Yearly Archives: 2009

Proxy Access and the Balance of Power in Corporate Governance

Posted by Scott Hirst, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, October 2, 2009
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This post comes to us from Roy J. Katzovicz of Pershing Square Capital Management, L.P.

Our experience with concentrated, long-term investments in large, public companies has taught us that the overwhelming majority of corporate directors are smart, diligent, and capable business people trying the best they can to faithfully discharge their fiduciary duties. They do not, however, always get it right.

Something is broken in corporate America. Particularly over the last decade, prudent risk management took a back seat to the quest for short term profits. Now we are all suffering the consequences. There is, however, reason for optimism. A number of tectonic trends in corporate governance appear to be converging, and a subtle rebalancing of power between management, their boards of directors and shareholders appears likely. We think that is a good thing.

Engaged shareholders with meaningful stakes in the companies in which they invest have the potential to regulate corporate conduct through private and market behavior. The existing tools of shareholder engagement, however, have not proven to be sufficient or optimally suited for that task. We believe that the SEC’s proposal to require public companies to include shareholder nominees in corporate proxy materials goes a long way toward better equipping shareholders to be more effective monitors of corporate behavior and, as a result, another force for good corporate governance.

We applaud this initiative and view it as a market-based solution in that the government is now trying to empower market actors to manage risk rather than trying to achieve the same goal through direct government intervention into the day-to-day affairs of corporations.

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Unblocking Corporate Governance Reform

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Thursday, October 1, 2009
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(Editor’s Note: This post is Lucian Bebchuk’s most recent column in his series of monthly commentaries titled “The Rules of the Game” for the international association of newspapers Project Syndicate, which are available here. The column builds on Investor Protection and Interest Group Politics, an article co-authored by Professor Bebchuk and Professor Zvika Neeman that puts forward a theory of how interest group politics affect investor protection reforms.)

When they met earlier this month, G-20 finance ministers and central bankers called for global improvements in corporate governance. Such appeals are often heard, but powerful vested interests make it hard for governments to follow through. So, if serious reforms are to be implemented, strong and persistent public pressure will be needed.

Many countries provide investors in publicly traded firms with levels of protection that are patently inadequate. Even in countries with well-developed systems of corporate governance, arrangements that are excessively lax on corporate insiders persist. In the United States, for example, insiders enjoy protections from takeovers that, according to a substantial body of empirical evidence, actually decrease company value.

Lax corporate governance rules are not generally the result of a lack of knowledge by public officials. Political impediments often enable lax arrangements to linger even after they are recognized as inefficient.

Ordinarily, corporate governance issues are not followed by most citizens. As a result, politicians expect that their decisions on investor protection will have little direct effect on citizens’ voting decisions. By contrast, interest groups with big stakes in the rules follow corporate governance issues closely, and they lobby politicians to get favorable regulations.

The group that, in normal times, can be expected to have the most influence is that which consists of insiders within publicly-traded companies. Corporate insiders are an especially powerful lobbying group because of their ability to use some of the resources of the companies under their control. They have the power to direct their firms’ campaign contributions, to offer positions or business to politicians’ relatives or associates (or to politicians upon retirement), and to use their businesses to support issues and causes that politicians seek to advance.

Because insiders gain the full benefits that arise through lobbying for lax corporate governance rules, while their firms bear most of the costs of such lobbying, insiders have an advantage in the competition for influence over politicians. Their lobbying, which is carried out at the expense of their companies, is subsidized by their shareholders.

While individual investors cannot be expected to invest in lobbying for stronger investor protection, it might be hoped that institutional investors – mutual funds, banks, insurance companies, and so forth – will do so. Institutional investors receive funds from individuals and invest them in publicly traded companies. Because institutional investors invest substantial amounts in such companies, they should be well informed about corporate governance issues.

But institutional investors usually do not provide a sufficient counter-weight to lobbying by corporate insiders. In contrast to corporate insiders, institutional investors cannot charge the costs of lobbying to the publicly traded companies whose investor protection is at stake. In addition, depending on their relationship with their own investors, some institutional investors (for example, mutual fund managers) may capture only a limited fraction of the increase in value of their portfolios as a result of governance reforms. This reduces the willingness of institutional investors to invest in counteracting insider lobbying.

