The Advisors' Blog

– Broc Romanek, CompensationStandards.com

Yesterday, we held the prep call for this newly scheduled webcast to be held tomorrow – “Say-on-Pay: A Primer for TARP Companies” – and I know it’s gonna be a “biggie.” Our panelists have a lot to say – with much practical guidance to provide. Join these experts:

– Mark Borges, Principal, Compensia
– Ning Chiu, Counsel, Davis Polk & Wardwell LLP
– Dave Lynn, Editor, CompensationStandards.com and Partner, Morrison & Foerster LLP
– Carol Bowie, Head, RiskMetrics’ Governance Institute

Delaware Dismisses Caremark Claims Against Citigroup: CEO Pay “Waste” Claim Survives

From Travis Laster of Abrams & Laster: Delaware Chancellor Chandler’s opinion in In re Citigroup Inc. Shareholder Litigation came out last week. The complaint alleged Caremark claims against the Citigroup directors based on Citi’s subprime losses. The Chancellor dismissed all but one aspect of the case – a waste claim based on former Citi CEO Charles Prince’s exit compensation agreement. [We have posted memos regarding this case in a newly-created “Risk Management” Practice Area.]

The opinion confirms that existing principles of Delaware law apply even in the midst of an unprecedented financial crisis, and that the Delaware courts will not go looking to hold directors up as examples for the economy’s current difficulties. It provides a good summary of existing Delaware law principles governing Caremark claims, which I won’t repeat.

Here are a few nuances worth highlighting:

1. The Chancellor distinguishes between (i) a Caremark monitoring system designed to protect against financial fraud and criminal wrongdoing and (ii) the identification of and protection against business risk. He holds that Citi’s problems fell squarely under the heading of unanticipated business risk. This will be a helpful distinction for other companies faced with similar problems brought on by the current financial crisis.

2. The Chancellor makes clear that “Directors with special expertise are not held to a higher standard of care in the oversight context.” (n.63). Likewise, for directors who sit on committees with oversight responsibility, “such responsibility does not change the standard of director liability under Caremark and its progeny.” (Id.)

3. Prior experience with scandals at other companies is not sufficient to make a director “sensitive to similar circumstances” and hence susceptible to a Caremark claim. (37).

4. In a point of interest to those who litigate in Delaware and face competing litigation in other fora, the Chancellor questions whether a lower standard should apply to a motion to stay in favor of a prior pending action versus a motion to dismiss, noting correctly that both have the same practical effect. (n.16).

5. In what I view as the most noteworthy section of the opinion, the Chancellor holds that the plaintiffs stated a claim for waste based on former CEO Prince’s $68M exit package. He explains: “[T]he discretion of directors in setting executive compensation is not unlimited. Indeed, the Delaware Supreme Court was clear when it stated that ‘there is an outer limit’ to the board’s discretion to set executive compensation, ‘at which point a decision of the directors on executive compensation is so disproportionately large as to be unconscionable and constitute waste.'” (55-56). The Chancellor held that there was a reasonable doubt as to whether the exit package awarded compensation that is beyond the “outer limit.” (56).

It used to be said that waste claims were easy to plead – but difficult to prove. Then for a long time they were also hard to plead. This one survived. It’s too early to say whether the Delaware courts will now be more receptive to compensation challenges based on waste theories, but I feel safe predicting that this aspect of the decision will not go unnoticed by members of the plaintiffs’ bar. Look for more waste claims to come based on big exit comp numbers.