One of the hottest issues in U.S. corporate governance over the last several years has been majority election of directors. Those advising public companies on governance issues must have a firm grasp on the basics of majority election and how it relates to other significant current developments that may change the way U.S. corporate directors are elected.
Plurality v. Majority Election
Plurality voting for directors has been, and continues to be, the prevailing legal rule throughout the United States. Nearly all state corporate statutes, including the Delaware General Corporation Law (“DGCL”), provide that, unless stated otherwise in a corporation’s charter, nominees receiving the most votes, up to the full number of seats open, are elected – even if such nominees do not receive a majority of votes cast in their favor. Plurality voting is intended to ensure continuity of the board.
Shareholder activists have maintained that plurality voting does not adequately permit shareholders to express disapproval. They argue that votes withheld have no real effect. In an uncontested election, each nominee in the board’s slate will still be elected so long as he or she receives at least one affirmative vote, even if a majority of votes are withheld. If directors must receive an affirmative majority of votes cast to be elected, then withheld or negative votes will have real meaning.
In 2003, the SEC proposed a new rule that would have given 5% shareholders of U.S. public companies the power to nominate their own director candidates in the company’s proxy materials under certain circumstances. As it became clear that the SEC was not going to move forward with its 2003 “shareholder-access” proposal, activists turned their attention to majority election as a means of expressing their influence and giving shareholder disapproval real teeth.
In 2005, shareholder activists, led by the Council of Institutional Investors and labor union pension funds, began flooding larger public companies with letters and formal shareholder proposals requesting boards to initiate amendments to their charters necessary to implement a majority-voting regime for directors. In 2005, 54 formal shareholder proposals calling for majority election were voted on, receiving an average of 44% of votes cast in favor (with 13 garnering majority favorable votes).
Pfizer’s Director-Resignation Policy
In June 2005, Pfizer Corporation announced that its board of directors had taken a different approach. Rather than adopt majority voting by charter amendment, the Pfizer board simply adopted a corporate governance principle requiring any nominee who receives more votes withheld than in favor to submit his or her resignation. Pfizer’s board governance committee would then decide whether to accept the resignation. The principle was later amended to apply only to uncontested elections and to require that the director in question not participate in the decision whether to accept the resignation, that such decision be made within 90 days and that the reasons for the decision be published in a press release.
In the face of increasing pressure from activists, dozens of other large public companies followed the Pfizer example and began adopting director-resignation governance principles.
Some shareholder activists, including most notably the United Brotherhood of Carpenters and Joiners pension fund, maintained that Pfizer-type governance principles did not go far enough, arguing (among other things) that the principle did not really adopt majority voting and that boards may choose not to accept the tendered resignations or may simply rescind a principle without consulting shareholders.
Nevertheless, in November 2005, Institutional Shareholder Services (now RiskMetrics Group) announced that, although it generally supported proposals calling for majority voting in uncontested elections, it would consider opposing such proposals in the future if the company in question had adopted formal governance principles offering a “meaningful alternative” along the lines of the Pfizer approach. There was, however, no assurance that any particular policy would suffice, and ISS has supported majority-election proposals since such announcement in nearly every case notwithstanding adoption of Pfizer-type governance principles at the companies in question.
In January 2006, the SEC staff refused to let Hewlett-Packard and Gannett Co. omit majority-election bylaw proposals (submitted by the Carpenters) from their proxies on grounds that the proposals had been “substantially implemented” within the meaning of the exclusion in Exchange Act Rule 14a-8(i)(10) by previous adoption of Pfizer-type governance policies.
Intel Majority-Election Bylaw
Following the Hewlett-Packard and Gannett no-action letters, Intel announced in January 2006 that it had adopted a new bylaw provision requiring election of directors by a majority of votes cast, except in contested elections. Under the Intel bylaw (as amended), a new director nominee, in an uncontested election, who fails to receive a majority of votes cast in his or her favor is not elected. An incumbent nominee who fails to get the required vote remains in place under the so-called “holdover” rule (i.e., directors remain in place until their successor is elected and qualified) contained in the DGCL and all other corporate statutes, but must tender his or her resignation. Intel’s board governance committee must decide whether to accept or reject the resignation within 90 days.
The Intel bylaw rapidly became the gold standard for shareholder activists promoting the cause of majority election. This is because it actually adopts a majority-vote standard (instead of just a resignation policy) and because it is part of the company’s charter documents and may be made less easy to change or eliminate without shareholder consent than a mere board-adopted governance principle.
A Delaware corporation, like Intel, may adopt a majority-election standard by bylaw amendment, which may be approved by either the board or the shareholders. Most other state corporate statutes (including the Minnesota Business Corporation Act) currently require that a change to the default plurality-voting rule be made in the articles of incorporation, not the bylaws. So, adoption of an Intel-type bylaw is not an option, and corporations incorporated in those states would have to amend their articles (usually requiring both board and shareholder approval) to adopt a true majority-voting requirement or instead adopt a Pfizer-type governance policy.
Activists have also called for states to change the default rule in their corporate statutes from plurality to majority and make other changes to accommodate majority-voting bylaws and policies.
