In this interview with Latham & Watkins partner Michele Johnson, who chairs the Orange County office's Litigation Department, she discusses how inventive plaintiffs’ firms are filing class action lawsuits before public companies’ annual shareholder votes, challenging the adequacy of proxy disclosures on executive compensation and equity plans. She characterizes this new brand of compensation injunction cases as lawyer driven, fast paced and opportunistic.
Johnson also describes how a handful of enterprising plaintiffs’ firms drew upon their experience filing M&A lawsuits and adapted that strategy in order to launch the latest wave of proxy litigation in the 2012-2013 timeframe.
What trends have emerged during the past five years in M&A litigation?
Johnson: Five years ago, half of public company mergers drew lawsuits, and most of the time the cases were filed in Delaware, where many public companies are incorporated. As of 2012, the percentage of deals in which M&A litigation was filed has gone up to about 93 percent for mergers valued at over $100 million and as high as 96 percent for transactions valued at more than US$500 million.1 In addition, cases are now typically filed in two or more jurisdictions — not just in the state of incorporation, but also in the state of the target company’s primary headquarters, as well as sometimes in federal court.
One reason plaintiffs’ firms often choose to file outside of Delaware is that another shareholder has already filed in the state of incorporation, and other firms want to get into the action too. These multiple filings represent plaintiffs’ lawyers fighting with each other for control of the shareholder class action case. The other reason is that the Delaware Court of Chancery is extremely sophisticated in these types of claims — they see these every single day. For plaintiffs, sometimes the experience of the bench can be a reason to file in the state, as Delaware courts will not hesitate to enjoin a transaction if they believe it needs to be enjoined. But it’s also a reason to file outside of Delaware, if the plaintiffs’ case is not particularly meritorious and plaintiffs would rather take their chances in a less predictable forum.
The whole point of these cases is to apply pressure and leverage in advance of a shareholder meeting by filing a motion to enjoin the vote on a transaction.
What new proxy litigation trends have emerged in the 2012-2013 timeframe?
Johnson: The Dodd-Frank Wall Street Reform and Consumer Protection Act went into effect in 2010 requiring non-binding say-on-pay votes regarding executive compensation. Despite the non-binding nature, where companies failed the vote, shareholders began bringing suit for breach of fiduciary duty, saying the board should have taken action to change executive compensation as a result of the views of the majority of shareholders. The first wave of say-on-pay cases were shareholder derivative suits, and those largely got dismissed. The plaintiffs got nowhere.
In 2012, a few enterprising plaintiffs’ law firms started filing injunction suits modeled after M&A litigation. Borrowing from their M&A litigation model, they began filing suits for breach of fiduciary duty, and then bringing preliminary injunction motions seeking to enjoin the upcoming annual shareholder vote until additional information is disclosed about executive compensation, equity plan amendments, or charter amendments.
Instead of litigating on the merits, plaintiffs are using that same pressure in advance of the annual shareholder meeting to try to obtain quick settlements.
How can companies prepare for a possible proxy injunction suit?
There is no blueprint a company can follow to avoid being named in a proxy disclosure strike suit. However, companies and boards of directors can prepare in advance to mount a strong defense and position to win the case or to settle on favorable terms.
Companies should consider the following to get a jump start on potential litigation:
- Build a careful record in compensation consultant reports and board and compensation committee minutes supporting proxy disclosures and actions taken by the board and the committee, especially in seeking shareholder approval for additional equity plan shares. Ideally, the proxy disclosure regarding company’s recommendations and underlying considerations reviewed by the board or committee will tie directly to board and compensation committee minutes.
- Review the proxy and CD&A carefully to make certain that disclosures are supported by board minutes and materials in the written record. Good disclosure is the best defense against potential lawsuits.
- Engage experienced litigation counsel and disclosure counsel to proactively assist in reviewing proxy disclosures and planning for possible litigation.
- Ensure that the board of directors and senior management are aware of the potential for litigation, no matter what the company does or what the proxy says.
- Review the company’s directors’ and officers’ liability insurance to assess coverage in the event of a suit.
- Monitor dockets and plaintiffs’ press releases, and be prepared to react quickly if the company is sued or named in an investigation by a plaintiff’s firm.
- Reach out to institutional shareholders to develop advance support for compensation and equity plan proposals.
- Consider tasking legal counsel with engaging a legal expert knowledgeable regarding the Dodd-Frank Act and other laws and regulations affecting compensation disclosures and equity plan proposals.