Is What's Past Prologue?

Rule 452

The amendment of NYSE Rule 452 generated great concern on the part of the corporate community due to fears that it would limit voting by retail investors, who are generally more likely than institutional investors to support company proposals. In some cases, companies were also concerned that the amendment of Rule 452 would make it impossible to get quorums for their shareholder meetings. (In this regard, it's worth noting that Rule 452 applies to broker discretionary voting regardless of whether or not a company is listed on the NYSE.) Companies that had implemented or were planning to implement “notice and access” were thought to be particularly vulnerable, because “N&A” also negatively impacts retail voting.

While the amendment of Rule 452 may have resulted in some lower quorum levels and reduced support for company nominees and other company proposals, there have been no reports of any significant quorum or voting problems. This may reflect the fact that companies and others made a concerted effort to alert and educate their retail holders about the amendment and to otherwise “get out the vote.” Moreover, reports indicate that more companies ' both large and small ' used N&A in 2010 than in 2009.

New Disclosures

On Dec. 16, 2009, the SEC adopted a number of rules calling for substantial new proxy statement disclosures. When these rules were proposed in early July, it was anticipated that they would be adopted relatively promptly, but when their adoption consistently failed to appear on SEC open meeting agendas, some SEC-watchers suggested that the delay resulted from controversy at the SEC and that at least some of the proposals would be adopted later or in different form, if at all. However, for the most part, the rules were adopted as proposed.

The new rules called for disclosure of the following matters:

• Board leadership structure ' whether a company combines the positions of chairman and chief executive officer; the reasons for the company's approach; and, if the company has a lead or presiding independent director, information about that role.
• Board risk oversight ' how the board of directors and its committees oversee risk.
• Compensation risk ' the relationship between compensation policies/practices and risk, but only if the risks are “reasonably likely to have a material effect” on the company.
• Directors' backgrounds and skill sets ' including the experience, qualifications and other attributes that “justify” service as a director, as well as additional information about public company directorships and involvement in certain legal proceedings.
• Board diversity ' whether and how diversity is considered in identifying nominees for the board and, if the company has a policy on board diversity, how the policy is implemented and how the effectiveness of the policy is assessed.

The new rules, and the timing of their adoption, posed some challenges for calendar-year companies that had already begun preparing their 2010 proxy materials. In addition, the new requirements relating to board diversity disclosure had not been issued in proposed form; this factor, combined with some late-breaking statements of SEC staff members concerning what constitutes a diversity “policy,” may have created some more work for companies. However, notwithstanding some grousing about the timing of adoption of the new rules, it appears that many companies used the new requirements as an opportunity to “tell their side of the story” on issues such as board leadership structure. As indicated below, support for shareholder proposals seeking separation of the chair and CEO positions was lower in 2010 than in the recent past; perhaps the more robust disclosures in this area contributed to the decline.

2010 Voting Results

As stated above, there were concerns that 2010 would be a year in which shareholder activism would reach new heights. These concerns were not borne out by events. In fact, for the most part, 2010 turned out to be a rather quiet year from the standpoint of shareholder activism. Some highlights follow.

Voting for Directors

Fears of a “perfect storm,” in which increasing numbers of company nominees would face serious election challenges, were caused not only by the aftermath of the financial crisis and the ongoing recession, but also by the end of broker discretionary voting in director elections and the increased use of a majority voting standard. However, the number of directors who failed to receive majority support remained substantially the same as in recent years.

Moreover, in at least one case, a “just vote no” campaign that appeared to have a high likelihood of success turned out to be a non-event. Following a mining accident that resulted in numerous deaths, as well a problematic safety record, it appeared that Massey Energy would be the ideal candidate for such a campaign. However, all three board-designated nominees standing for election at Massey's annual meeting received a majority of the votes cast (the vote opposing these candidates was approximately 42%).

Massey aside, a number of reasons have been cited for the 2010 results, including increased levels of engagement between companies and investors; a “plateau” in investor dissent generally; the use of enhanced proxy solicitation and “get out the vote” efforts by companies; and reluctance on the part of mutual funds and other investment managers to employ the “nuclear option” of unseating directors (absent clear violations of voting guidelines). In the absence of detailed surveys or other data, it is impossible to know whether these or other reasons accounted for the 2010 voting results.

