On July 1, 2009, the Securities and Exchange Commission (the “SEC”) voted to approve an amendment to New York Stock Exchange (“NYSE”) Rule 452, Giving Proxies by Member Organizations, to eliminate discretionary voting by brokers in uncontested director elections.1 The amendment will take effect for shareholder meetings held on or after January 1, 2010.2 The amendment applies to all brokers that are members of the NYSE and therefore impacts voting practices at all public companies, not just those listed on the NYSE.3
The amendment to NYSE Rule 452 may make it harder for directors of many public companies to achieve the vote necessary for their election. However, the amendment was not adopted without controversy—two SEC Commissioners voted against the change, in part, because they believed that any changes to Rule 452 should be made as part of a broader review of different aspects of the proxy voting process, such as e-proxy, company communications with shareholders, proportional voting and client directed voting of uninstructed shares, so-called “over-voting” and “empty voting”, and the role and influence of proxy advisory firms.
Current Rule 452
Between 70 to 80 percent of public company equity is held of record by brokers, banks or depositories rather than by the actual shareholders.4 Brokers are currently required to deliver proxy materials to the beneficial owners of shares and request instructions on voting. If the instructions are not returned by the tenth day before the date of a meeting, the broker may vote on behalf of the beneficial owners with respect to certain “routine” matters, including “uncontested” director elections. Proxy campaigns that challenged the incumbent board’s recommendations, but did not result in a competing solicitation, including “just vote no” and “withhold” campaigns, were not considered “contests” for purposes of Rule 452. Brokers traditionally voted uninstructed shares in accordance with the incumbent board’s recommendations. Consequently, broker-voted shares often helped incumbent management maintain their positions.
The amendment will prohibit brokers from voting on the election of directors, whether contested or uncontested, absent specific instructions from the beneficial owner of the shares.5 The amendment stems from recommendations provided by the Proxy Working Group (“PWG”), a committee formed in April 2005 by the NYSE to review the proxy voting process. The amendment is designed to ensure that persons with an actual economic interest in a company vote to elect directors. The PWG acknowledges that the change will result in increased costs for companies, but contend that the price is worth paying for better corporate governance and greater transparency in the election process.
It should be noted that several brokerage firms had adopted policies requiring brokers to vote uninstructed shares in the same proportion as instructed shares.6 While this had the effect of ensuring the representation of these shares at shareholder meetings, the PWG ultimately rejected this approach because it still ascribed a voting intent to uninstructed shares.
Disproportionate Impact On Retail Shareholder Vote
The inability of brokers to vote uninstructed shares in director elections will diminish the votes of retail shareholders disproportionately. Unlike institutional shareholders, relatively few retail shareholders—less than 21 percent in 2007, according to Broadridge—vote their shares.7 The impact of retail shareholder inaction was traditionally mitigated by the ability of brokers to vote in uncontested director elections and other routine matters. In addition, these votes tended to favor management either because the brokers voted uniformly for management proposals or because proportionate voting still resulted in greater than majority support for management proposals.
As a result, directors of companies that have a significant retail shareholder base and that have adopted a majority voting policy (approximately 70 percent of companies in the S&P 500 have adopted such a policy)8 may find it harder to achieve the requisite majority of votes.9 Conversely, in the face of a fall in retail shareholder voting, institutional investors and activist shareholders will find the power of their votes enhanced. As a result, directors of companies that have performed in the bottom half of their industry sector in 2008 will face an even greater challenge as a result of possible “withhold” or “vote no” recommendations by RiskMetrics in particular and other proxy advisors in general. This is likely to result in increased use of “vote no” campaigns, which do not require any solicitation in opposition and represent a cheap and, for companies with majority voting policies, effective way to remove board members.
In light of the foregoing, companies should review carefully the impact that the amendment would have had on their 2009 annual meeting in order to plan for their 2010 meeting. Companies may wish to consider ways to improve communications with their retail shareholder base in order to continue garnering their vote. In addition, it would be prudent for companies to review any majority voting policies to see if they offer the board some flexibility in the removal, or acceptance of the resignation, of a director that failed to meet the majority requirement.
The number of retail shareholder votes was on average halved among companies that adopted notice-and-access. In 2008, Apple Inc.’s use of notice-and-access was believed by many to have contributed to a 50.7 percent vote in favor of a say-on-pay proposal opposed by the board. In that case, only 4 percent of Apple retail shareholders went online to vote despite the fact that they held 30 percent of the company’s shares. Companies should consider carefully their strategies to use e-proxy following the amendment to NYSE Rule 452.
Cost is not the only obstacle companies face in communicating with retail shareholders. Companies may simply be unable to contact shareholders who choose to have their names and addresses withheld from companies seeking contact information from brokers. These shareholders, called objecting beneficial owners, or OBOs, present a major obstacle for companies attempting to communicate with investors. The SEC is likely to consider ways to address the challenges of shareholder communications, including OBOs.
Uninstructed shares voted by brokers in director elections counted for the purpose of determining whether a quorum was present for other matters voted upon at a shareholders’ meeting. Now that director elections are not considered routine, unless there is another routine item on the agenda, uninstructed shares will not count towards a quorum. The ratification of a company’s auditors will still be considered a routine item and a large number of companies submit this matter to a shareholder vote. Those companies will be able to continue using broker votes for that matter to achieve a quorum for other matters. Companies that do not have auditor ratification or another routine matter on the agenda should consider including at least one routine item to ensure they have a quorum for future shareholder meetings.