Legal challenges surrounding say on pay in the United States



FW speaks with Charles W. Pautsch at Arnstein & Lehr about the legal challenges surrounding say on pay in the United States.

FW: Could you outline the recent legal developments in the US relating to say on pay, and the reasons behind their introduction?

Pautsch: As a reaction to the 2008 worldwide financial meltdown and ensuing recession, the then Democratic-led US Congress passed sweeping legislation known as the Dodd-Frank Act, which was signed into law by President Obama in July 2010. Primarily aimed at financial institutions and the abuses that allegedly caused the crisis, the Act also contained the say on pay provisions that many have labelled the most sweeping changes in corporate governance in American economic history. These provisions arose out of a strong populist-oriented belief in the US that CEOs are significantly overpaid in relation to employees at the companies they govern and that recipients of recent TARP bail-out payments had abused the public trust by rewarding themselves with bonuses.

FW: What compliance provisions and procedures are US companies now obliged to observe?

Pautsch: The critical say on pay provisions established in Dodd-Frank require that publicly-held companies conduct advisory shareholders votes to ‘approve the compensation of executives’ at least every three years, and determine every six years how often these advisory say on pay votes should occur in the range of one through three years. Advisory, non-binding votes must also occur in regards to certain ‘golden parachute’ compensation provided to executives when the corporation seeks approval of merger and acquisition transactions.

FW: What disclosure requirements have been introduced under say on pay?

Pautsch: The CD&A in the proxy must include information as to whether and, if so, how the company considered the results of the most recent vote – as well as prior votes, to the extent these are material – in determining compensation policies and how they affected the proxy issuer’s current compensation decisions. Additional disclosure regulations are currently being formulated by federal agencies, most particularly the SEC. The most significant and controversial of these is a proposed requirement that public companies disclose the ratio of CEO compensation to the median compensation paid to all other employees. Proposals regarding the disclosure of clawback provisions are also being finalised.

FW: In what ways have the rights of shareholders been expanded and strengthened? How are shareholders exercising this enhanced influence?

Pautsch: These advisory votes were implemented before and during the 2011 proxy season and with the advent of this year’s shareholders meetings, institutional and other shareholders have actively challenged board compensation practices. Although the vast majority – 98 percent – of company shareholder groups approved the compensation plans of their company, standards for assessing these disclosures are developing, particularly at entities like ISS.

FW: What forces are leading board challenges in the US, and what are the specific legal responses recommended for each type of challenge?

Pautsch: Institutional investors and other significant interested parties in the particular corporation’s affairs have been the leaders in board compensation challenges. The AFL-CIO has issued its periodic Executive Compensation Watch and is uniquely motivated to either make these challenges directly or through surrogates such as affiliated pension funds. In some instances, provisions of the National Labor Relations Act can be used to curb this sort of tactic. In some instances, these challenges can amount to illegal secondary pressure, where for instance pressure is placed on a company’s lending institutions’ executives compensation plan in order to discourage future lending to the targeted company. Institutional shareholder organisations such as ISS have carefully outlined the manner in which they will probe compensation plans. These outlines should be carefully reviewed as each proxy season approaches.

FW: Against the backdrop of say on pay, what are some of the rights and restrictions that companies face when designing compensation packages for their top executives?

Pautsch: Of course, in designing a compensation plan, against this new backdrop established under Dodd-Frank, a company must be even more alert to all of the legal rules affecting executive compensation, including various tax and governance considerations emanating from such sources as Section 162(m) of the IRC and Sarbanes-Oxley. The scrutiny of potential board challengers will continue to include a full-scale legal analysis of the challenged compensation practices.

FW: To what extent have the legal obligations and potential liabilities of compensation committee members increased in recent years? What steps can they take to mitigate the risks inherent in discharging their duties?

Pautsch: Compensation committee members are under far greater legal scrutiny then ever before. Careful drafting of the compensation discussion and analysis (CD&A) is critical. This document should be drafted with a careful eye to the sort of detail often challenged by institutions such as ISS, and of course the broad array of laws noted above. And, perhaps most significantly, committee members should endeavour to establish that they are truly independent and that they are relying on independent advice in arriving at their compensation decisions. A variety of suits were filed following the 2011 proxy season that named compensation committee members as well as executives of the company as defendants. These suits are still in the early stages of litigation but a few early rulings have underscored the importance of independence in this realm of decision making.

FW: Clawbacks are a controversial area of executive compensation. How are clawback provisions being drafted and enforced?

Pautsch: They are being drafted very carefully and with an eye towards the many tax and other legal ramifications for both the potential recipient and the employer seeking to enforce them. These provisions, while useful and required by provisions of TARP legislation and Sarbanes-Oxley, should be drafted with a knowledge of applicable state wage-hour laws, as well as the tax implications under IRC section 409A rules regarding receipt of deferred compensation at the time of a triggering event. State law usually vests the rights to such payments at a certain point in time as they are deemed ‘accrued’ or ‘earned’ and not subject to return. Given these complexities, the employer may want to consider drafting a retention bonus program that requires the performance of certain services during the period of actual receipt of the bonus, thus making the clawback provision more readily enforceable.

FW: In your opinion, does the say on pay principle risk hampering the ability of US companies to attract top talent?

Pautsch: The law and regulations to date do not seem to have resulted in an appreciable effect on the ability to attract top talent, but that may change with further developments and as potential challengers become more adept at using these disclosures and rights. Unlike the severe, even draconian, absolute limitations placed on executive compensation in connection with TARP-recipient legislation, the approach taken by the say on pay rules under Dodd-Frank are designed to work over the long-term. Given the pace of developments in the financial world, and media focus on the same, one might expect that the current say on pay in the US is just a beginning. And, of course, the forced disclosure of the pay ratios noted earlier will serve to intensify the debate.

FW: What advice would you give to companies on developing appropriate compensation policies to meet the demands of the new regulatory environment? Further, how should companies go about implementing appropriate governance procedures, from a legal standpoint, to ensure they comply with say on pay provisions?

Pautsch: Independence and the proper analytical focus are the keys to success and risk-avoidance here. The company should employ independent counsel and compensation consultants to develop a carefully written CD&A. This plan should be drafted after engaging in a rigorous analysis of the applicable legal disclosure requirements and potential challenges to the plan as it is structured. In defending the legal challenges filed in US courts to date, corporate defendants have relied on the ‘business judgment’ rule as the primary line of defence to claims presented against named defendants. These defences are tremendously enhanced by a completely independent review of the proposed plan. Indeed, the company’s in-house counsel, and usual outside counsel, should normally be supplanted by independent counsel for this particular delicate, and often contested, task.


Charles W. Pautsch is a partner at Arnstein & Lehr and a member of the firm’s Labor & Employment Practice Group. Mr Pautsch has concentrated his practice in labour and employment law for over 34 years. He has represented corporations, as well as key executives in matters involving executive compensation, executive agreement development design and drafting, and litigation involving these issues. He has focused on Sarbanes-Oxley, Dodd-Frank and other legal and regulatory oversight of these matters in his stints as in-house counsel at two Fortune 500 companies as well as in private practice.  Mr Pautsch can be contacted on +1 (414) 220 4157 or by email:

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Charles W. Pautsch

Arnstein & Lehr

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