Lessons Learned From Initial 'Say-On-Pay' Litigation

While the "say-on-pay" provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act) is not even a year old, it has already spawned several derivative suits against corporate officers and directors. Litigation stemming from "say-on-pay" votes has been costly to companies, with one company paying nearly $2 million to settle its suit.1

In one respect, the commencement of such litigation is surprising given that the shareholder "say-on-pay" vote is nonbinding on a company, expressly does not expand the scope of an officer's or director's fiduciary obligations, and does not expressly provide for any remedy for shareholders if a company declines to change its executive compensation practices following a "no" vote by shareholders.

The initial wave of derivative litigation raises several issues that boards should consider in connection with their future decisions on executive compensation, and provides insight into several common allegations running throughout the "say-on-pay" litigation.

Background

As part of Section 951 of the Act, public companies are required to conduct a nonbinding shareholder advisory vote at least once every three years to approve the compensation of a company's named executive officers disclosed pursuant to Item 402 of Regulation S-K under the Securities Act of 1933, as amended.2 This section of the Act also mandates that every six years, companies ask shareholders in a nonbinding vote whether the "say-on-pay" vote should be held every one, two, or three years.3

So far, at least 41 companies have seen their "say-on-pay" proposals rejected by more than a majority of their shareholders who had authority to vote (a "no" vote).4 In fact, in a majority of these votes, less than 45% of the shareholders who voted at the meeting voted in favor of the company's executive pay.5 In other words, many of the votes that have occurred were not even that close.

Of the 41 companies that experienced a "no" vote, at least eight have become involved in derivative litigation in which, following a failed vote, the plaintiffs allege that the companies have excessive executive compensation practices. These companies are Occidental Petroleum Corporation (NYSE: OXY), Umpqua Holdings Corporation (NASDAQ: UMPQ), KeyCorp (NYSE: KEY), Jacobs Engineering Group (NYSE: JEC), Beazer Homes USA (NYSE: BZH), Hercules Offshore, Inc. (NASDAQ: HERO), Janus Capital Group (NASDAQ: JANSX), and Cincinnati Bell (NYSE: CBB). The shareholder suits name every company director and most—if not all—of the company's officers as defendants.

The allegations of several of the complaints generally claim that the directors breached their fiduciary duties in three different ways. The first alleged breach arises from allegations that the directors diverted corporate assets to the executives in a manner that put the executives' interests ahead of those of the shareholders. The second alleged breach arises from allegations that the companies that have adopted "pay-for-performance" compensation policies failed to disclose in their proxy statements that the compensation awards were made notwithstanding or in contravention to the policies. Finally, the complaints also bring claims for corporate waste against the directors based on the alleged excessive size of the executive compensation awards.

Maintaining the Status Quo with Respect to Compensation Practices Will Do Little to Discourage a Suit

Boards of directors—or, more typically, committees of these boards—are required to approve executive pay. Often, they rely upon a company's finance and human resource professionals and outside compensation consultants to provide them with information in order to make these decisions.

While it would seem that directors using compensation professionals to determine executive pay are acting consistently with their fiduciary obligations, the plaintiffs in these derivative suits have taken a different perspective. For example, directors that have been sued for awarding excessive compensation all engaged...