Ninth Circuit Vacates Dismissal and Remands Shareholder Derivative "Say-on-Pay" Suits to California State Court

In Dennis v. Hart, 2013 U.S. App. LEXIS 15648 (9th Cir. July 31, 2013), the United States Court of Appeals for the Ninth Circuit held that plaintiffs’ “say-on-pay” shareholder derivative suits alleging breach of fiduciary duty were improperly removed to federal court, vacated the district court’s decisions and dismissed the parties’ cross-appeals for lack of jurisdiction. The Ninth Circuit held that the federal court did not have jurisdiction to hear the action because defendants had held an advisory vote in compliance with the federal Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”), 15 U.S.C. § 78n-1, and plaintiffs had only alleged state law causes of action. This holding indicates that challenges to board actions in response to “say-on-pay” votes are not enough to confer federal jurisdiction without additional, specific violations of federal law.

Plaintiffs alleged that in 2010, despite reporting negative net income and free cash flow, the board of directors of PICO Holdings, Inc. (“PICO”) increased executive compensation. In a Dodd-Frank Act-mandated advisory vote held in May 2011, 61% of PICO’s shareholders voted against the proposed 2010 compensation package. The board, however, took no action in response to the vote. Shareholders later filed derivative actions in California state court against PICO and its board members. Plaintiff Ronald Dennis asserted claims for breach of fiduciary duty, gross mismanagement, contribution and indemnification, and unjust enrichment. He also requested a declaration “that the adverse May 13, 2011 shareholder vote on the PICO Board’s executive compensation rebutted the business judgment surrounding the PICO Board’s decisions to increase executive compensation.” Plaintiff George Assad asserted claims for unjust enrichment and breach of fiduciary duty relating to the Board’s issuance of false and misleading statements, compensation practices, and the Board’s lack of response to the say-on-pay vote.

Defendants removed the actions to federal court, and moved to dismiss. The United States District Court for the Southern District of California dismissed the request for declaratory judgment in Dennis for failure to state a claim, and determined the remaining claims should be remanded to state court. In Assad, the district court dismissed the breach of fiduciary claim due to the failure to respond to the say-on-pay vote, and determined the remaining claims should be remanded to state court. Plaintiffs appealed.

The Ninth Circuit reversed, holding that the district court lacked jurisdiction to do anything other than remand the cases to state court. The Ninth Circuit addressed and dismissed three potential avenues for defendants to assert federal jurisdiction: (1) Section 27 of the Securities Exchange Act of 1934 (“1934 Act”), 15 U.S.C. § 78aa, (2) the “significant federal issue” rule and (3) the complete preemption doctrine.

Defendants first argued that Section 27 of the 1934 Act provided the federal court with jurisdiction because Section 27 “vests federal courts with exclusive jurisdiction over actions ‘brought to enforce any liability or duty created by [the 1934 Act] or the rules and regulations thereunder.’” However, the Ninth Circuit held that “[n]othing in either complaint alleges any . . . violation of the say-on-pay provision or any other provision of the [1934] Act. On the contrary, the parties agree that PICO did what the Act requires: it held a vote.” The Court disagreed with defendants’ reliance on Sparta Surgical Corp. v. National Association of Securities Dealers, Inc., 159 F.3d 1209 (9th Cir. 1998), holding that while “Sparta’s complaint sought relief based upon violation of exchange rules[,]” plaintiffs here acknowledge that PICO complied with the act and instead only allege state law violations.

Defendants next argued that because Congress went to great lengths to ensure that say-on-pay votes were considered only advisory and would not create any new causes of action, Congress’ “desire to preclude liability” is a significant federal issue that confers jurisdiction. The Ninth Circuit again disagreed, holding that while defendants likely had a “very strong federal defense,” a federal defense does not confer federal jurisdiction.

Defendants finally argued that the doctrine of complete preemption conferred federal jurisdiction. The Ninth Circuit disagreed once again, holding that “[c]omplete preemption is a limited doctrine that applies only where a federal statutory scheme is so comprehensive that it entirely supplants state law causes of action.” The Court held that “[n]othing in the [1934] Act . . . specifically suggests that Congress intended to totally displace state law. On the contrary, we have recognized that the [1934] Act does not so fully displace state law as to invoke complete preemption.” The Court also noted that complete preemption did not apply because (1) the parties agreed that plaintiffs had not alleged a federal cause of action and (2) the Dodd-Frank Act expressly “created no new fiduciary duties and explicitly preserved existing state laws.”

Although this decision appears to limit the ability of defendants to remove to federal court claims attacking board responses to Dodd-Frank Act “say-on-pay” votes, it does not address other bases for removal, such as the Securities Litigation Uniform Standards Act of 1998, 15 U.S.C. § 78bb(f)(2). With the flood of “say-on-pay” cases receding over the past twelve months, the question of federal jurisdiction over “say-on-pay” cases may become less significant.

 

Topics:  Derivative Suit, Executive Compensation, Fiduciary Duty, Say-on-Pay, Shareholders

Published In: Civil Procedure Updates, Constitutional Law Updates, Securities Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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