Storm Clouds Gather over Director Elections

This post from Francis H. Byrd is based on an Altman Group publication titled Governance & Proxy Review Update.

This post has been updated below to reflect information provided in a subsequent Governance & Proxy Review Update.

This post is by my colleagues Domenick de Robertis and Reid Pearson.

In response to the recent decision by the SEC to approve the elimination of broker discretionary voting authority on the election of directors at annual meetings after January 1, 2010, NYSE Rule 452 is front and center on the minds of many in the proxy and governance arena.

The amendment to Rule 452 will be the end of the “stuffing of the ballot box” for the election of directors that some shareholders have long complained about. The question now is to what extent will the change impact the ability of corporations to get their directors re-elected each year? In addition, what should corporations and their advisors be thinking about?

Assessing the Risk

Since the July announcement of the change, The Altman Group has completed numerous analyses for corporate issuers projecting the voting impact from the amended NYSE Rule 452. We will share our findings in the next issue of the Governance & Proxy Review and answer some practical questions that a company should consider in preparing for what is likely to be the toughest proxy season in history.

Strategies to Consider When Counteracting the Loss in Broker Voting

Historical statistics show that approximately 25 to 35 percent of the retail shareholder base will respond by voting without being prompted. The variance in response rates is tied to a number of factors, such as stock price (higher apathy with lower priced stocks) and the distribution of shareholdings (are there a lot of odd-lot holders, for example).

As we pointed out in our comment letters to the SEC, (Comment Letter – March 27, 2009) (Comment Letter – May 23, 2007) (Comment Letter – July 14, 2006) small-cap issuers are likely to bear the brunt of the burden placed on Corporate America by this change. Any issuer with a heavy retail base is likely to incur additional solicitation costs. There is no magic bullet for getting retail holders to vote. Issuers will need to consider the costs, necessity and effectiveness of follow-up mailings and phone solicitation to unvoted holders.

Companies that are at least moderately held by institutional investors have their own set of challenges with the loss of the broker vote. First and foremost a company must understand its vulnerability to a withhold/against vote campaign by activist institutions or a withhold/against vote recommendation from any of the proxy advisory firms. These negative votes will now have a magnified impact given the loss of the broker vote. Problematic issues to consider include directors with poor attendance, non-independent members on key committees (shareholder definitions of independence are typically more rigid than the exchange listing requirements), perceived lack of overall independence, poor compensation practices, or any combination of the above.

It is generally advisable to have an understanding of the RiskMetrics Group (RMG) policy on uncontested director elections. RMG has a fairly extensive list of instances where they may recommend an against or withhold vote on a Board, committee, or individual director(s). Given that RMG can often influence 25 percent or more of a company’s shares, understanding their policy is extremely important. Depending on who the top institutions are, companies may need to also consider the policies of Glass Lewis, even though their guidelines are a bit less transparent, or PROXYGovernance, which tends to be more case-by-case than the other firms and takes factors such as the specific company’s performance and governance practices into account.

The Storm of Other Director Related Issues

In another time, the loss of the broker vote on directors may not have been so alarming. But we believe the change at this point in time has very serious implications for many issuers in light of recent developments, ongoing problems, and other major changes now looming on the horizon:

• The greatly reduced vote response from individual holders at companies using Notice & Access.• The majority vote standard as a replacement for plurality voting in director elections is becoming more commonplace, and may become a requirement in the not so distant future.

• The rise of “Just Vote No” campaigns by activist institutions targeting certain nominees. We expect these to increase as these investors hold Boards accountable for the current market morass. Consequently, we expect an increased likelihood of success for these campaigns. What would have happened to the directors up for election at Washington Mutual’s 2008 annual meeting without the broker vote? Without the benefit of these shares, we believe at least four of the director nominees who were elected would not have received sufficient votes.

• While the votes for directors are driven down, will hedge fund activists continue to spot weak companies to target? Companies that traditionally receive large against or withhold votes are ripe targets for activists.

• Along with the understanding that the power of proxy advisory firms will be amplified once broker voting goes away, it is also becoming very clear that more and more institutions are adhering strictly to the RMG or Glass Lewis recommendations.

• Finally, Proxy Access, if adopted, should be a concern for all companies, not just those with large retail holdings. Stay tuned, we will be addressing this issue in detail in the near future here in the TAG Governance & Proxy Review.

All of these evolving issues have turned the proxy voting world on its head, and companies need to be prepared. As these issues continue to develop, The Altman Group hopes, as stated in previous issues of this newsletter, that regulators will consider the following:

• What happened to the educating investors to vote initiative? When the NYSE Proxy Working Group’s recommendation on the broker vote was released in October 2006, it stated there would be an education process for investors on the voting process.• The SEC needs to address other “proxy plumbing” issues first before finalizing any further decisions that burden companies. These issues include empty voting, over-voting, share lending, and the antiquated OBO/NOBO standard, which limits the company’s ability to communicate with its shareholders.

