How Much Latitude Do Directors Have In Setting Executive Compensation?

Executive compensation decisions are core functions of a board of directors and, absent unusual circumstances, are protected by the business judgment rule.  As Delaware courts have repeatedly recognized, the size and structure of executive compensation are inherently matters of business judgment, and so, appropriately, directors have broad discretion in their executive compensation decisions.  In light of the broad deference given to directors’ executive compensation decisions, courts rarely second-guess those decisions.  That is particularly so when the board or committee setting executive compensation retains and relies on the advice of an independent compensation consultant.

Nevertheless, despite the high hurdle to challenging compensation packages, shareholder plaintiffs continue to aggressively challenge executive compensation decisions, in particular at companies that have performed poorly and received negative or low say-on-pay advisory votes. Read More

Texas Court Rules that Regardless of Fault, CEOs and CFOs Will Have to Pay Up Under Sarbanes-Oxley Section 304

A Texas federal judge denied defendants ArthoCare CEO Michael A. Baker and CFO Michael T. Gluk’s motion to dismiss the SEC’s claim against them under Sarbanes-Oxley (“SOX”) Section 304’s clawback provision. Section 304 requires CEOs and CFOs to reimburse their company for any bonus or similar compensations, or any profits realized from the sale of company stock, for the 12-month period following a financial report, if the company is required to prepare an accounting restatement due to material noncompliance committed as a result of misconduct.

Baker and Gluk, who were not alleged to have participated in the misconduct that led to ArthoCare’s restatement, challenged Section 304 as unconstitutional, arguing that the SEC could not require them to repay bonus compensation and profits from stock sales for merely holding CEO and CFO positions during the time of the alleged misconduct. In particular, they argued that Section 304 is vague and is unconstitutional because it does not require a reasonable relationship between the triggering conduct and the penalty as is required by the Due Process Clause.

Judge Sam Sparks of the Western District of Texas rejected the Officer-Defendants’ constitutional arguments. Judge Sparks first held that Section 304 was not vague because it clearly referred to misconduct on behalf of the issuer of the allegedly false financial statement. Judge Sparks noted that Defendants “should have been monitoring the various internal controls to guard against such misconduct; they signed the SEC filings in question, and represented they in fact were actively guarding against noncompliance. As such, they shouldered the risk of Section 304 reimbursement when noncompliance nevertheless occurred.” Read More