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The Impact of "Sue-on-Pay" Lawsuits on Proxy Statement Disclosures

(The following post originally appeared on ONSecurities, a top Minnesota legal blog founded by Martin Rosenbaum to address securities, governance and compensation issues facing public companies.)

July 11, 2011

Six companies so far have faced shareholder derivative lawsuits based on a negative Say-on-Pay vote – what I’m calling “Sue-on-Pay” lawsuits. As described in this prior post, I believe there are good defenses to these cases on the merits. However, it will take months, or longer, to get a final determination on the merits of these cases, and in the meantime, there may well be more claims.

Steve Seelig of Towers Watson has provided a good analysis of the possible impact of the Sue-on-Pay cases on companies’ proxy disclosures. His main point is that the disclosures in the Compensation Discussion and Analysis section of many companies’ proxy statements have tended to make the general point that the company has a “pay for performance” philosophy, without providing a lot of detail. This type of general language has opened the door to lawsuits attacking the board’s compensation decisions as being inconsistent with pay for performance. The complaints point out that total compensation went up in the last year while total shareholder return (TSR) declined, generally using simple charts to dramatize the point. As Seelig points out, this is an overly simplistic argument by plaintiffs, but it may help the plaintiffs survive a quick motion to dismiss and make a settlement more likely.

This heightens the need for companies to take additional care to demonstrate how they pay for performance and in a manner that reflects the consideration the compensation committee gave to the matter before making its pay decisions. Certainly, this should mean looking at what pay versus performance would look like for the company as it attains various levels of TSR. But, more importantly, it should take into account:

1. How the company measures pay

2. What it means by “performance”

3. Whether the company believes pay and performance should be measured absolutely or in relative terms (by comparison to peers), or in some combination

4. The time period over which they should be measured.

Good advice, especially because such disclosures will help set the stage for future years, when relative TSR may not look so good, but the compensation committee may still feel it is justified to increased total compensation to its executives. As Seelig says, “Enhancing the CD&A with this information can facilitate shareholder support for a favorable vote on say on pay — and a more proactive defense than not making the case at all.”

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