Ovitz Ruling Is a Limited Win for Directors

A judge’s ruling that Walt Disney Co. directors acted in good faith in approving a $130-million severance for Michael Ovitz will bring relief to corporate boardrooms, but the decision falls well short of giving directors free rein to act carelessly, experts said Tuesday.

Shareholder advocate Patrick McGurn said the judge’s strong language in rejecting a suit by Disney shareholders sent a warning to directors in similar situations.

“As it is, it is not open season on compensation committee members,” said McGurn, executive vice president for Institutional Shareholder Services in Rockville, Md. “But the court has put a ‘Please file claims’ sign on their door. What this has done is encouraged people to take their most egregious cases to the court to try to get another judgment.”

The suit, filed by Disney shareholders in 1997, alleged that the board did not fully review Ovitz’s 1995 hiring as president by Chief Executive Michael Eisner, and then improperly approved the severance deal 15 months later.

In rejecting those claims, Delaware Chief Chancery Court Judge William B. Chandler III said Disney’s board acted within its rights but criticized it for failing to meet high standards. He also noted that the suit was initiated long before the post-Enron Corp. era of corporate scrutiny -- a hint, perhaps, that the outcome might have been different if the case were filed today.

“Applying 21st-century notions of best practices in analyzing whether those decisions were actionable would be misplaced,” Chandler wrote.

McGurn and other corporate governance experts said the decision did not come as a surprise. Although critical of both Eisner and other Disney directors, the judge said they did not breach the threshold of “gross negligence” necessary to find them liable.

“Under the law, directors owe shareholders two things -- and neither of those are being right,” said Nell Minow, editor of Corporate Library, a corporate governance research and analysis firm. “They owe a duty of loyalty and a duty of care.

“As much as we would like to see them all write checks to the shareholders of Disney for every penny they paid to Ovitz, what we want more than that is to have directors free to consider all options and decide what is best for shareholders, not what is lowest-risk to all shareholders,” she said.

Alyssa Ellsworth, managing director of the Council of Institutional Investors in Washington, said that directors today were under greater scrutiny -- and were held to higher standards -- in the wake of the corporate scandals involving Enron, WorldCom Inc. and other discredited companies.

For example, the Sarbanes-Oxley law passed in the wake of Enron’s 2001 collapse put greater responsibility on directors to ensure that company financial statements were accurate.

The law did not address executive pay. Some critics of rising salaries for top executives had hoped that a decision against the Disney directors might have done for CEO pay what Sarbanes-Oxley did for accounting standards.

“Institutional investors feel that holding directors accountable is critical to ensuring that the executive compensation system functions in an above-board manner,” Ellsworth said. “Directors whose failures rise to an egregious level should be held financially accountable for their poor decision making.”

Brandon Rees, senior research analyst with the AFL-CIO’s office of investment, also was disappointed by the decision, saying it would “set back shareholders’ efforts to hold directors accountable for their decisions.”

Over the long run, however, Rees said he believed that corporate directors would be subject to increasing scrutiny.

“The strategy of this kind of litigation is just becoming understood by institutional investors,” he said. “For that reason, you will see more of an effort to use derivative lawsuits to make sure that directors do their jobs and are held accountable when they fail.”

Although the decision gave Disney’s board no more than “a good scolding,” it did not indicate that boards could let down their guard, said Keith Bishop, an attorney with the Irvine office of Buchalter, Nemer, Fields & Younger.

“The thrust of regulatory enforcement and litigation has been overwhelmingly hostile” over the last three years, Bishop said. “This is not a reason for directors to relax their diligence or think that they have carte blanche to do whatever they want.

“This is one piece of good news,” he added. “But it’s like going for three years without rain. A couple of clouds and a few sprinkles doesn’t mean that the drought is over.”