On July 1, 2009, the Securities and Exchange Commission approved an amendment to New York Stock Exchange Rule 452 that will prevent brokers from voting uninstructed client shares in director elections.1 Under NYSE rules, brokers are permitted to vote their clients' shares for "routine" matters if the beneficial owner of those shares has not provided voting instructions to the broker at least ten days before a scheduled shareholder meeting. Currently, an uncontested director election, including where there is a "withhold" vote campaign, is treated as a "routine" matter. The amendment changes the status of an uncontested director election from a "routine" to a "non-routine" matter. As a result, starting with meetings held on or after January 1, 2010, brokers who are members of the NYSE will not be able to vote their clients' shares in any director election (including in elections at companies not listed on the NYSE) without client instructions.2 While the amendment does not apply to elections at companies registered under the Investment Company Act of 1940, it does prohibit broker discretionary voting for material amendments to investment advisory contracts. Because foreign private issuers are not subject to the U.S. proxy rules, they are unaffected by the amendment of Rule 452, which allows discretionary voting only when a matter is submitted to shareholders by means of a proxy statement comparable to that specified in SEC Schedule 14A.
Background of the Amendment
The NYSE established a Proxy Working Group in 2005 to examine NYSE rules relating to the proxy solicitation process. The Working Group ultimately recommended that the NYSE propose an amendment to Rule 452 despite the potential negative impact the amendment might have on public companies. The Working Group concluded that it was necessary to recognize that the election of directors, even if uncontested, is not a "routine" matter for public companies.
Comment Letters and SEC Response
The SEC received more than 150 comment letters regarding the proposed amendment. Many of the comment letters, including a comment letter from the NYSE's Proxy Working Group, suggested that the SEC extend the comment period for the proposal, given its potentially broad impact on public companies, investors and other market participants. These commenters encouraged the SEC to take a comprehensive approach to revising the proxy voting system prior to approving the NYSE's proposal in isolation. The SEC ultimately concluded that it was not appropriate to delay action on the amendment of Rule 452 in light of the benefits of the proposal, including assuring that voting on matters as critical as the election of directors can no longer be determined by brokers who have not received instructions from beneficial owners.
Majority Voting. Numerous commenters expressed concern that the amendment would disproportionately impact companies that have adopted majority voting for director elections because these companies will no longer be able to rely on brokers voting uninstructed client shares to obtain the requisite majority vote. Specifically, these commenters expressed concern that companies that have adopted majority voting may have difficulty obtaining the requisite majority if they are facing a "just vote no" or "withhold" campaign. As a result, these commenters were concerned that the amendment could empower minority activist shareholder groups in a manner disproportionate to their economic interests.
The SEC order approving the amendment to Rule 452 noted that a study of director elections held in 2007 concluded that of the 2,718 directors subject to a "withhold" campaign in that year, eight directors received at least 50% withhold votes based on returned proxy cards and six directors received at least 50% withhold votes using broker voting. The SEC concluded that, while the amendment may make it more difficult for a director of a majority vote company to survive a "just vote no" or similar campaign, the amendment is consistent with the requirement that the rules of an exchange be designed to protect investors and the public interest by assuring that voting on matters as critical as the election of directors not be determined by brokers without instructions from the beneficial owner. In the SEC's view, corporate governance and accountability would be enhanced.
Obtaining a Quorum. The SEC order also addressed comments that the amendment to Rule 452 may cause companies to have difficulty obtaining the requisite quorum for all matters to be voted upon at a meeting if there are no "routine" matters on the ballot and to incur additional costs in soliciting votes from retail shareholders in order to obtain a quorum. The SEC noted that, in most cases, the ballot for a company's annual meeting includes the ratification of independent auditors, a "routine" matter on which broker votes may continue to be counted towards a quorum.
Accordingly, the SEC stated that most companies should not encounter difficulty achieving a quorum. In addition, the order referred to a report concluding that most companies would achieve a quorum even if brokers were not permitted to vote uninstructed client shares, although the SEC acknowledged that a quorum would be obtained closer in time to the meeting date than in prior years. In light of these observations, the SEC ultimately concluded that potential issues in obtaining a quorum were not appropriately resolved by continuing to permit discretionary broker voting in the election of directors.
