TheCorporateCounsel.net

March 14, 2007

Delaware Chancery Court Decision: Compensation Not Fair

I started blogging about this executive compensation case way back in 2005 – and at long last, we have an opinion in Valeant Pharmaceuticals v. Panic & Jerney – a case that went all the way to trial in Delaware’s Chancery Court (just like Disney). In the CompensationStandards.com “Executive Compensation Litigation Portal,” we have posted a copy of the opinion.

Here is a recap of the decision from Travis Laster of Abrams & Laster: Vice Chancellor Stephen Lamb of the Delaware Court of Chancery held that a transaction bonus received by a former director and president of ICN Pharmaceuticals, Adam Jerney, was not entirely fair. The Vice Chancellor ordered Jerney to disgorge the entire $3 million bonus. He also held Jerney liable for (i) his 1/12 share (as one of 12 directors) of the costs of the special litigation committee investigation that led to the litigation and (ii) his 1/12 share of the bonuses paid by the board to non-director employees. The Vice Chancellor also ordered him to repay half of the $3.75 million in advancements that INC paid to Jerney and the primary defendant, ICN Chairman and CEO Milan Panic, to fund their defense. The Vice Chancellor granted pre-judgment interest at the legal rate, compounded monthly, on all amounts.

The ICN decision is a must-read for any practitioner who advises boards of directors or compensation committees on compensation issues. It contains a number of key holdings and comments. Here are some highlights:

1. Vice Chancellor Lamb found that all of the members of the board were interested in the bonuses paid in connection with an IPO of ICN, because even the outside directors on the compensation committee received a minimum of $330,500 per director. The Vice Chancellor viewed this compensation as making the compensation committee members “clearly and substantially interested in the transaction they were asked to consider.”

2. The Vice Chancellor was highly critical of the process followed by the compensation committee and its reliance on a compensation report prepared by Towers Perrin. The Vice Chancellor found that Towers Perrin was initially selected by management, was hired to justify a plan developed by management, initially criticized the amounts of the bonuses and then only supported them after further meetings with management, and opined in favor of the plan despite being unable to find any comparable transactions.

3. The Vice Chancellor rejected an argument that the Company’s senior officers merited bonuses comparable to those paid by outside restructuring experts. “Overseeing the IPO and spin-off were clearly part of the job of the executives at the company. This is in clear contrast to an outside restructuring expert…”

4. The Vice Chancellor held that reliance on the Towers Perrin report did not provide Jerney with a defense under Section 141(e) of the General Corporation Law, which provides that a director will be “fully protected” in relying on experts chosen with reasonable care. “To hold otherwise would replace this court’s role in determining entire fairness under 8 Del. C. sec. 144 with that of various experts hired to give advice….” The Vice Chancellor also held separately that Towers Perrin’s work did not meet the standard for Section 141(e) reliance.

5. The Vice Chancellor held that doctrines of common law and statutory contribution would not apply to a disgorgement remedy for a transaction that was void under Section 144. Hence Jerney was required to disgorge the entirety of his bonus without any ability to seek contribution from other defendants or a reduction in the amount of the remedy because of the settlements executed by the other defendants.

As an aside, it bears noting that this case is one of the rare situations in which a special litigation committee has realigned the company as plaintiff and pursued the claims originally brought by a stockholder plaintiff as a derivative action.

The ICN opinion shows the significant risks that directors face when entire fairness is the standard of review. The opinion also shows the dangers of transactions that confer material benefits on outside directors, thereby resulting in the loss of business judgment rule protection. Although compensation decisions made by independent boards are subject to great deference, that deference disappears when entire fairness is the standard. “Where the self-compensation involves directors or officers paying themselves bonuses, the court is particularly cognizant to the need for careful scrutiny.” Contrast, for example, the outcome in ICN, involving an interested board, and the quite different outcome in Disney, involving an independent board.

[Broc’s Final Four Picks: Georgetown over Florida in the final, with Texas A&M and Kansas also making the last weekend; it was tough not to take Texas over Georgetown. I correctly picked Florida to win it all last year, so I can rest on those laurels for at least a decade, right?]

Backdated Options and ERISA Claims

In this CompensationStandards.com podcast, John Gamble of Fisher & Phillips provides some insight into how ERISA claims will be brought in the options backdating lawsuits, including:

– For what we can tell, what were the backdating circumstances at Mercury Interactive?
– What role do you think human resource professionals played in backdating (compared to other employees)?
– How do ERISA claims come into play regarding backdating?

International Investors Endorse Say-on-Pay

From ISS’ “Corporate Governance Blog“: An international coalition of 13 institutional investors has endorsed the right of U.S. shareholders to have an annual advisory vote on executive compensation practices.

In a letter to Securities and Exchange Commission Chairman Christopher Cox, the investor group argued that advisory votes on executive pay would “improve communication between shareholders and directors; encourage pay-for-performance practices; increase focus on individual company circumstances and strategic goals in the development and evaluation of executive compensation plans; and provide a counter-weight to upward pressure on executive compensation from enhanced disclosure requirements.”

The group urged the SEC to take action to establish shareholder votes on pay through regulatory action or through exchange listing standard changes. The investors also said they would support legislation to provide such a right. U.S. Rep. Barney Frank, the chairman of the House Financial Services Committee, introduced a bill in 2005 that called for votes on pay plans, but the measure stalled in Congress, which was then controlled by Republicans.

So far this proxy season, labor pension funds and other U.S. investors have filed more than 60 proposals seeking advisory votes on pay practices.

The Jan. 25 letter, which was orchestrated by the Universities Superannuation Scheme of the United Kingdom, was signed by eight other U.K. institutions, two from the Netherlands, one from Australia, and the Connecticut Retirement Plans and Trust Funds. Among the other signatories are ABP Investments from the Netherlands; Hermes Equity Ownership Services, F&C Asset Management, the Local Authority Pension Fund Forum, and Shell Pensions Management Services, all from the U.K.; and UniSuper Management from Australia.

Such advisory votes are required in the United Kingdom, Australia, and Sweden, while Dutch firms must submit pay policies to a binding shareholder vote. According to the international investor group, the votes in these markets have made companies more receptive to shareholders on compensation issues. The investors cited the example of British drugmaker GlaxoSmithKline, which adjusted its remuneration plan after a 51 percent negative vote in 2003. In Australia, shareholder opposition prompted gaming company Tabcorp to withdraw an options plan for its CEO last year, while packaging firm Amcor agreed to increase performance hurdles and extend vesting schedules, according to the investor group. Other firms in these markets now are using longer-term performance targets in incentive plans and have improved their pay disclosure.