Litigation: What will courts say about “say-on-pay”?

Early court decisions concerning say-on-pay votes will be important as shareholders file more derivative suits.

Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act amended the Securities Exchange Act of 1934 by adding Section 14A, which requires public companies subject to proxy rules to provide shareholders with an advisory vote on executive compensation. Following the SEC’s adoption of these rules earlier this year, all publicly traded companies, except smaller reporting companies with a public float of less than $75 million, were required to hold say-on-pay votes at annual shareholder meetings held on or after January 21.

Pursuant to the Dodd-Frank Act and the rules adopted by the SEC, shareholders of publicly traded companies must be permitted to vote on non-binding resolutions regarding executive compensation for the company’s top executives, including the CEO and CFO. At least once every three years, shareholders are required to vote either yes or no on the entirety of the compensation packages as described in the proxy statement. 

While public companies must hold say-on-pay votes, the new amendments to the Exchange Act provide a fair amount of flexibility as to the language of the non-binding resolution on which shareholders vote. For instance, a resolution may simply ask shareholders to approve the compensation of its named executive officers. It is important to note, however, that the say-on-pay votes are merely advisory and, unlike a binding vote, do not require the company to take specific action. But companies are required to address the results of the say-on-pay vote and discuss how the company considered the results in determining compensation packages.

As a result of the say-on-pay votes, the SEC has reported that, as of June, approximately 30 companies have failed to garner the support of a majority of their shareholders for their executive compensation packages, including Janus Capital Group Inc.. Janus shareholders held a say-on-pay vote in April by which 58 percent of shareholders voted against the proposed compensation. Despite its failure to win shareholder approval, Janus’ board of directors approved the compensation package, which included $41 million in cash and stock compensation to the company’s top executives. As a result, investors recently filed a derivative action in Colorado federal court against Janus alleging that the company violated its duty to shareholders by approving the company’s executive compensation package despite the shareholder vote against it. Swanson v. Weil et al, case number 1: 11-cv-02142 (D. Colo. 2011).

In overriding the shareholder vote, Janus argues that it was exercising its business judgment by approving the compensation packages. The shareholders, on the other hand, allege that the adverse say-on-pay vote rebuts the presumption that the board of directors exercised its business judgment related to executive compensation. As stated in the complaint, the plaintiffs argue that “[s]ay-on-pay is intended to promote increased accountability of board members and corporate management, and as such, the Janus board is not entitled to business judgment…as the adverse shareholder vote is evidence that rebuts the presumption.”

At this stage, it is unclear how much ammunition the say-on-pay vote provides to disgruntled shareholders. As in other derivative suits, though, the shareholders must overcome the “powerful presumptions of the business judgment rule” by alleging “sufficient particularized facts to support an inference that demand is excused because the board is ‘incapable of exercising its power and authority to pursue the derivative claims directly.’” White v. Panic, 783 A.2d 543, 551 (Del. 2001). Historically, overcoming this presumption is a heavy burden for plaintiffs because a board’s decision on executive compensation is entitled to great deference, and the size and structure of executive compensation have been said to be inherently matters of judgment. Indeed, for shareholder plaintiffs to succeed, they typically must demonstrate executive compensation decisions were not exercises of business judgment because they are so excessive as to constitute waste.

Despite these hurdles, shareholders will increasingly use the recently enacted say-on-pay rules as a platform for derivative suits. In fact, in a relatively short period of time, at least six other companies have been sued following say-or-pay votes that disapproved proposed executive compensation packages. In those suits, the plaintiffs have asserted a disconnect between executive compensation and performance, highlighting that compensation did not reflect the company’s performance in 2010. This may be just the beginning, and early judicial decisions will be critically important in guiding companies on whether, and how, the business judgment rule will come into play.  

Contributing Author

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Matthew Ingber

Matthew Ingber is a litigation partner at Mayer Brown.

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