Video Friday: Say-On-Pay Lawsuits, Crazy? + Daily Show Bonus

This Week in the Boardroom: 7/14/11 TK Kerstetter, President, Corporate Board Member; Scott Cutler, Executive Vice President, NYSE Euronext; and Stephen Lamb, Partner, Paul Weiss discuss the fact that losing a say-on-pay vote increases the likelihood of a shareowner lawsuit. See also Frivolous Say on Pay Lawsuits: Another Unintended Consequence.

This seems like a no-brainer to me. Over 98% of company say on pay votes passed. Isn’t it highly likely that those that fail such votes are more likely to be targeted? I think it is difficult for any company to truly show a direct link between CEO pay and performance. For those companies where shareowners couldn’t see enough of a link to vote yes, isn’t it likely that would open the door to a lawsuit? Eight cases doesn’t seem outrageous to me.

Yes, some may be frivolous, but the chances of finding problems seems likely to be higher at failed vote companies. There were many frivolous suits before say on pay. Vote failure is just one more indicator in the plaintiff bar toolkit.

Opponents of Dodd-Frank loudly complain these suits are an “unintended consequence” and articles like TK Kerstetter’s Board Blog, cited above, advise:

make sure your congressmen and the SEC see how ridiculous some of these lawsuits are and ensure they understand that nonbinding shareholder votes—even those won but where the percentages of votes were close—are not incidental, and often there is nothing “nonbinding” about them.

The real unintended consequence of say on pay is that shareowners have now given tacit approval to pay plans where the average large-cap CEO would be paid more than $10 million when most believe such pay is too much. The unintended consequence is that the “Lake Woebegone” effect of companies paying their NEOs more than average every year and those averages raising every year taking a larger proportion of corporate profits.

According to Bradley J. Andreozzi and Douglas C. Murray of Drinker Biddle & Reath LLP (Lawsuits in the wake of say-on-pay) there is a fact pattern emerging around allegations. The basic “fact pattern” targeted in these complaints is as follows:

  1. the company advises shareholders that it maintains a “pay for performance” compensation philosophy;
  2. the board relies in part on the advice of a compensation consultant to
  3. approve an executive compensation plan pursuant to which NEOs receive an increase in compensation, despite
  4. the company’s arguably poor financial results;
  5. directors who are also NEOs receive the compensation increases;
  6. a majority of the shareholders vote “no” in the say-on-pay vote; and
  7. the board fails to rescind the pay increases following the shareholder vote.

Based on this combination of factors, the plaintiffs allege that the directors’ approval of (and refusal to rescind) the compensation plan was irrational, unjustified, a profligate waste of corporate assets, and could not have been the product of a valid business judgment.

Given such a pattern, lawsuits doesn’t sound quite as crazy, do they? Companies that want to avoid the very small possibility of such suits should pay below the median, perform above average and clearly demonstrate the link of pay to performance in their CD&A. See also, Companies Altering Compensation Plans Over Say-on-Pay, Compliance Week, 7/28/2011.

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