Moreover, those who make decisions for institutional investors often have interests that discourage lobbying for stronger constraints on corporate insiders. Some institutional investors are part of publicly traded firms, and are consequently under the control of corporate insiders whose interests are not served by new constraints. And even those institutional investors that are not affiliated with publicly traded companies may have an interest in getting business from such companies, making these institutional investors reluctant to push for reforms that corporate insiders oppose.

So, interest-group politics commonly produce substantial obstacles to reform of corporate governance. However, some events – such as a wave of corporate scandals or a stock market crash – can interrupt the ordinary pro-insider operations of interest-group politics by leading ordinary citizens to pay attention corporate governance failures.

When citizens become so outraged that their voting decisions may be affected by politicians’ failure to improve investor protection, public demand for governance reform can overcome the power of vested interests. Indeed, most major governance reforms occur in such circumstances. In the US, for example, new securities laws were passed following the stock market crash of 1929, and the Sarbanes-Oxley Act was adopted in 2002, in the immediate aftermath of the collapse of the Internet bubble and the Enron and WorldCom scandals.

By creating a large public demand for reforms, the current crisis offers another opportunity to improve governance arrangements. This opportunity should not be missed.

The Economic Consequences of IPO Spinning

Posted by Jim Naughton, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, September 30, 2009
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This post comes to us from Xiaoding Liu and Jay Ritter of the University of Florida.

 

In our paper, The Economic Consequences of IPO Spinning, which was recently accepted for publication in the Review of Financial Studies, we investigate the practice of spinning using a sample of 56 companies that went public during the period 1996-2000. Spinning is the allocation by underwriters of the shares of hot initial public offerings (IPOs) to company executives in order to influence their decisions in the hiring of investment bankers and/or the pricing of their own company’s initial public offering. The term spinning refers to the fact that the shares are often immediately sold in the aftermarket, or “spun,” for a quick profit, and an IPO is termed “hot” if it is expected to jump in price as soon as it starts trading.

Despite the fact that IPO spinning is one of the four scandals associated with IPOs that have been the subject of regulatory settlements, it is the only scandal that has not yet received any systematic study due in large part to the unavailability of data. We overcome this limitation through the careful hand collection of a detailed dataset. More specifically, for our empirical analysis, we use data gathered from court cases, the media, and documents requested through the Freedom of Information Act. From these sources, we obtain data on 146 officers and directors at 56 companies that were recipients of hot initial public offering (IPO) allocations. All of these companies were taken public by Deutsche Morgan Grenfell (DMG), Credit Suisse First Boston (CSFB), and Salomon Smith Barney (SSB) during 1996-2000.

There is evidence in Securities and Exchange Commission (SEC) settlements and Congressional testimony that Piper Jaffray, Goldman Sachs, and other investment banking firms also engaged in spinning. Our empirical analysis, however, is restricted to IPOs for which DMG, CSFB, or SSB was the bookrunner. The reason that we impose this restriction is that the companies identified in press reports and settlements suffer from a selection bias, frequently containing examples of prominent executives at well-known companies. In contrast, the data for the three investment banking firms that we focus on is systematic, composed of all of the executives who were being systematically spun by CSFB as of March 21, 2000; executives who were being spun by CSFB and lived in Silicon Valley, including those being spun after March 21, 2000; or those being spun by SSB at any time during 1996-2000. For each executive that had a brokerage account with the SSB unit in charge of spinning, we have data on the allocations to each executive for 48 IPOs.

We estimate the effect of spinning on IPO underpricing and the awarding of future investment banking mandates. We find that holding everything else constant, IPOs in which the executives are being spun are 23% more underpriced (e.g., 43% vs. 20%). The average dollar value of this incremental underpricing, the incremental money left on the table, is approximately $17 million, where money left on the table is the underpricing per share multiplied by the number of shares issued. The average first-day profit received from hot IPO allocations by the executives of a company being spun is $1.3 million. The ratio of these numbers indicates that only 8% of the incremental amount of money left on the table flows back to the executives being spun. The effect of spinning on subsequent investment banking mandates relates to the literature that asks why firms do or do not switch underwriters—this literature has focused on performance dissatisfaction, graduation to a more prestigious underwriter, and analyst coverage reasons as factors that affect switching decisions. We add another reason, the co-opting of executive decision-makers, to this list. We find that companies with executives who are being spun are dramatically less likely to switch underwriters for their first seasoned equity offering. For companies not being spun, the probability of switching underwriters is 31%. For companies being spun, the probability of switching is only 6%.