In response, the American Bar Association Committee on Corporate Laws, which is responsible for the Model Business Corporation Act (the basis for the corporate statute in more than half the states) studied the question and, in 2006, finalized amendments to the Model Act. The amendments did not change the Model Act’s plurality-vote default rule. They did, however, permit either the shareholders or the board to amend the bylaws to provide that, in uncontested elections, a director nominee receiving more votes withheld than in favor would generally serve no more than a 90-day transitional term. If adopted by shareholders, such a bylaw amendment may not be rescinded or modified by the board. The Model Act amendments also confirm the validity of director resignations made conditional on the happening of a future event (such as failure to receive the favorable vote of a majority of those cast) and permit opting out of the “holdover” rule by amendment to the articles of incorporation. See ABA Committee on Corporate Laws, Changes in the Model Business Corporation Act – Amendments to Chapter 7 and Related Provisions Relating to Shareholder Action Without a Meeting, Chapters 8 and 10 Relating to Shareholder Voting for the Election of Directors, and Chapter 13 Relating to Appraisal and Other Remedies for Fundamental Transactions, 61 Bus. Law. 1427 (2006).
The Delaware legislature has also maintained the DGCL’s plurality-vote default rule. In 2006, however, the Delaware legislature amended the DGCL to provide that a shareholder-adopted bylaw requiring a greater vote for election of directors could not be rescinded or modified by the board and to affirm the validity of conditional director resignations.
In 2006 and 2007, California, Virginia and Washington adopted amendments to their respective corporate statutes retaining plurality default rules, but permitting public companies to adopt majority-election regimes by bylaw amendment under certain conditions. Ohio amended its corporate statute (after a Delaware re-incorporation shareholder proposal campaign directed at Ohio public companies by the Carpenters and the Sheet Metal Workers) to provide that an Ohio corporation may opt out of its plurality-voting default rule by amendment to the articles of incorporation. North Dakota adopted a new Publicly Traded Corporations Act which has a majority-election default in uncontested elections for corporations that do not have cumulative voting.
Shareholder Access, Street-Name Voting and E-Proxy Reform
Other recent developments also promise to have an important impact on corporate director elections and must be considered in conjunction with majority election.
- Shareholder Access. In 2006, a Second Circuit Court of Appeals panel held that AIG International Group could not exclude a binding shareholder-access bylaw proposal submitted by the AFSCME pension fund under the Rule 14a-8(i)(8) exclusion for matters that “relate to an election,” notwithstanding the SEC staff’s long-standing interpretation that such exclusion covers both proposals that would result in a contest in the immediate election and also those that would set up a process for contested elections in the future. AFSCME v AIG, 462 F.3d 121 (2d Cir. 2006). In part as a response to this opinion, the SEC made two contradictory proposals with respect to Rule 14a-8(i)(8) in July 2007. The first proposal explains the SEC staff’s interpretation and would clarify that the Rule 14a-8(i)(8) exclusion covers both proposals resulting in immediate election contests and those that would set up a process for contested elections in the future, in effect overturning AFSCME v. AIG. SEC Release No. 34-56161 (July 27, 2007). The second would instead amend Rule 14a-8(i)(8) to permit shareholders who hold 5% or more of a company’s shares for a year to propose a binding shareholder-access bylaw in the company’s proxy if certain additional disclosure requirements are met SEC Release No. 34-56160 (July 27, 2007). The comment period on the two releases closed October 2. SEC Chairman Christopher Cox has promised that final action on the two proposals, whatever it is, will be taken in time to be effective for the 2008 proxy season. However, the two Democrats on the Commission (Campos and Nazareth), both of whom supported the second shareholder-access proposal, have left or announced their departure. Representative Barney Frank, Chairman of the House Financial Services Committee, has announced that he believes it would be a serious mistake for the SEC to resolve this matter without full Democratic representation on the Commission. Consequently, the timing of any change in the post-AFSCME v AIG status quo is far from clear.
- Street-Name Voting. In response to a recommendation of its Proxy Working Group, the New York Stock Exchange approved and submitted to the SEC in October 2006 an amendment to NYSE Rule 452, which governs discretionary voting by brokers of shares held in street name when beneficial owners have not instructed how such shares should be voted. The amendment would make uncontested director elections (except those at registered investment companies) non-routine matters under NYSE Rule 452, so brokers would no longer be able to vote in favor of management’s slate without instruction from customers. If approved by the SEC, this amendment could have a significant effect on director elections. Vote “no” or “withhold” campaigns would no longer be “diluted” by a block (often in excess of 20% of votes cast) of broker discretionary votes in favor of management’s slate. Companies with majority-voting bylaws or policies may have to work much harder to ensure election of management’s slate. NYSE Rule 452 governs all brokers. Consequently, this proposed amendment would affect all public companies that have shares held in street name, not just NYSE- listed companies. In September 2007, the NYSE announced that the SEC intended to consider approval of the NYSE Rule 452 amendment “as part of a broad range of issues relating to shareholder communications and proxy access” and that, if adopted, the amendment would not be effective for the 2008 proxy season.
