SEC Eliminates Discretionary Voting by Brokers and Proposes Enhanced Proxy Disclosure and Say-on-Pay Rules for TARP Companies
 
August 20, 2009
 
Laurie L. Green- Ft Lauderdale
Francois Janson- New York

On July 1, 2009, the Securities and Exchange Commission (SEC) voted on three important measures:

• It approved a change to NYSE Rule 452 that eliminates broker discretionary voting for all elections of directors, whether contested or not.
• It proposed additional disclosure requirements regarding executive compensation and corporate governance and certain technical improvements to the proxy rules.
• It proposed rules requiring public companies receiving money from the Troubled Asset Relief Program (TARP) to provide for a shareholder “say-on-pay.”

The elimination of broker discretionary voting will apply to shareholder meetings held on or after January 1, 2010. Comments on the proposed proxy rules are due by September 15, 2009. Comments on the proposed TARP say-on-pay rules are due by September 8, 2009. The SEC is required to adopt final rules mandating the shareholder say-on-pay by February 17, 2010.

Elimination of Broker Discretionary Voting

The elimination of broker discretionary voting on the election of directors will have a significant impact on annual meetings, particularly for companies with a large retail shareholder base. Because Rule 452 applies to brokers that are members of the NYSE rather than to companies, the amendment will affect all U.S. public companies, not just those listed on the NYSE, as well as foreign private issuers whose securities are listed or traded in the United States. The amendment does not apply to investment companies registered under the Investment Company Act of 1940, however.

Background

Currently, Rule 452 provides that unless shareholders who hold their shares in “street name” tell their brokers how to vote at least 10 days before the meeting, brokers may vote the shares at their discretion on matters if there is no contest and the item does not authorize a merger, consolidation or substantially affect the rights or privileges of the stock. Rule 452 lists 18 specific matters that cannot be voted by the broker without instructions and are referred to as “non-routine” matters. Items about which the broker can vote without instruction, such as uncontested director elections and the ratification of auditors, are referred to as “routine” matters. Non-routine matters include matters that are the subject of a counter-solicitation or a stockholder proposal that is being opposed by management. The proposal would add to the list of “non-routine” items the election of directors, whether contested or not.

In April 2005, the NYSE formed a working group to review the proxy voting process. It concluded that “[d]irectors are simply too important to the corporation for their election to ever be considered routine.” In approving the rule change, the SEC agreed with the working group, stating that given the large proportion of shares held in street name, the importance of the election process and the potential for the distortion of election results, the election of directors should no longer be an item eligible for broker discretionary voting. The SEC believes that although companies may incur increased proxy solicitation costs, the proposal should better enfranchise shareholders by helping to assure that critical matters, such as the election of directors, are determined by those with an economic interest in the company rather than the broker, which has no such economic interest.

Impact of Amendment on Director Elections

The elimination of broker discretionary voting on the election of directors may have a significant impact on annual meetings, particularly for those companies with a large retail shareholder base, including the following:

• Increased costs. Companies will need to spend time and resources educating retail shareholders about the importance of providing voting instructions to their brokers. In addition, companies may need to hire proxy solicitation firms to ensure that their nominees receive the requisite vote.
• Difficulty in establishing quorums. In non-contested meetings, quorums will be more difficult to obtain except when companies include a routine matter on the ballot, such as the ratification of auditors.
• Majority voting. Companies with a majority voting standard for the election of directors may have difficulty in obtaining the requisite shareholder approval for their nominees. Generally, under a majority voting standard, nominees must receive a majority of the votes cast. Because brokers generally vote for management’s nominees, the loss of the broker discretionary vote will make it more difficult for management nominees to receive a majority of the votes cast. Companies that have adopted majority voting should review their bylaws to ensure that the loss of broker discretionary voting does not adversely impact the election prospects of its candidates. Companies that are considering adopting a majority voting standard will need to consider the impact of the loss of broker discretionary vote.
• Increase in shareholder activism. Campaigns to “just vote no” or to “withhold” voting for certain directors, were deemed “routine” under the current rule. Because brokers tend to vote in accordance with management’s recommendation, in a “just vote no” or “withhold” campaign, the broker discretionary vote could distort the election results by creating a perception that a candidate received more votes than would be the case considering only the votes of registered owners and in certain cases by changing the outcome of the election. With the elimination of the broker discretionary vote, campaigns to “just vote no” or “withhold” may become more prevalent.
• E-proxy more difficult. Without the broker discretionary vote, the “notice and access” method of disseminating proxy materials may result in an even greater drop in retail voting. Foreign private issuers that voluntarily use this method of dissemination to reach their U.S. shareholders may also experience a similar problem. These companies may consider using the services of a dedicated U.S. proxy solicitation firm to mitigate the adverse effect of the loss of broker discretionary voting on U.S. voters’ turnout.
• Increased influence of institutional shareholders and proxy advisory firms. Institutional shareholders and proxy advisory firms may have more influence on the election of directors unless companies are able to encourage retail shareholders to submit voting instructions to their brokers. This trend is likely to accelerate if the recent rules proposed by the SEC on shareholder access to companies’ proxy statements are adopted.

