On July 1, 2009, a divided SEC approved a longstanding proposal by the New York Stock Exchange to amend its Rule 452 and corresponding Section 402.08 of the NYSE’s Listed Company Manual. The rule change will eliminate the ability of brokers that are NYSE member organizations to vote at their discretion shares of their customers on uncontested elections of directors for which the customers do not provide voting instructions. The amendment, which is described in Release No. 34-60215, will apply to all proxies given by NYSE-member brokerage firms, without regard to where a company’s stock is listed, for shareholder meetings held on or after January 1, 2010.
NYSE Rule 452, “Giving Proxies by Member Organizations,” currently allows brokers that are NYSE member organizations to use their discretion under certain circumstances to vote proxies representing shares owned by their customers at shareholder meetings. Discretionary voting is permitted only on “routine” matters in situations where the broker forwards a company’s proxy materials to its customers and requests specific voting instructions, but does not receive the instructions at least ten days before the scheduled meeting date. Routine matters generally are those that do not substantially affect the rights or privileges of shareholders, and include matters such as the ratification of a company’s independent auditors. Before the rule change, an uncontested election of directors was considered a routine matter for purposes of Rule 452.
In June 2006, a proxy working group, formed the previous year by the NYSE to review the NYSE rules and regulations governing the proxy voting process, recommended that Rule 452 be amended to classify the election of directors as a “non-routine” matter. The NYSE adopted this recommendation based on the belief that director elections are not routine events for public companies and that precluding discretionary voting by brokers on such elections would improve corporate governance. To implement the proxy working group’s recommendation, the NYSE sought SEC approval of the amendment.
The amendment to Rule 452 and Section 402.08 will add the election of directors (whether or not contested) to the list of matters on which a broker may not vote shares without instructions from the beneficial owner of the shares. Thus, the right to vote shares of a customer held by an NYSE member organization on such an election will be exercisable only by the customer. Some of the other matters on which brokers may not exercise discretionary voting authority include proposals opposed by management, alterations of or increases in indebtedness, business combinations, and the adoption or material revision of equity compensation plans.
Many large brokerage firms are member organizations of the NYSE and subject to its rules. Accordingly, the rule change will affect not only companies listed on the NYSE, but also other public companies, including companies listed on the NASDAQ Stock Market and other national securities exchanges, to the extent that the clients of NYSE-member brokerage firms hold stock of such companies.
Notably, the amendment will not apply to investment companies registered under the Investment Company Act. The NYSE cited as the basis for excluding investment companies the special regulatory scheme governing them that sets apart such companies (regardless of their size) from operating companies. The amendment, however, will codify NYSE interpretations of Rule 452 that brokers may not vote uninstructed shares on proposals by investment companies at shareholder meetings to (1) adopt material amendments to investment advisory contracts or (2) enter into such contracts with new investment advisers.
Impact of the Amendment
The amendment is expected to have a significant impact on the proxy voting process for director elections in a number of respects.
Ability to Obtain a Quorum at Shareholder Meetings. The amendment is likely to increase the difficulty of some companies, particularly smaller companies whose shareholder base consists largely of retail investors, in obtaining a quorum at shareholder meetings. Retail investors historically have been less inclined to vote their shares than institutional holders, and broker discretionary votes have helped to compensate for the shortfall created by the low voting turnout of retail holders. With director elections no longer considered routine matters, these companies may need to include another routine matter (such as ratification of the company’s independent auditors) on their voting agendas to enable the uninstructed shares held by brokers to be counted toward a quorum.
Influence of Shareholder Activists and Proxy Advisory Firms. The inability of brokers to vote uninstructed shares on director elections could lead to greater influence by shareholder activists and special interest groups in the outcome of these elections. The NYSE acknowledged this possibility when it stated that the amendment may lead to an increase in “the influence of special interest groups or others with a particular agenda to challenge an incumbent board, at the expense of smaller shareholders.” The prospects of “vote no” campaigns by these parties for the non-election of particular directors are likely to be enhanced by the inability of brokers to use their discretionary voting authority to support management nominees, as had previously been common practice. In addition, the influence of proxy advisory firms, whose recommendations are often followed by institutional holders, but not by retail holders, are likely to carry more weight in director elections where retail holders do not instruct their brokers how to vote their shares.
Majority Voting for Directors. Increased difficulty in electing director nominees may be most pronounced for companies that have adopted “majority” voting, under which nominees who fail to receive the affirmative vote of a majority of the votes cast are not elected or, if already serving on the board, must resign. Because brokers typically vote for director nominees proposed by the company, the elimination of discretionary voting may make it more difficult for directors to achieve the majority threshold needed for election.
Proxy Delivery Options. The SEC’s notice and access option (“e-proxy”) for delivery of proxy materials has become increasingly popular with companies because of the expected cost savings associated with the nondelivery of paper proxy materials to shareholders. Use of the e-proxy option, however, appears to have contributed to a decline in participation by retail holders in the voting process, apparently because these investors have less interest than institutional holders in completing the steps necessary for electronic voting. Until now, this reduced participation has been ameliorated to some extent by the ability of brokers to vote uninstructed shares in director elections. Once brokers are no longer able to vote such shares, companies with large numbers of retail investors may find it necessary to engage in costly measures designed to reduce the risk that their director nominees will fail to receive sufficient votes for election. These measures could include foregoing the e-proxy delivery method (or supplementing electronic delivery with paper mailings) and engaging proxy solicitors to generate greater voting activity.
Increased Costs and Time Commitment. For many companies, the absence of discretionary broker votes on which companies typically could count in director elections may have a significant monetary impact. The need to address the concerns outlined above is likely to require companies to incur greater expense to reach shareholders who have not voted. It is apparent that many companies will have to devote more time and effort than in the past to improve the prospects of a favorable vote on the board’s proposals.
SEC Chairman Shapiro indicated that the SEC intends to consider other issues relating to shareholder communications and voting later this year. These considerations and the general regulatory desire for improved corporate governance and greater transparency in proxy voting suggest that additional changes will be forthcoming in relatively short order.