Netflix is facing an investor lawsuit that alleges board members “rigged” top executives’ bonuses to pay them millions regardless of how well the company performed.
The lawsuit, filed by the City of Birmingham Relief and Retirement System, claims the Netflix board “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 comes three months after Netflix converted its executives’ cash bonus system into salary under Donald Trump’s new tax law – a change that ensures executives are paid in full regardless of company’s performance.
The lawsuit claims Netflix’s chief content officer, Ted Sarandos, will receive a salary of $12m for the current year – more than last year’s salary and cash bonus combined. The chief product officer, Greg Peters, will get $6m in salary, also more than his combined total for 2017, according to the suit.
The suit alleges Netflix rigged the system so it could claim tax deductions and hand out bonuses irrespective “of achieving real accomplishments that serve the company and its shareholders”.
The lawsuit went on: “To qualify as ‘performance-based’ the compensation must, among other requirements, be contingent on the attainment of one or more pre-established, objective performance goals.” But according to the complaint, Netflix’s global subscriber-based performance goals were nearly always hit, with what the Financial Times last year described as “uncanny accuracy”.
Investors wondered if hitting its numbers so precisely was a fait accompli.
The complaint reads: “By July 2017, Netflix’s top officers had hit their target squarely in seven out of eight quarters, missing by just one percentage point in the other quarter. This artificial precision resulted in the company paying these officers approximately $18.73m out of a target pool of $18.75m.”
The distinction is important for Netflix, because if bonuses are not performance-based that could become a tax code violation. Under the guidelines, executive bonuses above $1m could be deducted from corporate taxes – but only if “the outcome is substantially uncertain”.
Prof Steven Balsam, a Temple University accounting professor, described the scenario of a company claiming an inherently unpredictable business model hitting its targets so squarely and consistently as “suspicious”.
“Either they are somehow changing to the targets, or they’re managing to the targets,” Balsam told the Guardian.
Regulatory filings show Netflix’s three top executives at the time – Sarandos, Peters and Neil Hunt – hit their targets in seven out of eight quarters between the beginning of 2015 and the end of 2016.
The company’s filings showed it never exceeded forecasts, and only missed by just one percentage point in one quarter. The company’s overall revenue target of $8.276bn was exceeded by $12m, or 0.14%. That meant that out of a target pool of $18.75m, Hunt, Peters and Sarandos collected $18.7295m.
But that contrasts with Netflix’s claim that its subscriber base is unpredictable, with profits and subscriber numbers often differing widely from company forecasts.
In July last year, for instance, Netflix reported 5.2 million new subscribers in the second quarter compared with its own prior estimate of 3.2 million.
Balsam said: “That again is an interesting signal, a red flag perhaps, to dig deeper. Revenue is almost totally off the subscriber base. How can you predict revenue but not the two factors that go into revenue?”
Last year, Netflix insisted its bonus scheme was compliant with the tax code. It claimed that because its targets are set during guidance early in any given quarter that this makes them “inherently uncertain, and not a foregone conclusion”.
Netflix said: “To hit the target, it requires effort and management skill by the executives. It is also a benefit to the company as we receive a tax deduction.”
Under the new tax law, performance-based bonuses are not tax deductible.
Balsam said: “It seems like it benefits them because it takes some of the risk away. If it’s truly a performance-based bonus, then in some quarters you’re going to miss the targets. But by making it salary, they’re now guaranteed.”
In a statement Netflix said: “We intend to respond to these claims at the appropriate time.”