The SEC did not, however, address the fact that including the ratification of independent auditors on the ballot would not help achieve a quorum of holders of a class of stock that is non-voting other than on the election of directors. Companies with such a class of stock or which do not seek shareholder ratification of the selection of auditors could consider amending their by-laws to reduce the quorum requirement to minimize the likelihood of not achieving a quorum. For example, under Section 216 of the Delaware General Corporation Law, the quorum requirement may be reduced to as little as one-third of the shares entitled to vote. Any decision to modify an existing quorum requirement should, however, be considered in light of applicable listing standards. For example, while Nasdaq Rule 5620(c) permits a company to have a one-third quorum requirement, Section 310.00 of the NYSE Listed Company Manual states that the NYSE will give "careful consideration" to provisions fixing any proportion less than a majority of the outstanding shares as the quorum for a shareholder meeting but has not objected to "reasonably lesser quorum requirements" where the company has agreed to make general proxy solicitations for future shareholder meetings.
Increased Influence of Proxy Advisory Firms and Institutional Holders. Various commenters also expressed concern that the amendment would increase the influence of proxy advisory firms such as RiskMetrics Group, Inc. (formerly known as Institutional Shareholder Services Inc., or ISS) and Glass, Lewis & Co., LLC over director elections. Proxy advisory firms often make recommendations concerning matters to be voted upon at a shareholder meeting and, like brokers, they have no economic interest in the company. Certain institutional investors follow the recommendations of proxy advisory firms without further consideration. In addition, some commenters expressed concern that if retail shareholders are not educated about the elimination of broker discretionary voting, fewer shares held by retail shareholders will be voted, resulting in disproportionate influence by institutional investors.
Ultimately, the SEC concluded that concern about the increased ability of proxy advisory firms to influence director elections was not "germane to, and does not need to be resolved to approve, the NYSE's proposal." The SEC did, however, recognize that the amendment could increase the ability of proxy advisory firms to influence director elections and indicated that it would consider the influence of proxy advisory firms on institutional investors as it examines broader proxy system issues.
Commentary
The elimination of broker discretionary voting in director elections will likely take effect at approximately the same time as other changes to the proxy and proxy disclosure rules currently proposed by the SEC. Specifically, the SEC has proposed new rules that would require companies to include in their proxy materials director candidates nominated by shareholders who satisfy certain ownership and procedural requirements,3 potentially increasing the number of "contested" elections (for which brokers have not historically had the ability to exercise discretionary voting). In addition, the SEC has proposed new disclosure requirements that would require a company to describe in its proxy statement its risk management approach as it relates to compensation practices, the use of compensation consultants and director nominee qualifications.4
In light of the elimination of discretionary broker voting in director elections and the potential implementation of proxy access and additional proxy disclosure requirements, companies should review their internal policies and practices for preparing their proxy statements and related disclosures and procedures. Additional time may be required to collect relevant information and, in some cases, companies may want to consider mailing proxy materials further in advance of the meeting date than they have done so in the past in order to provide additional time for obtaining a quorum. In some cases, this may require that companies revisit their advance notice by-laws in order to assure that the deadlines for shareholder nominations and other business are appropriate in light of the revised timetables. In addition, companies may determine to hire proxy solicitors to help solicit proxies from "retail" shareholders, even in ordinary course elections where they may not have done so in the past. Importantly, each company should consider the various possible scenarios (and appropriate responses thereto) that could arise (e.g., a lack of quorum) in light of the application of amended NYSE Rule 452 in combination with the company's by-laws (and/or articles of incorporation) and its own unique shareholder profile and shareholder voting history.
While the SEC has encouraged the NYSE and member firms to develop an investor education effort to inform shareholders about the proxy voting process, companies will separately need to develop or enhance their own communications strategies for communicating with retail investors regarding the importance of instructing their respective nominees how to vote in director elections.
Footnotes
1 Order Approving Proposed Rule Change to Eliminate Broker Discretionary Voting for the Election of Directors, SEC Release No. 34-60215 (July 1, 2009), at http://www.sec.gov/rules/sro/nyse/2009/34-60215.pdf .
2 While other self-regulatory organizations currently allow discretionary voting in uncontested director elections, the SEC has stated that it expects those markets to make changes to conform to the NYSE's new rules to eliminate any disparities involving voting depending on where shares are held.
3 Facilitating Shareholder Director Nominations, SEC Release No. 33-9046 (June 10, 2009), at http://www.sec.gov/rules/proposed/2009/33-9046.pdf . See the Fried Frank memorandum entitled "SEC Proposes Shareholder Proxy Access Rules," July 7, 2009, available at: http://www.friedfrank.com/siteFiles/Publications/509B448BE6B99F2F20967BA59CC62D2C.pdf .
4 Press Release, SEC Proposes Measures to Improve Corporate Governance and Enhance Investor Confidence (July 1, 2009), at http://www.sec.gov/news/press/2009/2009-147.htm .
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