Overall, our findings suggest that the spinning of executives accomplished its goal of affecting corporate decisions. More generally, this paper presents evidence on the economic consequences of an agency problem arising from the delegation of decision-making to corporate managers.

The full paper is available for download here.

Davis Polk Releases Comprehensive Review of Financial Crisis Laws

Posted by Margaret E. Tahyar, Davis Polk & Wardwell LLP, on
Tuesday, September 29, 2009
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This post is by Margaret E. Tahyar of Davis Polk & Wardwell LLP.

It has been my privilege to support my partners as the editor of Davis Polk’s recently issued Financial Crisis Manual, which has been written by 21 Davis Polk partners and counsel working in a collaborative team that is the hallmark of our firm culture. The Manual is a comprehensive review of financial crisis laws as they apply to US financial institutions. Written for anyone who wants to understand the flurry of new legislation and other rulemaking that has occurred at a dizzying speed over the last year and a half, it covers the major Federal Reserve programs, Treasury’s capital investments and warrants, the FDIC’s debt guarantees, the public-private investment program, the enforcement landscape and executive compensation. It is also meant to be, through the hyperlinks in each Chapter, a reference work gathering in one place the scattered primary sources of financial crisis laws, regulations and contracts.

As practicing lawyers, we leave to others the tasks of analyzing the causes of the crisis and assessing the government’s responses to it. That said, the political and social context in which financial crisis rulemaking occurred resulted in regulations with characteristics that affect the way lawyers interpret the law and provide advice to clients. According to one commentary, this system “married transactional practice to administrative law.” Here are a few observations about the characteristics of US financial crisis laws.

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Sharp Increase in Shareholder Votes Opposing Director Nominees

Posted by Scott Hirst, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Tuesday, September 29, 2009
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This post comes to us from Scott Fenn of Proxy Governance Inc.

Recent data compiled by PROXY Governance, Inc. show a significant increase in the percentage of director nominees who received high percentages of shareholder votes cast in opposition in director elections during the 2009 proxy season. Although the vast majority of director nominees continue to be elected with little opposition, for companies with director election results available through August 2009, 9.8 percent of unopposed director nominees had at least 20 percent of shares voted against them or withheld, up from 5.5 percent in 2008. This trend was apparent at other threshold levels as well, with the percentage of directors having at least 40 percent of shares voted in opposition doubling from 1.0 percent in 2008 to 2.1 percent in 2009, and the percentage of directors failing to attain majority support tripling from 0.2 percent in 2008 to 0.6 percent in 2009. (See Table 1)

Table 1.
Percentage of Directors Receiving
High Percentages of Votes in Opposition
(2007 – 2009)

2007 2008 2009 [1]
20%+ opposition vote 4.8 % 5.5 % 9.8 %
30%+ opposition vote 2.2 % 2.5 % 5.0 %
40%+ opposition vote 0.8 % 1.0 % 2.1 %
Majority opposition vote 0.2 % 0.2 % 0.6 %
[1] Based on 2,441 meetings held with voting results available through
Aug. 31, 2009. Results for 2007 and 2008 are for full calendar year.

While declines in stock prices and the financial crisis no doubt played a role in the apparent increase in shareholder discontent with directors during 2009, compensation and corporate governance concerns also appear to have been primary drivers behind the increasing number of shares voted in opposition to directors. Of all director nominees who had more than 20 percent of shares withheld or voted against them in board elections, more than 57 percent served on compensation committees. Governance concerns – ranging from ignoring a majority vote on a shareholder proposal to adopting or renewing a poison pill without shareholder approval – also appear to have played a role in the high opposition votes at many companies.

