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From Securities Regulation Daily, March 21, 2013

Failed Say-On-Pay Vote Did Not Excuse Demand on Board

By Mark S. Nelson, J.D.

The federal court in Delaware has held that a failed say-on-pay vote did not excuse a shareholder derivative suit plaintiff from making a demand on the company’s board under Delaware law. The complaint had alleged that Hercules Offshore, Inc.’s board, on the advice of its compensation advisor, Frederick W. Cook & Co., Inc., approved an overly generous compensation plan despite Hercules Offshore’s poor track record. The suit also alleged that Hercules Offshore’s definitive proxy statement falsely claimed a “strict” corporate focus on rewarding executive performance (Pinchus E. Raul v. John T. Rynd, et. al., March 14, 2013, Stark, L.).

Background. Hercules Offshore issued its definitive proxy statement on March 25, 2011 and held its first say-on-pay vote at its May 10, 2011 annual shareholders meeting. By a margin of 59 percent, shareholders opposed the pay plan adopted and recommended to shareholders by Hercules Offshore’s board. Shareholders again rejected the pay package on May 15, 2012, but this time only 52 percent of shareholders were opposed.

Hercules Offshore’s proxy statement listed numerous executive compensation goals: (1) attract and retain top talent, (2) align executive pay with shareholders’ interests, (3) reward performance, (4) discourage executives from taking excessive risks, and (5) require executives to forfeit pay if they opt to leave the company.

Pursuant to these goals, Hercules Offshore’s 2010 pay plan upped executive pay by 40 to 190 percent. CEO John T. Rynd’s 2010 pay climbed to $2.5 million from $1.3 million; CFO Stephen M. Butz’s pay rose from $333,000 to $963,000; Senior Vice President and General Counsel James W. Noe got a 108 percent raise to $1.23 million; Chief Accounting Officer Troy L. Carson’s pay increased 160 percent to $800,000; Vice President of Worldwide Operations Terrell L. Carr received $1 million or 150 percent more; and Vice President of Human Resources Lisa W. Rodriguez obtained a 40 percent raise to $950,000.

According to the complaint, Hercules Offshore had performed poorly during the period for which the 2010 pay plan allegedly dramatically increased executive pay. In particular, Hercules Offshore posted a $1.17 per share net operating loss for the relevant period. The loss translated into a one-year drop of 11 percent in total revenues and corresponding declines in shareholder equity and share price.

Demand not excused. The court applied Delaware law regarding demand futility because Hercules Offshore is a Delaware corporation. Under the Delaware Supreme Court’s Aronson formulation, a derivative plaintiff must offer particularized facts that cast reasonable doubt on whether a board’s directors were disinterested and independent or that the board’s offending act violated the business judgment rule. If a plaintiff is unable to show lack of disinterestedness or independence, Delaware law presumes the board made a valid business judgment.

Here, the court found that the derivative plaintiff failed to allege particularized facts that satisfy Aronson’s first prong. Specifically, the plaintiff did not make allegations against each individual director. The plaintiff instead pleaded generally that all of the defendants were Hercules Offshore directors when the 2010 pay plan was approved, that they all had a hand in issuing the allegedly false proxy statement, and that the directors may face a substantially likelihood of personal liability resulting from these actions.

The court said these general allegations were insufficient to excuse demand. However, the court did acknowledge the Cincinnati Bell opinion, in which a federal district court found demand excused where the named defendants were all of a board’s directors who voted in favor of a contested action. Nevertheless, the court cited several contrary opinions in its decision not to follow Cincinnati Bell.

The court also emphasized that Exchange act Section 14A (added by Dodd-Frank Act Section 951) explicitly states that the shareholder say-on-pay vote does not alter a board’s duties. In particular, the court noted that this provision may not be construed to overrule a board’s compensation decision.

Earlier in its opinion, the court had noted that while the plaintiff focused narrowly on aspects of Hercules Offshore’s pay-for-performance goals (i.e., apparently the punishment of poor performance), the court said other goals may have motivated Hercules Offshore’s board. Specifically, the court posited that increased pay may have aided retention of key executives during the company’s 2010 financial woes.

Citing Aronson’s admonition that the mere threat of directors’ personal liability is insufficient, the court said, “[a]ccordingly, the Board's failure to change course in light of the say-on-pay vote does not give rise to a substantial likelihood of personal liability, nor demonstrate that the Board would have been unable objectively to evaluate a demand to bring suit.”

Suit failed to state claim. The court ventured its opinion on whether the derivative plaintiff stated a claim for purposes of FRCP Rules 9(b) and 12(b)(6), even though it had already found demand unexcused. Here, the court opined that Hercules Offshore did not have a “strict” pay-for-performance pay policy as the plaintiff had alleged. As a result, the plaintiff’s claim that Hercules Offshore’s definitive proxy statement was false would have to be dismissed.

For similar reasons, the court would dismiss breach of fiduciary duty claims against Hercules Offshore and claims that the compensation adviser aided and abetted these breaches. The court also found that the plaintiff did not allege any breach by the adviser, so breach of contract claims would be dismissed. The court also said it would dismiss professional negligence claims against the adviser because the plaintiff failed to alleged how the adviser breached any duty of care to Hercules Offshore.

The case is C.A. No. 11-560-LPS.

Attorneys: Ryan M. Ernst (O'Kelly, Ernst, & Bielli, LLC) for Pinchus E. Raul. William M. Lafferty (Morris, Nichols, Arsht & Tunnell) for John T. Rynd, James W. Noe, Stephen M. Butz, Troy L. Carson, Terrell L. Carr, Frederic W Cook & Co., Inc. and Hercules Offshore Inc.

Companies: Hercules Offshore, Inc.; Frederick W. Cook & Co., Inc.

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