On July 1, 2009, the Securities and Exchange Commission approved a change to New York Stock Exchange Rule 452 (and Section 402.08 of the NYSE Listed Company Manual) that eliminates the ability of brokers to exercise discretionary voting in uncontested director elections. Specifically, this change adds the election of directors to the list of specified “non-routine” matters on which NYSE member organizations are prohibited from giving a proxy without receiving voting instructions from a beneficial owner. Because NYSE Rule 452 applies to all brokers that are members of the NYSE, this change will impact virtually all U.S. public companies regardless of the exchange on which they trade, not just NYSE-listed companies.
The revision to NYSE Rule 452, which will be effective for shareholder meetings that are held on or after January 1, 2010, could have a significant impact on many public companies, particularly those with a large base of retail shareholders. The rule change and its potential impact are discussed in greater detail below.
The Rule Change
NYSE Rule 452 provides, in part, that an NYSE member organization may give a proxy to vote stock on a matter without customer instructions if the broker has transmitted proxy soliciting material to the customer and the customer does not provide the broker with voting instructions on that matter at least ten days before the scheduled meeting. However, NYSE Rule 452 contains a specific list of matters on which brokers may not give a proxy to vote without first receiving instructions from the customer. Generally, this list includes “non-routine” matters that would substantially affect the rights and privileges of shareholders, such as matters relating to a merger or consolidation or authorizing the alteration of the terms or conditions of existing stock.
Historically, an uncontested election of directors—that is, where no other party proposes nominees in opposition to the management slate—was considered a routine matter, and thus not subject to NYSE Rule 452. As a result, brokers had discretion to vote uninstructed shares in an uncontested election of directors, which they typically did in favor of the management slate.
In April 2005, in the continuing wave of post-Enron corporate governance reforms, the NYSE created a Proxy Working Group to review NYSE rules regulating the proxy voting process. The Proxy Working Group concluded that the election of directors should no longer be considered a “routine” event in the life of a corporation, in part because of the authority that directors have over the most fundamental issues of corporate governance, and recommended that brokers be prohibited from voting uninstructed shares with respect to any election of directors.
The NYSE filed the original proposed rule change with the SEC on October 24, 2006, and it was circulated to NYSE listed companies for comment. As a result of issues raised by the investment company community, the NYSE amended the proposal to exclude companies registered under the Investment Company Act of 1940 (i.e., registered investment companies). The NYSE subsequently filed a total of four amendments to the original proposal, and the proposal as revised was formally published by the SEC on February 26, 2009 for public comment. In total, the SEC received 153 comment letters with respect to the proposed rule change.
Impact of the Revised Rule
These changes to NYSE Rule 452 could have a potentially significant impact on the ability of issuers to obtain sufficient votes for the election of directors. They are likely to afford institutional investors, proxy advisory firms and activist shareholders greater influence over the election of directors for many public companies.
Issuers who have adopted, or are considering the adoption of, a majority voting standard also should pay close attention to the rule change. The inability of brokers to vote uninstructed shares makes it likely that fewer shareholder votes will be cast in an uncontested election of directors. Because fewer votes will be cast, it may be more difficult for a director standing for election to the board of an issuer that has adopted majority voting to receive the number of votes necessary for his or her election (or re-election).
Higher Costs for Uncontested Elections
Revised NYSE Rule 452 may force issuers to be more active in soliciting shareholder votes to achieve a quorum and to achieve a majority vote, which could materially increase the cost of uncontested elections. The Proxy Working Group itself noted that “[the rule change] is likely to increase the costs of uncontested elections, as issuers will have to spend more money and effort to reach shareholders who previously did not vote. These costs may increase substantially with the rise of majority voting for directors, as issuers have to obtain the votes from shareholders who may not realize that their failure to vote constitutes a ‘no’ vote.” The Proxy Working Group went on to note that “[t]hese consequences could fall most dramatically on smaller issuers, who have a smaller proportion of institutional investors and/or have greater difficulty in contacting shareholders and convincing them to vote in uncontested elections.”
Increased Influence of Certain Constituencies
If the changes to NYSE Rule 452 result in fewer shares of retail shareholders being voted, then the votes of other constituencies, such as institutional investors, will become of increasing relative importance in the determination of uncontested elections. Some commenters believe that this will give disproportionate influence to institutional investors and the proxy advisory firms that advise them. Others believe that it will allow activist shareholders to wield greater power, especially in a “no” or “withhold” vote campaign waged on an issuer who has adopted majority voting for the election of its directors. Regardless of whether these effects will be as dramatic as some commenters predict, issuers may find that, at least in the near term, they need to spend more time soliciting the support of institutional and activist shareholders in advance of their annual meetings.
Establishment of a Quorum
Many commenters have noted that the rule change could make it more difficult for an issuer to establish a quorum for the conduct of business at its annual meeting. That could occur if brokers do not receive voting instructions in an uncontested election situation, and no other routine matters (such as the ratification of an issuer’s independent auditor) is included on the ballot, unless brokers nonetheless return proxies for such shares as “non-votes” and the shares are thereby considered, under applicable state law, as present at the meeting for purposes of establishing a quorum. It is uncertain whether brokers will return proxies in such situations, or that such “non-vote” shares will be deemed under state law as “present” and “entitled” to vote at the meeting—the typical standard for a quorum—even though they cannot be voted as a practical matter.
Accordingly, where all matters on the ballot are non-routine, an issuer may be required to enlist a proxy solicitor, or otherwise incur additional costs, to ensure the presence of a quorum.
Interaction with New E-Proxy Rules
Notably, these changes to NYSE Rule 452 follow on the heels of the advent of e-proxy and the recent implementation by many issuers of the new “notice-only” model for delivery of proxy materials. By all accounts, issuers who have elected the notice-only delivery method have seen a significant decrease in participation by retail shareholders. In 2008 and 2009, many of the shares held by the non-participating shareholders were voted by brokers exercising discretionary voting power under NYSE Rule 452, but in 2010 brokers will no longer be able to vote these uninstructed shares. As a result, it could be even more difficult for issuers electing the notice-only delivery method to establish a quorum for their post-2009 annual meetings. In addition, issuers who have adopted majority voting for the election of directors should carefully consider whether to use the notice-only method to deliver proxy materials for any such meeting, especially if the participation of retail shareholders is important to the election.
Voter Education Needed
In its report, the Proxy Working Group recommended that the amendment to Rule 452 be one part of a broader review of the proxy voting process, and stressed the importance of conducting a “large scale investor education effort” in connection with the amendment. The Proxy Working Group went on to note that “[i]n the absence of such an education effort, there is a danger that investors’ questions about the proxy process will remain, leading to an even greater decline of retail investors in the proxy process.” While an education campaign of the sort referred to by the Proxy Working Group may eventually counteract some of the potential negative effects of the amendment, any such campaign will take some time to affect the behavior of retail investors. In the meantime, the changes to NYSE Rule 452 will impact many annual shareholder meetings in 2010 (and perhaps beyond), and issuers would be wise to consider the potential impact well in advance of their meetings.