Despite fewer organized “Vote No” campaigns against directors in 2009 – where a group of shareholders mount a public campaign to oust specific directors – at least 84 directors at 48 companies failed to attain majority support from shareholders through August 2009 at more than 2,400 companies where director voting results were available. Most of these 48 companies still use plurality voting, so the practical impact on most of the directors will be limited. Southwestern Energy Co., Pride International Inc., Cablevision Systems Corp., Pulte Homes Inc., Southwest Airlines Co., Massey Energy Co. and Kansas City Southern were among the larger companies where at least one director failed to achieve a majority vote. A list of the 48 companies where such votes have occurred so far in 2009 is shown in Table 2.

Table 2.
Companies Where At Least One Director Nominee
Failed to Achieve Majority Support in 2009

ACI WORLDWIDE INC
ADVANCED ANALOGIC TECH
ANIXTER INTL INC
ASSOCIATED ESTATES RLTY CORP
ASSURANT INC
CABLEVISION SYS CORP -CL A
CATALYST HEALTH SOLUTIONS
CHECKPOINT SYSTEMS INC
CIRCOR INTL INC
COGNEX CORP
COMPUTER PROGRAMS & SYSTEMS
DIGI INTERNATIONAL INC
DOLLAR TREE INC
ESSEX PROPERTY TRUST
FIRST MERCURY FINANCIAL CORP
FIRSTENERGY CORP
HEALTHCARE SERVICES GROUP
HMS HOLDINGS CORP
INTERLINE BRANDS INC
KANSAS CITY SOUTHERN
LAYNE CHRISTENSEN CO
LIFEPOINT HOSPITALS INC
MARINER ENERGY INC
MASSEY ENERGY CO		 MEDNAX INC.
MENTOR GRAPHICS CORP
NATCO GROUP INC
NBTY INC
NV ENERGY INC
PLEXUS CORP
PRIDE INTERNATIONAL INC
PULTE HOMES INC
RED ROBIN GOURMET BURGERS
SKYWEST INC
SOUTHWEST AIRLINES
SOUTHWESTERN ENERGY CO
SPSS INC
SWIFT ENERGY CO
SYNIVERSE HOLDINGS INC
TENNANT CO
TETRA TECHNOLOGIES INC/DE
THORATEC CORP
TRIQUINT SEMICONDUCTOR INC
UNITED ONLINE INC
UNITED THERAPEUTICS CORP
VALUECLICK INC
ZAPATA CORP
ZOLL MEDICAL CORP

High profile “Vote No” campaigns aimed at unseating directors at financial firms such as Bank of America Corp. and Citigroup Inc. had mixed results – while the directors targeted in such campaigns were re-elected, several targeted directors at Bank of America later resigned, including the bank’s lead director.

The level of opposition to director candidates is likely to increase further next year as a number of existing and proposed regulatory changes related to proxy voting in director elections come into play. Beginning in 2010, under a rule change adopted by the New York Stock Exchange and approved by the Securities and Exchange Commission, discretionary voting by brokers of shares where they have not received voting instructions from shareowners will no longer be allowed in director elections. Because uninstructed broker votes can account for up to 20 percent of the vote at many companies, and are routinely voted with management’s recommendations, the new rule could result in many more directors failing to achieve majority support. For example, out of the universe of more than 2,400 companies, 284 director nominees were elected with less than 60 percent support of the shares cast and 473 nominees were elected with less than 65 percent support of the shares cast. Many of these directors might not have received majority support without the benefit of broker discretionary votes.

In addition to the impact of the rule change on broker discretionary voting, various bills are pending in Congress that would mandate annual elections for all directors and/or a majority voting system for all companies in uncontested elections. Annual elections would put many more directors up to a shareholder vote each year, potentially resulting in a greater total number of directors failing to achieve majority votes. Legislation mandating majority voting, while it might not impact the number of votes in opposition to directors, would certainly change the impact of those votes. Finally, the SEC has proposed a proxy access rule granting large shareholders access to the corporate proxy for purposes of nominating directors which, if implemented, could also have a significant impact on the director election process.

The Momentum For Reform Must Be Maintained

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Monday, September 28, 2009
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(Editor’s Note: The post below by Lord Adair Turner is a transcript of his remarks at London’s City Banquet, on September 22, 2009.)

