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On July 1, 2009, the Securities and Exchange Commission approved an amendment to New York Stock Exchange Rule 452 that will eliminate "broker discretionary votes". This rule change will likely have a significant impact at companies' annual meetings. Annual meetings may no longer be as uneventful as they once were. Under NYSE rules, brokers are allowed to vote their clients' shares in "routine" matters as long as the owner had not previously provided voting instructions to the broker at least ten days before the annual meeting. Previously, that included the voting for the election of directors in uncontested elections. The NYSE rule change, however, changes the uncontested director elections from a "routine" matter to a "non-routine" matter, which means brokers will no longer be able to vote the shares. The rule will be effective for annual meetings in 2010.
This change could significantly increase the power of institutional shareholders and activist shareholders specifically in influencing director elections and generally in corporate affairs of companies. This is just another reform in the rapidly changing corporate governance environment. The change will have a significant effect on those companies that have adopted majority voting and those companies that electronically disseminate shareholder materials.
The retail vote is what is likely to suffer the most under the new rules. The retail vote has already declined for companies that have chosen to use the e-proxy system for delivering shareholder materials. According to Broadridge, less than 21 percent of retail shareholders voted in 2007. Generally, most institutional shareholders vote, and many of them follow the recommendations of the proxy solicitation firms like RiskMetrics (formerly Institutional Shareholder Services (ISS)) and Glass Lewis. This will just magnify the influence of those proxy solicitation firms.
The loss of retail votes is especially acute because evidence shows that the broker discretionary vote typically supports management. In its comment letter to the SEC on the proposed NYSE rule change, the Society of Corporate Secretaries & Governance Professionals states that Broadridge estimated that more than 98 percent of retail shareholders who provided voting instructions to their brokers in 2007 supported the boards' nominees for director. In addition, during the past several years many brokers instituted proportional voting policies in which they voted uninstructed shares in the same proportion as the actual retail vote they received. This made the broker discretionary vote an even more accurate reflection of the views of the retail shareholders. The NYSE rule change eliminates that process. Studies have shown that many retail shareholders were not aware that if they do not vote their proxy on routine matters, their shares were voted by the broker in its discretion. There is a substantial misunderstanding of the voting process. The new rule therefore creates an incentive for companies to communicate directly with retail shareholders, but it is not always possible for a company to know the identity of the ultimate beneficial owners of its shares. Between seventy and eighty percent of shares are held through brokers, banks or depositaries like DTC, rather than by the actual shareholders. Current SEC rules prevent companies from contacting certain shareholders, namely OBOs (objecting beneficial owners). These are shareholders who choose not to identify themselves and do not want to be contacted by companies. The revised rule also may make it more difficult to achieve a quorum for shareholder meetings dealing only with non-routine matters, since uninstructed shares will not count towards meeting the quorum. Companies will now have to bear additional costs to make sure that a sufficient quorum is present, and may want to have at least one routine item on the agenda, such as the vote on the ratification of the outside auditor, to help it achieve reaching a quorum at the annual meeting.
Many companies have adopted bylaws providing for a majority voting standard in the election of directors. Riskmetrics data shows that by year-end 2008, approximately 70 percent of S&P 500 companies had a majority voting standard. Under these standards, a director nominee must receive at least a majority of the number of votes cast with respect to that director's election in order to be elected to a board of directors. If the nominee does not receive a majority of the votes cast, the incumbent director must tender his or her resignation. Achieving the majority vote is more difficult because brokers are now unable to vote shares for which they have not received voting instructions. As noted earlier, the lack of votes could amount up to eighty percent of the company's retail vote. It will be particularly problematic where an activist shareholder launches a "vote no" campaign or where a proxy solicitation firm recommends voting against an incumbent director. Companies with majority voting standards are likely to have a more difficult time in attracting and retaining qualified directors.
This change will also likely increase the costs of uncontested elections, as companies will have to spend more money and effort to reach shareholders who previously did not vote in order to counter any "vote no" campaign. The rule may also increase the influence of special interest groups or activist shareholders who have a particular agenda to challenge an incumbent board. The change to the NYSE rule also needs to be considered in light of the SEC's new "eproxy" rules, which allow companies to post proxy statements on their web page rather than mailing the materials to shareholders. Companies that have taken advantage of these new rules have seen a significant drop in voting from their retail shareholders. The savings of delivering proxy material electronically and the benefits of being "green" may be offset by the increased risk of potential "vote no" campaigns.
Some states like Delaware proposed amendments to the state statutes concerning director elections, which would permit the adoption of a bylaw providing shareholder access to the company's proxy statement for the purpose of director elections. The changes would allow for the imposition of conditions upon access, such as minimum stock ownership requirements, disclosure of stock ownership (including economic exposure through derivatives) and other disclosures. Another proposed amendment would permit the adoption of a bylaw to require the company to reimburse shareholders that have incurred expenses in connection with their solicitation of proxies for director elections (again, with a company able to impose reasonable conditions to the right of reimbursement). Bylaws permitted by the new legislation could be proposed and adopted by the shareholders or by corporate boards. These changes would allow states to have significant influence in the area of corporate governance, rather than allowing the SEC to dictate a uniform approach to this issue.
The NYSE rule regarding broker non-votes will increase the power of institutional investors and activist shareholders, at the same time as companies are dealing with recent changes like majority voting and the "e-proxy" delivery process. It may make it more challenging for boards of directors to weigh the powerful interests of these shareholders and activists against the interests of all shareholders. Although the SEC believes the change is necessary to promote "better corporate governance and transparency of the election process," it effectively will disenfranchise most retail shareholders while significantly increasing the costs to companies. There is also a risk that the effect of all these reforms will be a dramatic shift in power toward proxy solicitation firms like Riskmetrics and Glass Lewis.
Companies may want to take action now to try to minimize any negative consequences of the rule. The company may want to implement an outreach program especially to retail investors to increase the voter turnout to offset any "vote no" campaign. The company should also carefully review its existing corporate governance procedures and disclosures to try to minimize any negative report from one of the proxy solicitation firms to try to prevent those firms from issuing a report that recommends a "withhold" or "against" vote for some or all of the company's directors.
About the Author
Thomas Berkemeyer is associate general counsel and secretary to the American Electric Power Company in Columbus, Ohio. He also serves as the chair of the Corporate Governance Committee of the American Bar Association's Section of Public Utility, Communications, and Transportation Law. This article is excerpted from the Committee's Fall 2009 Report. You can read the full report along with the reports of many other committees by becoming a member of the Section of Public Utility, Communications, and Transportation Law, which is found at http://www.abanet.org/pubutil/.