Compensation Matters

Compensation matters seem to have generated somewhat more interest ' and greater levels of opposition to companies ' than director elections in 2010, although the results varied depending upon the matter voted upon as well as company-specific factors. Notably, while the average vote in favor of company-sponsored “say on pay” proposals was high at approximately 89%, such proposals were defeated at three companies: Key Corp., Motorola and Occidental Petroleum. Since the conventional wisdom is that company-sponsored say on pay proposals are rarely defeated, these negative votes came as a shock to the corporate community. Two other companies, American Express and Valero Energy, received lower-than-expected votes (in each case less than 70%) in favor of their say on pay proposals. Although say on pay votes are advisory in nature and have no binding effect on a company, negative votes suggest that a company may need to reconsider its approach to executive compensation, additional shareholder engagement, or both.

Shareholders also defeated a long-term stock plan submitted for approval by Abercrombie & Fitch and nearly defeated two compensation committee members standing for re-election as directors of Nabors Industries.

On the other hand, shareholder proposals seeking to have companies submit say on pay proposals did not do quite as well in 2010 as in 2009; the average vote in favor of these proposals in 2010 was approximately 44%, vs. 46% last year. One possible reason for the decline is that a number of companies ' particularly larger-cap companies ' have adopted say on pay, either voluntarily or in response to (or anticipation of) shareholder proposals on the topic.

Other compensation proposals, such as those questioning “golden parachutes” and “golden coffins,” generated mixed results in 2010.

Other Issues

Shareholder proposals seeking to limit or eliminate anti-takeover devices, such as supermajority voting requirements, classified or staggered boards and prohibitions against shareholder action by written consent, continued to show strong support. However, proposals seeking to permit shareholders to call special shareholder meetings or to lower the percentage of shareholders needed to call such meetings, did not fare as well as in 2009, possibly due to actions taken by companies in response to proposals that received high votes in prior years; the average vote in favor of these proposals was approximately 43% in 2010, compared with 51% in 2009.

Support for shareholder proposals seeking separation of the chair and CEO positions (and similar proposals seeking the designation of an independent board chair) also were less successful in 2010 than in 2009. The average vote in favor of these proposals was approximately 29% in 2010, vs. 34% in 2009.

The Outlook for 2011 and Beyond

The enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act in July 2010, and a number of related actions by the SEC, will likely lead to a new round of excitement for future proxy seasons. (See article by Michael R. Littenberg, infra.) Companies will face the following challenges, among others:

Proxy Access

The Dodd-Frank Act gives the SEC statutory authority to adopt proxy access rules. It is therefore virtually certain that the SEC will adopt such rules in the near future. Depending upon a number of variables, including the eligibility thresholds set by the SEC and the extent to which investors use proxy access, it could lead to significant changes in both the form and substance of proxy statements and director elections in the future.

Say on Pay

The Dodd-Frank Act requires companies to sponsor say on pay votes in 2011. In addition, the Act requires companies to conduct a separate vote in 2011 on whether future say on pay votes should take place annually, biennially or triennially. The mechanics of the “frequency” votes are unclear; for example, must the vote be conducted on a multiple-choice basis, or does the company have to propose a particular frequency and get the shareholders' approval for that frequency? If that approval is not forthcoming, is annual say on pay the default? And if, for example, triennial voting is approved, will a shareholder proposal seeking annual votes be permitted under SEC Rule 14a-8? While the Act does not require SEC rulemaking on say on pay, it is expected that the SEC will clarify these and other interpretive questions.

Further Erosion of Broker

Discretionary Voting

Dodd-Frank imposes a statutory ban on discretionary broker voting, not only with respect to the election of directors (as was the case in 2010 due to the amendment of NYSE Rule 452), but also with respect to executive compensation matters and any other matter deemed “significant” by the SEC. Although the amendment of NYSE Rule 452 does not appear to have created serious quorum or voting problems in 2010, the unavailability of broker discretionary voting on additional matters may trigger the need for additional solicitation efforts and related costs.

