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Elimination of Broker Discretionary Voting in Director Elections

January 1, 0001

 

On July 1, 2009, the Securities and Exchange Commission, by a 3-2 vote, approved an amendment to New York Stock Exchange Rule 452, Giving Proxies by Member Organizations, to eliminate broker discretionary voting in director elections. Pursuant to this amendment, beginning with shareholder meetings held on or after January 1, 2010, a broker will no longer be permitted to vote a customer’s shares on the uncontested election of directors at a company’s meeting of shareholders except in accordance with voting instructions received from the customer. This amendment expands current Rule 452 to prohibit brokers from voting uninstructed customer shares in all director elections -- whether contested or uncontested.

Background

Under current Commission and NYSE rules, each broker who receives proxy materials relating to a company’s meeting of shareholders is required to transmit those materials to the beneficial owners of the shares -- that is, to each of its customers holding company shares in their accounts -- and is required to request voting instructions from those customers regarding how to vote their shares at the meeting.[1] If the broker has not received voting instructions from the customer ten days before the meeting date, Rule 452 permits the broker to exercise its discretion to vote these “uninstructed shares” at the meeting on matters the NYSE designates as “routine” but not on matters the NYSE designates as “non-routine.”[2]

Prior to today’s amendment, the NYSE identified eighteen matters that are considered “non-routine” such that a broker is not permitted to exercise its discretion to vote shares held in customer accounts on the matter without instructions from the customer. These “non-routine” matters include shareholder proposals that are opposed by management, the adoption or material revision of an equity compensation plan, matters relating to a merger or consolidation and director elections that are the subject of a counter-solicitation (i.e., election contests). For “routine” matters, however, brokers generally exercise the discretion permitted by Rule 452 to vote shares held in customer accounts even if the customer has not provided voting instructions. Historically, these brokers have exercised their discretion by voting the uninstructed shares on the “routine” matter in accordance with the recommendation of the company’s board of directors.[3] Matters treated as “routine” under Rule 452 generally include ratification of the appointment of a company’s independent auditors and, prior to today’s amendment, the uncontested election of directors.

The Amendment

The amendment to Rule 452 approved by the Commission today will expand the list of matters that are considered “non-routine” by the NYSE to include all director elections, whether or not they are contested. As noted above, the amendment will apply to proxy voting of customer shares by brokers for all shareholder meetings held on or after January 1, 2010.[4] If a meeting was originally scheduled to be held prior to January 1, 2010 but was properly adjourned to a date on or after January 1, 2010, amended Rule 452 will not apply to voting at the adjourned meeting.

Commission approval of the amendment comes four years after the NYSE first established a Proxy Working Group to review NYSE rules regulating the proxy voting process, with a particular focus on Rule 452.[5] The Proxy Working Group concluded in a June 2006 report that director elections should no longer be treated as “routine” under Rule 452, noting that the election of directors is not a routine event in the life of a corporation, even where the election is not contested. The NYSE adopted this conclusion and believes the amendment will improve corporate governance and provide for a more transparent election process.

Practical Implications

The amendment to Rule 452 to eliminate broker discretionary voting in director elections is expected to have a potentially significant impact on the operation and outcome of a typical annual meeting of shareholders. The key practical implications of the amendment are summarized below.

Increased Difficulty in Obtaining a Quorum. In its June 2006 report, the NYSE’s Proxy Working Group acknowledged that companies often depend on broker discretionary voting of uninstructed shares in order to establish a quorum at their shareholder meetings. This is especially true for companies with a higher proportion of their shares held by retail investors (i.e., individual investors who hold shares through brokerage or similar accounts). These investors are less likely than larger shareholders, such as institutional investors, to vote their shares. Accordingly, companies with a large retail investor base have historically depended on brokers voting uninstructed shares in order to achieve a quorum at their shareholders’ meetings. In the absence of other “routine” items on the agenda on which brokers will be permitted to vote uninstructed shares, some companies may be unable to achieve a quorum and will not be able to conduct business at the meeting. Further, because brokers were previously able to vote uninstructed shares as many as ten days prior to the meeting date, these companies may also be forced to wait longer -- potentially right up to the meeting date -- before knowing whether a quorum has been achieved.

The practical response to this concern is for companies to include at least one item on their agenda that is “routine” under Rule 452, such as shareholder ratification of the appointment of the company’s independent registered public accounting firm. Brokers will be permitted to vote uninstructed shares on these routine items, thereby also facilitating the company’s ability to obtain a quorum at the meeting.

Majority Voting in Uncontested Director Elections. Over the past few years, a growing number of companies (including approximately 2/3 of all S&P 500 companies) have adopted some form of majority voting in director elections. The various formulations of these policies generally require that a nominee will not be elected and/or will resign from the board of directors if the nominee fails to receive the affirmative vote of a majority of the votes cast. Historically, because brokers have generally exercised the discretion permitted by Rule 452 by voting uninstructed shares in accordance with the recommendation of the company’s board of directors in uncontested elections, these broker votes favored the director nominee. Following the amendment of Rule 452 to eliminate broker discretionary voting in director elections, these uninstructed shares will no longer be counted as either affirmative or negative votes and thus it may become more difficult for a director nominee to achieve majority approval.

