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Welcome to Washington, a town where at any given moment: Congress may pass a law, an agency may issue a rule or a judge may deliver a verdict. Each time, we might think the story is over. But directors know that when it comes to policy, it ain’t ever over. From experience in the twists and turns of governance mandates, directors get it: Our government has three branches, not one, and nothing that happens in one branch is immune from hindrance or help from another sooner or later.
President Barack Obama signs the JOBS Act at the White House.
Additional complexity comes from the “twigs” on the branches. Congress has two: the House and the Senate. Executive agencies are legion, sometimes with overlapping jurisdiction. And federal courts have three levels: district courts (in 12 circuits), appeals courts and the Supreme Court. Federal courts may apply the laws of states, as well, which also have a threefold system (with legislative, executive and judicial branches). Moreover, branches aren’t uniform politically. Laws, rules and verdicts may vary based on party. Bipartisan consensus aside, if an action would reduce a business “burden” (e.g., through decreased obligations or penalties), it tends to be driven by Republicans. Conversely, if an action would heighten business “accountability” (e.g., through increased obligations or penalties), it tends to be driven by Democrats.
So what’s a Washington watcher to do when it comes to the matters directors want to know? With governance mandates always in flux, it’s not always easy for directors to determine the best and most compliant governance policies.
Let’s take a look at how our system is working on three current board issues: proxy access, say on pay and “neither admit nor deny.”
Proxy Access Fate
Consider the 1-2-3 fate of proxy access. In this matter an appeals court, responding to a private legal action, put the brakes on what could have been an agency juggernaut enabled by our legislature.
The Securities and Exchange Commission spent years preparing for it, but nothing ever happened because SEC jurisdiction was in question. In July 2010, via the Dodd-Frank Act, Congress affirmed SEC jurisdiction, and two proxy access rules followed. Then the Business Roundtable and U.S. Chamber of Commerce challenged the rules in the U.S. Court of Appeals for the District of Columbia, which struck one of them down. Today shareholders have proxy access— but only if they change their company bylaws to allow for it.
So far in 2012, fewer than 20 companies have received proposals to amend bylaws to permit proxy access, according to a March report by Thomson Reuters. It is possible that the long check-and-balance delay, combined with rising interest in social issues, forced this cause célèbre further down the wish list for activist shareholders.
Say-on-Pay Repercussions
Another good example of the three branches at work over time is say on pay, which has gone from Congress to an agency to the courts. Via Dodd-Frank, Congress in July 2010 mandated periodic shareholder approval of executive compensation practices. Although the Jumpstart Our Business Startups (JOBS) Act of 2012 may exempt new public companies from this requirement (among other changes), for most public companies it is law, implemented in the rules approved by the SEC on Jan. 25, 2011.
The courts are now having their say, and they are saying no to the lawsuits filed against a dozen of the 47 companies that lost say-on-pay votes in 2011—a target rate of one in four. The total number of lawsuits is higher, though, because some companies have seen multiple lawsuits: two were filed against Cincinnati Bell Telephone (CBT), two against Hercules Offshore Inc., and three against Occidental Petroleum.
Of the 16 say-on-pay lawsuits so far, one is in the process of being settled out of court (CBT) and two have already been settled (one of the Occidental cases and one against Keycorp). Seven cases have been dismissed; judges threw out legal attacks on Beazer Homes, BioMed Realty, Jacobs Engineering, Pico Holdings and Umpqua Holdings, as well as two of the cases against Occidental Petroleum.
The remaining six cases are pending (a CBT case, both Hercules cases, and cases against Dex One Corp., Janus Capital and Johnson & Johnson). So far there has not been a single court judgment against directors.
Only two companies have lost say-on-pay votes so far this year, and, based on the low success rates of the lawsuits, the legal attacks may lessen.
The weakness of say-on-pay litigation was predicted colorfully in January by attorney Robert E. Scully Jr., writing in The Federal Lawyer: “In practice, the issue either will not arise or will turn out to be much ado about nothing if it does arise because §952 [of Dodd-Frank] creates a set of game-changing ‘Compensation Committee Independence’ rules. Those rules, if followed, will completely insulate the directors of publicly traded corporations against all challenges—except claims of waste—to their business judgments regarding executive compensation. Thus, paradoxically, the Compensation Committee Independence rules in the act render the ‘say-on-pay’ resolutions as useful to plaintiffs’ lawyers as an ashtray on a motorcycle.”
“Neither Admit Nor Deny”
The issue of settlements has received special multi-branch scrutiny recently with the March 2012 stay of Securities and Exchange Commission v. Citigroup Global Markets Inc. (2011). It seems that while investigating the causes of the recent financial crisis, the SEC determined it did not like the way Citigroup had been marketing certain collateralized debt obligations (mortgage-backed securities) a few years back. The agency charged Citigroup with violating the 1933 Securities Act.
The two parties agreed on a settlement: Citigroup would pay a fine but “neither admit nor deny” the wrongdoing. But this “neither admit nor deny” approach, an option commonly taken by companies, got shot down. Last November Judge Jed Rakoff, who wields the gavel in the New York Southern District Court in the busy Second Circuit, rejected the agreed-upon settlement, causing widespread concern. Might this genteel corporate settlement style be bound for extinction? On March 15, a three-judge panel of the U.S. Court of Appeals for the Second Circuit stayed the Rakoff decision, declaring that the matter deserved closer scrutiny: “The challenge by both parties [Citigroup and SEC] to the District Court’s order raises important questions. These include the division of responsibilities as between the executive and the judicial branches and the deference a federal court must give to policy decisions of an executive administrative agency as to whether its actions serve the public interest (and as to the agency’s expenditure of its resources). They include also the question of a court’s authority to reject a private party’s decision to compromise its case on the ground that the court is not persuaded that the party has incurred any liability by its conduct.”
Profound issues indeed. The Appeals Court is now scheduled to hear the case in September.
These examples of our government at work can make the head spin. It’s a lot to track for compliance-minded directors. At the same time, let us remember: Checks and balances—through the three government branches and the two political parties—contribute to the greatness and durability of American enterprise.
It is nice to know that someone other than my mother read my Federal Lawyer piece on executive compensation litigation.