Dodd-Frank required companies to give their shareholders a vote on the pay packages provided to top executives, but it characterized that as an advisory vote. Still, a number of companies whose say-on-pay resolutions failed to win majority support this year subsequently are facing compensation-related lawsuits from their investors.

Just 37 companies, or less than 2%, failed to win majority support on say-on-pay proposals this year, according to the Council of Institutional Investors. Investors filed lawsuits citing the say-on-pay vote against nine of those companies, including Cincinnati Bell, Dex One, Hercules Offshore, Janus Capital and Johnson & Johnson. The lawsuits target not only the companies, but also board members and executives.

“The two common threads are that one, the companies each received a majority vote against their [say-on-pay] resolutions and two, the plaintiffs' lawyers argue executive compensation was increased or maintained despite the fact that stock performance was lagging,” says Michael Melbinger, global head of the employee benefits and executive compensation practice at Winston Strawn.

Mark Poerio, co-chair of the executive compensation practice at Paul Hastings, calls the lawsuits “a clear heads up to companies in terms of an incentive to avoid the unfavorable vote.”

Last month, a U.S. district court judge in Cincinnati upped the ante when he refused to dismiss a pension fund's lawsuit charging that Cincinnati Bell erred in paying more than $8 million to top executives in a year when its net income fell.

Melbinger calls the Cincinnati ruling “significant” for the encouragement it provides the plaintiffs' bar. “Despite the fact that the lawsuits appear to be totally without merit, to the extent the plaintiffs' lawyers can demonstrate to a company that there is a possibility, however small, of actually losing the lawsuit, the company might be more inclined to pay a settlement to avoid future litigation costs and the uncertainties of proceeding/fighting,” he says.

Invoking a say-on-pay vote in a lawsuit seems to run counter to the Dodd-Frank legislation's statement that the votes are not binding on boards and do not alter the fiduciary duty of board members.

Poerio says that in the Cincinnati Bell ruling, “the vote itself isn't the source of the lawsuit, but the court in Cincinnati is taking it as an indication of unreasonableness.”

“I think Cincinnati Bell is regarded as an extreme decision,” he adds. “It remains to be seen if other courts follow suit or if that's just a total aberration.”

In any case, the lawsuits highlight the need for companies to carefully prepare for say-on-pay votes.

Melbinger says that going into this year's proxy season, companies feared being embarrassed if they didn't get a majority of favorable votes on say-on-pay. “Now we know that losing the [shareholder say on pay] vote is not just embarrassing, it may lead to a lawsuit being filed,” he says. “The stakes are much higher.”

Poerio says companies must communicate their pay policies effectively to investors. His No. 1 advice for companies preparing their proxies “is to start out with a summary that shows the pay-for-performance story in a way that's convincing,” he says.

There are situations when a board wants to reward or retain executives even though the company's not doing that well, Poerio says. “A poorly performing company can pay people to keep performing, but it still has to be in a situation to explain that to shareholders.”

Companies should also keep in mind best practices in executive compensation, such as longer-term vest and longer performance periods, he says.

This year, shareholders also voted on the frequency of say-on-pay votes. For more, see A Say on Voting on Pay.

Instant Insights /

Failed Say-on-Pay Votes Spur Lawsuits

Related Stories

Recommended For You