Section 951 of the Dodd-Frank Act requires public companies to hold an advisory shareholder vote on executive compensation at least once every three years, and most public companies are now holding annual votes. In imposing this periodic requirement, Congress made clear that shareholder say-on-pay votes are not only non-binding, but that they neither “create [n]or imply any change to the fiduciary duties” governing corporate directors’ conduct under applicable state laws. Nevertheless, in 2010 and 2011, enterprising shareholder plaintiffs’ firms brought suits challenging board action following negative say-on-pay votes or disclosures made in connection with such votes. In reaction to the mounting decisions denying relief on say-on-pay claims, the plaintiffs’ bar shifted its strategy to challenge other proposals related to executive compensation, most notably proposals to increase the number of shares authorized under equity incentive plans. While most of these suits have been unsuccessful, companies seeking shareholder approval of compensation plans remain at risk for shareholder class action litigation challenging the adequacy of proxy disclosures. This article reviews recent litigation developments and sets forth recommendations for minimizing D&O liability risks in connection with compensation-related disclosures.
Following the first round of say-on-pay votes in 2010, plaintiffs’ firms specializing in shareholder litigation filed a series of shareholder derivative lawsuits against companies whose shareholders registered negative say-on-pay votes. Those suits were brought under state law and alleged that boards’ decisions to approve executive compensation plans in the face of negative say-on-pay votes amounted to breaches of fiduciary duty or waste of corporate assets. Conspicuously absent from those lawsuits was any allegation that the defendant companies had violated Dodd-Frank. Rather, the plaintiffs attempted to use Dodd-Frank as a catalyst for expanding existing state law fiduciary duties – a result Congress explicitly rejected in the text of the statute. Although plaintiffs’ firms scored limited early successes, the courts have largely rejected these lawsuits, primarily on the ground that plaintiffs had not made a prior demand on the board or adequately pled that demand would be futile. These decisions appropriately recognized the primacy of the board’s business judgment in making compensation decisions, even in the face of negative advisory shareholder votes, and essentially ended this particular variety of say-on-pay litigation.
Following their defeats in the early round of say-on-pay litigation, plaintiffs’ firms shifted gears and adopted a technique similar to now-ubiquitous shareholder litigation challenging proposed mergers. In this second wave of litigation, plaintiffs’ firms filed suits seeking to enjoin annual meetings based on purportedly inadequate proxy disclosures concerning compensation-related proposals. Such suits have challenged disclosures relating to both say-on-pay advisory votes and proposals to adopt or amend equity compensation plans, especially when such proposals involve potentially dilutive share issuances.
These disclosure-based lawsuits follow a common pattern. Soon after a company issues its annual proxy statement, a plaintiffs’ firm announces an “investigation” into the company’s compensation proposals. Once the firm finds a shareholder willing to serve as a plaintiff, a class action is filed in the state courts of the state in which the company’s headquarters is located. These actions seek to enjoin the company from holding its annual meeting, unless and until additional proxy disclosures are made. The plaintiffs generally allege that the challenged proxy statements violate the boards’ state law-based disclosure duty (duty of candor) by failing to apprise shareholders of all facts the board considered in recommending executive and/or equity compensation plans. As with merger litigation, the unstated yet obvious goal of these suits is to pressure the company into a quick and expedient settlement to avoid the delay, inconvenience, and cost of possibly postponing its annual shareholder meeting and re-soliciting proxies.
Any company soliciting a say-on-pay advisory vote or a vote to approve an equity compensation plan is at risk of such litigation, and that risk appears to be heightened for equity compensation plan proposals. For example, during the first two weeks of June 2013, one particular plaintiffs’ firm announced “investigations” of companies seeking shareholder approval to (a) modify a stock plan to increase shares reserved for issuance from 333,333 to 833,333, (b) amend the articles of incorporation to double the number of authorized shares of preferred stock, and (c) approve an amendment to increase the number of shares available for issuance under an incentive plan by 12,000,000 shares.