Additional Requirements and Disclosures

Dodd-Frank also mandates several new or expanded disclosures relating to executive compensation and corporate governance matters, as well as a requirement that compensation committee members be independent. Since the Act suggests that the new independence requirements will be substantially the same as those currently applicable to audit committees (as required by another famously hyphenated statute, Sarbanes-Oxley), many if not most public companies should not need to reconstitute their compensation committees; however, some examination of compensation committee composition and charter provisions, as well as expanded disclosure, is likely to be called for.

Proxy 'Plumbing'

On July 14, 2010, the SEC issued a long-anticipated “concept” release on a wide variety of proxy voting issues, including voting borrowed shares, the extent to which companies can communicate directly with their owners (rather than through intermediaries) ' possibly by eliminating or modifying the concept of “objecting beneficial owners” or “OBOs.” In addition, the SEC has indicated that it is considering whether and to what extent it can or should regulate proxy advisory firms such as Institutional Shareholder Services. At a minimum, this concept release will require careful consideration by companies and other participants in the proxy voting arena; at a maximum, it may lead to significant changes in proxy voting that these participants will need to address.

Conclusion

In short, given the constantly evolving state of statutory and regulatory requirements, as well as governance practices, it is probably incorrect to refer to the “proxy season”; in fact, preparing the proxy statement has become a year-round responsibility.

Robert B. Lamm, a member of this newsletter's Board of Editors, is Assistant General Counsel and Assistant Secretary at Pfizer Inc. Mr. Lamm acknowledges that certain voting and other information in this article was provided by Morrow & Co., Inc. and by Marc S. Gerber of Skadden, Arps, Slate, Meagher & Flom LLP.

Corporate America was not looking forward to the 2010 proxy season. First, in July 2009, the Securities and Exchange Commission (SEC) approved the amendment of New York Stock Exchange Rule 452 to prevent brokers from exercising discretionary voting authority in the election of directors. Second, companies had to contend with significant new proxy statement disclosure requirements adopted in December 2009. Third, 2010 was heralded as the year when shareholder activism would reach new heights in the wake of the financial crisis and the ongoing recession. As a result, there were predictions that larger-than-ever numbers of directors would not be re-elected and company proposals would go down to defeat, while all sorts of shareholder initiatives would prevail.

It didn't quite work out that way. In fact, while the regulatory changes may have added to companies' workloads, they did not wreak havoc, and the new disclosures were generally well received. And as far as shareholder activism was concerned, 2010 represented more of a “whimper” than a “bang.” This article considers changes in the regulatory climate prior to the 2010 proxy season and the actual voting results, and looks at some issues that will affect proxy seasons in 2011 and beyond.

The Regulatory Climate

Rule 452

The amendment of NYSE Rule 452 generated great concern on the part of the corporate community due to fears that it would limit voting by retail investors, who are generally more likely than institutional investors to support company proposals. In some cases, companies were also concerned that the amendment of Rule 452 would make it impossible to get quorums for their shareholder meetings. (In this regard, it's worth noting that Rule 452 applies to broker discretionary voting regardless of whether or not a company is listed on the NYSE.) Companies that had implemented or were planning to implement “notice and access” were thought to be particularly vulnerable, because “N&A” also negatively impacts retail voting.

While the amendment of Rule 452 may have resulted in some lower quorum levels and reduced support for company nominees and other company proposals, there have been no reports of any significant quorum or voting problems. This may reflect the fact that companies and others made a concerted effort to alert and educate their retail holders about the amendment and to otherwise “get out the vote.” Moreover, reports indicate that more companies ' both large and small ' used N&A in 2010 than in 2009.

New Disclosures

On Dec. 16, 2009, the SEC adopted a number of rules calling for substantial new proxy statement disclosures. When these rules were proposed in early July, it was anticipated that they would be adopted relatively promptly, but when their adoption consistently failed to appear on SEC open meeting agendas, some SEC-watchers suggested that the delay resulted from controversy at the SEC and that at least some of the proposals would be adopted later or in different form, if at all. However, for the most part, the rules were adopted as proposed.

