Is shareholder democracy inching forward?

By Cydney Posner

The shareholder democracy movement seems to be reinvigorated, with a number of proposals being revived or introduced at the state and federal levels that could be viewed to enhance the role of shareholders in the nomination and election of directors.

Proposed Amendments to Rule 452

First, after a couple of years in the deep freeze, amendments to Rule 452 to eliminate discretionary broker votes for director are again proposed to be adopted by the NYSE. Note that this rule would apply to NYSE member brokers and, therefore, would generally affect all issuers, no matter where listed.

Rule 452 allows a broker to vote in its discretion on "routine" proposals if the beneficial owner of the shares has not provided specific voting instructions to the broker at least 10 days before a scheduled meeting. Brokers may not vote without instruction on matters determined to be non-routine. "Non-routine" matters are generally those involving a contest or a matter that may substantially affect the rights or privileges of shareholders, such as mergers or shareholder proposals. (In material supplementary to the Rule, the NYSE identifies matters that are generally viewed to be non-routine. In addition, the NYSE publishes a list of meetings of shareholders in a Weekly Bulletin in which it designates whether, for each meeting, (a) members may vote a proxy without instructions of beneficial owners, (b) members may not vote specific matters on the proxy or (c) members may not vote the entire proxy.) Among the matters defined as "routine" under the current Rule is an "uncontested" election for a company’s board of directors.

Historically, brokers have typically voted in accordance with the board's recommendations on these uninstructed "discretionary" matters and, as a result, they regularly voted in favor of routine proposals and director candidates. More recently, the democratic impulse has influenced a number of brokerage firms to adopt other policies aimed at a more representative vote, for example by requiring that broker discretion be exercised by voting in proportion to the votes cast by stockholders.

In June 2006, the NYSE Proxy Working Group recommended, among other things, that the election of directors no longer be viewed as routine under Rule 452, which would preclude brokers from casting discretionary votes in the election of directors. The Working Group recognized that, if adopted, the proposal would likely result in a number problems, including the increased cost associated with communicating with shareholders who previously did not vote, a cost that would fall disproportionately on smaller issuers with fewer institutional investors. This challenge would be compounded for a company that had adopted majority voting for directors. In addition, the proposal would increase significantly the influence of shareholder activists and other special interests seeking to advance their own agendas. Nevertheless, the Working Group contended that these challenges were outweighed by the need for better corporate governance and transparency in the election process.

In response to the Working Group's recommendation, in 2006, the NYSE originally proposed this amendment, but it met with much consternation and was essentially shelved to be reconsidered as part of a whole package relating to shareholder rights and proxy access. Now, perhaps given the more benevolent attitudes expressed by the new SEC chair toward shareholder democracy issues, the proposed amendments have been revived. The new proposed amendment would be applicable to proxy voting for shareholder meetings held on or after January 1, 2010, unless the SEC did not approve the amendment until after August 31, 2009, in which case, the effective date would be delayed to a date that was at least four months after the approval date and that did not fall within the first six months of the calendar year. In any case, the proposed amendment would not apply to a meeting that was originally scheduled to be held prior to the effective date, but was properly adjourned to date on or after the effective date.

Uninstructed or discretionary votes are especially important in establishing a quorum at shareholder meetings. If the proposal is approved by the SEC, a company that did not submit to its shareholders a proposal to ratify its auditors (which would still be considered "routine") may have difficulty achieving a quorum for its annual meeting. In addition, a company that has adopted "majority vote" policies or bylaws will undoubtedly find it more of a challenge to elect its directors, especially those that have in the past received significant "withhold" votes. Significant withhold votes have become fairly common as shareholder activists seek to hold boards more accountable (or create disorder, depending upon your point of view.) As a result, if approved, the amendment could create a perverse incentive for companies to delay or reject adoption of majority voting provisions.

Proposed Changes to Delaware Corporate Law

Recently, the Delaware State Bar has proposed several amendments to the Delaware General Corporation Law addressing shareholder access to company proxy statements and related matters. The proposals are expected to be introduced in the Delaware General Assembly shortly.

First, the proposed amendments expressly enable Delaware corporations to adopt bylaws that allow shareholders to include within the corporation’s proxy solicitation materials the shareholders’ nominees for election as directors, subject to conditions the bylaws may impose. The proposal identifies a non-exclusive list of restrictions that are deemed to be reasonable, such as requirements to satisfy a threshold percentage of record or beneficial ownership, to provide indemnification for misleading statements or to furnish specified information, or limitations on the number or proportion of directors that may be nominated or on the use of the procedure by certain holders of large recent accumulations of shares (in essence, to prevent this vehicle from being used to effect a change in control).

Second, the proposed amendments allow adoption of a bylaw providing for reimbursement by the corporation of expenses incurred by a stockholder in soliciting proxies in connection with an election of directors, subject to conditions the bylaws may impose, including limitations based on the number of nominees, prior reimbursements or success of the slate. You may recall that a proposed bylaw related to proxy expense reimbursement was the subject of CA, Inc. v. AFSCME Employees Pension Plan, decided by Delaware Supreme Court following the certification to that court of questions by the SEC. (See the posting on 7/17/08) The specific questions certified were (1) whether the proposal is a proper subject for action by stockholders as a matter of Delaware law, and (2) whether the proposal, if adopted, would cause CA to violate any Delaware law to which it is subject. The court concluded that, while the proposal was a proper subject for action by the stockholders, if adopted, it would cause CA to violate Delaware law because the bylaw contained no provision that "would reserve to CA’s directors their full power to exercise their fiduciary duty to decide whether or not it would be appropriate, in a specific case, to award reimbursement at all.'

Commentators have suggested that the amendments are designed to remove any uncertainty regarding the availability of bylaws addressing proxy access and reimbursement. However, they may also represent an acknowledgement that proxy access and related approaches to address shareholder democracy concerns, whether effected by the SEC or through state law changes, are essentially "done deals." In that vein, the proposals would allow companies faced with shareholder action or otherwise desiring to be proactive in corporate governance practices to mitigate the impact of potentially disruptive shareholder activism by the adoption of bylaws that include significant restrictions and conditions already blessed by the legislature.

Third, the proposed amendments would permit Delaware corporations to set separate record dates for determining stockholders entitled to notice of stockholder meetings and stockholders entitled to vote at those meetings, a provision designed to address the problem of "empty voting." "Empty voting" refers to the use by hedge funds and others of swaps and other complex derivatives to stalk companies or influence the vote in change-of-control and other transactions by acquiring voting rights without acquiring the related economic interests. This activity is often criticized because of its potential to distort vote outcomes as a result of voting by holders who do not have any economic interest in the shares. In addition, the sale of shares by holders between the record date and the date of the meeting, especially in the M&A context, can often lead to lower vote returns. While notice of the meeting may require a record date well in advance of the meeting, fixing a record date for voting closer to the date of the meeting may provide companies the opportunity to inhibit empty voting mischief, as well as to increase voter participation.

Rumor has it that a speaker from Richards, Layton will be at the next public companies meeting to make a presentation on all of these proposed changes, so mark your calendars.

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