- E-Proxies. In December 2006, the SEC approved rules permitting public companies and other soliciting parties, beginning July 1, 2007, to satisfy their proxy information delivery requirements by posting materials on a publicly accessible internet site (other than EDGAR) and sending a prescribed notice (which may not be accompanied by a proxy card) to shareholders at least 40 days before the meeting. Shareholders who wish to receive paper or e-mailed proxy materials may continue to do so by so informing the company or other soliciting party. SEC Release No. 34-55146 (January 22, 2007). In June 2007, the SEC adopted additional amendments to the proxy rules making internet posting of proxy materials mandatory for public companies and other soliciting persons. Under the mandatory e-proxy rules, public companies and other soliciting persons may comply with proxy delivery requirements by the notice-and-access method or may continue full-set delivery of materials (with prescribed notice of internet availability rolled into the proxy materials). The mandatory e-proxy rules go into effect for large accelerated filers (other than mutual funds) on January 1, 2008 and for all other public companies and soliciting persons subject to the proxy rules on January 1, 2009. SEC Release No. 34-56135 (July 26, 2007). The e-proxy rules are intended to decrease the cost of proxy solicitations and make it more cost-effective for persons other than the company to undertake their own solicitations. The rules permit persons making dissident solicitations to avoid printing costs by sending materials only to those shareholders who have not previously asked for paper or e-mail delivery in response to previous notices. It is, however, too early to tell whether the e-proxy rules will result in substantial cost savings, whether significant numbers of public companies will elect notice-and-access solicitation and whether cost reductions will translate into more contested director elections.
Conclusion: Where Do We Go from Here?
Majority-election proposals have remained high on shareholder activist agendas through the 2006 and 2007 proxy seasons, with such proposals receiving average support of over 47% of votes cast in 2006 and over 50% of votes cast in 2007 according to RiskMetrics Group. Proponents, including the Carpenters, have generally not refrained from making a proposal just because a company has a Pfizer-type governance principle in place, but shareholder support for such proposals has generally been lower at companies with a policy in place. Faced with a majority-election shareholder proposal, many companies have adopted Intel-type bylaws. In fact, total numbers of majority-election proposals put to a vote decreased sharply from 2006 to 2007, not because the Carpenters and others were initiating fewer proposals, but because more and more companies were agreeing to adopt provisions preemptively to head off a vote.
By mid-2007, RiskMetrics Group reports that over 60% of the S&P 500 companies have adopted some type of election reform. More than a third of those companies have retained plurality voting but adopted a Pfizer-type resignation policy and a little less than two-thirds have adopted actual majority voting through an Intel-type bylaw or an articles amendment.
In a sign that majority election is here to stay, prominent corporate law firms in Delaware and elsewhere have circulated recommended forms of majority-election policies and bylaws to their clients and essentially indicated that the question, at least for larger public companies, is more “when” than “whether.“
Companies that have not already adopted a majority-election bylaw or policy should consider several points:
- For companies that have not received a shareholder proposal and are not otherwise under pressure from activists to adopt a majority-election measure, there is no compelling reason to rush into doing so. This is especially true given the uncertainties posed by the pending Rule 14a-8 shareholder-access proposals, the proposed amendment to NYSE Rule 452 and the lack of practical experience with the new e-proxy rules. As companies watch and wait to see how these developments play out, boards must be kept thoroughly advised on the majority-election options and their relation to these other developments.
- It appears unlikely that many state legislatures will change the plurality default rule in their corporate statutes to a majority default rule. It remains to be seen how many states will follow the Model Act amendments or those recently adopted in California, Virginia and Washington permitting adoption of majority voting by bylaw amendment – as is already permitted in Delaware. Until that happens, boards of companies incorporated in most states outside Delaware will not be able to adopt Intel-type bylaws and will have to seek shareholder approval to amend the articles in order to adopt majority voting – or be satisfied with a Pfizer-type policy.
- Once approached by activists, a company may be much better off working with the proponent and adopting a measure preemptively rather than permitting the proposal, especially a binding bylaw proposal, to go to a vote. By acting preemptively, the company retains more control over the process and the actual provision adopted. A bylaw proposal, once approved by shareholders, may be impossible to change without another shareholder vote.
- Majority-voting requirements should apply only to uncontested elections. It is crucially important to have an appropriate advance notice requirement in place before a majority-election provision is adopted so the applicable voting regime can be determined an adequate time before the meeting.
The practical realities of majority voting are unlikely to constitute a significant departure from the practical realities of the plurality-voting past for most public companies. Successful “withhold” or vote “no” campaigns in uncontested elections will be rare, even if the proposed amendment to NYSE Rule 452 is approved and broker discretionary voting blocks disappear. But the cumulative effect of majority voting, absence of broker discretionary voting for directors, shareholder access, lower-cost e-proxy solicitation and the next wave of reforms to emerge from the burgeoning corporate governance industry may have a more profound impact on how corporate directors are elected. It remains to be seen whether any of these reforms will advance the real business of our public corporations.