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From Securities Regulation Daily, May 13, 2013

Shareholders’ Derivative Say-On-Pay Suit Tossed

By Mark S. Nelson, J.D.

The federal court in Cleveland has dismissed a shareholders’ derivative suit contesting a corporate board’s refusal to act in reply to a negative say-on-pay vote. According to the court, the derivative action was barred by the Dodd-Frank Act and demand was not otherwise excused because the challenged directors were disinterested and independent and met the business judgment rule (Robinson Family Trust v. Greig, May 10, 2013, Gaughan, P.).

Background. Robinson Family Trust, Ryan C. Smalley, and Haverhill Retirement System alleged in a derivative action on behalf of FirstMerit Corporation (FirstMerit) that its board breached its fiduciary duty by, among other things, failing to take corrective action following a negative say-on-pay shareholder vote. According to the complaint, FirstMerit awarded excessive 2011 executive compensation despite the company’s waning performance.

Specifically, the complaint alleged that FirstMerit’s board awarded total 2011 executive compensation of $12.1 million (a 16-percent rise) while the company’s stock price that year swooned by 20 percent. The CEO alone took home $6.63 million. These awards followed a five-year period that returned FirstMerit’s shareholders negative 19.4 percent and saw the company’s shares fall by 31 percent.

The plaintiffs also noted language in FirstMerit’s proxy statement that they say implied the company would reward executives for actions that promote “meaningful and long-term performance,” but not for a subpar track record. As a result, the plaintiffs alleged false and misleading statements by the company in violation of Exchange Act Section 14(a).

Dodd-Frank Act. The court noted that Dodd-Frank Act Section 951 amended the Exchange Act to require periodic shareholder say-on-pay votes. However, this provision made clear that a shareholder vote is not binding on a company’s board. The provision also did not alter boards’ fiduciary duties nor did it impose new ones. As a result, the plaintiffs here could not assert liability based solely on the board’s inaction after the negative say-on-pay vote.

Demand not excused. The court also considered whether the plaintiffs adequately alleged facts that would excuse their making a demand on FirstMerit’s board. According to the court, Ohio courts would apply Delaware law, which all parties here relied on, so the court used Delaware’s familiar Aronson test.

Although the court noted that two FirstMerit directors may be interested (Paul G. Greig for getting 2011 compensation and Steven H. Baer for working for a consultant that advises FirstMerit), the plaintiffs did not allege facts showing that the five members of FirstMerit’s compensation committee were interested.

Moreover, the court was unpersuaded by the plaintiffs’ claim that FirstMerit’s directors could be liable for awarding allegedly outsized pay packages in a year in which the company’s share price also fell because the company’s proxy implied poor performance would not be rewarded. The plaintiffs also failed to allege that the company’s 10 outside directors were interested.

Having found that FirstMerit’s directors met Aronson’s first prong, the court next found that they also met the second, business judgment rule prong. Here, the complaint failed to allege any facts showing that FirstMerit’s directors lacked good faith or were not adequately informed about executive pay. The court said that differences in how FirstMerit’s shareholders and directors viewed the company’s pay policy did not require a finding that the board acted in bad faith. The court favorably cited the Delaware federal court’s recent decision in Raul v. Rynd.

Cincinnati Bell rejected. The court explained why it rejected the plaintiff’s Cincinnati Bell argument. In Cincinnati Bell, a federal district court in Ohio in 2011 concluded that demand was excused where a company’s board recommended shareholder approval of the company’s pay package and the plaintiff there named all of the directors in its suit.

The court here noted the federal courts’ almost-universal criticism of Cincinnati Bell. The court said the defendants correctly argued that the Exchange Act’s say-on-pay requirement by itself cannot operate to excuse demand on a company’s board. The court also said that Cincinnati Bell relied on dicta from Ohio state cases, which the Ohio Supreme Court likely would reject and which also go against the Delaware corporate law that Ohio courts follow.

Lastly, in a footnote, the court observed that the defendants here had noted that counsel for the Cincinnati Bell plaintiffs had been sanctioned for not backing-up its say-on-pay theory with authority and that that court later questioned its jurisdiction.

The case is No. 5:12 CV 1713.

Attorneys: Christopher L. Nelson (Weiser Law Firm) for Robinson Family Trust. Drew T. Legando (Landskroner Grieco Merriman) and W. Scott Holleman (Levi & Korsinsky) for Ryan C. Smalley. David R. Scott (Scott & Scott) for Haverhill Retirement System. Geoffrey J. Ritts (Jones Day) for Paul G. Greig, Terrence E. Bichsel, William P. Richgels, David G. Goodall, Larry A. Shoff, Steven H. Baer, R. Cary Blair, Robert W. Briggs, John C. Blickle, Gina D. France, J. Michael Hochschwender, Terry L. Haines, Clifford J. Isroff and Phillip A. Lloyd, II. Carlton E. Langer (FirstMerit Bank) for FirstMerit Corporation.

Companies: FirstMerit Corporation; Haverhill Retirement System; Robinson Family Trust

MainStory: TopStory CorporateGovernance DirectorsOfficers DoddFrankAct ExecutiveCompensation OhioNews Proxies

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