The new rules called for disclosure of the following matters:

• Board leadership structure ' whether a company combines the positions of chairman and chief executive officer; the reasons for the company's approach; and, if the company has a lead or presiding independent director, information about that role.
• Board risk oversight ' how the board of directors and its committees oversee risk.
• Compensation risk ' the relationship between compensation policies/practices and risk, but only if the risks are “reasonably likely to have a material effect” on the company.
• Directors' backgrounds and skill sets ' including the experience, qualifications and other attributes that “justify” service as a director, as well as additional information about public company directorships and involvement in certain legal proceedings.
• Board diversity ' whether and how diversity is considered in identifying nominees for the board and, if the company has a policy on board diversity, how the policy is implemented and how the effectiveness of the policy is assessed.

The new rules, and the timing of their adoption, posed some challenges for calendar-year companies that had already begun preparing their 2010 proxy materials. In addition, the new requirements relating to board diversity disclosure had not been issued in proposed form; this factor, combined with some late-breaking statements of SEC staff members concerning what constitutes a diversity “policy,” may have created some more work for companies. However, notwithstanding some grousing about the timing of adoption of the new rules, it appears that many companies used the new requirements as an opportunity to “tell their side of the story” on issues such as board leadership structure. As indicated below, support for shareholder proposals seeking separation of the chair and CEO positions was lower in 2010 than in the recent past; perhaps the more robust disclosures in this area contributed to the decline.

2010 Voting Results

As stated above, there were concerns that 2010 would be a year in which shareholder activism would reach new heights. These concerns were not borne out by events. In fact, for the most part, 2010 turned out to be a rather quiet year from the standpoint of shareholder activism. Some highlights follow.

Voting for Directors

Fears of a “perfect storm,” in which increasing numbers of company nominees would face serious election challenges, were caused not only by the aftermath of the financial crisis and the ongoing recession, but also by the end of broker discretionary voting in director elections and the increased use of a majority voting standard. However, the number of directors who failed to receive majority support remained substantially the same as in recent years.

Moreover, in at least one case, a “just vote no” campaign that appeared to have a high likelihood of success turned out to be a non-event. Following a mining accident that resulted in numerous deaths, as well a problematic safety record, it appeared that Massey Energy would be the ideal candidate for such a campaign. However, all three board-designated nominees standing for election at Massey's annual meeting received a majority of the votes cast (the vote opposing these candidates was approximately 42%).

Massey aside, a number of reasons have been cited for the 2010 results, including increased levels of engagement between companies and investors; a “plateau” in investor dissent generally; the use of enhanced proxy solicitation and “get out the vote” efforts by companies; and reluctance on the part of mutual funds and other investment managers to employ the “nuclear option” of unseating directors (absent clear violations of voting guidelines). In the absence of detailed surveys or other data, it is impossible to know whether these or other reasons accounted for the 2010 voting results.

Compensation Matters

Compensation matters seem to have generated somewhat more interest ' and greater levels of opposition to companies ' than director elections in 2010, although the results varied depending upon the matter voted upon as well as company-specific factors. Notably, while the average vote in favor of company-sponsored “say on pay” proposals was high at approximately 89%, such proposals were defeated at three companies: Key Corp., Motorola and Occidental Petroleum. Since the conventional wisdom is that company-sponsored say on pay proposals are rarely defeated, these negative votes came as a shock to the corporate community. Two other companies, American Express and Valero Energy, received lower-than-expected votes (in each case less than 70%) in favor of their say on pay proposals. Although say on pay votes are advisory in nature and have no binding effect on a company, negative votes suggest that a company may need to reconsider its approach to executive compensation, additional shareholder engagement, or both.

Shareholders also defeated a long-term stock plan submitted for approval by Abercrombie & Fitch and nearly defeated two compensation committee members standing for re-election as directors of Nabors Industries.

On the other hand, shareholder proposals seeking to have companies submit say on pay proposals did not do quite as well in 2010 as in 2009; the average vote in favor of these proposals in 2010 was approximately 44%, vs. 46% last year. One possible reason for the decline is that a number of companies ' particularly larger-cap companies ' have adopted say on pay, either voluntarily or in response to (or anticipation of) shareholder proposals on the topic.

Other compensation proposals, such as those questioning “golden parachutes” and “golden coffins,” generated mixed results in 2010.

