Companies Cave In To Demands For Comp. "Refunds"

A new front has been opened in the war on alleged “excessive” executive compensation. Shareholders are beginning to sue companies and top executives whom they deem to be overpaid. And, in the past few weeks, at least two companies have agreed to settle the charges and roll back compensation for several of these executives.

Earlier this month, Abercrombie & Fitch said it will cut the "stay bonus" of Chief Executive Officer Michael Jeffries, from $12 million to $6 million, and in the future tie that bonus to certain performance measures.

The agreement is in response to two lawsuits filed only this past February that challenged his compensation. The complaints allege, among other things, that A&F’s board of directors and the compensation committee breached their fiduciary duties in granting stock options and an increase in cash compensation to Jeffries in February 2002, and in approving his current employment agreement in January 2003.

The complaints also assert that the disclosures related to Jeffries' compensation were deficient.

In late March, Fairchild Corp. settled a shareholder lawsuit filed in late November asserting that a number of top executives unjustifiably received certain payments related to compensation, loans and reimbursements.

Under the settlement, Chairman and Chief Executive Jeffrey Steiner agreed to make a $1.5 million payment to the company for legal expenses. Steiner and the company also agreed to cut in half Steiner’s term of employment, and his base salary will be reduced by 20 percent.

In addition, Eric Steiner, a director and president as well as Jeffrey Steiner’s son, agreed to have his current term of employment reduced by a year, to a two-year term, and his base salary reduced by 15 percent.

Meanwhile, hedge fund K Capital Partners, which owns about 6.2 percent of OfficeMax, asked in a letter accompanying a securities filing that Executive Chairman George Harad give up his pay and pension benefits.

Growing Assault

Brossman

Lawyers and other experts say these incidents are not merely isolated events, but rather part of a growing assault on executive pay. “Executive compensation is under attack,” concurs Mark Brossman, a partner at Schulte Roth & Zabel.

This is partially due, of course, to the high-profile scandals at Enron, WorldCom, Adelphia, HealthSouth and dozens of other companies, which are still fresh in the minds and sensibilities of investors; the same goes for the disputed pay package awarded to former New York Stock Exchange Chairman Richard Grasso.

As Compliance Week has chronicled repeatedly over the past few years, shareholders have also been submitting dozens of resolutions seeking to rein in what they believe to be excessive compensation. In doing so, investors are increasingly calling for a larger percentage of total compensation to be tied to some sort of company performance measure. They are also petitioning companies to scale back golden parachute payments. In addition, shareholders want a say in awarding supplemental retirement plans, expensing stock options, and increasing the usage of restricted stock, preferably tied to performance rather than tenure.

Last year, CalPERS and other activists also challenged several mergers because they felt executives involved in the deal would receive gargantuan payouts if they subsequently left the newly combined firm. And The Amalgamated Bank is suing Tyson Foods and Cisco Systems, alleging that executives at the two companies granted themselves stock options before they announced good news.

Shareholders and activists are also calling for executives whose companies restated results to return bonuses received under the previously “inflated” financials.

For example, this year the Investor Responsibility Research Center says is tracking four "bonus clawback" proposals—where the company would recoup bonuses paid in the event they restate their financials—at Bristol Myers Squibb, Dynegy, JP Morgan, and Qwest Communications, according to Carol Bowie, director, governance research service at the IRRC.

Indeed, Section 304 of Sarbanes-Oxley states that in the event of an accounting misstatement due to “material noncompliance” with financial reporting requirements, certain bonuses must be returned by the chief executive officer and chief financial officer.

And, recently former directors at Enron and WorldCom agreed to reimburse harmed shareholders partly from their own bank accounts.

Latest Assault

But, the Abercrombie and Fairchild deals are slightly different from all of the other cases. Shareholders of these two companies sought the return of compensation of several executives even though the companies didn’t restate prior results and weren’t implicated in a crime.

The Abercrombie lawsuit, for example, reportedly drew on language from the retailer’s own proxy that stressed that the company’s bonuses are commensurate with industry averages and the company's financial performance, according to reports. It also partly made the case that Jeffries was overpaid by citing a Bloomberg column written by long-time compensation expert Graef Crystal, who asserted last year that Jeffries’ average salary was the past three years was the highest among 12 comparable retailers, say reports.

Hecht

And Abercrombie and Fairchild each agreed to settlements very quickly, especially Abercrombie, which reached its pact with plaintiffs just two months after the suit was filed. “They didn’t want to take the chance of an adverse ruling,” asserts Steven Hecht, a member of the Litigation Department and the Securities Litigation and Enforcement Practice Group at Lowenstein Sandler.

What’s behind this latest frontal assault? One word: Disney.

A number of lawyers believe the Abercrombie and Fairchild suits were inspired by the mere fact that the Delaware Court of Chancery allowed a lawsuit to go forward related to the roughly $140 million severance package paid to former Walt Disney executive Michael Ovitz. The plaintiffs in the Disney case alleged that directors breached their fiduciary duty “when they blindly approved an employment agreement” with Ovitz, “and then, again without any review or deliberation, ignored defendant [and then Chairman and Chief Executive Officer] Michael Esiner’s dealings with Ovitz regarding his non-fault termination,” according to the suit.

They are seeking the rescission of the compensation.

Disney sought to have the suit dismissed. But, the Court ruled that the complaint “sufficiently pleads a breach of fiduciary duty by the Old and the New Disney Board of Directors so as to withstand a motion to dismiss.”

Elson

“I think it gave people confidence the judge will hear these kinds of cases,” asserts Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. “The fact the Judge allowed it to go to trial is the significant thing. I think we will see more of these suits.”

The judge in the trial is expected to issue a ruling as early as next month, although it could come late in the year. Of course, all bets could be off if he applies the traditional business judgment rule and decides that Disney’s officers and directors acted in good faith, with due care, and within the officer or director’s authority, says Hecht.

After all, the Delaware judge never said the claims are valid, he asserts.

But as Brossman points out, “There’s a trend that is beginning and I don’t expect it to abate.”