By PATRICIA VOWINKEL, who has worked for national media outlets for more than 20 years
Populist outrage over the compensation paid to senior executives--particularly bankers and Wall Street CEOs--is creating an environment ripe for litigation.
At least one lawsuit has been filed so far this year against Goldman Sachs and a lawsuit against Citigroup filed in late 2008 is working its way through the legal system.
Experts in litigation against corporate directors and officers believe this could be just the tip of the iceberg.
"The key thing here is there's a lot of investor anger," said Kevin LaCroix, the author of the D&O Diary blog and an attorney and partner in OakBridge Insurance Services. "It wouldn't surprise me at all if there were further lawsuits about executive compensation practices."
One reason is that, after a federal bailout to rescue the nation's largest banks and financial services companies from a near-death experience in 2008, banks rebounded in 2009 and are now rewarding executives who stuck it out through the tough times. While Wall Street had a good year last year, Main Street has not been so fortunate, with unemployment running at about 10 percent.
Wall Street, not unaware of the anger over its pay culture, has made some effort to rein in compensation. Compensation for the top Wall Street bankers in 2009 reflects the changing times. Goldman Sachs CEO Lloyd Blankfein, for instance, received just $9 million in equity-based compensation in 2009 compared with the $67.9 million he was awarded in 2007.
Jamie Dimon, the head of JPMorgan Chase, meanwhile, received about a $17 million stock bonus compared with a $28 million bonus in 2007. Blankfein and Dimon did not receive bonuses in 2008.
Even though compensation is down sharply from 2007 levels, the controversy over executive pay is not likely to die down any time soon.
President Obama has been harshly critical of the Wall Street pay culture and the size of the bonuses awarded to bankers. And although he has said he does not "begrudge" the success of Americans, he also has called for shareholders to have more of a say on executive pay.
Shareholders may indeed seek to change the Wall Street culture by bringing lawsuits against boards that award top executives with big paydays.
"The plaintiffs bar is constantly threatening to be more litigious on this point," said Steve Shappell, managing director of legal and claims for Aon's Financial Services Group.
In the Goldman Sachs case, an institutional shareholder, the Southeastern Pennsylvania Transportation Authority (SEPTA), sued the Wall Street firm's board for awarding excessive bonuses and wants the company's management--and not the company itself--to make the $500 million in charitable donations that firm had earlier pledged to make.
Executive compensation was also an issue in a lawsuit that was filed against Citigroup in late 2008. In that lawsuit, plaintiffs called into question compensation paid to former CEO Charles Prince upon his departure.
In both of these cases, the companies were accused of corporate waste or failure in their duty to direct corporate assets to appropriate uses, according to Neil B. Posner, an attorney with the Much Shelist law firm in Chicago.
As derivative actions, the plaintiffs are not seeking damages on behalf of themselves, but rather on behalf of the company.
"They may want to bring suits for excessive compensation just to put it on the table and force a dialogue with management," said Tripp Sheehan, U.S. D&O practice leader for Marsh. "There are a lot of upset institutional investors who just want to force that dialogue."
This was the case with the options backdating derivative claims several years ago. These lawsuits centered on board failure to appropriately supervise compensation, LaCroix said. A lot of these cases ended with settlements that sought to change business practices.
While more litigation is likely, how successful that litigation will be is another story. These lawsuits are likely to be expensive to litigate but may also be hard to win because courts are reluctant to second-guess business decisions, Shappell said.
The so-called "business judgment rule" provides a certain amount of protection to directors and officers to shield them from liability for decisions made in good faith, according to Posner.
The Delaware Chancery Court, for instance, found in 2005 that directors for Walt Disney Co. did not breach their fiduciary duty in awarding a $130 million severance package to former President Michael Ovitz in 1997. The Delaware Supreme Court upheld the ruling in 2006, finding the board made a rational business decision, according to one news report.
Insurers, meanwhile, are concerned about the potential for claims as the typical D&O policy would respond to cover legal defense costs. Even so, underwriters will still review policies carefully to see if there is any language that would exclude coverage.
"D&O carriers look very closely at their policies and raise every potential coverage defense that they can as early as they can," Posner said.
There are several key exclusions and coverage defenses that underwriters may use to deny claims related to executive compensation. The exclusions include:
-- Conduct, Personal Profit or Fraud. Claims arising out of criminal conduct, profit or advantage that the defendant is not legally entitled to, and fraudulent conduct are not covered under D&O policies.
-- Disgorgement. Insurers usually will not cover settlements that would return money to the plaintiffs.
-- Insured vs. Insured. This exclusion prevents companies from suing their own directors and officers and could become a factor if one of the plaintiffs is a former board member.
-- Late Notice, Breach of Duty to Cooperate. Insurers expect claims to be reported to them in a timely manner and expect their insureds to cooperate in their own defense.
"For those of us who practice law on this side of things, we see a lot of rejected claims. That just comes with the territory," Posner said.
March 1, 2010
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