The so-called “say-on-pay” provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act are beginning to make headlines as more domestic public companies grapple with shareholder advisory votes on executive compensation. In 2011, the Securities and Exchange Commission (SEC) adopted final rules implementing Dodd-Frank section 951’s requirement that SEC-registered issuers provide shareholders at least once every three calendar years with a separate non-binding say-on-pay vote regarding the compensation of the company’s named executive officers, the chief executive officer, the chief financial officer, and the company’s three other most highly compensated officers. Although the vote on compensation is non-binding, the company must include a statement in the Compensation Discussion and Analysis of the proxy statement whether and, if so, how its compensation policies and decisions have taken into account the results of the shareholder say-on-pay vote. As a result, the vote of the shareholders will be taken seriously not only by the company, but other companies in the same marketplace.
Amidst negative media attention on executive compensation packages, approximately 1.5% to 2% of the many non-binding say-on-pay votes occurring in the 2011 proxy season failed to secure shareholder approval. In some cases where a majority of shareholders voted against the say-on-pay resolutions of a company, a shareholder derivative lawsuit against the Board of Directors has followed. In Teamsters Local 237 v. McCarthy, No. 2011-cv-197841 (Sup. Ct. Fulton County Ga. Sept. 16, 2011) (slip op.), a Georgia state court dismissed a shareholder derivative suit because, among other things, a negative say-on-pay vote failed to create a reasonable doubt that the challenged compensation decisions were valid exercises of business judgment.
However, an Ohio federal court declined to dismiss a derivative suit against the Board of Cincinnati Bell – brought after 66% of the company’s shareholders voted against the 2010 executive compensation package. More recently, in the financial services industry, shareholders of a large financial institution voted against the pay package of the CEO. There were concerns that the compensation package lacked significant and important goals to provide incentives for improvement in the shareholder value of the institution. Consequently, a shareholder filed a derivative lawsuit against the CEO, the Board of Directors, and other directors and executives for allegedly awarding excessive pay to its senior officers.
While shareholder disapprovals remain uncommon, it is clear that compensation and the manner in which it is awarded should be carefully considered before subjecting the compensation to a shareholder vote. CEOs often engage counsel to advocate for a compensation package. It is increasingly obvious, however, that compensation committees must also receive independent counsel to evaluate performance objectives and analyze executive compensation in similarly-situated companies. Without an independent assessment and in a media-focused environment, negative reaction from shareholders is a growing concern. Once shareholders register their disapproval through the say-on-pay vote, the company and the Board of Directors are at risk for a shareholder derivative lawsuit. Thus, the implications and risks of the Dodd-Frank rules on say-on-pay reverberate beyond the advisory, non-binding shareholder vote.