In a move that could affect future elections of corporate directors, the Securities and Exchange Commission (the “SEC”) has voted to approve amendments to New York Stock Exchange (“NYSE”) Rule 452, as submitted by the NYSE. Beginning January 1, 2010, discretionary voting by brokers in uncontest-ed elections of directors will no longer be permitted. This rule impacts any public companies with stockholders who are clients of NYSE-member brokerage firms, not just those companies listed on the NYSE.
The amended rule will prohibit the long-established practice of NYSE member brokers voting for a slate of directors where their clients, the beneficial holders of stock, have failed to provide any explicit instruction on how to vote. Such failures to provide instruction have been common occurrences in the past among retail holders, and have allowed their brokers to play a significant role in a number of elections.
In its July 2009 press release, the SEC stated that “the NYSE proposal is designed to enhance corporate governance and accountability by helping assure that investors with an economic interest in the company vote on the election of directors.”
While acknowledging that 93 out of 137 public commenters urged further consider-ation of the proposed amendment, the SEC also noted that only 12 commenters opposed the amended rule compared to 28 commenters who supported its immediate adoption. See SEC Release No. 34-60215 at http://www.sec.gov/rules/sro/nyse/2009/34-60215.pdf.
The impetus for reform
In April 2005, the NYSE formed a working group to review its rules regarding the proxy voting process (the “Proxy Working Group”).
Under NYSE Rule 451, when a public company furnishes proxy materials to its record shareholders, securities intermed-iaries (such as brokers) who hold the securities for their clients in street name must then deliver the proxy materials to the beneficial holders and request voting instructions from them.
If shareholders do not return any voting instructions, then securities intermediaries may vote those shares at their discretion under Rule 452, provided that “the person in the member organization giving or authorizing the giving of a proxy has no knowledge of any contest as to the action to be taken at the meeting and provided such action... does not include authorization for a merger, consolidation or any matter which may affect substantially the rights or privileges of such stock.” Thus, brokers, when they have not received voting instructions from their clients, historically could and have cast votes for a management slate of directors running without a contest (as well as other matters deemed “routine”, such as ratification of auditors). The Proxy Working Group noted that a large proportion of shares are now held in street name, which has increased the potential influence of brokers in elections. In fact, past broker votes (brokers typically have voted for management recommendations) have made the difference in some “just vote no” campaigns where directors have needed a majority of votes for election.
Furthermore, in recent years, the NYSE interpretation of a “contested election” has come under some scrutiny, especially as an increasing number of proxy campaigns have targeted the election of directors without any formal contest.
Thus, the Proxy Working Group recommend-ed that “the election of directors should no longer be viewed as a ‘routine’ matter in the life of a corporation” that would allow for discretionary broker voting under NYSE Rule 452. “Investors, courts, regulators and others expect directors to be accountable for the corporate decision-making process, and the primary way that accountability is expressed is through the director election process,” the Proxy Working Group said.
The NYSE ultimately adopted the 2006 recommendation to amend Rule 452, as well as the 2007 addendum of the Proxy Working Group, which clarified that the amendment should not apply to investment companies registered under the Investment Company Act of 1940.
In July of this year, the SEC agreed with the recommendation, stating that “the Commiss-ion believes that the NYSE proposal should better enfranchise shareholders by helping assure that votes on matters as critical as the election of directors are determined by those with an economic interest in the company, rather than the broker who has no such interest.” The SEC added that “research conducted on behalf of the Proxy Working Group indicates that the NYSE proposal may, in fact, be consistent with an assumption of many shareholders that only they can vote their shares.”
As commenters have noted, this rule change could affect the election of directors at public companies in several ways:
1. Increased Costs to Achieve Quorums
Many corporate commenters have suggested that the relatively low retail shareholder participation rate in corporate elections could increase the difficulty of obtaining a quorum to elect directors under the new rule.
This could result in higher proxy solicitation costs and necessitate more vigorous campaigns urging voter participation. Smaller companies in particular are likely to be affected because of their typically greater percentage of retail holders.
Based on statistics presented by public commentary, it would appear that in 2004, 23 percent of companies would not have achieved a quorum under this rule because of lack of voter participation.
But the SEC noted that a vast majority of affected companies include the ratification of independent auditors as a “routine” matter for shareholders to approve (even though generally not required by law to do so), so that these companies could obtain a quorum for annual meetings involving elections of directors by including both matters on the ballot (allowing brokers to cast votes and be counted present under the auditor approval measures). The SEC added that where necessary state laws could be amended to allow for broker discretionary ballots to be counted solely for purposes of establishing a quorum.
2. Influence of Proxy Advisory Firms
Several commenters expressed concerns that the new rule would shift disproportionate weight to institutional investors while increasing the influence of proxy advisory firms which provide voting recommendations for their institutional clients.
The SEC acknowledged that greater shareholder education and communication might be necessitated by this measure, but asserted that such steps would be positive. It also noted that “institutional investors, whether relying on proxy advisory firms or not, must vote [their] own shares and, in so doing, must discharge their fiduciary duties to act in the best interests of their investors.”
3. Impact on Companies with Majority Vote Requirements
Commenters suggested that those companies requiring each director to receive a majority of the votes cast (rather than a plurality) could be impacted as well.
But the SEC noted that 74.9 percent of companies in the Russell 3000 still use a plurality standard for voting. It also cited a recent report on companies with majority vote standards, noting that only two directors out of 2,718 would have received at least 50 percent “withhold” votes based on the failure to include broker discretionary votes in 2008.
Effective date for compliance
The SEC agreed that improved shareholder education about the proxy process and the importance of casting votes was appropriate prior to the rule becoming effective, but stated that “there should be sufficient time for NYSE to inform market participants of the changes to its rules on broker discretionary voting” because of the effective date of the amended rule.
NYSE amended Rule 452 will apply to all shareholder meetings held on or after January 1, 2010, except to the extent that a meeting was originally scheduled for prior to that date but was properly adjourned to a later date thereafter.