In a September 20, 2011 Opinion, Judge Timothy Black of the Southern District of Ohio ruled that a lawsuit brought against senior executives and directors of Cincinnati Bell, Inc. alleging a breach of fiduciary duty regarding compensation would be allowed to proceed. The lawsuit focuses on the "say-on-pay" provisions of the Dodd-Frank Act: specifically, attacking the Board’s decision to increase 2010 executive compensation in light of the nonbinding vote by 66% of the voting shareholders to reject that increase. Although the defendants argued that they are entitled to rely upon the business judgment rule in proceeding with the increase in compensation, the Court held that the issue of whether defendants properly exercised that judgment or, as plaintiff claimed, acted with deliberate intent to injure the company (or reckless disregard for the company) would be an issue based on the evidence (at trial or summary judgment) and not decided at the pleading stage.
According to the plaintiff (the NECA-IBEW Pension Fund), the Board of Directors recommended an increase in executive compensation for 2010, including a 71% increase for the company’s CEO and an 80% increase for the CFO. This recommendation was made despite the fact that Cincinnati Bell’s net income fell $61.3% in 2010 and there was a negative 18.8% annual shareholder return.
Under Section 951 of the Dodd-Frank Act, Cincinnati Bell was required to submit these recommendations to its shareholders for an advisory vote. The Board recommended that the shareholders approve the increases. On May 3, the shareholders voted resoundingly against the increase – 66% of those who voted were against it. However, the Board did not change or rescind the 2010 executive compensation.
On July 5, 2011, the NECA-IBEW Pension Fund filed a derivative suit against senior executives and directors, alleging breach of fiduciary duty and unjust enrichment. On July 29, 2011, the defendants moved to dismiss, arguing that: (1) the decision by the Board was protected by the business judgment rule; and (2) the plaintiff failed to allege a proper excuse for not making a pre-suit demand on the Board (as required in derivative suits).
In his September 20, 2011 Opinion, Judge Black rejected both arguments. With respect to the business judgment rule issue, the Court noted that "decisions on compensation rendered by disinterested directors are presumed to be the product of a valid business judgment," and that the plaintiff is requited to establish facts rebutting that presumption. The Court emphasized that the plaintiffs must prove the facts at trial rebutting the presumption imposed by the business judgment rule – plaintiff is not required to plead those facts with particularity at the initial pleading stage. Judge Black found that Plaintiff had properly alleged that the defendants’ decision on compensation constituted an abuse of discretion or bad faith. The Court cited plaintiff’s allegation that the negative shareholder vote was "direct and probative evidence that the 2010 executive compensation was not in the best interests of the Cincinnati Bell shareholders."
He further ruled that defendants could assert the business judgment rule as an affirmative defense at trial, and plaintiff will need to prove by clear and convincing evidence that the directors acted with a deliberate intent to injure Cincinnati Bell (or reckless disregard for the company’s best interest) and noted: "that is all for trial, or summary judgment – it is not fodder for dismissal."
With respect to the demand requirement, Judge Black ruled that such a demand would be futile, pointing out that "the director defendants devised the challenged compensation, approved the compensation, recommended shareholder approval of the compensation, and suffered a negative vote on the compensation."
Judge Black’s decision has triggered commentary from a number of bloggers, including Kevin LaCroix, who noted in his D & O Blog that "it is somewhat surprising that Judge Black in effect conceded the shareholder’s entitlement to rely on the [nonbinding] negative say on pay vote. … Section 951(c) of the [Dodd-Frank] Act expressly states, among other things that the shareholder vote ‘may not be construed’ to ‘create or imply any change to the fiduciary duties of such issuer or board of directors’ or to ‘create or imply any additional fiduciary duties for such issuer or board of directors.’"
Steven Quinlivan took a much harsher approach, writing on the Dodd-Frank.com site that Judge Black’s decision "appears to be poorly reasoned," and noting "Wow. Given this precedent, any company that increases pay in a year when net income drops will not be able to defend a derivative law suit at the motion to dismiss stage."