It’s a year and four days since Callum McCarthy spoke here on his second last day as Chairman of the FSA. I know he always received a warm welcome here and I am grateful, Lord Mayor, for your kind words, given that I now seem to be regarded as somewhat of a heretic in certain quarters of the City.  Heretics used to be burned at Smithfield, not far from here, so perhaps I should have been worried coming here. But I will not be recanting this evening. I will try, however, to be socially useful by addressing head on the complexities involved in distinguishing the benefits of a vibrant financial sector from the problems of excess and instability.

To say a lot has changed in the year since Callum stood before you is inadequate.  Callum’s speech came a few days after Lehman’s collapse, but before we understood the full consequences.  When I became Chairman two days later, I didn’t know I would spend my first three weeks at the FSA amidst the biggest financial crisis for at least 70 years.

Today the world looks much less scary than it did then.  The financial system is no longer fragile: growth is returning in many countries, confidence to many markets.  I say that with some trepidation because, of course, there may be setbacks and unexpected events.  But it is important to recognise the positives: a bias to over-cautious pessimism in official statements can be as harmful as a bias to unjustified optimism.

The banking system is stable. House prices have fallen much less than anticipated. The big emerging economies have proved far more robust than we feared.  The Bank of England mid-point forecast suggests fairly robust UK growth over the next three years.

But even if that is the case – even indeed if the path of growth, unemployment and housing prices turns out to be better than current expectation – we must not forget what occurred last autumn.   This was the worst crisis for 70 years – indeed potentially it could have been the worst in the history of market capitalism.  Real disaster – a new Great Depression – was only averted by quite exceptional policy measures.  Despite these measures major economic harm has occurred. Hundreds of thousands of British people are newly unemployed; tens of thousands have lost houses to repossession; and British citizens will be burdened for many years with either higher taxes or cuts in public services – because of an economic crisis whose origins lay in the financial system, a crisis cooked up in trading rooms where not just a few but many people earned annual bonuses equal to a lifetime’s earnings of some of those now  suffering the consequences.  We cannot go back to business as usual and accept the risk that a similar crisis occurs again in ten or 20 years’ time.

We need radical change.  Regulators must design radically changed regulations and supervisory approaches, but we also need to challenge our entire past philosophy of regulation.

And parts of the financial services industries need to reflect deeply on their role in the economy, and to recommit to a focus on their essential social and economic functions, if they are to regain public trust.

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Stapled Finance

Posted by Jim Naughton, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, September 28, 2009
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This post comes to us from Paul Povel of the University of Houston, and Rajdeep Singh of the University of Minnesota.

 

In our recently accepted Journal of Finance paper, Stapled Finance, we investigate the relatively new, but now quite common occurrence of a loan commitment that is “stapled” onto an offering memorandum by the investment bank advising the seller in an M&A transaction. Stapled finance provides for credit at pre-specified terms to whoever wins the bidding contest for the asset or firm that is being put up for sale; but the winner is under no obligation to accept the loan offer.

We show that arranging stapled finance affects the bidding itself, by making it more competitive. We show that an appropriately designed stapled finance package increases the expected price that will be paid to the seller. Three characteristics are crucial for this to be beneficial for the seller. First, the stapled finance offer is optional: the winning bidder has the right, but not the obligation, to accept a loan whose terms have been fixed before the takeover contest started. Second, the stapled finance is a non-recourse claim, i.e., the debt is supported only by the target’s assets and cash flow, not by the other assets and operations that the winning bidder owns. Third, there are bidders who plan to hold the target as a portfolio company, i.e., who do not plan to integrate it into their other operations if they win. Our arguments do not rely on financial constraints of any sort; stapled finance is accepted by bidders for strategic reasons, even if they have sufficient internal or outside funds to pay for an acquisition.

In addition, we show that if the stapled finance package is designed optimally, then the investment bank providing it expects not to break even. The reason is that stapled finance is optional, so it is accepted only if the terms are attractive to the bidder—and therefore unattractive to the lender. This suggests that stapled finance that benefits the seller can be arranged only if it is possible to compensate the investment bank for its expected loss, for example with an up-front fee, or by retaining it for other fee-based services. It also suggests that stapled finance loans that investment banks and other financial institutions retained on their balance sheets should perform worse than buyout loans that were negotiated independently.

