This year's proxy season could be very turbulent for corporate boards of directors, thanks to increased shareholder activism and new rules that increase proxy disclosure.
"Companies need to reach out and have good relations with their shareholders," said Amy Goodman, a partner and co-head of the securities regulation and corporate governance practice at Gibson, Dunn & Crutcher. "This is going to be a very difficult proxy season. Boards should be attuned to where potential problems may be."
The new proxy disclosure requirements, which take effect Feb. 28, address compensation policies and practices as they relate to risk management; stock and options awards to executives and directors; the board's role in risk oversight; the background and qualifications of board directors and nominees; the consideration of diversity in selecting board members; the posting of 10 years of history of legal actions involving executives, directors and nominees; and any potential conflicts of interest among compensation consultants.
The new rules also require companies to disclose the results of shareholder votes within four business days, amending Form 8-K and replacing Forms 10-K and 10-Q.
"Shareholders are the owners of our publicly traded companies," said Mary Schapiro, chairman of the Securities and Exchange Commission.
"Owners cannot responsibly exercise their oversight without good information about the issues that drive voting decisions. Good corporate governance is a system in which those who manage a company-that is, officers and directors-are effectively held accountable for their decisions and performance," Schapiro said.
Sharp Increase in Shareholder Activism
Companies have seen a gradual rise in the number of shareholder proposals, along with a corresponding reduction in the number of no-action letters from the SEC.
Gibson Dunn said that in 2009, 71.6% of shareholders supported removing a supermajority voting requirement, 65.8% supported declassifying board members, 59.1% favored the requirement of a majority vote in uncontested board director elections, and 51.1% of shareholders favored allowing 10% of outstanding shares to call special meetings.
There was a notable increase in the number of and support for shareholder proposals regarding social issues, climate change and executive compensation, Gibson Dunn said.
For a long time, regulators and board members considered proposals on social responsibility, the environment and climate change to be a nuisance, but that's beginning to change.
"Historically, the SEC has excluded issues related to risk management as ordinary business, "but the agency has recently narrowed its scope of exclusions," said Jim Moloney, a partner and co-head of the securities regulation and corporate governance practice at Gibson Dunn.
"It's no surprise the SEC has done an about-face, changing how they approach the exclusion of these," Moloney continued.
Pending changes to shareholder proxy access and "say on pay" could lead to an additional rise in shareholder activism.
"I am hopeful that we will adopt rules to facilitate the effective exercise of the rights of shareholders to nominate directors to the boards of the companies they own," Schapiro said. "This so-called proxy access rule is designed to increase shareholders' ability to hold boards accountable."
"Shareholder proposals are going every which way," said Peter Casey, senior managing director of corporate proxy at the Altman Group. "It just seems that the momentum is going in ways people aren't accustomed to."
For example, Casey said shareholder groups are continuing to go after anything related to executive compensation, including in areas like executive death benefits. This is also putting a lot of pressure on board compensation committees, he said.
"This caught a lot of people by surprise," Casey said. "If it's going to be forced upon you, you need to be thinking outside the box."
Nonetheless, it will still be very difficult for shareholders vote in a change that goes against the board's wishes. Boards of directors are given so much power and responsibility that it can be difficult for shareholders to hold directors accountable for their actions. It can be done, but the coordination and communication required can be very expensive.
Most investors typically choose to have their broker, bank or other financial institution act as their proxy and vote on their behalf. Voting by proxy gets even more complicated for mutual fund shareholders, most of whom are buy-and-hold investors and tend to support management. Voter participation is typically very low.
NYSE Rule 452, also known as the 10-day rule, allows brokers to vote on "routine" proposals if the beneficial owner of the stock has not provided specific voting instructions to the broker at least 10 days before a scheduled meeting. This ability to vote uninstructed shares is vital in helping establish a quorum at shareholder meetings, said Paul Schulman, executive managing director of corporate proxy at the Altman Group.
A 2006 report by the Proxy Working Group determined that voting on elections of board members was not routine, and the rule was recently amended to take away the ability of brokers to vote uninstructed shares in these elections, even when uncontested.
"Ballots cast by retail shareholders will finally reflect their own decisions, not the decisions of their brokers," said Commissioner Elisse Walter.
Because of the normal low voter turnout, electing new directors can be problematic, Schulman said, especially if a company doesn't have enough votes to make the election legitimate. Participation by electronic voting, or e-proxy, has so far been abysmally low.
"This is not a big concern for companies mostly held by institutions, but it is a concern for companies held by retail holders," such as small- and mid-cap companies, he said.
The loss of the broker discretionary vote has had a major impact on a large number of companies, particularly those who don't have direct access to their shareholders, Casey said.
"In order to counteract the loss of the broker vote, it is important to know your investors," he said. Some ways to improve turnout include telephone solicitations, reminder mailings, e-mails and investor education programs.
"Investors need to know how important their votes are with Rule 452 gone," he said, adding that most brokers have made little effort to inform shareholders of this new responsibility.
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