Investor Activism and “Just Vote No” Campaigns. The elimination of broker discretionary voting in director elections is likely to lead to an increase in “just vote no” campaigns by investor activists. Under Rule 452, prior to today’s amendment, a contested director election existed only if the dissident shareholder solicited proxies in support of its director nominees and only with respect to those brokerage accounts solicited. Therefore, absent an opposing solicitation targeted at a broker’s customers and notwithstanding a shareholder’s “just vote no” campaign efforts, the broker was still able to vote uninstructed shares in accordance with the recommendation of the company’s board of directors. By treating all director elections as “non-routine” without regard to the existence of a contest, the amendment to Rule 452 makes it more likely that “just vote no” campaigns will have an impact on director elections and, for companies who have adopted majority voting in director elections, it increases the possibility that a director nominee that is the target of a “just vote no” campaign will not receive majority approval.

Increased Influence of Proxy Advisory Firms. Proxy advisory firms (such as RiskMetrics) who issue recommendations on the voting of proposals at shareholder meetings are likely to hold more sway over director elections following the amendment of Rule 452. These firms increasingly recommend withhold or against votes on director nominees where they believe the company lacks adequate corporate governance or effective oversight over certain matters such as executive compensation. Historically, the effect of these withhold/against recommendations could be limited by brokers who typically exercised the discretionary voting authority permitted by Rule 452 by voting uninstructed shares for all of the board’s nominees. Following the amendment of Rule 452, director nominees will no longer receive the benefit of these uninstructed shares being voted in their favor.

Notice and Access (or “E-Proxy”). Due to the considerable decline in voting by retail holders for companies who have implemented the Commission’s new notice and access rules, some companies have decided not to use notice and access if they have significant non-routine items on the agenda. These companies fear that the failure of voting by retail holders, and the inability of brokers to vote uninstructed shares on the non-routine matters, could make it more difficult to achieve the requisite shareholder approval. The amendment to Rule 452, which will treat all director elections as “non-routine,” may further discourage companies, especially those with high retail ownership, from using notice and access. Even for companies that do use notice and access, the resulting cost savings may be diminished by the need for additional mailings to encourage retail holders to vote.

Expense of Proxy Solicitation. Due to all of the above concerns, proxy solicitation efforts are likely to become more expensive and time consuming. Companies will need to pay close attention to voting results as they come in and may need to supplement the proxy statement with follow-up mailings to remind shareholders to vote. This will be especially important for companies with a higher percentage of retail holders as well as for companies that have adopted majority voting in director elections. Companies may also find it necessary more than ever before to involve a proxy solicitor in these efforts.

Time will tell whether the benefits of the Rule 452 amendment advanced by the NYSE -- improved corporate governance and a more transparent election process -- will be overshadowed by the concerns described above. In advance of next year’s proxy season, companies should carefully consider the likely impact that the elimination of broker discretionary voting in director elections will have on the outcome of the election of directors and evaluate whether any changes should be made to the company’s typical annual meeting and proxy solicitation process to minimize any impact.


[1] See NYSE Rule 451, Transmission of Proxy Material. See also SEC Rule 14b-1.

[2] All brokers registered as members with the NYSE are subject to Rule 452 and, accordingly, Rule 452 applies to the voting of all shares held in a customer’s account, including shares of a company listed on The NASDAQ Stock Market LLC or NYSE Amex (formerly known as NYSE Alternext U.S. and the American Stock Exchange).

[3] In recent years, several brokers have departed from the prevailing practice to vote uninstructed shares in accordance with the board of director’s recommendation. Some of these brokers have refused to exercise the discretion permitted by Rule 452 and will only vote those shares for which they have received instructions from their customers. Certain other brokers have adopted “proportional” voting and will vote uninstructed shares on routine matters in proportion to those shares for which they have received instructions from other customers. Notwithstanding these recent developments in proxy voting, the vast majority of brokers continue to exercise the discretion permitted by Rule 452 to vote uninstructed shares on routine matters in accordance with the board’s recommendation.

[4] The amendment will apply to all companies listed on the NYSE, The NASDAQ Stock Market LLC or on other exchanges, but it will not apply to companies registered under the Investment Company Act of 1940.

[5] Following a June 2006 recommendation of the Proxy Working Group, in October 2006, the NYSE first submitted a proposal to the SEC to amend Rule 452 to require that all director elections be treated as “non-routine.” The NYSE agreed to delay SEC approval of the proposal after learning that the SEC was considering the proposed amendment as part of a broader review of shareholder communications and proxy access. The NYSE resubmitted the proposal in February 2009.