Other Issues

Shareholder proposals seeking to limit or eliminate anti-takeover devices, such as supermajority voting requirements, classified or staggered boards and prohibitions against shareholder action by written consent, continued to show strong support. However, proposals seeking to permit shareholders to call special shareholder meetings or to lower the percentage of shareholders needed to call such meetings, did not fare as well as in 2009, possibly due to actions taken by companies in response to proposals that received high votes in prior years; the average vote in favor of these proposals was approximately 43% in 2010, compared with 51% in 2009.

Support for shareholder proposals seeking separation of the chair and CEO positions (and similar proposals seeking the designation of an independent board chair) also were less successful in 2010 than in 2009. The average vote in favor of these proposals was approximately 29% in 2010, vs. 34% in 2009.

The Outlook for 2011 and Beyond

The enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act in July 2010, and a number of related actions by the SEC, will likely lead to a new round of excitement for future proxy seasons. (See article by Michael R. Littenberg, infra.) Companies will face the following challenges, among others:

Proxy Access

The Dodd-Frank Act gives the SEC statutory authority to adopt proxy access rules. It is therefore virtually certain that the SEC will adopt such rules in the near future. Depending upon a number of variables, including the eligibility thresholds set by the SEC and the extent to which investors use proxy access, it could lead to significant changes in both the form and substance of proxy statements and director elections in the future.

Say on Pay

The Dodd-Frank Act requires companies to sponsor say on pay votes in 2011. In addition, the Act requires companies to conduct a separate vote in 2011 on whether future say on pay votes should take place annually, biennially or triennially. The mechanics of the “frequency” votes are unclear; for example, must the vote be conducted on a multiple-choice basis, or does the company have to propose a particular frequency and get the shareholders' approval for that frequency? If that approval is not forthcoming, is annual say on pay the default? And if, for example, triennial voting is approved, will a shareholder proposal seeking annual votes be permitted under SEC Rule 14a-8? While the Act does not require SEC rulemaking on say on pay, it is expected that the SEC will clarify these and other interpretive questions.

Further Erosion of Broker

Discretionary Voting

Dodd-Frank imposes a statutory ban on discretionary broker voting, not only with respect to the election of directors (as was the case in 2010 due to the amendment of NYSE Rule 452), but also with respect to executive compensation matters and any other matter deemed “significant” by the SEC. Although the amendment of NYSE Rule 452 does not appear to have created serious quorum or voting problems in 2010, the unavailability of broker discretionary voting on additional matters may trigger the need for additional solicitation efforts and related costs.

Additional Requirements and Disclosures

Dodd-Frank also mandates several new or expanded disclosures relating to executive compensation and corporate governance matters, as well as a requirement that compensation committee members be independent. Since the Act suggests that the new independence requirements will be substantially the same as those currently applicable to audit committees (as required by another famously hyphenated statute, Sarbanes-Oxley), many if not most public companies should not need to reconstitute their compensation committees; however, some examination of compensation committee composition and charter provisions, as well as expanded disclosure, is likely to be called for.

Proxy 'Plumbing'

On July 14, 2010, the SEC issued a long-anticipated “concept” release on a wide variety of proxy voting issues, including voting borrowed shares, the extent to which companies can communicate directly with their owners (rather than through intermediaries) ' possibly by eliminating or modifying the concept of “objecting beneficial owners” or “OBOs.” In addition, the SEC has indicated that it is considering whether and to what extent it can or should regulate proxy advisory firms such as Institutional Shareholder Services. At a minimum, this concept release will require careful consideration by companies and other participants in the proxy voting arena; at a maximum, it may lead to significant changes in proxy voting that these participants will need to address.

Conclusion

In short, given the constantly evolving state of statutory and regulatory requirements, as well as governance practices, it is probably incorrect to refer to the “proxy season”; in fact, preparing the proxy statement has become a year-round responsibility.

Robert B. Lamm, a member of this newsletter's Board of Editors, is Assistant General Counsel and Assistant Secretary at Pfizer Inc. Mr. Lamm acknowledges that certain voting and other information in this article was provided by Morrow & Co., Inc. and by Marc S. Gerber of Skadden, Arps, Slate, Meagher & Flom LLP.