The Errors in the Cincinnati Bell Say-on-Pay Decision
As we noted, the United States District Court for the Southern District of Ohio recently declined to grant a motion to dismiss filed by the officers and directors of Cincinnati Bell that resulted from a failed say-on-pay vote required by the Dodd-Frank Act. The Court’s decision appears to be poorly reasoned. A link to the decision can be found on thecorporatecounsel.net.
Did the Court Understand the Facts?
The Court found that plaintiff made adequate pleadings that the Cincinnati Bell board is not entitled to business judgment protection for its 2010 executive pay hikes. In footnote 2, the court pointed to the allegations made by the plaintiffs. In sum, the allegations amount to noting more than (i) pay increased and (ii) net income dropped.
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.
Notwithstanding the gapes in the Court’s decision from a policy perspective, the Cincinnati Bell compensation program had nothing to do with net income. In 2010, incentive payments were tied not to net income, but to EBITDA, revenues and individual performance. In 2010, Cincinnati Bell met or exceeded the EBITDA and revenue targets for the incentive compensation program. Net income declined because of one time events associated with an acquisition and refinancing of debt. These key factors are absent from the Court’s reasoning.
The Court Did Not Properly Consider the Role of the Business Judgment Rule in a Motion to Dismiss
In Cincinnati Bell, the Court held that “the business judgment rule imposes a burden of proof, not a burden of pleading.” Admittedly, the role of the business judgment rule in a motion to dismiss in Federal courts has been much more confused than more refined law in Delaware courts. However, the Supreme Court of the United States in the 2007 Twombly decision and the 2009 Iqbal decision arguably requires that plaintiffs must rebut the presumptions of the business judgment rule in their pleadings. See Federal pleading standards and the business judgment rule after Twombly and Iqbal, Journal of Securities Law, Regulation & Compliance, Vol. 3 No. 4 (2010).
In the Cincinnati Bell decision, the Court appeared to rely on decisions which predated the Twombly and Iqbal decisions. The uninformed “pay up, net income down” rational, coupled with the specifics of the Cincinnati Bell incentive plans, which have nothing to do with net income, seem to be clear error by the Court, as there were not enough facts pled to overcome the presumptions of the business judgment rule.
What Did Say-on-Pay Have to Do With This?
Section 951 of the D0dd-Frank Act provides the say-on-pay vote shall not be binding on the issuer or the board of directors of an issuer, and may not be construed:
- as overruling a decision by such issuer or board of directors;
- to create or imply any change to the fiduciary duties of such issuer or board of directors;
- to create or imply any additional fiduciary duties for such issuer or board of directors; or
- to restrict or limit the ability of shareholders to make proposals for inclusion in proxy materials related to executive compensation.
In Cincinnati Bell, the Court appears to give weight to the plaintiff’s contention that the failed say-on-pay vote provides evidence that the compensation decisions were a breach of the director’s duties (See footnotes 1 and 4). That appears contrary to the Dodd-Frank Act.
As we noted, were glad the Georgia courts have dismissed a similar law suit brought against Beazer. The likely result of the Cincinnati Bell decision is the defendants there are going to be forced to settle the non-meritorious litigation rather than face the unknown risks of a trial.
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