In late October, as expected, the SEC proposed proxy rule changes that would require that “universal proxy cards” be used in contested elections of directors, giving shareholders the ability to pick and choose among all of the nominees put forth by the company’s board and by a dissident shareholder when deciding how to vote. Observers have commented that, if adopted, the proposed rule changes, by making it easier for shareholders to elect director candidates nominated by dissident shareholders, would alter the dynamics of contested director elections—increasing the prevalence of proxy contests and the leverage of activist investors. In our view, adoption of the universal proxy card mandate now appears improbable. In any event, we believe that adoption of the mandate probably would not have a significant effect on contested proxy elections or activist situations. In this Briefing, we:
- Describe the proposed universal proxy card mandate and explain our view that it probably will not be adopted;
- Clarify how a universal proxy card differs from “proxy access” (which continues apace);
- Note the concerns that observers have expressed about a universal proxy card mandate;
- Discuss our view that a universal proxy card mandate, if adopted, likely would not significantly affect contested director elections and activist situations; and
- Note some possible effects of the universal proxy card mandate not being adopted.
The comment period for the proposed rule changes ends January 9, 2017. Thus, even if adopted, the rules would not be in effect for the 2017 proxy season. A universal proxy card permits shareholders who vote by proxy to split their vote between the board’s nominees and a dissident’s nominees Currently, shareholders who vote by proxy in a contested election must choose to vote either for the board’s nominees (on the company’s proxy card) or for the dissident’s nominees (on the dissident’s proxy card). Under the new proposed rules, both the company and the dissident shareholder would distribute a “universal proxy card” to shareholders, listing both the board’s nominees and the dissident’s nominees, and each shareholder voting by proxy could choose to vote for any combination of the nominees on the two lists. Current rules effectively preclude shareholders who vote by proxy from splitting their vote between the board’s nominees and a dissident’s nominees, although a split vote is permitted for shareholders who vote in person at a meeting or otherwise properly instruct the company regarding their Fried Frank M&A Briefing 2 vote. The impetus for the universal proxy card mandate has been to redress the artificial difference in voting flexibility for shareholders who vote by proxy as compared to those who vote in person or instruct the company. We note that, currently, institutional and other large shareholders have the knowledge and resources to vote at a meeting or to instruct the company when they wish to split their vote, while retail shareholders typically do not have the knowledge or resources to do. In our view, adoption of the universal proxy card mandate now appears improbable Of the three current SEC Commissioners, only SEC Chair White has been a strong proponent of the universal proxy card approach. Chair White has announced that she will be resigning by the end of President Obama’s term. SEC Commissioner Pinowar, who is reportedly being considered for the position of interim SEC Chair pending selection of a successor SEC Chair by President-Elect Trump, has been against a universal proxy card mandate, arguing that it would increase the likelihood of proxy fights and thereby distract managements from their core mission of operating companies. Further, the universal proxy card concept has been strongly disfavored by Republicans in the House of Representatives, who passed a bill this summer prohibiting the SEC from using any funds to propose or enforce a universal proxy card requirement. Particularly given the likelihood of new or different priorities at the SEC under the incoming Presidential administration, in our view, it is now unlikely that the universal proxy card mandate will be adopted. The universal proxy card mandate is different from “proxy access” Following the SEC’s failed effort to enact rules requiring “proxy access,” approximately 40% of S&P 500 companies now have adopted “proxy access” bylaws (up from 1% in 2014 and 5% in 2015). Like a universal proxy card, “proxy access” allows a shareholder to have its director nominees listed on the company’s proxy card and allows shareholders voting by proxy to split their vote between the board’s and the dissident’s nominees. However, proxy access does not have the same objective or effect as a “universal proxy card” would. “Proxy access” has been intended as a vehicle to facilitate the nomination of director candidates by major, long-term shareholders in non-control contests—not intended to facilitate nominations by activists or other short-term shareholders who seek to influence or change control of the company. Unlike the proposed universal proxy card mandate, proxy access bylaws: Do not apply to contested control elections—that is, in most cases, the bylaws do not permit proxy access if the shareholder has, or has had, an intention to change or influence control at the company (as in the case, for example, of an activist investor who has approached the company to propose changes); Almost invariably apply only to shareholders who have held at least 3% of the company’s shares for at least three years and who are not nominating more than 20% of the board; and Permit a shareholder making nominations to avoid the expense of proxy materials and a proxy solicitation (by providing that the company will include in its own proxy statement information about the shareholder and its nominees, as well as a