What you need to know:
Broker discretionary voting in uncontested director elections will be eliminated beginning in 2010, with the result that public companies will face new challenges in what has historically been a routine process. One inevitable consequence of this change will be a dramatic increase in the influence of institutional investors and proxy advisory firms and, for companies that have adopted a majority vote standard, a heightened risk of failed director elections.
What you need to do:
Public companies should take defensive measures to guard against failed director elections, including outreach and education to increase stockholder participation; limiting use of e-proxy delivery of stockholder materials; and deferring the transition to majority voting standards and de-classified boards of directors.
Earlier this month, the Securities and Exchange Commission approved a change to New York Stock Exchange Rule 452 to eliminate broker discretionary voting of uninstructed shares in uncontested elections of corporate directors. The change to Rule 452 will apply to shareholder meetings held after January 1, 2010 and, as a result, will be effective for the 2010 proxy season. Because Rule 452 governs the conduct of brokers and banks that are NYSE members, the amendment to Rule 452 will affect director elections of all public companies, not just NYSE-listed companies.
Currently under Rule 452, brokers who hold shares in street name are obligated to deliver proxy materials to the beneficial owners and to solicit instructions for the voting of those shares. If the beneficial owner does not provide voting instructions at least ten days prior to the stockholder meeting, Rule 452 permits the broker to vote those “uninstructed” shares at its discretion on all “routine matters.” Prior to the July 1 amendment of Rule 452, uncontested director elections were considered to be “routine.” Under the amendment, uncontested director elections will be characterized as non-routine, and brokers may not vote street name shares without express instruction from the beneficial owners.
Discretionary voting for directors by brokers has historically been the predominant manner by which street name shares owned by retail customers are voted in uncontested director elections. Brokers typically cast their discretionary votes in favor of the incumbent board’s nominees, as well as in accordance with management’s recommendations on other routine matters. Critics have contended that this practice affords persons who hold no economic stake in companies a disproportionate influence on the outcome of corporate voting. In approving the amendment to Rule 452, the SEC stated that the change will enhance corporate governance and accountability by assuring that investors with an economic interest in a company will determine the outcome of corporate elections.
Implications for Public Companies
The elimination of broker discretionary voting in uncontested director elections will have far-reaching implications for all public companies, and particularly for those that have a significant retail stockholder base. These implications include:
Substantially reduced stockholder participation in director elections. In the absence of broker discretionary voting, a large percentage of shares held in street name, generally by retail investors, may simply fail to participate in uncontested director elections. Lower stockholder turnout for uncontested elections will, among other matters, increase the unpredictability and volatility of what had historically been, in the NYSE’s parlance, a routine matter.
Increased influence of institutional investors. Because institutional investors tend to participate more actively in corporate elections than retail stockholders, the proportionate influence of those investors will increase dramatically. Correspondingly, the influence of proxy advisory firms such as RiskMetrics and Glass Lewis will also increase as their voting recommendations are followed by many institutional clients. Unless creative efforts to increase retail investor participation are devised, the traditionally pro-management voice of the retail stockholder base will diminish.
Higher risk of “withhold vote” campaigns. Increasingly, proxy advisory firms and activist shareholders have promoted “withhold vote” and “vote no” campaigns against incumbent board nominees in uncontested director elections as a means of influencing board and management behavior on a variety of corporate governance and compensation issues. With the elimination of broker discretionary voting for directors, the effectiveness of these campaigns will increase, as institutional voting in support of proxy advisor recommendations will no longer be offset by proincumbent votes from brokers exercising discretionary voting authority over uninstructed street name shares. In the case of companies that retain a plurality standard for director elections, the consequence may be that director nominees run the risk of a high (potentially more than 50%) “withhold” vote, but with no effect on the actual outcome of director elections. For companies that have adopted majority vote standards for director elections, however, the prospect of failed director elections looms large.
Increased costs of securing quorum for stockholder meetings. Broker discretionary votes are often critical to the fundamental purpose of assuring that sufficient shares are present at a stockholder meeting to constitute a quorum for the conduct of business. Quorum for a stockholders meeting is generally determined by the percentage of outstanding shares that are present in person or by proxy and entitled to vote at a meeting, with the percentage determined as a matter of state law or the company’s charter or bylaws. If the only matter to be put to the vote of the stockholders at a meeting is an uncontested election for directors, there is a risk that insufficient shares that are “entitled to vote” will be present in order to enable an election to proceed. This risk can be mitigated if there is at least one “routine” matter, for example, ratification of the selection of auditors, that is on the agenda for the stockholder meeting.
Action Items for Companies
In light of the risks facing companies due to the elimination of broker discretionary voting for directors in uncontested elections, the following action items are recommended:
- Analyze your current stockholder base and voting behavior from your 2009 annual meeting of stockholders to determine how many votes in favor of directors were cast by brokers exercising discretion and the extent to which stockholder participation in director elections is likely to diminish due to the elimination of discretionary broker voting.
- Develop techniques to increase stockholder participation in future director elections, including enhanced and creative communications to the retail stockholder base. Inevitably the use of proxy solicitation firms to generate voting for previously routine corporate elections will increase, and companies should also consider the use of tailored stockholder meeting websites and other outreach to educate retail stockholders about the importance of voting in corporate director elections.
- Reconsider use of e-proxy “notice and access” initiatives first undertaken in 2009. Experience during the 2009 proxy season demonstrated that e-proxy solicitations, in which hard copies of proxy materials are not routinely sent to stockholders, reduced retail stockholder voting significantly. The potential cost savings of e-proxy notice and access delivery of proxy materials will likely be outweighed by the adverse consequences of a low voting turnout by street name beneficial owners.
- Delay or abandon a transition to majority voting standards for director elections. Companies that have already adopted majority director voting standards have no alternative but to combat the heightened risk of failed director elections as described above. In addition, these companies should review director resignation policies to retain maximum flexibility in the face of a failed director election (for example, board discretion to reject a tendered resignation from a nominee who receives a majority “withhold” vote). For companies that currently employ a plurality voting standard, however, any move to a majority vote standard or to de-classify a board of directors should be deferred as long as possible, at least until the investor community has devised effective means of increasing voting participation across the entire spectrum of street name stockholders.
- Companies with a September 30 fiscal year should accelerate their annual stockholder meeting if possible to precede the January 1, 2010 effective date for the elimination of broker discretionary voting for uncontested director elections.
- Include at least one “routine” matter on the agenda for your annual stockholder meeting. Broker discretionary votes may continue to be cast for routine matters, such as ratification of the selection of auditors, and these shares will be counted toward meeting quorum requirements to conduct business generally, as well as to act upon both routine and non-routine matters.