Nonbinding? Not totally: say on pay votes apparently have more teeth than heretofore imagined.

• Author: Zacharias, Carol A.N.
• Position: RISK MATTERS

AVERDANT NEW FIELD of litigation against corporate board directors is sprouting from the Dodd-Frank Wall Street Reform and Consumer Protection Act. Among the 2010 law's many provisions is Section 951, which required public companies to submit the board's executive compensation recommendations to shareholders for an advisory vote.

The vote in the so-called shareholder say on pay provision is nonbinding, meaning that the board of directors can disagree with the majority of shareholders that say "No" on the compensation plan and vote for the compensation committee's initial pay suggestions instead. While this would appear to shield directors from possible litigation by shareholders arguing excessive executive compensation practices, recent case law gives pause for consideration. Even though the shareholder say on pay vote is non-binding, the shareholders can still subsequently sue the directors, saying they allegedly breached their fiduciary duty by allowing the excessive compensation plan to proceed.

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Many shareholders, urged on in part by their proxy advisers, are doing just that, resulting in what Thomson Reuters reported as a "surge" in shareholder derivative suits claiming directors breached their fiduciary duty by greenlighting a pay package that shareholders had given a thumbs down. A dozen cases so far have been reported, with two reaching undisclosed settlements. While some legal experts question the legality of the lawsuits, others predict it will trigger a fusillade of costly litigation against board directors.

One case currently wending its way through an Ohio federal courthouse indicates that the business judgment rule customarily protecting board directors when making decisions on executive compensation may be porous in certain instances.

In September 2011, Judge Timothy Black of the Southern District of Ohio ruled against dismissing a class action brought by shareholders against senior executives and directors of Cincinnati Bell Inc. for approving the telephone and cable provider's executive compensation plan. The board had recommended and eventually approved a 71% increase in the compensation of Cincinnati Bell's CEO and an 80% increase for its CFO, despite a 61 % plunge in the company's net income in 2010, and a negative 19% shareholder return. The shareholders had overwhelmingly rejected the executive compensation plan.

Defendants argued in court that the business judgment rule protected their decisions...