statement by the shareholder in support of its nominees). Fried Frank M&A Briefing 3 Proxy access is not designed to have a significant impact on proxy contests or activist situations As noted, proxy access is focused on allowing a long-term major investor of a company to piggyback on the company’s proxy materials in a non-control election. By contrast, the universal proxy card approach is focused on making it easier for shareholders to split their vote, in either a control or non-control election, and, as a practical matter, making it just as possible for a retail investor (who does not necessarily have the knowledge or resources to vote in person or to properly instruct the company with respect to the vote) to split his or her vote as it is for an institutional investor (who typically does have the resources to vote in person or to properly instruct the company). So far, proxy access has been used to nominate directors only one time. In November 2016, GAMCO Asset Management Inc., which is affiliated with activist investor Mario Gabelli, nominated director candidates for election at the 2017 annual meeting of National Fuel Gas Company, using National Fuel Gas’s proxy access bylaws. Like most proxy access bylaws, GAMCO’s bylaws included a requirement that the nominating shareholder must have acquired its shares in the ordinary course of business and not with the intent to change or influence control of the company, and that the shareholder must not presently have such an intent. According to National Fuel Gas, GAMCO had expressed an intention to change or influence control of the company and therefore was ineligible to use proxy access. GAMCO withdrew its nominations (without challenging or conceding the company’s contention). We believe that proxy access is likely to continue to be utilized only infrequently. Activists in most cases will not be eligible to use proxy access because, typically, they will not meet the 3%-ownership-for-atleast-three-years requirement or the “passive investment”-type restriction. Moreover, both activists and large shareholders in most cases want to engage in a more typical election contest process in which they produce their own materials and conduct their own solicitation. For these shareholders, generally, the potential cost-saving benefits of piggy-backing on the company’s proxy statement would be outweighed by the disadvantages of not conducting one’s own proxy solicitation. Opposition to a universal proxy card mandate has centered on concerns that it will lead to more proxy contests and increased leverage for activists Opposition to a universal proxy card mandate has been based primarily on concerns that: Dissident nominees would garner more votes if shareholders can vote for one or more of them while also voting for one or more of the board’s nominees—and that this will lead to more proxy contests, more pressure on companies to settle with dissidents to avoid the risk of loss of proxy contests, more replacement of existing directors with dissident directors, and more “shorttermism” by companies to appease shareholders; The election process could become based not on the fundamental shareholder-oriented judgment about support-for-the-board versus need-for-change, but, instead, on a more personal kind of judgment about each individual director candidate’s qualifications for office; Greater proxy costs would be imposed on companies (which, for smaller companies, could be significant); Greater confusion could result for retail investors as to which nominees are being supported by the board and which by a dissident shareholder; and Fried Frank M&A Briefing 4 A universal proxy card mandate could come to be viewed as a substitute for, and therefore limit further adoption of bylaws providing for, proxy access. In our view, the universal proxy card mandate, if adopted, would not significantly affect the outcome of proxy contests or activist situations As noted, the prevailing view has been that a universal proxy card mandate would increase the leverage of dissident shareholders in achieving election of their director candidates and thus would increase the prevalence of proxy contests and/or settlements to avoid proxy fights. In our view, in most cases, the universal proxy card mandate, if adopted, likely would not have a significant impact on the outcome in control elections or activist situations because: Strategic considerations override considerations relating to mechanics. The strategic decision for an activist whether to commence a proxy contest, and, if so, whether to seek to seat a few nominees or to replace the entire board, will be based primarily on the fundamental strategic considerations involved, not whether the available mechanics do or do not to some extent facilitate shareholders’ ability to split their vote. Institutional and other large shareholders already have meaningful incentive, and the ability, to split their vote when they wish to do so. By providing a ready-made, easy mechanism (merely checking a box on the single proxy card received) for splitting a vote between a board’s and a dissident’s nominees, shareholders may be encouraged to some extent to split their vote more often than currently (as the current mechanism for doing so is more difficult, involving either attending the meeting in person or properly instructing the company with respect to the shareholder’s vote). However, making it easier to split-vote by proxy should not significantly affect an institutional or large shareholder’s incentive as to whether or not to split its vote, and that decision is likely going to be made, as it is now, primarily based on the shareholder’s view of the substantive merits, not on the ease with which a split vote can be accomplished. While the universal card mandate would have a significant effect on retail shareholders’ ability