Say on pay is becoming “sue on pay” at some companies.
In the past year, shareholders have initiated litigation against Apple Inc., Microsoft Corp., Brocade Communications Systems Inc. and Symantec Corp., among other companies, assailing their executive pay disclosure.
Such shareholder lawsuits generally accuse companies of providing insufficient disclosure in detailing executive compensation policies and packages, and not being in compliance with the disclosure rules of the Securities and Exchange Commission. As a result, they allege, shareholders are unable to properly evaluate the proxy statement presentations to cast informed votes on whether to ratify the companies' executive compensation programs.
The lawsuits add new complexity to holding companies accountable for their executive pay policies and practices.
Richard H. Zelichov, Los Angeles-based partner of the law firm Katten Muchin Rosenman LLP, in a webcast March 22 called the trend a “gathering storm of litigation.”
The Day Pitney LLP law firm, in a Feb. 28 analysis, characterized the focus on disclosure of executive compensation policies in proxy statements as a “relatively new wea--pon in the arsenal of plaintiffs' counsel.”
Say on pay is intended to confer on investors an oversight of executive pay. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 requires an advisory shareholder vote at every U.S.-based publicly traded company. The requirement grew out of proposals shareholders began to sponsor in the early 2000s to quell perceived compensation excesses and better align executive incentives with shareholder interests, a trend intensified by the financial market collapse that exposed misalignment of pay and performance at many companies.
The say-on-pay vote is non-binding, but it is a crucial vote. Companies ignoring the results of the vote are not only subject to reputational risk, possibly alienating shareholders, but also may drive active investors away from their stock, damaging its value. They now also increasingly risk becoming defendants in lawsuits.
For their part, pension funds, investment management firms and other institutional shareholders face risks related to executive pay disclosure. They could themselves wind up as defendants if participants sue them for breach of fiduciary duty claiming insufficient due diligence in analyzing executive pay programs at companies in portfolios, and inattention in voting proxies. Pension funds and their money managers have a fiduciary duty to vote their proxies.
At the same time, pension funds and other institutional investors should step up to defend companies when they believe the suits filed over inadequate disclosure are groundless. These suits force companies to spend resources in defending themselves and potentially pay settlements, while distracting them from their operations. The California State Teachers' Retirement System intervened in November to support Microsoft in a lawsuit attacking the company's executive compensation disclosure.
Say on pay isn't the only vote shareholders have on compensation. Typically shareholders vote on company-sponsored proposals authorizing the issuance of shares for use in executive incentive plans, or other executive compensation programs.
Unlike say on pay, voting on share authorization is often binding. Shareholder plaintiffs have initiated litigation on this issue for reasons of insufficient disclosure to enable them to evaluate current plans.
Pay-disclosure lawsuits seek to delay company annual meetings and voting on such issues. Such action comes at a cost to companies and potentially harms shareholder value.
At Brocade, a stockholder lawsuit succeeded in winning court approval to delay the company's vote at last year's annual meeting on a company proposal seeking additional shares for an executive stock plan. The stockholder claimed the disclosure “was misleading and incomplete,” according to a company statement. In a settlement, Brocade agreed to postpone the vote and issue additional disclosures on the proposal. The supplemental disclosures were filed with the SEC last April 12 and stockholders approved the proposal April 20.
Apple was subject to a shareholder legal action on its say-on-pay voting. The case sought to enjoin the vote at the company's annual meeting scheduled for Feb. 27, contending Apple's compensation discussion and analysis section of the proxy statement was not in compliance with SEC rules on disclosure.
The case focused on four executives, each granted $60 million in restricted stock units. Plaintiffs argued the disclosure provided insufficient information on the company's compensation decision-making process. Judge Richard Sullivan of the United States District Court in New York ruled the disclosure was SEC compliant and denied delaying the vote.
A lawsuit against Symantec in Santa Clara County Superior Court in California sought to delay the company's annual meeting, contending the company's directors breached their fiduciary duty by failing to provide adequate disclosure on executive compensation. The court denied the motion to enjoin the meeting and then, on Feb. 22, it granted a motion to dismiss the case.
In the Microsoft case, filed last Oct. 11 in King County Superior Court in Seattle, Anne Sheehan, director of corporate governance at CalSTRS, filed the motion in support of the company. In her declaration, she said Microsoft's proxy statement disclosures “are sufficient for CalSTRS to understand” the company's executive compensation program and an employee stock purchase plan the company proposed to amend, and to make informed votes.
“I believe it is against the interest of Microsoft's shareholders for Microsoft to incur the costs and inconvenience of making more disclosures and to delay the advisory say-on-pay vote and or the ESPP vote,” Ms. Sheehan said in her declaration filed with the court.
The case was ultimately dismissed.
“Sue on pay” won't escalate if companies reach out to shareholders, as many already have done, and shareholders do their fiduciary duty to scrutinize the practices and bring attention to issues of concern about pay practices, including disclosure. In addition, institutional shareholders should do more to intervene in support of companies where disclosure is sufficient. Shareholders and companies might also ask the SEC to clear up any ambiguity in disclosure rules that might lead to litigation.
Otherwise, companies might face further litigation, even if most shareholders believe it is a distraction and a waste of corporate resources, ultimately hurting shareholder value.