Previously published by Law360, July 10, 2012

The year 2011 brought the U.S. Securities and Exchange Commission's final rules on "say on pay" advisory votes under the Dodd-Frank Wall Street Reform and Consumer Protection Act — and a slew of say-on-pay lawsuits to go with them. Under the SEC's rules, companies are directed to hold periodic shareholder votes approving or disapproving of executive compensation.1

Despite the Dodd-Frank's Act's statements that say-on-pay votes are nonbinding, and that the say-onpay requirement should not be construed "as overruling a decision by such issuer or board of directors" or creating or implying any changes or additions to the fiduciary duties of a company and its board2, several shareholder lawsuits were filed after negative say-on-pay votes in 2011.

One early decision on the issue indicated that courts might find failed say-on-pay votes persuasive evidence of wrongdoing. In the past few months, however, courts have repeatedly disavowed this approach, rejecting the argument that a negative say-on-pay vote overcomes the business-judgment presumption attached to a board's decision on executive compensation.

One of the first cases to face a negative say-on-pay vote was NECA-IBEW Pension Fund ex rel. Cincinnati Bell Inc. v. Cox.3 In Cincinnati Bell, the U.S. District Court for the Southern District of Ohio denied a company's motion to dismiss shareholder derivative claims that the board breached its fiduciary duty of loyalty after a negative say-on-pay vote "when it decided to approve large pay raises and bonuses to its top three officers in a year when, according to plaintiff, the company performed dismally."4

The court concluded "that plaintiff's allegations create a reasonable doubt that the challenged transaction is the result of a valid business judgment, and, accordingly, the directors possess a disqualifying interest sufficient to render pre-suit demand futile and hence unnecessary."5

Cincinnati Bell was settled in late December 2011, as was a similar suit filed by shareholders of KeyCorp6 after a negative say-on-pay vote. But the Cincinnati Bell plaintiff's success in getting past the motion-to-dismiss stage and demonstrating demand futility after a negative shareholder vote raised the question: Would other courts conclude that an adverse say-on-pay vote was evidence of bad faith, or a disqualifying interest that would preclude dismissal of the demand requirement?

Subsequent decisions suggest that the answer is no. In many cases decided since Cincinnati Bell, courts have rejected shareholder arguments that a negative say-on-pay vote rebuts the business judgment rule or constitutes a disqualifying interest. These cases indicate that Cincinnati Bell's approach is quickly falling into disfavor.

For example, in Assad v. Hart7 and Dennis v. Hart8 — two suits brought by shareholders of PICO Holdings — the U.S. District Court for the Southern District of California found that an adverse say-onpay vote did not rebut the business judgment of the board's decision to increase executive compensation, citing the Dodd-Frank Act's assertion that say-on-pay requirements neither altered nor expanded a board's fiduciary duty.9 The court further found that the shareholders failed to state a claim based on the negative shareholder vote.10

Similarly, in Plumbers Local No. 137 Pension Fund v. Davis11, the court explicitly disapproved of Cincinnati Bell in concluding that the adverse say-on-pay vote did not rebut the presumption of business judgment or render demand futile.12 Other courts from a variety of jurisdictions have followed suit. 13

Of course, these recent decisions do not mean that adverse say-on-pay votes will be meaningless. There are indications, such as in Laborers' Local v.Intersil, that a negative shareholder vote weighs in favor of rebutting the business judgment rule, but is not itself enough to do so.14 Nor does it mean that companies will cease to be sued for negative say-on-pay results; indeed, Citigroup was sued in federal court almost immediately after its negative vote.15 However, these decisions do suggest that derivative suits in the wake of an adverse say-on-pay vote may soon be less common than before.

Footnotes

1. Section 951 of the Dodd-Frank Act provides that public companies are required to conduct a nonbinding shareholder advisory vote at least once every three years to approve the compensation of a company's named executive officers disclosed pursuant to Item 402 of Regulation S-K under the Securities Act of 1933, as amended. See Securities Exchange Act of 1934, § 14A(a)(1).

2. Exchange Act § 14A(c).

3. No. 1:11-cv-451, 2011 WL 4383368 (S.D. Ohio Sept. 20, 2011).

4. Id. at *1.

5. Id. at *4.

6. Amended Stipulation and Notice of Settlement, In Re KeyCorp Derivative Litig., No. 1:10-cv-01786 (N.D. Ohio Apr. 26, 2011).

7. No. 11-cv-2269, 2012 WL 33220 (S.D. Cal. Jan. 6, 2012).

8. No. 11-cv-2271, 2012 WL 33199 (S.D. Cal. Jan. 6, 2012).

9. Id. at *3; see also Assad, 2012 WL 33220, at *4.

10. Assad, 2012 WL 33220, at *3-*4; Dennis, 2012 WL 33199, at *3.

11. No. 03:11-633-AC, 2012 WL 104776 (D. Or. Jan. 11, 2012).

12. Id. at *8.

13. See, e.g., Weinberg ex rel. BioMed Realty Trust, Inc. v. Gold, –F. Supp. 2d –, 2012 WL 812348 (D. Md. Mar. 12, 2012) (rejecting plaintiffs' reliance on Cincinnati Bell and holding that negative say-on-pay vote was insufficient to rebut business judgment rule or demonstrate demand futility); Haberland v. Bukeley, No. 5:11-CV-463-D, 2012 WL 1564519 (E.D.N.C. May 2, 2012) (denying preliminary injunction on shareholder vote on executive compensation on the basis that plaintiff was unlikely to succeed on the merits of fiduciary-duty claim).

14. No. 5:11-CV-04093, 2012 WL 762319 (N.D. Cal. Mar. 7, 2012) (concluding that Congress intended for the shareholder vote on compensation to have some weight but that the vote alone is insufficient to rebut the business judgment rule).

15. See Moskal v. Pandit, No. 1:12-CV-3114 (S.D.N.Y. Apr. 19, 2012). The negative vote took place on April 17, 2012.

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