February 21, 2019

Shareholder Suits Target Non-Employee Director Compensation at Public Companies

Recent shareholder suits show a heightened scrutiny of routine proxy disclosures in order to challenge non-employee director compensation. Plaintiffs’ attorneys are focusing on non-employee director compensation and compensation plans, particularly in comparison to peer companies. This trend was expected following the late-2017 decision by the Delaware Supreme Court in In re Investors Bancorp, Inc. Stockholder Litigation, 177 A.3d 1208 (2017), which clarified that stockholder approval of director compensation plans is only sufficient to ratify director compensation awards (and thus make those awards subject to the more favorable business judgment standard of review) if the awards were either specifically approved or granted pursuant to a non-discretionary formula included in the plan. Without ratification, director compensation is subject to entire fairness review, making it easier for a plaintiff to survive a motion to dismiss a lawsuit and force a case into the expensive document and deposition discovery process. In light of this trend, during the upcoming proxy season, particular attention should be paid to proxy disclosures concerning director compensation.

Two cases asserting allegations of excessive director compensation have already been filed in 2019, and at least 10 cases were filed in 2018. In Stein v. Benioff, Civil Action No. 2019-0028 (Del. Ch. Ct. Jan. 15, 2019), the plaintiff alleges that the non-employee directors of Salesforce awarded themselves excessive cash and stock compensation (averaging $608,406) when compared to the company’s self-selected peer group (averaging $366,524). The plaintiff also alleges that the compensation plan had no meaningful limits and that attempted ratification of the compensation plan by shareholders was ineffective because the proxy disclosures concerning stock compensation were false and misleading for several reasons. Specifically, the plaintiff asserts that the proxy misstated that prior-year grants were restricted stock when they were actually fully vested shares, omitted the grant date fair value of stock compensation, falsely approximated the total value of stock compensation under the new plan to be $427 million (when the 10-K subsequently disclosed actual value of $997 million), and misstated where to find the assumptions for the calculation of stock awards.

Similarly, in Heng Ren Silk Road Investments LLC v. Chen, Civil Action No. 2019-0010 (Del. Ch. Ct. Jan. 7, 2019), the plaintiffs allege that the average $138,000 compensation for non-employee directors of China Automotive Systems Inc. was three times that of non-employee directors of comparably sized Nasdaq-listed Chinese companies, who all averaged $50,000 or less in compensation. 

Complaints frequently contain some variation of the following allegations:

  • When compared to similar companies — either a company’s self-selected peer group or similar companies by industry or market cap — the non-employee directors are compensated at least twice as much as the average non-employee director.
  • The plans under which the non-employee director’s compensation was granted were not ratified by shareholders, the shareholder vote to approve the director compensation plan was ineffective because of misstatements in the proxy, or an approved compensation plan has been amended or changed since initial shareholder approval. 
  • Proxy statements seeking shareholder ratification of compensation plans contain any number of materially false or misleading statements or omissions, including: the grant date fair value of prior stock compensation, the expected value of stock compensation to be granted, the types of shares or equity granted, and the assumptions used to calculate stock compensation under a plan.
  • If approved, the compensation plan fails to contain meaningful limits on either the number or value of shares that may be granted.

Going into proxy season, companies should focus on ensuring a robust process for determining director compensation and consider shareholder ratification of director compensation plans.  Companies should also focus on ensuring the accuracy of proxy disclosures concerning non-director compensation and the company’s equity incentive plans and practices. For further information please contact your Goodwin attorney.