In a case involving Clorox, Superior Court Judge Wynne Carvill in Alameda County, California, rejected an injunction request on November 13.
While noting the "public controversy surrounding executive compensation," Carvill said there was "no risk of any interim, much less irreparable harm" if a say-on-pay vote went forward.
"This is not a merger or takeover case that would require the court after a trial on the merits to 'unscramble the eggs' if plaintiff were to prevail," Carvill wrote.
Kathryn Caulfield, a spokeswoman for Clorox, said the company was "pleased with the ruling."
A day later, New York state Supreme Court Justice Thomas Whelan in Suffolk County rejected a similar injunction request in a case involving Globecomm Systems Inc.
Jonathan Wagner, a lawyer at Kramer Levin Naftalis & Frankel who represents Globecomm, said courts recognize that the information the plaintiffs are seeking is not material. The plaintiffs are trying to turn the rules for disclosure in compensation proposals "upside down," he said.
Elsewhere in New York, state Supreme Court Justice Vito DeStefano in Nassau County on November 16 rejected an attempt to get an injunction in an investor lawsuit against Hain Celestial Group Inc.
The chance of shareholders being irreparably harmed by letting the say-on-pay vote go forward was "purely speculative given the advisory nature of the vote," DeStefano wrote.
A spokesman for Hain Celestial did not respond to a request for comment.
Not all of the cases make it to a decision or settlement. In some cases, Faruqi dropped lawsuits before a judge could rule on the injunction request and without a settlement.
Last week, Faruqi withdrew a lawsuit against Microsoft. The company said in a statement that the lawsuit was "meritless" and that it was "confident that courts will continue to recognize these cases don't serve the best interests of shareholders."
Despite the recent defense wins, few lawyers believe they've seen the last of this kind of lawsuit.
Faruqi last week issued a news release saying it was investigating the directors of Greenbrier Companies Inc over their conduct in seeking shareholders' approval of an amendment to its stock incentive plan. Jack Isselmann, a spokesman for Greenbrier, said the company believed the investigation "is without merit."
Sarah Good, who co-authored Pillsbury's report, said there was little companies could do to avoid being hit with these lawsuits.
"Where the plaintiffs securities bar sees that they will get a return on their investment, they're going to keep filing them," she said.
(Reporting by Nate Raymond; Additional reporting by Tom Hals; Editing by Eddie Evans, Martin Howell and Steve Orlofsky)