Suits resulting from such “investigations” typically allege that the proxy statement omitted “facts” such as: (1) the factors the company considered in determining how many additional shares should be issued; (2) the dilutive impact that issuing additional shares will have on existing shareholders and other potential costs of issuing the shares; and (3) a “fair summary” of any compensation consultant’s analysis, opinions, or recommendations, including a burn rate and overhang analysis and projections for the number of shares expected to be paid out under the plan. Such alleged omissions are somewhat similar to allegations challenging say-on-pay disclosures, where plaintiffs have alleged that proxy statements omitted details concerning pay practices, factors the compensation committee considered in awarding compensation, and compensation benchmarking and other analyses performed by compensation consultants. The wide range of allegations suggests that, no matter how detailed a company’s disclosures might be, creative plaintiffs’ firms will find some basis on which to allege that the board failed to satisfy its fiduciary duty of candor.
In filing these suits, plaintiffs’ firms are avoiding Delaware courts, which have a well-established body of law concerning the disclosure obligations imposed on directors under Delaware law, in favor of the state court system where the company is located, which will usually have far less familiarity with corporate governance and disclosure litigation.
Initially, several companies, including WebMD, Martha Stewart Living Omnimedia, and H&R Block, chose to settle say-on-pay disclosure claims rather than litigate and run the risk of any disruption to their annual shareholder meetings. In cases where defendants did not settle, courts have largely rejected plaintiffs’ efforts to enjoin annual meetings on the basis of purportedly inadequate disclosures concerning say-on-pay votes. These courts have reached a general consensus that allegedly inadequate disclosure concerning non-binding advisory votes does not pose the threat of irreparable harm, a prerequisite to the award of injunctive relief. Moreover, at least one court has determined that an injunction should not issue where the company’s proxy disclosures contain the required compensation-related line item disclosures listed in Item 402(b) of SEC Regulation S-K.
In addition to rejecting plaintiffs’ attempts to enjoin annual meetings, courts have also dismissed disclosure claims at the pleadings stage for failure to state a claim. In Gordon v. Symantec, the court dismissed the plaintiff’s grab bag of disclosure claims, concluding that the plaintiff had not adequately alleged that those disclosures would alter the “total mix” of information available to shareholders and were thus not material. The court also opined that once the vote occurred, any purported harm resulting from the say-on-pay proposal, such as allegedly wasteful compensation arrangements, would be harm to the company, and could only be pursued as a derivative claim following a showing of demand futility. In the closely followed Noble v. AAR Corp. decision, a federal court in the Northern District of Illinois recently dismissed a say-on-pay disclosure suit on much broader grounds, holding that a company complies with say-on-pay disclosure requirements by listing the disclosures required under Section 951 of Dodd-Frank and Items 402 and 407 of SEC Regulation S-K. The court thus rejected the plaintiff’s attempt to manufacture state-law disclosure claims in the wake of Dodd-Frank.
While pure say-on-pay litigation appears to be flagging, plaintiffs’ firms may continue to file litigation challenging equity incentive plan disclosures. The obvious difference in these cases is that shareholder approval is often required to issue additional shares under a proposed equity incentive plan. In the plaintiffs’ bar’s most notable success to date, a California state court judge enjoined Brocade’s annual meeting, finding that the plaintiff had demonstrated a potential threat of irreparable harm resulting from allegedly inadequate disclosures concerning the issuance of 35 million new shares in connection with an equity incentive plan. The court found that the plaintiff had a reasonable likelihood of success on his claim that the defendants should have provided a fair summary of the company’s projections concerning future stock grants. Rather than continue to fight the claim, the Brocade defendants settled for additional disclosures and approximately $625,000 in attorneys’ fees. A federal court in California also preliminarily enjoined a shareholder vote to amend an equity incentive plan until the company (Abaxis, Inc.) made additional disclosures explaining the reasons for the proposal. The facts of that case, however – which included allegations that the company had already violated its equity plan by issuing excess restricted stock units – were unusual, and the case does not appear to portend a broader trend.
Most plaintiffs, however, have been unsuccessful on their claims for injunctive relief in connection with equity incentive plans. Several courts have determined that injunctive relief is not warranted because the allegedly inadequate disclosures do not pose a risk of irreparable harm, reasoning that, unlike in the merger context, if the plaintiffs prevail at trial, the courts will not have to “unscramble the eggs” and unwind a complex transaction. Rather, the target company can simply re-solicit votes on the plan based on a proxy that includes the disclosures sought in the litigation. Notwithstanding these decisions, given the plaintiff’s success in Brocade, equity incentive plan proposals appear to be the most likely source of continued shareholder proxy litigation related to executive compensation.
