In a new shareholder derivative suit unveiled this week, several Netflix executives – but not the CHRO – and individual members of the Compensation and Audit Committees were accused of breaching their fiduciary duties by the City of Birmingham Relief and Retirement System for providing “sham” bonuses to executives by setting performance targets at levels the union alleges were known to be easily achievable in violation of 162(m). The suit, filed in federal court in the Northern District of California, points to specific details of the company’s annual incentive Performance Bonus Plan, which was instilled in 2014 and contained a target for "streaming revenues” which served as the basis for the bonus plan for Netflix’s top three executives. However, as the lawsuit points out, Netflix “hit the nail on the head” on the revenue targets seven out of eight quarters with the lone miss being a difference of only one percent.
Specifically, the lawsuit alleges the low targets result in a violation of 162(m)’s performance-pay exception which requires that all performance goals be “substantially uncertain” at the time the goals are established. As the complaint states, the performance goals “were, in fact, not ‘performance based,’ as required under Section 162(m), because [Netflix] set global streaming revenue goals to amounts they knew the company was substantially certain to achieve.” To back up the claim, the plaintiffs point to the result of the bonus program paying $18.73 million of a potential total target of $18.75 million. The complaint further states this indicates “the defendants rigged the compensation process, guaranteeing Netflix officers huge cash payments while misleading investors into believing that these payments were justified by attainment of real performance goals.” The complaint argues that the company’s promotion in multiple years of proxy statements of the performance plan as complying with 162(m) and the “substantially uncertain” language constituted materially false and misleading statements.
The content and arguments of the lawsuit demonstrate yet another level of growing sophistication with plaintiff’s attorneys looking to target companies for executive compensation practices. The plaintiffs rely on articles in the Financial Times covering Netflix’s bonus plan as support for the complaint. Regardless of the genesis, the complaint provides a detailed review of Netflix’s proxy statement as well as comments the company made about the purpose and rigor of its bonus plan to build its case that the company characterized the plan and the metrics as being difficult to achieve. It then contrasted Netflix’s characterization of plan and the rigor of the targets with the company’s actual results, quoting the Financial Times characterizing the uncanny accuracy” in their “artificial precision.” Given that 162(m) is repealed for new grants made after December 31, 2017, these specific claims will be limited in duration, but investors increasingly are focused on the rigor of incentive targets.