On July 1, 2009, the Securities and Exchange Commission (“SEC”) approved long-awaited amendments to the New York Stock Exchange (“NYSE”) Rule 452 and corresponding Section 402.08 of the Listed Company Manual that eliminate broker discretionary voting for the election of directors, except for companies registered under the Investment Company Act of 1940.1 The amendments apply to shareholder meetings held on or after January 1, 2010. The amended Rule 452 will affect nearly all public companies because most large brokerage firms are member organizations of the NYSE and subject to its rules. After the rule becomes effective on January 1, 2010, these brokerage firms will be unable to engage in discretionary voting for the election of directors of most public companies, even those not listed on the NYSE.
History of Discretionary Voting
A shareholder of a public company can hold shares directly, as a record holder, or indirectly, through a broker. Over the years, the quantity of shares that are held indirectly, or “in street name,” has grown dramatically and now represents the vast majority of publicly traded shares. Under NYSE rules, brokerage firms controlling shares held in street name are required to deliver the proxy materials to the beneficial shareholders and request voting instructions regarding matters to be considered at the shareholder meeting. If the broker has not received voting instructions from a beneficial shareholder by the tenth day preceding a shareholder meeting, the broker may vote on behalf of the shareholder on any matter that is considered “routine” by the NYSE.
Historically, “uncontested” director elections were considered routine while “contested” director elections were considered “non-routine.” Thus, brokers could exercise their discretion in voting on uncontested elections but not contested elections. The amendment eliminates the distinction between contested and uncontested elections by reclassifying uncontested elections as a non-routine matter, thereby prohibiting brokers from exercising voting discretion on any director elections.
Reason for the Amendments
In 2005, the NYSE formed a “Proxy Working Group” to focus on NYSE Rule 452 and other proxy rules in response to criticism that participation in director elections should be limited to persons who have an economic interest in the company. Opponents of the discretionary voting rule also argued that limiting discretionary voting to uncontested elections was not sufficient because the NYSE’s definition of uncontested elections included elections which were quite competitive through “vote no” campaigns. The Proxy Working Group concluded that “[d]irectors are simply too important to the corporation for their election to ever be considered routine,” and submitted a proposal to the SEC to categorize uncontested director elections as non-routine.2
Potential Negative Impacts
As a result of amended Rule 452, public companies will experience greater costs and challenges soliciting shareholder votes. The impact will likely be most significant for smaller companies which have a higher proportion of retail stock ownership and broker discretionary voting than larger companies.
We expect that amended Rule 452 will have the following consequences:
- Difficulty in obtaining a quorum for shareholder meetings
Many state corporation statutes allow broker discretionary votes cast on a routine matter to count toward establishing a quorum for all matters, including non-routine matters, considered at a shareholder meeting. Therefore, broker votes have typically played an important role in establishing a quorum in uncontested director elections. Because brokers will now be unable to cast discretionary votes on director elections, companies will need to find alternative ways of establishing a quorum.
- Difficulty in achieving a majority vote
Many companies have modified their organizational documents so that the election of a director requires a majority of the votes be cast in favor of the director nominee. The loss of broker discretionary votes could significantly lessen the votes in favor of the directors and make it more difficult for the nominees to obtain the required majority vote. Achieving the majority standard could be especially difficult if there is a “vote no” campaign, as discussed below.
- Greater influence of activist shareholders through “vote no” campaigns
As a cheaper alternative to proxy contests, some activist shareholders have sought to influence a company by encouraging other shareholders to withhold their votes for one or more of the company’s nominees for director. Brokers generally cast their discretionary votes in favor of the company’s nominees; therefore, eliminating broker discretionary voting in uncontested elections could increase the effectiveness of “vote no” campaigns because the brokers’ discretionary votes will no longer counter-balance the votes cast in opposition of the nominees.
- Greater control by institutional investors and proxy advisory firms
Because brokers will be unable to cast discretionary votes and institutional investors typically vote in higher percentages than retail investors, the votes cast by institutional investors will account for a larger percentage of the returned votes. Thus, institutional investors may have more influence on the election of directors. In addition, proxy advisory firms, who advise institutional investors on how to vote, may also exert more influence on director elections.
Your company should consider these recommendations in preparing for its 2010 proxy season:
- Educate your company's investor relations group, senior management and board about the potential effects of eliminating broker discretionary votes for directors, including additional costs.
- Consult a proxy solicitation firm about your company’s shareholder base and the likely impact of eliminating broker discretionary votes for directors.
- Consider possible changes to your company's annual meeting bylaws, to increase the likelihood of a successful vote.
- Evaluate the risk of “vote no” campaigns based on proxy advisory firm reports about your company.
- Coordinate with institutional shareholders and proxy advisory firms on their governance assessments and voting recommendations.
- Increase the likelihood of a quorum for your annual meeting by including in the agenda a routine matter, such as auditor ratification, on which brokers can cast discretionary votes.
- Consider possible changes in how your company communicates with its retail shareholders (e.g., supplementing proxy solicitation efforts, decreasing reliance on electronic delivery of proxy materials to retail investors under the SEC’s notice and access rules).
- Educate your retail shareholders about the increased importance of their vote (e.g., describing in the cover letter that accompanies the proxy materials the elimination of broker discretionary voting for directors).