Being a fairly recent creation, stapled finance has not yet entered the academic mainstream, and therefore there is little existing empirical research. However, the institutional details about stapled finance are consistent with our results. In our paper, we discuss (informal) explanations for the popularity of stapled finance that practitioners provide, and how our results differ from predictions that follow from those explanations.

The full paper is available for download here.

Proposed Rules regarding Ratings Agencies and Flash Orders

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Sunday, September 27, 2009
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(Editor’s Note: This post includes the transcripts of Chairman Schapiro’s statements on nationally recognized statistical rating organizations and flash orders at the SEC’s recent Open Meeting.  The statements of each of the other Commissioners on the two subjects are available here.)

Nationally Recognized Statistical Rating Organizations

Today we are considering a series of proposal that would significantly bolster the regulatory framework around nationally recognized statistical rating organizations, or “NRSROs.”

We are also considering a recommendation to propose a ban on the practice of flashing marketable orders. Flash orders provide a momentary head-start in the trading arena that can produce inequities in the markets and create disincentives to display quotes.

We begin with the credit rating recommendations. In 2006, the Credit Rating Agency Reform Act gave the Commission the exclusive authority over rating agency registration and qualifications. In the three years since, the Commission has undertaken several rulemaking initiatives. But as I have said previously, more needs to be done.

So, today we will consider six items that are intended to create a stronger, more robust regulatory framework. In particular, these proposals would improve the quality of ratings by requiring greater disclosure, fostering competition, helping to address conflicts of interest, shedding light on rating shopping, and promoting accountability.

These proposals are needed because investors often consider ratings when evaluating whether to purchase or sell a particular security. That reliance did not serve them well over the last several years and it is incumbent upon us to do all that we can to improve the reliability and integrity of the ratings process and give investors the appropriate context for evaluating whether ratings deserve their trust.

Collectively, the changes and concepts being adopted, proposed and considered today would benefit investors in many ways:

  • They would promote greater accountability by requiring compliance officers to file annual reports with the Commission.
  • They would foster competition by enabling unsolicited ratings for structured finance products.
  • They would decrease the level of undue reliance on the nationally recognized statistical rating organizations by beginning the process of removing references to NRSRO ratings in certain existing rules. It is time that we started this process to systematically minimize the use of ratings in the SEC’s rules and, while I know, there is much to do in this regard, I am pleased that we are taking these steps today.
  • And finally, they would empower investors to make more informed decisions by helping to expose rating shopping and potential revenue-linked conflicts.

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SEC Proposes Rule to Prohibit Pay-to-Play Practices

Posted by Charles M. Nathan, Latham & Watkins LLP, on
Saturday, September 26, 2009
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This post is based on a client memorandum by Kathleen Walsh, Andrea Schwartzman and Matthew Chase of Latham & Watkins LLP.

On August 3, 2009, the US Securities and Exchange Commission (the SEC) released a proposed rule under the Investment Advisers Act of 1940 (the Advisers Act) aimed at preventing “pay to play” practices by investment advisers that seek investment advisory business — including investment commitments in private equity funds — from state and local government entities.  As described in the proposing release, pay to play practices “may take a variety of forms, including an adviser’s direct contributions to government officials, an adviser’s solicitation of third parties to make contributions or payments to government officials or political parties in the State or locality where the adviser seeks to provide services, or an adviser’s payments to third parties to solicit (or as a condition for obtaining) government business.”  Referencing a number of enforcement proceedings in the area, the proposing release further states that “it has become increasingly clear that pay to play is a significant problem in the management of public funds by investment advisers.”

Proposed Rule

In response, the proposed rule would prohibit an investment adviser, as well as its “covered associates” from:

(1) providing or agreeing to provide payments (broadly defined) to a third party to solicit a government entity for investment advisory business on behalf of such investment adviser;

(2) receiving compensation from government entities within two years of making a contribution to an official of the government entity; and

(3) soliciting third parties to make a political contribution to an official of a government entity to which the investment adviser is providing or seeking to provide investment advisory services. The proposed rule would also require an investment adviser to maintain detailed records relating to its covered associates and their political contributions.

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Storm Clouds Gather over Director Elections

Posted by Francis H. Byrd, Laurel Hill Advisory Group, on
Friday, September 25, 2009
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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.

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