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NECA-IBEW PENSION FUND v. COX
NECA-IBEW PENSION FUND, Derivatively on Behalf of CINCINNATI BELL, INC., Plaintiff,
v.
PHILLIP R. COX, et al., Defendants.
Case No. 1:11-cv-451.
United States District Court, S.D. Ohio, Western Division.
September 20, 2011.
ORDER DENYING DEFENDANTS' MOTION TO DISMISSTIMOTHY S. BLACK, District Judge. This civil lawsuit presents the question, among others, whether a shareholder of a public company may sue its directors for breach of the duty of loyalty when the directors grant $4 million dollars in bonuses, on top of $4.5 million dollars in salary and other compensation, to the chief executive officer in the same year the company incurs a $61.3 million dollar decline in net income, a drop in earnings per share from $0.37 to $0.09, a reduction in share price from $3.45 to $2.80, and a negative 18.8% annual shareholder return. Normally, a board of directors is protected by the "business judgment rule" when making decisions about executive compensation, and courts "will not inquire into the wisdom of actions taken by a director in the absence of fraud, bad faith, or abuse of discretion." Radol v. Thomas, 772 F.2d 244, 257 (6th Cir. 1987). However, the business judgment rule is a presumption that may be rebutted by a plaintiff with factual evidence that board members acted disloyally, i.e., not in the best interests of the company or its shareholders. See, e.g., Koos v. Cent. Ohio Cellular, Inc., 641 N.E.2d 265, 272 (Ohio Ct. App. 1994). Under the recently enacted federal law, The Dodd-Frank Wall Street Reform Act, publicly traded companies must include a separate shareholder resolution to approve executive compensation in their proxies at least once every three years. See 15 U.S. Code § 78n-1(a) (2010). Pursuant to that requirement, the Cincinnati Bell Board included a shareholder resolution in its March 21, 2011 proxy seeking shareholder approval of the 2010 executive compensation. The Board recommended that the shareholders vote in support of the resolution. On May 3, 2011, 66% of voting shareholders voted against the 2010 executive compensation.1 Citing, inter alia, the overwhelming rejection by shareholders of 2010 executive compensation, plaintiff filed this lawsuit alleging that the Cincinnati Bell Board breached its fiduciary duty of loyalty when it decided to approve large pay raises and bonuses to its top three officers in a year when, according to plaintiff, the company performed dismally. The directors and officers, in turn, have filed their motion to dismiss the lawsuit. A. Standard of Review
1. Some "commentators are now identifying excessive executive compensation as the No. 1 problem in corporate governance. . . . While private sector wages rose only 2% in 2010 . . ., the median compensation for chief executive officers at Standard & Poor's 500 index companies was up by 18% from 2009 to an average of $12 million. . . . In 1965, the typical chief executive made 24 times the salary of the average worker. [Today], the typical chief executive makes 275 times the salary of the average worker. . . . The top 1% of earners now take in about a quarter of our nation's income and own 40% of its wealth. . . ." Morrissey, Daniel J. "Courts Should Curb Executive Pay" The National Law Journal (Aug. 15, 2011). (See Ex. 2 to plaintiff's memo contra; Doc. 24).
Against this backdrop, Congress passed the Dodd-Frank Wall Street Reform Act and included within it the "say-on-pay" provision which requires public companies to allow their shareholders an advisory vote on the compensation of their top officials. Although Dodd-Frank states that those expressions are not binding and do not alter the fiduciary duties of directors, some commentators opine that "[a] negative say-on-pay vote gives the court evidence that there's been a breach of duty. It doesn't mean there's been a breach of duty, but it can support a finding of breach." Myles, Danielle "Experts Disagree on Validity of Say-on-Pay Lawsuits" International Financial Law Review (Aug. 2011). (See Ex. 1 to plaintiff's memo contra; Doc. 24)
Critics of Dodd-Frank's "say-on-pay" provisions worry that extensive, frivolous litigation will ensue, but a report issued by Shulte Roth & Zabel on the 2011 annual meeting season shows that only 1.6% of public companies which have held their annual meetings as of the end of June 2011 received negative shareholder recommendations. (See Ex. 1 to plaintiff's memo contra; Doc. 24). Cincinnati Bell is one of those companies.
2. The Directors awarded CEO Cassidy an annual performance bonus of $1,335,840, a special bonus of $600,160, and a retention bonus of $2,100,000, bringing his total compensation to over $8.5 million, representing a 71.7% increase in his prior total yearly compensation. (Doc. 1 at ¶¶ 11-13; 30-31; Doc. 3 at 11-12). CFO Wojtaszek received an annual incentive award of $282,762, a special bonus of $531,300, and a long-term incentive award of $552,174, bringing his total compensation to over $2 million and constituting an 80.3% increase over his prior compensation. (Id.) Vice President and General Counsel Wilson was awarded an annual incentive award of $282,762 and a long-term incentive award of $538,486, bringing his total compensation to over $1.5 million and constituting a 54.3% increase over his prior yearly compensation. (Id.) All of the compensation awards were approved by the full Board. (Doc. 3 at 11-12). The awarding of these bonuses occurred in a year when the company incurred a $61.3 million dollar decline in net income, a drop in earnings per share from $0.37 to $0.09, a reduction in share price from $3.45 to $2.80, and a negative 18.8% annual shareholder return. (Doc. 1 at ¶ 28). The company's 2010 net income applicable to common shareholders and total shareholders' equity also materially declined. (Id.)
3. Plaintiff alleges that the compensation violated Cincinnati Bell's written compensation policy, which states that "a significant portion of the total compensation for each of our executives is directly related to the Company's earnings and revenues and other performance factors" and that at-risk compensation should be "tied to the achievement of specific short-term and long-term performance objectives, principally the Company's earnings, cash flow, and the performance of the Company's common shares, thereby linking executive compensation with the returns realized by shareholders." (Doc. 1 at ¶ 27) (emphasis supplied).
4. Plaintiff asserts that the negative shareholder advisory vote on executive compensation, in which 66% of voting shareholders voted against the 2010 executive compensation, provides "direct and probative evidence that the 2010 executive compensation was not in the best interests of the Cincinnati Bell shareholders." (Doc. 1 at ¶ 36).
5. Two Ohio Court of Appeals cases have held that suing all of the directors may establish demand futility. Carlson, 789 N.E.2d at 1128 ("Examples of when demand would be excused as futile include when all directors are named as wrongdoers and defendants in a suit"); Drage, 694 N.E.2d at 483 ("when all directors are named as wrongdoers/defendants in a suit, futility may exist.") (emphasis in original). Here, plaintiff has sued all members of the board who devised and approved the challenged compensation. While there is one member of the Cincinnati Bell Board, Alan Schriber, who is not a party to this litigation because he joined the Board after the approval of the 2010 executive compensation, "the issue is whether the particularized factual allegations are sufficient to create doubt about the disinterestedness and independence of a majority of the directors." McCall, 239 F.3d at 818, n.10. Because plaintiff has established that demand would have been futile as to seven of the eight members of the Board, Mr. Schriber's independence does not preclude a finding of futility.
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