Recent Facebook Settlement Over Director Pay Could Signal More Litigation Against Directors

Executive compensation experts were unpleasantly surprised by the settlement in late January of Espinoza v. Zuckerberg, a case challenging the reasonableness of stock awards to Facebook’s non-employee directors. The facts surrounding this settlement create concern that unless a company has a shareholder-approved plan with meaningful limits on both the cash and equity compensation that can be awarded to non-employee directors in a year, it faces a risk of being sued, particularly where the actual amount of compensation gives plaintiffs’ lawyers a credible argument that pay is “above market.”

There are several reasons why Espinoza is concerning. First, the amount of the allegedly “excessive” compensation did not seem particularly large. Second, the plaintiff’s lawyers are expected to receive attorneys’ fees of $525,000 even though it appears highly likely that Facebook would have eventually prevailed because its controlling shareholder approved the transaction. Last, the settlement can be read to require a shareholder vote every time there is an increase in director pay, thus creating a precedent of a “Say-on-Director-Pay” standard. It should be noted that Frederic W. Cook & Co. has no knowledge of the facts in Espinoza outside the public filings.

In light of Espinoza and other recent cases involving director compensation we believe it prudent for corporations to consider adding specific director limits on both equity and cash compensation the next time the stock plan is presented to shareholders. Further, if the risk of litigation is determined to be potentially higher, consider submitting the plan for shareholder approval earlier than would otherwise be required.