Developments: Crash Landing?
Shareholders start to challenge executive pay packages.
The American Lawyer
By Matt Straquadine
November 01, 2009
In February, ruling in a shareholder suit against Citigroup Inc., Chancellor William Chandler III of the Delaware Chancery Court dismissed every claim except one: Citigroup shareholders' claim that the $68 million golden parachute paid to departing CEO Charles Prince wasted the company's money. For plaintiffs attorneys, Chandler's decision helps clear a path into the courthouse for derivative suits over executive compensation.
Executive pay used to be off-limits in shareholder suits. Courts considered it protected by the business judgment rule, which prevents shareholders from second-guessing decisions by executives. "Now courts are more sympathetic to these claims," asserts Lee Rudy of plaintiffs firm Barroway Topaz Kessler Meltzer & Check. His firm just filed a shareholder claim against Chesapeake Energy Corporation, a natural gas company, for awarding CEO Aubrey McClendon a $75 million pay package last December after the company's market capitalization dropped $14 billion in 2008. (The company has moved to dismiss.)
In May a shareholder suit in state court in South Carolina over a golden parachute paid to an executive at The South Financial Group, Inc., was settled with the clawback of $250,000 — 13 percent of the ex – CEO's bonus. In April a shareholder sued the Missouri company Furniture Brands International, Inc., for paying $10 million to directors and officers in salary and bonuses despite a stock price that fell from $12 to just 70 cents per share.
The defense bar is girding for more litigation. "This will be an area that hits," says Paul Bessette, a securities litigation partner at Greenberg Traurig, who says that his clients are seeing more demand letters from angry shareholders ordering directors to reduce or claw back executive pay. In April the pension funds administered by the Service Employees International Union sent 29 demand letters to American International Group, Inc., Morgan Stanley, The Goldman Sachs Group, Inc., and other companies, arguing that they had squandered more than $5 billion on excessive pay. "If the complaints of the SEIU aren't addressed, we'll consider derivative litigation," says SEIU counsel Jay Eisenhofer of Grant & Eisenhofer.
The most high-profile executive compensation suit in recent years — The Walt Disney Company shareholders' challenge to former CEO Michael Ovitz's $130 million pay package — ended in defeat for the plaintiffs. Still, the Delaware Supreme Court made it clear that when pay becomes overly disproportionate to performance, shareholders will be allowed to recover damages. Today, with companies swallowing millions in losses and write-downs, it's easier for shareholders to make this argument, says Kevin LaCroix of Oakbridge Insurance Services, an executive liability insurer.
A case headed to the U.S. Supreme Court is also likely to be closely watched. In August the Court granted certiorari in Jones v. Harris Associates, after the U.S. Court of Appeals for the Seventh Circuit upheld a lower court's dismissal of the case. Although the case involves mutual fund fees, not executive compensation, it was noteworthy for a scathing dissent by conservative Seventh Circuit judge Richard Posner that attacked ballooning executive pay.
"Executive compensation in large publicly traded firms often is excessive because of the feeble incentives of boards of directors to police compensation," Posner wrote. But now, that may all change.
