California Court of Appeals, Second District, Fifth Division
CHARTER TOWNSHIP OF CLINTON POLICE AND FIRE RETIREMENT SYSTEM et al., Plaintiffs and Appellants,
CRAIG L. MARTIN et al., Defendants and Respondents.
APPEAL from a judgment of the Superior Court of Los Angeles County No. BC454543, Kenneth R. Freeman, Judge.
Robbins Geller Rudman & Dowd, Travis E. Downs III, Kevin K. Green and Amanda M. Frame for Plaintiff and Appellant Charter Township of Clinton Police and Fire Retirement System.
The Weiser Law Firm and Kathleen A. Herkenhoff for Plaintiff and Appellant Colleen Witmer.
Robbins Umeda, Brian J. Robbins and Shane P. Sanders for Plaintiff and Appellant Daniel Himmel.
Paul Hastings, William F. Sullivan, D. Scott Carlton; Wachtell, Lipton, Rosen & Katz, Warren R. Stern and Kim B. Goldberg for Defendants and Respondents Craig L. Martin, Noel G. Watson, Joseph R. Bronson, John F. Coyne, Robert C. Davidson, Jr., Edward Fritzky, John P. Jumper, Linda Fayne Levinson, Benjamin F. Montoya, Thomas M.T. Niles, Peter J. Robertson, John W. Prosser, Jr., Thomas R. Hammond, George A. Kunberger, Gregory J. Landry, and Frederic W. Cook & Co., Inc.
Gibson, Dunn & Crutcher, Joel A. Feuer; and Michael M. Farhang for Nominal Defendant and Respondent Jacobs Engineering Group Inc.
Three plaintiffs filed the operative consolidated amended shareholder derivative complaint on behalf of nominal party Jacobs Engineering Group, Inc., against multiple defendants, including the individual members of Jacobs’s Board of Directors (the Board),  senior Jacobs’s executives covered by a May 2010 executive compensation plan adopted by the Board, and Frederic W. Cook & Co., Inc., a consultant to Jacobs on the creation of the compensation plan. The consolidated complaint alleged the Board members violated fiduciary duties by adopting the compensation plan in the face of poor performance by Jacobs, misrepresenting compliance with the plan and company performance in a proxy statement, and failure to alter the plan in response to its rejection by a majority of Jacobs’s shareholders in a nonbinding vote. Plaintiffs alleged it was “useless and futile” to file a pre-suit demand on the Board to rescind the plan.
The trial court sustained defendants’ demurrer to the consolidated complaint on the grounds that plaintiffs had failed to adequately plead pre-suit demand futility, and alternatively, the complaint failed to state a cause of action under applicable California and Delaware law. Plaintiffs challenge both aspects of the court’s order sustaining the demurrer. We agree with the trial court that plaintiffs have failed to allege facts excusing pre-suit demand on the Board with allegations of particularized facts showing wrongdoing by a majority of directors on a director-by-director basis. In reaching this conclusion, we agree with and cite in detail from the recent opinion in Raul v. Rynd (D. Del., Mar. 14, 2013, C.A. No. 11-560-LPS) U.S. Dist. LEXIS 35256 (Rynd), which dismissed a complaint containing allegations strikingly similar to those against defendants in this case for failure to allege pre-suit demand futility. Accordingly, we affirm and need not reach the issue of whether plaintiffs have alleged facts sufficient to state a cause of action.
A. The Operative Complaint
Plaintiffs filed the operative consolidated complaint in December 2011, described as “a failed ‘say-on-pay’” derivative shareholder action against defendants. The complaint alleged three causes of action against the individual defendants for breach of fiduciary duty based upon institution of the 2010 executive compensation program (first cause of action), false and misleading statements by the Board claiming it had adhered to Jacobs’s “pay for performance” policy (second cause of action), and false and misleading statements comparing Jacobs’s performance to its “peer group” (third cause of action). Plaintiffs alleged causes of action against Cook for aiding and abetting breaches of fiduciary duties (fourth cause of action) and breach of contract (fifth causes of action).
The pertinent factual allegations of the operative complaint can be summarized as follows. In May 2010, the Board adopted a pay-for-performance compensation policy designed to promote a performance-based culture and align the interests of Jacobs’s executives with those of shareholders by linking compensation to the corporation’s performance. Contrary to the stated policy, the Board increased executive pay by substantial amounts, even though Jacobs was experiencing a weak financial performance in 2010, including a revenue shortfall of more than $1.5 billion.
The Board filed a Proxy Statement (Proxy) with the United States Securities and Exchange Commission (SEC), which was disseminated to Jacobs’s shareholders on December 17, 2010, unanimously recommending approval of the compensation package approved in May 2010. A shareholder’s vote on executive compensation under the provisions of the Dodd-Frank Act is nonbinding. The Proxy described Jacobs’s philosophy of awarding compensation based on superior performance and providing consequences for poor performance.