In a recent analysis of the 2009 proxy season (available at http://www.broadridge.com/investor-communications/us/2009ProxyStats.pdf), Broadridge reported that the broker vote represented 26 percent of total votes cast by shareholders holding between 5,000-9,999 shares, and close to 40 percent for shareholders holding between 1,000-4,999 shares. Overall, the broker vote represented 19.1 percent of the total vote in the 2009 proxy season. This statistic highlights the need for companies to develop a strategy for addressing the impact that the elimination of broker discretionary voting will have on their annual board election. This will likely be apparent to companies that have a large retail shareholder base. However, even companies that have a largely institutional shareholder base should not underestimate the impact that the lack of broker vote can have on the outcome of a close election with majority voting and a “just vote no” campaign. As these types of situations can only be addressed on a “case by case” basis, these companies may consider asking a proxy solicitor to do a stockholder composition analysis prior to setting a record date for an annual meeting to get a better sense of how to approach the annual meeting campaign.

Proxy Enhancements

The SEC also proposed additional disclosure requirements regarding executive compensation and corporate governance, and amendments to the proxy rules that are intended to clarify how they operate.

Enhanced Compensation Disclosure

Compensation Discussion and Analysis. The proposed rules would require a company to discuss and analyze its compensation policies and actual practices for employees generally (and no longer solely for its executive officers), if risks arising from these policies or practices may have a material effect on the company. In preparing this disclosure, companies would need to consider the level of risk employees might take to meet their incentive compensation goals. Examples of situations that would trigger this disclosure include compensation policies and practices are as follows:

• at a business unit of the company that carries a significant portion of the company’s risk profile
• at a business unit with compensation structured significantly differently than other units within the company
• at business units that are significantly more profitable than others within the company
• at business units where the compensation expense is a significant percentage of the unit’s revenues
• where policies and practices vary significantly from the overall risk and reward structure of the company, such as when bonuses are awarded upon accomplishment of a task, while the income and risk to the company from the task extend over a significantly longer period of time

The proposed amendments provide examples of the types of issues that companies should discuss and analyze, as follows:

• the general design philosophy of the company’s compensation policies for employees whose behavior would be most affected by the incentives established by the policies, as such policies relate to or affect risk taking by those employees on behalf of the company, and the manner of its implementation
• the company’s risk assessment or incentive considerations, if any, in structuring its compensation policies or in awarding and paying compensation
• how the company’s compensation policies relate to the realization of risks resulting from the actions of employees in both the short term and the long term, such as through policies requiring claw-backs or imposing holding periods
• the company’s policies regarding adjustments to its compensation policies to address changes in its risk profile
• material adjustments the company has made to its compensation policies or practices as a result of changes in its risk profile
• the extent to which the company monitors its compensation policies to determine whether its risk management objectives are being met with respect to incentivizing its employees.

Stock Awards and Option Grants. In a reversal of its amendment in 2006, the SEC is proposing amending the Summary Compensation Table and the Director Compensation Table to report stock awards and option grants based on aggregate grant date fair value in accordance with FAS 123R. This would replace the current disclosure of the dollar amount recognized for financial statement reporting purposes in accordance with FAS 123R. In revising its position, the SEC noted that many investors believe that disclosure of how much equity compensation a company decides to award during a fiscal year is more informative than the dollar amount recognized for financial statement reporting purposes.

