As we begin the 2009 annual meeting season, there are several issues of which public companies should be aware. New York Stock Exchange listed companies seeking approval of equity compensation plans need to make sure that they are counting stockholder votes consistent with NYSE guidance. Companies with significant retail ownership should be cognizant of the increasing trend toward proportional voting by brokers. Finally, for all companies, this may be the last annual meeting season under the current NYSE rules on broker discretionary voting.
Vote Counting for NYSE–Listed Companies
For most Delaware corporations, approval of most items at an annual meeting of stockholders requires the affirmative vote of a majority of shares present and entitled to vote on the proposal. Shares held by brokers that have not received instructions from their customers who beneficially own the shares cannot be voted on nonroutine items, including approval of equity compensation plans. These so-called “broker non-votes” are considered shares present for purposes of obtaining a quorum under Delaware law, but Delaware courts have held that they are not shares “entitled to vote.” As a result, a proposal, including one to approve an equity compensation plan, will pass if it receives the affirmative vote of a majority of the shares that actually vote on the proposal, regardless of how many broker non-votes occur.
Under NYSE Rule 312.07, however, an equity compensation plan proposal must receive not only a majority of the votes cast on that proposal, but the total votes cast on the proposal must represent a majority of the securities entitled to vote on the proposal. Broker non-votes are not considered votes cast. Therefore, even if the votes “For” outweigh the votes “Against” and the proposal is considered passed under Delaware law, the proposal will not be considered approved under NYSE Rule 312.07 until the total votes actually cast (votes “For” plus votes “Against” plus abstentions) is at least a majority of the shares outstanding.
As a result of the NYSE position, a company that barely achieves a quorum and has a significant number of broker non-votes may find itself unable to obtain approval of equity compensation plan proposals.
Under current NYSE Rule 452, when a broker does not receive instructions from its customer as to how to vote shares on routine annual meeting items, the broker may exercise its discretion in determining how to vote those “uninstructed” shares. The list of routine items includes the election of directors. Rule 452 applies to all NYSE member brokers, regardless of whether the company holding the stockholder meeting is listed on the NYSE or Nasdaq or is unlisted. Historically, most brokers tended to vote uninstructed shares in accordance with the board’s recommendations (i.e., in favor of the board’s slate of director nominees). For companies with majority voting for the election of directors, this typically meant uninstructed shares could be counted on as “Yes” votes for director nominees.
In recent years, a number of major brokers (including Schwab, Ameritrade, Morgan Stanley, Merrill Lynch and Goldman Sachs) have begun allocating uninstructed shares in the same proportion as instructed shares on routine items. In other words, if customers provide voting instructions directing that, in the aggregate, 60 percent of their shares be voted “For” director nominees and 40 percent voted “Against,” the broker will also vote 60 percent of uninstructed shares “For” and 40 percent “Against.” This means that uninstructed shares can no longer be counted on as automatic votes “For” director nominees. Furthermore, customers who actually provide voting instructions to these brokers will effectively have their voting power magnified to the extent of uninstructed shares that are voted proportionally with their instructed shares.
The proportionally voted shares also tend to show up as a last-minute surprise in voting results. While brokers normally vote instructed shares 10 days prior to an annual meeting (as well as discretionary votes if that broker does not vote in a proportional manner), brokers who vote uninstructed shares in a proportional manner do not submit those votes until 72 hours before the annual meeting and then update those votes daily to reflect any new instructions.
Companies that have adopted majority voting for director nominees and expect significant “No” votes should be mindful of this trend toward proportional voting. These companies may want to increase their proxy solicitation efforts directed at retail holders to minimize the number of uninstructed shares. In addition, their proxy solicitation firms need to closely monitor the vote total in the last few days prior to the meeting, as proportionally voted shares can result in a significant uptick in “No” votes.
Proposed Changes to NYSE Rules for Brokers on Discretionary Voting
NYSE Rule 452 currently permits brokers to exercise discretion to vote uninstructed shares on routine items. Over time, the list of routine items has been narrowed (e.g., equity compensation plan proposals became nonroutine items in 2003). In October 2006, the NYSE proposed to amend Rule 452 to eliminate broker discretionary voting on director nominees. This proposal, which was revised in 2007, needed SEC approval before it could become effective. The SEC had indicated that it intended to act on the Rule 452 proposal in parallel with adopting new rules on stockholder access to the proxy statement. When the stockholder access proposals became bogged down in politics, the Rule 452 proposal stalled. With the new SEC Chairman recently indicating that stockholder access “is back on the table,” it appears that the NYSE has decided that the time is right to move the Rule 452 amendments forward.
The NYSE filed its latest version of the proposed amendment to Rule 452 on February 26, 2009. If adopted, the amendment would add uncontested director elections to the list of nonroutine items on which brokers would not be allowed to cast discretionary votes. The NYSE argues that adoption of this amendment will lead to “better corporate governance and transparency of the election process.”
Adoption of the proposed amendment would likely result in a reduction in the number of votes “For” the board slate of director nominees (since brokers that have not adopted proportional voting currently tend to vote uninstructed shares in favor of the board’s slate). For companies that have adopted majority voting, this could make it harder to achieve a successful election. Adoption of the amendment to Rule 452 would also magnify the impact of “No” vote campaigns by activist stockholder groups. Finally, since institutional holders tend to be more likely to vote their shares than retail investors, the amendment will magnify the impact of the institutional holders’ votes.
If adopted, the proposed amendment could also make it harder to achieve a quorum at stockholder meetings. At many annual meetings, there are no items of business other than election of directors and, perhaps, approval of equity compensation plans. If election of directors joins approval of equity compensation plans on the list of nonroutine items, then uninstructed shares will not be eligible to vote on any items before the meeting. In Delaware, all shares covered by a proxy card executed by a broker count toward achieving a quorum, even if the proxy card includes broker non-votes. Where the business at a meeting includes only nonroutine items, however, a broker that has received no voting instructions might not return a proxy card at all, thereby reducing the number of shares counted as present for purposes of the quorum. For companies with a significant retail stockholder base, achieving a quorum may become much more difficult and require increased spending on proxy solicitation firms and follow-up mailings. One way of avoiding a quorum problem would be to include ratification of auditors as an action item at the meeting. Since ratification of auditors would remain a routine item even if the proposed amendments to Rule 452 are adopted, uninstructed shares would count toward a quorum since they could be voted by brokers on a discretionary basis.
If approved by the SEC prior to August 31, 2009, the amendment would be applicable to proxy voting for stockholder meetings held on or after January 1, 2010.