July 21, 2011
Dodd-Frank@1: What to Say about Say on Pay?
Posted by Lisa Fairfax

Last year Dodd-Frank's say on pay rules sparked considerable debate.  At least one poll revealed that 85% of shareholders supported say on pay, while 95% of directors opposed it.  Investors hoped such rules would finally give them a chance to curb excessive compensation awards and better align pay with performance.  Criticswere not only skeptical about the rules' ability to influence pay packages, but also feared that the rules would have distinctly negative repercussions such as forcing companies to adopt ill-conceived pay practices or otherwise sparking costly litigation.   So what have we learned about say on pay thus far?   

It has only been since January of this year that most public companies have been subject to the SEC's say on pay rules, adopted pursuant to Dodd-Frank.  As a result, there is not a lot of data out there from which we can draw conclusions.  However, there have been a few interesting developments--though it is not clear what they tell us about the impact of say on pay.

First, empirical evidence indicates that shareholders have rejected pay packages at less than 2% of companies at which votes were taken.  Indeed, more than two-thirds of companies received a favorable vote of 90% or more.  At least one commentator characterized shareholders' rate of rejection as a "bust," presumably because it suggest that shareholders arenot using their votes to challenge company's compensation practices.  On the other hand, to the extent at least one goal of the say on pay rules was to prompt dialogue around compensation practices and thus avoid negative votes, perhaps that rate suggest enhanced dialogue between shareholders and directors.  Of course it is too soon to tell the more important question--whether the rules or the negative votes have any impact on compensation.

Second, shareholders have been more willing to reject say on frequency recommendations.  Existing data shows that early on in the proxy season it became clear that while 60% of boards favored triennial say on pay votes, most shareholders favored annual pay votes and were not shy in rejecting recommendations for triennial votes.  As a result of this trend, more companies began recommending annual say on pay votes.  As this data reveals, for better or worse, shareholders clearly want to be able to have a voice in compensation decisions every year.  The data also reveals that corporations are watching the voting trends in this area and adjusting their policies accordingly.

Third, while companies are not required to disclose whether and to what extent they have factored vote results into their compensation decisions until next year's proxy statement, there are some that already have indicated their intent to alter their practices to address shareholder concerns, and engage in greater dialogue with shareholders,suggesting that companies are not simply ignoring the vote (or at least they are not saying that they are ignoring the vote).

Fourth, as some predicted, negative say on pay votes have triggered litigation.  There are at least seven lawsuits that have been filed after a negative say on pay vote.  The lawsuits have similar allegations against directors and officers of breach of the duty of loyalty, waste, and unjust enrichment.  They also include aiding and abetting claims against the company's executive compensation consultants.  While one should never predict what courts will do, it is hard to imagine that these suits will have any traction, particularly given (a) the relative deference courts give to compensation decisions, and (b) that Dodd-Frank specifically states that the say on pay rules are not intended to create or imply any changes or additions to directors' fiduciary duties.  Interestingly, shareholders have sought to use the negative say on pay vote as evidence that the board failed to act in the best interests of the company, thereby rebutting the presumption of the business judgment rule and excusing demand.  If a negative say on pay vote could be interpreted as enabling shareholders to avoid a pre-suit demand, such a vote would have important procedural ramifications for derviative suits--at the very least prolonging them.  Of course, the court in the KeyCorp litigation appears to have rejected this pre-suit demand argument, thus forcing shareholders to make demand on the board.  Nevertheless, that suit ended in a settlement where the corporation agreed to changes in its compensation practices.  Hence, in the end, such a suit does appear to have ramifications for the board's pay practices.

Alas, as I noted at the outset, it is really too soon to tell what this all means.  Perhaps in year two we will be able to draw some (albeit tentative) assessments regarding the say on pay rules, but it is still an interesting trend to watch.

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