Shareolders Using ‘Say-on-Pay’ Votes in Lawsuits Against Boards

By | May 13, 2011

Shareholders upset with ever-higher executive compensation packages are using new “say-on-pay” votes to challenge the payouts in court, a tactic raising eyebrows among legal experts.

The lawsuits are zeroing in on companies that lose these advisory votes by shareholders on top management compensation. The plaintiffs accuse the companies of waste or excessive pay and in some cases cite “no” votes as confirmation boards violated their duties to shareholders.

KeyCorp, Beazer Homes USA Inc and Jacobs Engineering Group Inc. have already had to fend off lawsuits and more cases may follow, legal experts said.

Mandated by the Dodd-Frank financial reform act, say on pay was meant to give shareholders more input on executive compensation after lavish payouts drew fire during the financial crisis.

The lawsuits are ratcheting up pressure on boards to quickly respond if they lose a say-on-pay vote. But since these votes were meant to be nonbinding, some legal experts find the spate of lawsuits troubling.

“It’s an unfortunate, unintended consequence of a federal mandate,” said Claudia Allen, a partner at law firm Neal, Gerber & Eisenberg LLP. “If you read the rule, it pretty clearly states that it does not modify a board’s fiduciary duties.”

Stephen Bainbridge, a law professor at UCLA in Los Angeles, is among those who warned say-on-pay would trigger costly litigation.

“I think they (plaintiffs’ lawyers) are aggressively trying to use this as an opportunity to make new law on executive compensation,” he said.

The suits are unlikely to be successful, he said.


CEO pay, which fell in 2009, jumped sharply last year as a surging stock market triggered more bonus awards tied to share performance.

Median pay for S&P 500 company executives rose 28 percent to about $9 million in 2010, according to Equilar, an executive compensation data firm.

Activist shareholders and proxy advisors have been urging more “no” votes as CEO pay gets fatter. Walt Disney Co., Hewlett Packard Co. and General Electric Co., among others, have had their pay practices challenged this year. Compensation was approved at Disney and GE after they tweaked their packages, although Hewlett-Packard’s was voted down.

Despite popular outrage over pay, courts have been reluctant to intervene.

“Boards of directors have very wide latitude on decision-making about employment and compensation,” said Lawrence Cunningham, a law professor at George Washington University. “It’s very difficult for anybody to challenge these arrangements.”


Courts generally follow the business judgment rule on board decisions, said Allen, the lawyer at Neal, Gerber & Eisenberg. In other words, they do not step in if directors make an informed decision, without conflicts of interest and in good faith.

“The notion is, you shouldn’t have boards being constantly second-guessed,” she said.

Even so, lawsuits can be distracting for boards and costly to defend.

Cleveland-based KeyCorp, for example, has said it agreed to pay $1.75 million in attorneys’ fees and expenses to settle a lawsuit filed against its compensation practices. The derivative lawsuit was filed on behalf of the company.

The complaint alleged the board breached its fiduciary duties by increasing executive compensation and failing to take action after its May 2010 say on pay vote. KeyCorp denied the allegations and said it was reviewing its compensation practices when the lawsuit was filed.

From a legal standpoint, boards can disregard say-on-pay votes as long as they have taken shareholders’ views into account, said law professor Cunningham.

“I think what the courts would say is that the way our system works, we can have some degree of confidence that directors will hear that noise and incorporate it into their thought process,” he added.

(Reporting by Dena Aubin; editing by Andre Grenon)

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