Question and Answers About the Schwartzman V. McGavick Lawsuit

What is the lawsuit about?
The central claim in the suit is that a significant portion of the $28 million McGavick received from Safeco after he resigned as Safeco’s CEO resulted from a fraudulent transaction between McGavick and the Board of Directors that breached defendants’ fiduciary duties to shareholders. Rather than being a “golden parachute,” the suit claims that the $28 million payment was a “stolen parachute.” The suit alleges that McGavick did not earn these improper payments, he was not entitled to them, and breached his duties to shareholders by taking them. The suit also alleges that the Board of Directors violated their duties to shareholders by not protecting corporate assets and violated federal securities laws by concealing the magnitude and extraordinary nature of the payout.

Who is bringing the suit?
As a partial derivate suit, the lawsuit is brought on behalf of Safeco Corporation. Emma Schwartzman is the plaintiff bringing the case on the company’s behalf and on her own behalf. Ms. Schwartzman is a 27-year old student at the University of Washington. She holds Safeco shares that were passed down from her great, great grandfather. He was a founder of General Insurance Company, which later became Safeco. Ms. Schwartzman’s great grandmother was also on the company’s board of directors.

Why is a shareholder bringing the suit?
In addition to challenging the actions of Mike McGavick, the suit alleges that the Safeco Board of directors also violated their duties to shareholders. Because one cannot expect the Board of Directors to sue itself, a shareholder stepped into the shoes of the corporation to bring the lawsuit.

What relief does the suit seek?
The lawsuit seeks to compel McGavick and the Board to account for the $28 million payment and to compel McGavick to return the improper payments. It also seeks an order from the court preventing McGavick from spending the money until it is returned to Safeco and shareholders. The suit also seeks to require the Board of Directors to issue a corrected proxy statement to remedy a previous proxy statement that concealed the value and extraordinary nature of McGavick’s compensation.

Wasn’t McGavick entitled to receive a “golden parachute?”
No, a “golden parachute” is a provision in an executive’s employment contract that entitles him to receive a major payout in the event that he or she is involuntarily terminated.

This case presents the opposite situation. McGavick was not forced out, but decided to voluntarily resign. McGavick’s contract with Safeco promised him generous termination payments if he was fired. Under the terms of McGavick’s 2005 Employment Contract – negotiated and executed only seven months before he announced his resignation – McGavick’s voluntary resignation required him to forfeit all compensation, including bonuses and stock options, with the exception of his final paycheck.

How were the forfeited bonus and options reinstated?
The Board of Directors entered into an “Executive Transition Services Agreement” with McGavick on December 6, 2005 – three weeks before McGavick resigned as CEO and Chairman. The Transition Agreement required McGavick to provide transition services in January and February 2006. In exchange for what was at most two months of part time consulting, the Board acknowledged giving McGavick a $2.3 million bonus and $3.3 million in stock options.

What elements of McGavick’s compensation were concealed from shareholders?
The Board and McGavick acknowledged only this $5.6 million in payouts, but the actual compensation paid to McGavick for two-months of part time work was far greater. The Transition Service Agreement allowed McGavick to provide transition services as an “employee” during the first two months of 2006. In fact, this “employee” status was an artifice to allow McGavick to vest in millions of dollars of additional stock options in late February 2006. In truth, McGavick was not a bona fide employee during this period and the “employee” designation was granted only as a means to conceal this additional multi-million dollar payment to McGavick. During January and February, McGavick was a full time candidate for the U.S. Senate, as shown by the facts in the Complaint.

What securities laws were violated?
The suit alleges that defendants caused false and misleading proxy statements to be filed with the Securities and Exchange Commission and sent to shareholders. Specifically, the 2006 proxy statement was carefully drafted to conceal the full value of McGavick’s compensation and its extraordinary nature. It told shareholders that McGavick received a $2.3 million “2005 bonus,” when in fact such bonus had been forfeited by his voluntary resignation. It also carefully concealed the multi-million dollar payout that McGavick would receive by being labeled an “employee” for two months after he ceased being a bona fide employee.

Was any of the $28 million payment proper?
It is likely that some portion of the $28 million payment represented vested stock options, but it is not clear how much. The suit alleges that the entire $28 million should be returned, including proceeds from vested stock options. The option contracts require McGavick to forfeit all proceeds if he were to take actions contrary to the best interests of the company. The allegations that McGavick looted the company of millions of dollars, if proven, certainly meet that standard.

Where did the $28 million come from?
The math doesn’t seem to add up, and even Mike McGavick is confused. On June 16, 2006, he officially disclosed his 2006 salary to the US Senate as $15 million. Three days later, he amended this figure to $28.4 million without explanation.

Are there any similar cases that set precedence for this action?
Yes, there have been an increasing number of suits brought by shareholders and regulators regarding improper executive compensation. One example is the derivative case brought by shareholders against Charles Wang of Computer Associates. In settlement of that claim, Wang was required to return approximately $150 million of stock to the company and its shareholders.

Is this case really just a partisan attack on McGavick’s run for the U.S. Senate?
No. This lawsuit is about corporate corruption and is non-political and non-partisan. Two of the defendants are high profile members and/or leaders of the Democratic Party, including former governor Gary Locke. While everyone is aware of McGavick’s candidacy, the participants in the lawsuit have taken every possible effort to avoid even the appearance of partisanship. For example, both the Democratic and Republican parties are learning of this lawsuit for the first time on August 1st, after the case is filed. This lawsuit is non-political and extremely well supported both factually and legally.