Recent case filings suggest that the plaintiffs’ bar has lost interest in bringing say-on-pay challenges, and instead intends to focus its efforts on challenging proposals seeking equity incentive plan approval. Although filings in this area also have decreased this proxy season, plaintiffs’ firms continue to announce “investigations” into equity plan proposals. As with shareholder litigation challenging merger transactions, the objective of these cases is to leverage the threat of a delay in the shareholder vote into a settlement involving modest additional disclosures and a fee for plaintiffs’ counsel. Although some companies initially found it expedient to avoid litigation through settlement, recent decisions suggest that defending these lawsuits may be the better course. Companies seeking to defend their compensation-related proxy disclosures would be well-advised to do some or all of the following:
 15 U.S.C. § 78n-1(c)(2).
 See, e.g., Robinson Family Trust v. Greig, No. 5:12 CV 1713, 2013 WL 1943330, at *2-6 (N.D. Ohio May 10, 2013); Raul v. Rynd, No. 11-560-LPS, 2013 WL 1010290, at *10-13 (D. Del. March 14, 2013); Teamsters Local 237 Additional Sec. Benefit Fund v. McCarthy (Beazer Homes USA, Inc.), No. 2011cv197841 (Ga. Sup. Ct. Sept. 16, 2011).
 Faruqi & Faruqui LLP was foremost among the pioneers into the say-on-pay litigation sweepstakes, and has outlined many of its legal theories on its website, http://www.faruquilaw.com/news/show/id/80. Competing plaintiffs’ firms have recently sought to pursue similar claims.
 See, e.g., Mancuso v. Clorox Co., No. RG12-651653, 2012 WL 5874640 (Cal. Super. Ct. Nov. 13, 2012); Noble v. AAR Corp., No. 12-C-7973 (N.D. Ill. Oct. 9, 2012); Gordon v. Symantec Corp., No. 1-12-CV-231541 (Cal. Super. Ct. Oct. 17, 2012).
 See Greenlight Capital, L.P. v. Apple, Inc., No. 13-CV-00900-RJS, 2013 WL 646547, at *13 (S.D.N.Y. Feb. 22, 2013).
 Gordon v. Symantec, No. 1-12-CV-231541, 2013 WL 657791 (Cal. Super. Ct. Feb. 22, 2013).
 Noble v. AAR Corp., No. 12-C-7973, 2013 WL 1324915, at *3-6 (N.D. Ill. Apr. 3, 2013).
 Knee v. Brocade Comms. Sys., Inc., No. 1-12-CV-220249 (Cal. Super. Ct. Apr. 10, 2012).
 St. Louis Police Retirement Sys. v. Severson, Case No. 12-cv-5086 (N.D. Ca. Oct. 3, 2012).
 Mancuso v. Clorox Co., No. RG12-651653, 2012 WL 5874640 (Cal. Super. Ct. Nov. 13, 2012); Wenz v. Globecomm Sys. Inc., No. 31747-12, 2012 WL 5832319, at *4 (N.Y. Sup. Ct. Nov. 14, 2012).
 Plaintiffs’ firms have also begun what some are calling a third wave of compensation-related shareholder litigation. These lawsuits do not seek to enjoin the annual meeting, but rather allege that a company’s compensation policies violate federal law (usually Section 162(m) of the Internal Revenue Code) or the company’s own governance documents, for example, by issuing shares in excess of the equity plan’s stated limits. To the extent these claims have any merit, they can be avoided relatively easily by paying close attention to the requirements imposed by the company’s own governance documents prior to awarding equity under the plan.
Michael R. Smith is Co-Chair of King & Spalding’s Securities Litigation Group, focusing his practice on securities and shareholder litigation and related board investigations. David E. Meadows is Counsel in King & Spalding’s Business Litigation Group. He specializies in securities and shareholder litigation and related government investigation. J. Andrew Pratt is an Associate in the Business Litigation Pratice Group.