In a speech yesterday, SEC Chair Shapiro commented, “While I have long supported these amendments, I also recognize that eliminating broker non-votes in director elections, along with the potential for proxy access in the 2010 proxy season, will place a greater spotlight on some of the long-smoldering concerns about the mechanics of the proxy voting process within the United States. I have committed to looking at these additional issues — including OBO/NOBOS and the role of proxy advisory and voting services — in the next few months”

Interesting times indeed.

(Update:  The information below was provided by Domenick de Robertis and Reid Pearson in a subsequent Governance & Proxy Review Update.)

Impact Projection Statistics

Based on an analysis of 32 companies we have completed to date since the rule change was formally adopted, we estimate the following averages:

• Companies mailing proxy material using the traditional full-set method will experience a drop of 20.6% of shares outstanding.
• Companies that adopt a full Notice & Access mailing approach will see their director vote drop by 25.9% of shares outstanding.

These averages were derived from a widely dispersed data set, as the companies we looked at had varying market capitalizations, stock prices and shareholder profiles (e.g. levels of institutional vs. retail ownership).  So while the numbers are interesting to note, they cannot be generally applied to a particular company without looking at the specific criteria for each issuer.

We thought it would be helpful, therefore, to present a sample cross-section of various shareholder profiles split between institutional and retail ownership (the names have been changed to protect the innocent) that issuers could use as a closer match:

• Alpha Company:  81% institutionally owned (% of FOR votes lost)
Traditional Mailing:  10.3% drop
Notice and Access:  13.8% drop

• Bravo Company:  65% institutionally owned  (% of FOR votes lost)
Traditional Mailing:  20.1% drop
Notice and Access:  24.9% drop

• Charlie Company:  41% institutionally owned (% of FOR votes lost)
Traditional Mailing:  35.5% drop
Notice and Access:  44.0% drop

• Delta Company:  28% institutionally owned (% of FOR votes lost)
Traditional Mailing:  31.1% drop
Notice and Access:  40.4% drop

Percentages are based on shares outstanding

Assessing the Risk

The loss of the broker vote will present each company with unique challenges.  Here are some issues we believe that company management should consider:

• Management has an obligation to notify its board of the changes and the new voting risks now, so that the board’s expectations can be set accordingly, and they can have time to consider all options rather than having to make tough decisions under the gun on the eve of a proxy mailing.

• What is the breakdown of a Company’s shareholder base, and the balance of voting power among institutional holders, retail holders, and other voting constituencies?  The results from the data above is clear, companies with higher retail shareholder ownership will be impacted with a greater drop in support votes due to the amended Rule 452, as opposed to companies having higher institutional ownership.

• Company officers need to assess the voting profiles of shareholders targeted in new stock issuances and investor relations.  For example, we have spoken to companies who have recently been trying to attract retail holders, who tend to be very loyal and stable.  Significant alterations to the shareholder makeup may be beneficial in many aspects, but issuers now need to account for the risk of diminished vote returns from a more retail-dominated shareholder base.

• Are there any individual nominees or entire key committees at risk of receiving withhold/against votes due to corporate governance or compensation-related issues that violate the policies of the largest institutional holders or proxy advisory firms?  Some of these problems result from a checklist approach that these firms use and consistently follow, but which, if spotted in time, can potentially be rectified.

• How influential will the recommendations of the proxy advisory firms be on the voting decisions of institutional investors?  Companies should seriously consider having an analysis prepared as to the level of influence each independent advisory firm has on the institutional investor base.  It is likely that RiskMetrics Group (formerly ISS) will wield the most influence, possibly upon as much as 25% or more of the shares outstanding.  Depending on who the largest holders are, however, Glass Lewis and PROXY Governance could also have a noteworthy impact.

• The decision as to whether to use Notice and Access for the proxy mailing should no longer be based on cost savings alone.  As noted above, the percentage of votes lost due to the amended rule 452 is greater when a company uses Notice and Access than a traditional full-set mailing.   There are alternate options for issuers to consider.  A hybrid version of mailing instructions may be prepared by a solicitation advisor on mailing strategies to a select range of shareholders, for example:
– Holders of 1,000 shares & up – Traditional Mailing
– Holders of 999 shares & below – Notice & Access

Overall, companies will need to thoughtfully analyze the impact of this change well in advance of their 2010 annual meetings and have a plan in place to ensure a successful re-election process.

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