to split their vote (as they typically do not have the knowledge or resources to appear in person or instruct the company, even in a contested election in which they would want to split their vote), the retail vote in the aggregate is typically a relatively small percentage of the overall vote and in most cases does not have a meaningful impact on the outcome of a proxy contest. Most contested situations are settled before a vote. Currently, the vast majority of cases involving a potential proxy contest or activist situation end in a settlement, without a proxy contest. Settlements occur because both sides usually prefer to avoid the expense, distraction, and, especially, the uncertainty of result, of a proxy fight. At the same time, both sides usually have a good sense of the likely support (or lack of support) from the large shareholders, leading to settlement. Availability of a universal proxy card and split voting would not likely affect these fundamental facts-on-the-ground in a significant way. Dissidents rarely propose full slates. With a universal proxy card, when a dissident shareholder proposes a full slate of director candidates (i.e., a wholesale replacement of a board, or at least directors who represent control of the board), shareholders would no longer have to choose between the dissident’s full slate and the board’s full slate. Thus, a universal proxy card could make it less likely that, when a dissident puts forth a full slate, the full slate (as opposed to just some of the nominees) would be elected. However, most dissident campaigns already are Fried Frank M&A Briefing 5 focused on the election of a small number of nominees rather than wholesale replacement of the board. We note that there may be circumstances where a universal proxy card mandate could encourage activity that would not otherwise have occurred. These situations could involve “second tier,” less well-funded activist investors; activists with smaller than usual equity positions or positions in smaller companies; specific dissident or board nominees that attract an unusual amount of attention (whether positive or negative); and/or mid-tier companies not primarily institutionally owned or other situations where the vote of the retail investors is likely to be particularly important. Possible effect of universal proxy card mandate not being adopted If, as we expect, the universal proxy card mandate is not adopted, companies may face increased pressure from shareholders to: Expand proxy access. Shareholders may increase the pressure on companies that have not adopted proxy access to do so. Further, shareholders may seek to revise proxy access bylaws in order to make proxy access available to shareholders owning a smaller percentage of shares and/or that were held for a shorter period of time than is the case currently; and/or to make proxy access available in contested elections. Agree to use of a universal proxy card. Institutional or other shareholders may more often request that a company allow shareholders to use a universal proxy card in a proxy situation. With the consent of the company and the dissident shareholder, as well as the board’s and the dissident’s respective nominees, use of universal proxy card would permit a split vote without any change to the SEC proxy rules. A company may decide to agree to use of a universal proxy card when the board believes that there is a reasonable likelihood that, without a universal card, the entire dissident slate would be elected—and, therefore, the company would be willing to increase the chance that only part of the dissident’s slate would be elected, while reducing the change that the full slate would be elected. A dissident shareholder might request, or agree to a company’s request, to use of a universal card when it doubts that its entire slate would be elected—and, therefore, the dissident would want to reduce the risk that none of its candidates would be elected. (In the 2015 Trian-DuPont proxy contest, activist investor Trian, which had nominated a short slate, requested that DuPont allow use of a universal proxy card, contending that it would “reflect best-in-class corporate governance.” DuPont, with a shareholder base comprised of a relatively large percentage of retail shareholders, rejected the request. None of Trian’s nominees were elected. In recent years, Tessera Technologies, Shutterfly, and GrafTech International have proposed use of a universal card where they viewed the chance of defeating all of a shareholder’s nominees as remote and wanted to increase the likelihood that only some of those nominees would be elected rather than the full slate.) Adopt bylaws requiring a universal proxy card. Shareholders may seek to pressure companies into adopting bylaws that require use of a universal proxy card when a dissident shareholder makes director nominations. No change to current SEC rules would be required for a company to use a universal proxy card if a company’s bylaws provided that a nomination would not be valid unless the nominee consented in advance to his or her name being included on a universal proxy card. Fried Frank M&A Briefing 6 We note, also, that, if the universal proxy card mandate is not adopted, shareholders of companies that have adopted proxy access bylaws may be more incentivized to preserve their ability to utilize proxy access. In this regard, shareholders should be mindful that their 13D filing disclosures may foreclose use of proxy access if an intention to change or influence control of the company has been indicated, including in a 13D filing. Shareholders that file 13Ds as a routine matter on companies in which they invest, in order to avoid any possible 13D issues in the future, should reconsider that approach to the extent that they may wish to preserve the option of utilizing proxy access.