Michael McFarland, derivatively on behalf Payment Data Systems, Inc. and individually on behalf of himself and all other similarly situated shareholders of Payment Data Systems, Inc.,
vs
Michael R. Long, Louis A. Hoch, Larry Morrison, Kenneth Keller and Peter G. Kirby
2:15-cv-01221 Filed 06/26/15
1. Plaintiff asserts this action for breach of fiduciary duties derivatively on behalf of Payment Data Systems, Inc. ("Payment Data" or the "Company") against the Company's Board of Directors (the "Board") and certain executive officers in connection with the excessive and unfair compensation that the Defendants self-interestedly granted themselves during 2013 and 2014. Plaintiff also asserts, on behalf of himself and the other public minority shareholders of Payment Data, a direct claim against the Defendants for breaching their fiduciary duties in connection with their improper misappropriation of substantial voting power from the Company's minority public shareholders.
2. Between 2004 and April 2015, the Company's executive officers and directors consisted of jiist five individuals: (1) Michael R. Long ("Long"), who has served as the Company's Chief Executive Officer and Chairman of the Board since co-founding the Company in 1998; (2) Louis A. Hoch ("Hoch"), who has served as the Company's President, Chief Operating Officer, and a director since co-founding Payment Data in 1998, and has also served as Vice Chairman of the Board since 2007; (3) Larry Morrison ("Morrison"), who has served as the Company's Senior Vice President, Sales and Marketing Officer since July 2003; (4) Kenneth Keller ("Keller"), who has served as the Company's Senior Vice President and Chief Technology Officer since 2007; and (5) Peter G. Kirby ("Kirby"), who, has served on the Board since 2001, and was the Company's lone "independent" non-employee director responsible for overseeing management (Long, Hoch, Morrison and Keller are collectively referred to herein as the "Officer Defendants," and these individuals along with Kirby are collectively referred to as the "Defendants").
3. Though Kirby originally set the compensation of the Company's executive officers, by 2008 Kirby relinquished his fiduciary duties altogether and allowed the Officer Defendants to establish their own compensation. As described in detail below, with no one minding the store the Officer Defendants abused their discretion and granted themselves excessive compensation during 2013 and 2014.
4. In its 17-year existence, the Company has accumulated net losses of over $50 million. In 2013 the Company had gross profits of just $974,896, while the Officer Defendants received salaries and cash bonuses of $724,200 in the aggregate. In other words, during 2013 the Officer Defendants literally transferred to themselves a staggering 74.28% of the Company's gross profits for the year. In large part due to the compensation payments, the Company suffered a net loss of $789,039 during 2013.
5. In 2014 Pnyment Data had gross profits of $4,18 million, while the Officer Defendants granted themselves compensation valued at $4.53 million in the aggregate. Thus, during 2014 the Officer Defendants transferred to themselves the economic equivalent of the Company's entire gross profit for the year and then some.
6. The Company has been damaged as a result of the excessive compensation, and accordingly Plaintiff seeks to recover on behalf of the Company damages resulting from Defendants' unfair self-dealing.
7. Defendants' decision to pay themsel-ves excessive compensation had more than merely economic consequences. A substantial part of Defendants' 2014 compensation consisted of 22 million shares of Payment Data common stock — valued at $3.74 million, an improper and excessive amount. At the same time, Defendants' decision to the grant themselves 22 million shares increased their collective corporate voting power from 42.97% to 49.97%, effectively giving them voting control over the Company.
8. In determining their own compensation in 2014 Defendants wrongfully misappropriated economic value and voting power from the Company's minority shareholders, thus harming them uniquely, individually, and in direct proportion to Defendants' benefit.
9. As a result, Plaintiff brings a direct claim on behalf of the minority public shareholders to recover damages resulting from the improper stock grant.
Complaint is 22 pages long, but some of the noteworthy allegations:
24. During the initial years of its existence, Payment Data had a functioning Board to oversee management. Between 1999 and 2003, the Company had a Board consisting of between five to seven members, including Long (who served as Chairman of the Board) and Hoch. During this time, the Board had an independent Audit Committee and an independent Compensation Committee, both of which were comprised of at least two and as many as four members.
25. Following the resignation of four directors between 2002 and 2003, by 2004 the Board consisted of just three individuals: (1) Long (the Chairman), (2) Hoch (who became Vice Chairman in 2007), and (3) Kirby.
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29. Between 2004 and April 2015, Kirby served as the lone member of the Board's Audit Committee. In its public filings, Payment Data acknowledges that Kirby does not meet the criteria to constitute an "audit committee financial expert" as defined under the SEC's rules.
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32. Instead, beginning in 2007 Kirby simply allowed the executive officers themselves to decide how they would be paid. And the looting began.
33. On February 27, 2007, Long entered into an employment agreement with the Company which, among other things, provided for an annual salary, bonus payments, and stock awards, through December 31, 2011. Hoch signed the employment agreement on behalf of the Company. That same day, Hoch himself entered into an employment agreement with the Company which, among other things, provided for an annual salary, bonus payments, and stock awards through December 31, 2011. Long signed the employment agreement on behalf of the Company.
35. With Kirby missing in action, between 2007 and 2012 Long, Hoch, Keller, and Morrison raided the Company's coffers by paying themselves excessive salaries and cash bonuses, i.e., precisely what the "market" will bear when individuals determine the value of their own services and the "buyer" is captive.
36. Specifically, as reflected in the following chart, between 2007 and 2012, Payment Data made gross profits of approximately $7.4 million, while the Officer Defendants literally took for themselves in excess of $3.14 million in the form of self-determined salaries and cash bonus payments, a staggering 42.45% of the Company's gross profits (which does not even include certain compensation paid to Keller and Morrison that was not disclosed in Payment Data's public filings):
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62. On June 5, 2015, Payment Data filed a Schedule 14A Proxy Statement with the SEC (the "2015 Proxy") with the SEC in connection with its 2015 Annual Meeting of Shareholders. The 2015 Proxy included a Summary Compensation Table which purportedly set forth "all compensation paid or earned by" the Company's executive officers during 2014. Nowhere in the Summary Compensation Table, or the accompanying footnotes or narrative is there any mention of the December 2014 Stock Grant. Indeed, in past years the Company disclosed the value of stock awards that were granted in the prior year in the "Bonus" column of the Summary Compensation Table with a discussion of the award in the footnotes to the table. The 2015 Proxy contains no such disclosure of the December 2014 Stock Grant.
63. In only one instance in the entire 2015 Proxy is there any sign that these awards were made. The 2015 Proxy includes an "Outstanding Equity Awards at Fiscal-Year End" table, which displays unvested stock awards held by each of Long, Hoch, Morrison, and Keller, including awards made as far back as December 2005. Each insider has an entry devoted to the December 2014 Stock Grant, simply noting the date of grant (December 29, 2014) and the number of shares received. Indeed, in footnote 2 to the table, the terms of each award included in the table are explained, except for the December 2014 Stock Grant which has no discussion or explanation.
64. The Officer Defendants' actions in granting themselves excessive compensation during 2013 and 2014 harmed the Company and constitute a breach of their fiduciary duties.
