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From Securities Regulation Daily, July 31, 2013

Liability for inaction following adverse say-on-pay vote is a state, not federal, question

By Anne Sherry, J.D.

A Ninth Circuit panel held that a federal district court lacked jurisdiction to decide shareholder derivative actions challenging a board’s inaction on a negative shareholder say-on-pay vote. The U.S. District Court for the Southern District of California had dismissed portions of two cases challenging PICO Holdings, Inc.’s executive compensation policies and remanded the remaining issues to state court. The appeals court panel held that there was no federal jurisdiction and that the district court lacked jurisdiction to do anything other than remand the cases to state court (Dennis v. Hart, July 31, 2013, Fisher, R.).

Say-on-pay vote. As required by the Dodd-Frank Act, PICO held an advisory say-on-pay vote on its 2010 compensation plan, which increased executive compensation despite the fact that the company reported negative net income and free cash flow in that year. The plan was disapproved by 61 percent of shareholders. The plaintiffs filed separate shareholder derivative actions in California state court after the PICO board declined to take action in response to the vote.

Procedural history. The plaintiffs asserted claims for breach of fiduciary duty, gross mismanagement, contribution and indemnification, abuse of control, waste, and unjust enrichment. One plaintiff also requested a declaration that the adverse vote rebutted the business judgment surrounding the decision to increase compensation. The defendants removed the cases to federal court, and the plaintiffs moved to remand. The district court dismissed the request for declaratory judgment and dismissed the count of the other case alleging that the board breached its fiduciary duty. The court held that all other claims failed to state a federal claim or involve a substantial issue of federal law, declined to exercise supplemental jurisdiction over the remaining claims, and remanded the cases to state court.

No federal question. The appellate panel held that there was no federal-question jurisdiction over the complaints, which alleged state rather than federal causes of action. Section 27 of the Exchange Act is inapplicable, the court wrote, because the suits did not seek to enforce any liability or duty created by the Exchange Act or its underlying rules. The parties agreed that PICO did what the Exchange Act required, which was to hold an advisory vote.

Furthermore, the court noted, even if the defendants were correct that Congress has precluded liability based on an adverse say-on-pay vote, a federal defense is inadequate to confer federal jurisdiction, even if the defense is that federal law preempts the state law claim. The defendants identified no significant federal issue that would confer jurisdiction.

Finally, the court found the defendants’ argument based on the doctrine of complete preemption unavailing. “Complete preemption applies only where a federal statutory scheme is so comprehensive that it entirely supplants state law causes of action,” the court wrote, and courts have recognized that the Exchange Act does not do so. Additionally, the complete preemption doctrine applies only to claims that come within the scope of a federal cause of action, and the advisory-vote requirement under the Dodd-Frank Act created no new fiduciary duties and explicitly preserved existing state laws. “This is the exact opposite of the type of comprehensive federal regime that would justify complete preemption,” the panel concluded.

The panel accordingly vacated the orders with instructions to remand to state court, dismissed the defendants’ cross-appeals for lack of jurisdiction, and awarded costs to the plaintiffs.

The cases are Nos. 12-55241, 12-55266, 12-55282, and 12-55291.

Attorneys: Kathleen A. Herkenhoff (The Weiser Law Firm, P.C.) for Plaintiff-Appellant-Cross-Appellee George Assad. Louis N. Boyarsky (Glancy Binkow Goldberg LLP) for Plaintiff-Appellant-Cross-Appellee Ronald Dennis. Robert W. Brownlie (DLA Piper LLP) for Defendants-Appellees-Cross-Appellants John R. Hart, Ronald Langley, Robert G. Deuster, Richard D. Ruppert, Julie H. Sullivan, Kristina M. Leslie, Carlos C. Campbell, Kenneth J. Slepicka and nominal party PICO Holdings, Inc.

Companies: PICO Holdings, Inc.

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