Last September, when U.S. District Judge Timothy Black of Cincinnati federal court denied Cincinnati Bell's motion to dismiss a say-on-pay derivative suit, I noted that the ruling could be a harbinger in cases claiming a breach of duty against boards that override shareholder votes against executive compensation. But a ruling Wednesday by a Portland, Ore., federal magistrate in a say-on-pay case against Umpqua Bank's board not only recommends dismissing the suit but also explicitly rejects the Ohio judge's reasoning -- and notes that the Ohio case is now in limbo, thanks to a jurisdictional problem that surfaced after Black's ruling on Cincinnati Bell's motion to dismiss. Shareholder prospects in federal court say-on-pay litigation are looking considerably dimmer now than they were just a few months ago.

Dodd-Frank, you'll recall, gave shareholders of public companies the right to vote on executive compensation every three years, though their votes are merely advisory. In a least a dozen cases in which corporate boards declined to take the advice of their shareholders, plaintiffs' lawyers have filed breach-of-duty derivative suits in state and federal court. A couple of the cases have settled; a couple more have been dismissed in state court.

The Ohio ruling was a milestone because it endorsed a theory espoused by Robbins Geller Rudman & Dowd, which has led the way in shareholder say-on-pay litigation. Plaintiffs in derivative suits, in which shareholders purport to bring claims on behalf of the corporation, must show that it would have been futile to demand that the board itself take action. In the say-on-pay cases, Robbins Geller has argued that board members can't make independent judgments because they face personal liability. The Ohio judge agreed: "Given that the director defendants devised the challenged compensation, approved the compensation, recommended shareholder approval of the compensation, and suffered a negative shareholder vote on the compensation," he wrote, "plaintiff has demonstrated sufficient facts to show that there is reason to doubt these same directors could exercise their independent business judgment over whether to bring suit against themselves for breach of fiduciary duty."

Robbins Geller made the same argument in the Umpqua case, which asserted that the Umpqua board breached its duty of loyalty to shareholders in approving giant raises for executives in a year in which shareholder returns fell by almost 8 percent. Shareholders voted down the board's compensation proposal by a two-to-one margin, but the board adopted it anyway.

This time around, though, Robbins Geller's reasoning was rejected. John Acosta, the Portland federal magistrate in the Umpqua case, found the firm's demand-futility argument "circular and thus unpersuasive." If shareholders merely had to show that board members faced breach-of-duty liability, Acosta wrote, "this would permit every derivative action plaintiff to argue that demand is futile and need not be made because no board would be able to act objectively in evaluating a presuit demand. Such a result would effectively erase the demand requirement and negate its purpose."

The magistrate also held that the Umpqua board is protected by Delaware's business judgment rule, which is the standard that guides Oregon. Acosta distinguished Oregon from Ohio, again rejecting the Robbins Geller's reliance on the Cincinnati Bell ruling.

Moreover, as Acosta noted in his Umpqua recommendation, the Cincinnati Bell decision is right now in doubt. After Black declined to dismiss the case, Cincinnati Bell's counsel at Frost Brown Todd realized that one of the defendants resides in Georgia, which is also the home of the lead plaintiff. The defense said the case shouldn't have been filed in federal court, since there's no diversity jurisdiction. Robbins Geller then dismissed the Georgia defendant and amended its complaint. In December, Black found that the plaintiffs' firm had taken those actions without first seeking his permission. And though he said that Robbins Geller had made an honest mistake in asserting diversity jurisdiction, he revoked the pro hac vice admission of one of the firm's lawyers. Black did, however, say that the plaintiffs' firm could move for permission to amend the complaint, which is what Robbins Geller intends to do, according to name partner Darren Robbins. (Grant Cowan of Frost Brown Todd declined comment.)

Umpqua is represented by Wachtell, Lipton, Rosen & Katz, which issued a client alert on the ruling. The case "is a powerful reminder that directors of both financial and non-financial companies may base compensation on long-term goals and choose the yardsticks by which to measure executive performance with confidence that courts will respect their good faith business judgment," the alert said. Wachtell partner Paul Rowe didn't return my call, and Robbins didn't respond to an email request for comment on the Umpqua ruling.

Acosta's recommendation now goes to U.S. District Judge Michael Mosman for final review.

(Reporting by Alison Frankel)

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