Shareholders Speak Up, Then They Sue: Derivative Lawsuits Follow Negative Say-on-Pay Votes

A version of this article will appear in the winter 2011 Informer magazine, published by Thomson Reuters.

Focus on corporate executive compensation levels and practices is at an all-time high, thanks in large part to the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) enacted in 2010.1 The Dodd-Frank Act mandated that public companies give their shareholders some say on executive pay, by allowing the shareholders to vote on non-binding resolutions regarding executive compensation. And perhaps not surprisingly, when the shareholders' voices have been ignored, lawsuits have followed. To date, shareholders have sued the boards of directors of at least nine companies that did not receive majority approval on say-on-pay proposals. These derivative suits have been filed in various state and federal courts across the United States. Two cases have already been settled, with the settling companies paying significant sums toward plaintiffs' attorney's fees and expenses. The potential for expensive and intrusive shareholder litigation is yet another reason for companies to take great care in crafting compensation policies and communicating with shareholders on compensation-related topics.

What Are Say-on-Pay Votes?

Section 951 of the Dodd-Frank Act provides that, no less frequently than every three years, public companies must provide their shareholders with an opportunity to vote on a resolution to approve or reject the compensation of certain of the company's executives. Section 951(c) specifically states that the shareholder voting results on these resolutions "shall be non-binding" on companies or their boards of directors and may not be construed:

As overruling a decision by the issuer or board of directors; To create or imply any change to the fiduciary duties of the issuer or board of directors; To create or imply any additional fiduciary duties for the issuer or board of directors; or To restrict or limit the ability of shareholders to make proposals for inclusion in proxy materials related to executive compensation. Legislative history of the Dodd-Frank Act confirms that the voting results on these "say-on-pay" resolutions are to be non-binding.2

The Securities and Exchange Commission adopted rules implementing the requirements of Section 951 that became effective on April 4, 2011. The rules state that starting on January 21, 2011,3 and not less frequently than once every three years thereafter, all public companies that are subject to the proxy rules are required at shareholder meetings to hold non-binding votes of the shareholders on the compensation of the CEO, CFO, and at least three other of the most highly compensated executives (i.e., "say-on-pay votes").

How Have Shareholders Voted?

Approximately 290 say-on-pay votes were taken in 2010, and a majority of votes were cast against the company's compensation of named executive officers in only three instances — approximately 1 percent of the votes. So far in 2011, of the more than 2,800 companies that have reported say-on-pay voting results, more than 40 companies — or approximately 1.5 percent — did not receive majority shareholder support for their say-on-pay proposals.

What Is the Impact of a Negative Say-on-Pay Vote?

The fact that the majority of a company's shareholders disapprove of the company's executive compensation plan is clearly embarrassing and may create bad publicity. But the impact of a negative say-on-pay vote does not end there. In many cases, the next step after the negative vote — assuming the compensation packages are still paid despite the shareholder disapproval — is a shareholder derivative...