Corporate Governance

The SEC proposed to introduce the following additional disclosure requirements:

• Expanded disclosure of the qualifications of directors to help investors assess what makes a candidate particularly suited to serve on the board, e.g., any directorships at public companies held by directors and nominees during the past five years (instead of currently held directorships) and any legal proceedings during the past 10 years (instead of five years).
• New disclosure of the company’s leadership structure, including information regarding the company’s decision to separate or combine the position of chief executive officer and chairman and whether the company has a lead independent director. In addition, disclosure regarding the board’s role in the company’s risk management process would be required.
• Expanded disclosure of the fees paid to compensation consultants if they provide other services to the company in addition to advising on executive or director compensation, and a description of such other services.
• Disclosure of the results of a shareholder vote within four business days after the meeting in a Form 8-K, rather than in the next Form 10-Q or 10-K.

Enhancements to the Proxy Process

The SEC also proposed the following amendments to the proxy rules to clarify how they operate and to facilitate shareholder communications and voting:

• Amend Rule 14a-2(b) – which exempts certain proxy solicitations from the proxy rules – to clarify that an unmarked copy of management’s proxy card that a shareholder sends to other shareholders with a request that it be returned directly to management, is not a “form of revocation” (which would render the exemption unavailable) because the shareholder does not solicit authority to vote. In addition, the proposal would clarify that a person does not need to be a shareholder to have a substantial interest in the subject matter of a solicitation and thus be disqualified from relying on the exemption.
• Amend Rule 14a-4(d) to provide that a short slate can be rounded out with nominees named in a third-party proxy statement.
• Amend Rule 14a-4(e) to clarify that, if a proxy grants conditional authority to vote, any such conditions must be objectively determinable.
• Amend Rule 14a-12 to clarify that information regarding the identity and interests of the participants in a solicitation must be on file with the SEC no later than the first time a soliciting communication is made.

Say-on-Pay for TARP Recipients

Section 111(e) of the Emergency Economic Stabilization Act of 2008 (EESA) requires that any company receiving financial assistance under the TARP provide a separate shareholder vote to approve the compensation of its executives, as disclosed under the SEC’s compensation disclosure rules, including the compensation discussion and analysis and the compensation tables. The shareholder vote required by Section 111(e) is not binding on the board of directors, and such vote will not be construed as overruling a board decision or as creating or implying any additional fiduciary duty by the board. The SEC is proposing amendments to the proxy rules to help implement this vote requirement.

Separate Shareholder Vote Required

Under proposed Rule 14a-20, companies that are TARP recipients would be required to provide this separate shareholder vote in proxies solicited during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding. This period would not include any period during which the government only holds warrants of the TARP recipient. The separate shareholder vote would only be required on a proxy solicited for an annual or special meeting where directors are being elected. An instruction to proposed Rule 14a-20 would clarify that smaller reporting companies would not be required to include a compensation discussion and analysis to comply with the rule.

Disclosure Requirements

The SEC also proposed new Item 20 to Schedule 14A which will require TARP companies to disclose that they are providing a separate shareholder vote on executive compensation pursuant to the requirements of the EESA, and to briefly explain the general effect of the vote, such as whether the vote is non-binding. The SEC did not provide specific language to be used. However, the SEC clarified that the vote must be to approve the compensation of executives, as disclosed in the proxy statement. A vote to approve only compensation policies and procedures would not be sufficient. A shareholder proposal to adopt a policy providing for periodic, non-binding shareholder votes on executive compensation in the future would also not be sufficient.

Preliminary Proxy Statement Required

The say-on-pay vote for TARP recipients will trigger a preliminary proxy statement filing with the SEC. The SEC declined to amend Rule 14a-6 to add the TARP say-on-pay vote to the list of items that do not trigger a preliminary filing. The SEC believes that given the early state of the development of disclosures under these requirements and the special policy considerations relating to this shareholder vote for TARP recipients, it is appropriate for the staff to be able to comment on the disclosure before final proxy materials are mailed.

Related Practices

• Public Companies and Securities