The May 2010 compensation package increased compensation to executives Martin, Prosser, Hammond, Kunberger, and Landry by 27.5, 19.3, 10.3, 16.3, and 18.6 percent, respectively. Combined compensation for these executives increased from approximately $13.5 million in 2009 to almost $17 million dollars in 2010. The increased executive compensation neither rewarded superior performance nor recognized the consequences for poor performance, contrary to the Board’s stated policy, casting doubt upon the Board’s loyalty and business judgment.
The Board justified its recommendation in the Proxy by greatly overstating Jacobs’ performance compared to self-selected peer companies. The Board misrepresented that: Jacobs’s financial performance for the last fiscal year was above the median in growth of its peers, when the company ranked below 90 percent of those companies for fiscal 2010; Jacobs’s performance for the last fiscal year was in the median range for net income growth compared to the industry peer group, although net income decline for fiscal 2010 was so large ($153 million) that Jacobs ranked below at least 80 percent of its own self-selected peers; Jacobs’s fiscal 2010 return on average shareholders’ equity of 8.97 percent wasin the median range for its self-selected peer group, but Jacobs’s results for fiscal 2010 were well below the numbers for 9 out of 11 self-selected peers and the median 12-month return of equity for Jacobs’s peers was actually over 30 percent higher than that of Jacobs as of September 30, 2010; and Jacobs’s financial performance for the 2010 fiscal year was above the median of its peer group in return on invested capital, although the one and two-year return on invested capital ranked below at least 63 percent of the members of its peer group.
Institutional Shareholder Services, Inc., (ISS) issued a recommendation advising Jacobs’s shareholders to vote against the Board-recommended executive compensation proposal. Contrary to other companies when confronted with an ISS report recommending a no vote in advance of a shareholder “say-or-pay” vote, Jacobs refused to modify the executive compensation. On January 27, 2011, 55.2 percent of Jacobs’s shareholders voted against the Board’s 2010 executive compensation program.
Plaintiffs alleged Cook is an executive compensation advisory firm that assisted the Board in its evaluation of the May 2010 executive compensation plan. According to the Proxy, Cook reviewed and made recommendations concerning all of the components of Jacobs’s executive compensation program. The 2010 Proxy stated that Cook “serves as an objective, third party counsel on the reasonableness of compensation levels in comparison with those of other similarly situated companies, and the appropriateness of [Jacobs’s] compensation program structure.”
The operative complaint contained identical allegations against the 11 Jacobs’s directors, with the exception of Martin, who as president and chief executive officer of Jacobs benefited from the May 2010 compensation plan. As to each director, the operative complaint alleged (1) the amount of time the director had served on the Board, and (2) that the director “issued the 2010 Proxy representing that Jacobs’s executive compensation practices follow a pay-for-performance policy, and that [Jacobs] performed well for 2010 when compared to its own self-selected peers in terms of revenue growth, net income growth, [return on equity], and [return on invested capital], when clearly it did not. [He or she] also signed Jacobs’s 2010 Form 10-K containing Jacobs’s diminished 2010 results.”
As to the failure to make a pre-suit complaint to the Board, the complaint alleged a “pre-suit demand upon the Board is a useless and futile action” because “[t]here is doubt that the Board’s decision to increase 2010 executive compensation was a protected business judgment, which excuses demand” and “[a] majority of the Board was interested in a demand because there is a substantial likelihood that they will be held liable for their conduct” in failing to fulfill their fiduciary duties of loyalty and good faith, including making the allegedly false and misleading statements.
B. The Proxy Filed with the SEC
1. The December Proxy
The December 2010 Proxy included materials relevant to an advisory vote on executive compensation as required by Dodd-Frank. The Board unanimously recommended a “yes” vote on the May 2010 executive compensation plan.
“Consistent with [Jacobs’s] compensation philosophy, our executive compensation program has been designed to promote a performance-based culture and align the interests of executives with those of shareholders by linking a substantial portion of compensation to [Jacobs’s] performance. The program is designed to award superior performance and provide consequences for underperformance. The program is also designed to attract and to retain highly-qualified executives who are critical to the success of [Jacobs].”
To accomplish these goals, “[Jacobs] provides pay that is highly leveraged toward equity in order to align total compensation with shareholder interests.” Demonstrating that the majority component of executive compensation in fiscal 2010 was in equity, approximately: (1) 71 percent of total compensation for the chief executive officer was in equity, 18 percent was in base salary, and 11 percent in short-term incentive; and (2) “53 [percent] (on average) of total compensation for” ...