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April 7 — There has been an uptick in shareholder lawsuits targeting director compensation, putting companies on notice that investors are closely scrutinizing how boards set their own pay.
According to a March 28 National Association of Corporate Directors report, there has been a significant amount of litigation over director pay over the last 18 months.
“After simmering on the back burner for several years, the issue of director pay administration and governance has been or soon will be appearing on the radar screen at most companies due to various court cases and lawsuits,” said the report, authored by compensation consultant Pearl Meyer.
Companies that are litigating actions over their director pay packages include Chipotle Mexican Grill Inc. and Goldman Sachs Group Inc. .
In light of the litigation, attorneys are advising their clients to review their director compensation practices. “Director compensation may not have been a topic that has been front of mind for many issuers, so a new look may be warranted,” Doreen Lilienfeld, a partner at Shearman & Sterling LLP, told Bloomberg BNA in an April 7 e-mail.
Lilienfeld, who is Shearman & Sterling's compensation, governance & ERISA practice group leader, added that recent rulings provide guidance as to when companies' director compensation decisions will be accorded deference by the Delaware Chancery Court. She authored a Bloomberg BNA insights article on the cases .
While the decisions provide valuable guidance, they are spurring the increased litigation, attorneys said.
The chancery court last year clarified the application of the stockholder ratification defense. Under the defense, Delaware courts will apply the more deferential business judgment rule when self-interested director compensation decisions are approved by shareholders.
In an April 2015 decision —Calma v. Templeton, 2015 BL 125718—the chancery court ruled that Citrix Systems Inc. directors, who approved their own compensation, couldn't rely on the affirmative defense because the plan didn't set the specific compensation to be granted to non-employee directors or meaningful ceilings on potential pay .
Later that year, the court refused to apply the defense in an investor lawsuit challenging Facebook Inc.'s director pay because Mark Zuckerberg, the company's chief executive and controlling stockholder, signed off on the stock grants in an affidavit and a deposition taken after the complaint was filed—Espinoza v. Zuckerberg, 2015 BL 353714 .
The chancery court decisions narrowing the stockholder ratification defense has enabled plaintiffs in these actions to survive the defendants’ motion to dismiss, Yafit Cohn, an attorney based in Simpson Thacher & Bartlett LLP's New York office, told Bloomberg BNA in an April 7 e-mail. “It seems that some shareholders have been encouraged by these recent successes in overcoming the motion-to-dismiss hurdle, causing the uptick in director compensation suits,” Cohn said.
While the lawsuits have increased, the actions aren't linked to outrageous jumps in director pay. According to a recent joint memorandum from Simpson Thacher and Frederic W. Cook & Co., director pay programs are now simpler, more transparent and designed to reward board members based on their level of responsibility. Overall, there has been only a modest increase in board pay, the memo said.
Instead, much of the litigation centers on whether director compensation plans have meaningful caps. “Shareholders bringing these cases are targeting compensation plans that they perceive not to have a `meaningful limit' on director compensation and thus do not meet the requirements of the stockholder ratification defense under Delaware law,” Cohn said.
The NACD report and the Simpson Thacher/Frederic W. Cook memo caution that companies must set meaningful caps on potential director awards.
For the best protection, Simpson Thacher and Frederic W. Cook recommended that a shareholder-approved annual total director compensation cap should apply to both cash and equity compensation.
“That said, the meaningful director compensation limit should provide enough flexibility to address special circumstances (non-executive chair, special litigation or transaction committees, etc.) and reasonable annual increases in compensation until the plan is next taken to shareholders for their approval,” their memo added.
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