Tuesday, March 20, 2012

Maryland Federal Judge Says Demand Not Excused on Directors Who Failed to Rescind Compensation Package after Negative Say on Pay Vote

A federal judge (DC Md) has ruled that demand was not excused as futile in a shareholder derivative action simply because board members and the compensation committee participated in the decision to go forward with an executive compensation plan after the plan was rejected in a shareholder advisory vote. Although it can be reasonably argued that a say on pay vote provided the board an opportunity to reconsider its decision regarding executive compensation, conceded the court, it should not be seen as the equivalent of a pre-suit demand. (Weinberg v. Gold, DC Maryland, Civil No. JKB-11-3116, March 12, 2012)

Applying the Maryland common law standard on demand futility, the court said that, although a say on pay vote may be considered as a factor in the demand futility analysis, it was not conclusive in this case. A shareholder advisory vote is fundamentally different from a demand for litigation, explained the court, with the former producing unfavorable publicity, but not inevitably resulting in a lawsuit. The latter is much more likely to result in a lawsuit if the shareholder concerns are not resolved.

The shareholder cited a say on pay decision from the Southern District of Ohio in which the court found demand futile because the directors devised the challenged executive compensation, approved the compensation, recommended shareholder approval of the compensation, and suffered a negative shareholder vote on the compensation, thus establishing reason to doubt that the challenged transaction was the result of a valid business judgment. (NECA-IBEW Pension Fund ex rel. Cincinnati Bell, Inc. v. Cox, SD Ohio, Sept. 20, 2011).

The court noted that the Ohio case was analyzed under Ohio and Delaware standards for demand futility, neither of which is comparable to the Maryland standard. Under Ohio law, according to Cincinnati Bell, demand is presumptively futile where the directors are involved in the transactions attacked. But in Maryland, however, mere involvement by directors in the challenged transaction does not excuse demand. The Delaware standard was previously noted to focus on the merits of the transaction at issue, contrary to the standard set forth in the leading Maryland case, which eschewed consideration of the merits in analyzing demand futility. Thus, the Cincinnati Bell case was not persuasive.

The court also rejected the shareholder’s contention that the directors exhibited antipathy towards the relief being sought by recommending approval of the executive compensation plan and then failing to rescind their decision following the say on pay vote. This reason falls within the category of generalized or speculative allegations that the directors would be hostile to the action, which the leading Maryland case considered inadequate to excuse demand.

Similarly rejected was the contention that the company has not sought recovery of the
amounts the shareholder believes ought to be recovered. This is only marginally different from the allegation that the board has not rescinded its approval of the executive compensation plan, noted the court, or the allegations that the board’s actions are not the result of a valid business judgment, noted the court, neither of which is sufficient to excuse demand under the Maryland standard.

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