Public companies have historically been able to solicit proxies for their annual meetings without the sort of litigation that typically accompanies the solicitation of votes for special meeting to approve a merger or acquisition. However it now appears that the landscape may be rapidly changing. A series of recent lawsuits have sought to enjoin annual meetings based on alleged deficiencies in the proxy statement disclosures for proposals to approve increases in equity plan reserves and advisory votes on executive compensation. The presence of these lawsuits will create challenges for many public companies as we approach the 2013 proxy season.
A new tactic creates new pressures for the proxy process
The new wave of lawsuits allege breaches of fiduciary duties by management and directors of public companies, as well as aiding and abetting by the company itself, based on purported disclosure deficiencies in the proxy statements seeking shareholder votes on an increase in the amount of shares reserved for an equity compensation plan and/or advisory votes on executive compensation. These claims are not based on a failure to include disclosure required in the proxy statement by the SEC’s rules, but rather based on state law fiduciary duty concepts.
Usually the lawsuits allege that, with respect to proposals to increase the size of the equity plan, the company has failed to adequately describe the reason for an increase in the amount of shares reserved for the equity compensation plan, as well as the projections considered and the potential dilution that may result. With regard to advisory votes on executive compensation, the plaintiffs have alleged a failure to adequately describe the role and advice of compensation consultants, to provide additional disclosure regarding peer group compensation practices and to disclose the rationale for the mix of short-term and long-term compensation.
The plaintiffs seek a tactical advantage by filing these lawsuits after the company mails the definitive proxy statement and before the annual meeting, thus providing typically only one month for the court to decide on the request to enjoin the annual meeting. Given the fact that many companies are reluctant to postpone an annual meeting or have either an advisory vote on executive compensation or a vote to approve an increase in shares available for an equity plan enjoined, many may feel compelled to quickly seek a settlement, which usually involves the publication of additional disclosure that is responsive to the claims as well as the payment of some settlement amount (including attorneys’ fees). Then again, it may be that case that some issuers will feel compelled to litigate, and could thus face the costs associated with expedited discovery and rapid briefing and argument in the case.
Plaintiffs have had limited success thus far
Earlier this year, a judge in Santa Clara County, California granted the plaintiffs’ motion for preliminary injunction and enjoined a vote on a proposal to increase the shares authorized under an equity incentive plan until the defendants provided additional disclosures. The company thereafter provided additional disclosure, the vote was ultimately held and the company settled the litigation. In a more recent decision, a different California court dismissed a similar case which alleged inadequate disclosure only in the context of the advisory vote on executive compensation, distinguishing that action from the earlier challenge to the vote seeking a potentially dilutive increase in the shares reserved under an equity compensation plan. There have been a number of settlements prior to a court decision in other similar cases.
Contrast with prior litigation on advisory votes on executive compensation
In prior litigation involving advisory votes on executive compensation, plaintiffs have alleged breaches of fiduciary duties by directors and management in connection with deficient disclosures and compensation decisions, focusing on situations where the company failed to achieve majority support for an advisory vote on executive compensation. Plaintiffs alleged that the failure to achieve majority support for the advisory vote served to overcome the applicability of the “business judgment rule” that would otherwise protect the compensation decisions of the directors. By contrast, the new litigation focuses on disclosure deficiencies in connection with the solicitation and thus the defendants’ alleged breaches of the duties of care, loyalty, candor and good faith that are owed to shareholders. Moreover, the latest lawsuits seek to enjoin the annual meeting, whereas prior litigation focused on other remedies after the vote was completed.
Preparing for this new form of annual meeting litigation
A company may first learn of these lawsuits when the plaintiffs’ law firm issues a press release to announce a “pending investigation.” Upon learning of the pending investigation or receiving a complaint, companies should consult with outside counsel to discuss the approach to handling such cases including a settlement strategy or, alternatively, the possible defenses that could be raised should the company choose to litigate. In following either path, public companies facing these lawsuits can expect to experience a difficult process in connection what would otherwise be considered a routine annual meeting process.