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Litigation: Not much actual “say on pay” for shareholders

The Dodd-Frank provision requiring shareholder approval of executive compensation often doesn’t hold up in court

Since becoming effective in January 2011, the say-on-pay provision of the Dodd Frank Wall Street Reform and Consumer Protection Act has been a springboard to numerous shareholder derivative actions. The Dodd-Frank say-on-pay provision requires a vote for shareholder approval of senior executive compensation at least once every three years. The vote does not bind the issuer or board of directors; it is merely an advisory vote and creates no fiduciary duty on behalf of the company.

Throughout 2011, say-on-pay votes resulted in shareholder derivative actions in the wake of falling stock prices and companies’ dipping financial performances. These suits generally alleged a breach of companies’ fiduciary duties and attempted to use the failed say-on-pay votes to circumvent traditional obstacles to shareholder derivative suits, such as showing demand futility or the presumption of the business judgment rule.

In early March, a California state court held in Jacobs Engineering Group Inc. Consolidated Shareholder Derivative Litigation that the shareholders had failed to properly state a claim in their suit against Jacobs Engineering Group Inc., which accused the directors and officers of awarding senior executives excessive compensation for 2010 despite “abysmal 2010 revenues and earnings performances.”

The judge specifically held that the shareholders failed to satisfy the demand futility requirement of shareholder derivative litigation. The court also held that the company’s board of directors’ decisions regarding executive compensation fit within the business judgment rule: “Merely ignoring a non-binding vote of the shareholders and approving an increase in executive compensation is decidedly not a breach of fiduciary duty, by itself, under Dodd-Frank.”

On March 12, a Maryland federal court likewise threw out a shareholder derivative suit over executive compensation brought against BioMed Realty Trust Inc. Weinberg ex rel. BioMed Realty Trust, Inc. v. Gold. Although a majority of BioMed’s shareholders voted against the proposed executive compensation plan for 2010, the board of directors did not withdraw its approval. The judge found that plaintiffs failed to meet the demand futility requirement, adding that a say-on-pay vote was not the same as a pre-suit demand.

The plaintiffs attempted to use the Ohio federal court’s decision in NECA-IBEW Pension fund, derivatively on behalf of Cincinnati Bell, Inc. v. Cox, et al. to support his argument that demand would have been futile. In Cincinnati Bell, which was decided under Ohio law, the court found that approval of “multi-million dollar bonuses” by the board of directors while the company was declining financially was not in the best interests of shareholders and therefore “constituted an abuse of discretion and/or bad faith.”

Important to the holding was that the business judgment rule under Ohio law “imposes a burden of proof,” not pleading, and therefore plaintiff’s allegations that the failed shareholder say-on-pay vote rebutted the business judgment rule was sufficient for the case to proceed. The Maryland court distinguished BioMed on the grounds that Ohio and Maryland’s demand futility requirements differed.

These decisions have hardly deterred disgruntled shareholders from continuing to bring derivative claims for purportedly excess executive compensation. In fact, most recently, Citigroup shareholders filed a derivative suit against the company and several of its executives for approving executive compensation that allegedly included $54 million in pay for its top executives.

According to the complaint, filed in New York federal court, the Citigroup board approved an excessive compensation plan despite the company’s poor 2011 performance, citing a 44 percent drop in stock price. What’s more, according to plaintiffs, Citigroup ignored the shareholder vote against the executive pay packages only days before it was approved.

Notably, this is the first reported instance in which shareholders rejected a major Wall Street bank’s executive compensation plan since the passage of Dodd-Frank’s say-on-pay provisions. It remains to be seen whether it will be the last.

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