In state law, executive compensation decisions by the board of directors is subject to the business judgment rule, making shareholder pay lawsuits extremely hard to win.
When the federal government decided to stick its nose into the pay imbroglio (at the behest of unions and some academics with time on their hands), the Congress decided to let the shareholders vote on executive compensation--so-called say on pay.
As I will explain in my forthcoming book Corporate Governance After the Crises:
Dodd-Frank § 951 creates a new § 14A of the Securities Exchange Act, pursuant to which reporting companies must conduct a shareholder advisory vote on specified executive compensation not less frequently than every three years. At least once every six years, shareholders must vote on how frequently to hold such an advisory vote (i.e., annually, biannually, or triannually). The compensation arrangements subject to the shareholder vote are those set out in Item 402 of Regulation S-K, which includes all compensation paid to the CEO, CFO, and the three other highest paid executive officers. In addition, a shareholder advisory is required of golden parachutes.
Now here's the kicker. Dodd-Frank and the legislative history make clear that while both the say on pay and say when on pay votes must be tabulated and disclosed, neither is binding on the board of directors. The act and its legislative history further make clear that the votes shall not be deemed either to effect or affect the fiduciary duties of directors. S. Rep. No. 111-176, at 134 (2010).
Despite all this, Broc Romanek reports that:
Mike Melbinger in his blog on CompensationStandards.com ... blogged about how some of the first companies to fail to receive majority support on their SOP have been sued (as well as their compensation committee members and even their compensation consultants) in shareholder derivative suits. Not only have the early failures of this proxy season been sued, but two of the companies that failed last year were sued (one case has been settled and one is still pending, as noted in this Schulte Roth memo).
It'll be interesting to see what legal theories these plaintiffs lawyers come up with. My guess is a waste claim that will go nowhere and a securities fraud claim attacking the company's CD&A disclosures. Surely they won't have the brass balls to claim that say on pay is binding, will they?
I don't blame the plaintiffs' lawyers who brought these suits. Bringing suits even though it is clear the legislature intended for a statute to to give rise to a cause of action is what plaintiff lawyers do. And why not? Sharks got to eat. Until Rule 11 has real teeth and we adopt loser pays with respect to class action legal fees, lawyers are going to bring these sorts of cases.
I blame Congress for having passed this asinine law in the first place, even though folks like yours truly had repeatedly warned Congress that say on pay would be abused and turned from a supposed non-binding voting exercise into a club to beat directors with. As that Schulte Ross memo makes clear, that's exactly what's happening:
In 2010, out of approximately 290 SOP votes held, a majority of votes cast were voted against NEO compensation in only 3 instances. Given the number of SOP votes still to come in 2011, now that SOP is mandatory for a much larger group of companies, it is safe to assume that there will be more negative SOP votes than in 2010. Although the vote is advisory in nature, a negative SOP vote can have serious repercussions. The vote may translate into votes against directors. It also is likely to result in significant unfavorable publicity, which was the case at all 3 of the companies that received negative votes on SOP in 2010. In addition, lawsuits alleging breach of fiduciary duty and corporate waste were filed against directors at 2 of the companies that received a negative SOP vote in 2010. In one case, the lawsuit was settled, while it is still pending at the other company. At both of these companies, there also were changes to executive compensation policies and/or leadership.
At the 2 companies that have thus far had negative outcomes on SOP resolutions in 2011, in preparation for a possible lawsuit, plaintiffs’ firms already have announced investigations on behalf of shareholders concerning breaches of fiduciary duty relating to historical and potential NEO compensation.
