Dodd-Frank required companies to give their shareholders a voteon the pay packages provided to top executives, but itcharacterized that as an advisory vote. Still, a number ofcompanies whose say-on-pay resolutions failed to win majoritysupport this year subsequently are facing compensation-relatedlawsuits from their investors.

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

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

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

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

Melbinger calls the Cincinnati ruling “significant” for theencouragement it provides the plaintiffs' bar. “Despite the factthat the lawsuits appear to be totally without merit, to the extentthe plaintiffs' lawyers can demonstrate to a company that there isa possibility, however small, of actually losing the lawsuit, thecompany might be more inclined to pay a settlement to avoid futurelitigation costs and the uncertainties of proceeding/fighting,” hesays.

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

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

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

In any case, the lawsuits highlight the need for companies tocarefully 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 offavorable votes on say-on-pay. “Now we know that losing the[shareholder say on pay] vote is not just embarrassing, it may leadto a lawsuit being filed,” he says. “The stakes are muchhigher.”

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

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

Companies should also keep in mind best practices in executivecompensation, such as longer-term vest and longer performanceperiods, he says.

This year, shareholders also voted on the frequency ofsay-on-pay votes. For more, see ASay on Voting on Pay.