The vast majority of companies that must file a proxy statement in mergers and acquisitions transactions that seek special shareholder meetings to approve a deal face shareholder lawsuits asserting that such proxy statements contain inadequate disclosure .
Now, routine public company proxy statements for annual meetings of stockholders are under threat from a new variation on the same genre of shareholder lawsuits. This latest twist asserts that board members have breached fiduciary duties by approving purportedly deficient disclosure when seeking shareholder approval for increases to equity incentive plans or advisory votes on executive compensation (say-on-pay).
In March 2012, a plaintiff-side securities litigation firm filed suit in Santa Clara County, California against Brocade Communications. The complaint alleged that the disclosure in Brocade’s proxy statement for its annual meeting, which had been filed with the SEC the prior month, failed to contain sufficient disclosure regarding a proposed increase to the number of authorized shares available for grant under Brocade’s equity incentive program. The judge in the case issued a preliminary injunction on April 10, thereby setting at risk Brocade’s proposed April 12 annual meeting, on the basis that projections and estimates considered by the company’s board in determining the number of additional shares to authorize would be material to a shareholder.
On April 11, Brocade announced a settlement under which it filed a proxy supplement on April 12 and held the annual meeting that same day, but adjourned the stock incentive plan proposal at issue for seven calendar days. On April 20, it resumed the annual meeting and the stockholders passed the stock incentive plan. Apart from the supplemental disclosure, the only other material item of note in the settlement was the reimbursement of up to $625,000 of the plaintiff firm’s fees, not an insubstantial sum, which was approved in principle by the court on October 5.
Public companies in Brocade’s position face an unpleasant dilemma if such a lawsuit is filed. One option is to vigorously defend the lawsuit. However, due to the inherent unpredictability of litigation, a company may be forced to postpone its annual meeting during which important company business is to be transacted; in addition, arranging a substitute or additional meeting at short notice may be logistically difficult. Moreover, the prospects of an injunction may disrupt important compensation plans. The other option is to quickly enter into settlement discussions, meaning the company is likely pay legal fees to the plaintiff’s firm and add additional disclosure. There may be little downside to including such disclosure (even though its benefit to stockholders may be marginal); however, a plaintiff may demand the disclosure of internal projections or forecasts that the company otherwise would not disclose for competitive and other reasons. Having to make such a choice within the tight time frame surrounding an annual meeting (including, for example, SEC and Delaware rules on the timing of a record date and proxy distribution) makes settlement clearly the path of least resistance.
In recent years, disclosure-related claims in shareholder suits stemming from requests to stockholders to approve acquisitions have become routine. In fact, the vast majority of proxy statements for special meetings in the M&A context have attracted disclosure-related litigation. These cases almost inevitably involve revising proxy disclosure with supplemental information, as well as payment of the plaintiff’s legal fees, the latter of which would appear to be significant incentive for future additional cases. The degree of detailed information that is disclosed has reached the point where, for certain sections of an M&A proxy statement, such as the summary of a financial adviser’s opinion on the fairness of an acquisition, some observers are wondering whether a soliciting company should just attach the financial adviser’s full presentation and jettison the plain English summary of what may be (mis)charactertized as financial jargon.
Thus enter threats to annual meeting proxy statements. On the same day the Brocade settlement was approved in principle, the same plaintiff’s firm filed suit against two large technology companies and announced “pending investigations” by the same law firm against approximately half a dozen more public companies. Claims in these suits are no longer confined to the original idea in Brocade; that is, the new lawsuits do not challenge only increases in equity incentive plans. Rather, the latest spate includes allegations of insufficient disclosure for advisory proposals on approval of executive compensation (otherwise known as say-on-pay proposals) and on the renewal of senior executive bonus compensation plans. The claims assert the need for additional detail regarding such issues as peer group usage and stock ownership levels and demand a more complete explanation of the recommendations and work of outside compensation consultants.
The rationale for the nascent claims in these lawsuits is troubling. Such suits suggest a bottomless demand. Regardless of the amount and detail of information a company may disclose in its proxy statement, a plaintiff may assert that even more disclosure is required. Indeed – paradoxically – a company that chooses to disclose more rather than less may be penalized for its candor, because every piece of information it discloses may provoke a plaintiff to argue that yet more backup information is required.
The demands for such detailed disclosures also are troubling because a corporation’s compensation decisions, while important, do not present the same degree of significance to the shareholders as the measures sought for approval in the M&A context – namely, the sale of the company. Neither Delaware nor California law gives shareholders the right to micromanage the human resources functions of an ongoing corporation or sit in on compensation committee meetings, and an outside compensation consultant’s advice that may be part of the mix of information considered in a compensation committee’s compensation proposals to the shareholders is simply not analogous to an investment advisor’s fairness opinion that is almost always a key basis for an M&A proposal to the shareholders.
This potential rash of these lawsuits focuses attention to exclusive forum proposals by public companies. Such proposals ask stockholders to ratify the amendment of a company’s bylaws or charter to mandate that any derivative suits can only be brought before Delaware courts – rather than any other state court where nexus can be shown. Proponents of such proposals often posit that suits in Delaware would centralize suits under one streamlined judiciary, avoid the obtuse situation of a separate state court applying Delaware law as must be done with Delaware incorporated companies (a California judge applied Delaware case law in the Brocade suit) and deter filing of such suits due to increased costs for plaintiff’s firms to appear in Delaware. The proposals are controversial, not least with courts in states other than Delaware, which generally do not endorse the subversion of their jurisdiction. Perhaps more importantly, it is unclear that exclusive forum proposals would effectively reduce frivolous litigation, given that the Delaware docket already bustles with disclosure cases in the M&A context.
For the plurality of companies with December 31 fiscal year ends, proxy season generally runs in the spring. Will the fresh tactics wither away under judicial scrutiny over this winter? Or will other plaintiff firms take them up and make them a regular feature of the securities litigation landscape?
For more information about the implications of this case, please contact Ed Batts and David Priebe.