Director elections have fundamentally changed. The SEC’s adoption of the amendment to NYSE Rule 452 (effective January 1, 2010) causes a major shift in the treatment of an uncontested election of directors. Brokerage firms, which previously could vote uninstructed shares in their discretion on director elections, will only be able to vote shares for which they receive instructions from the underlying beneficial owners. While the impact of this rule change will vary depending upon a company’s retail ownership, there is one indisputable fact: Director elections will never be the same.
The new landscape of majority vote standards, eliminating classified boards, distributing proxy materials electronically, and now losing discretionary voting, makes every director election a potential challenge, whether or not there is active opposition. The system is now structured to facilitate an activist agenda, even without a specific catalyst or a costly opposition campaign. In many cases, a much lower level of opposition will suffice to prevent a director from being re-elected or to compel a director to resign.
To be successful in this new environment requires a year-round solicitation strategy. The following outline provides a blueprint of actions to prepare for 2010.
1. Review Potential Triggers for Opposition to Director Nominees
Determine if any directors are at risk of an against or withhold recommendation from proxy advisory firms such as RiskMetrics (ISS) and Glass Lewis. Their voting policies change annually, so familiarity with their guidelines and application is essential. Understanding the voting policies of large institutions is also critical, as a growing number of money managers are becoming more independent and less reliant on the opinions of proxy advisors.
2. Understand the Shareholder Profile from a Voting Control Perspective
Know your stock ownership profile; it is the only way to accurately assess proxy agenda items, including the impact that the loss of broker discretionary voting will have on director elections. Many institutional investors vote fewer shares than they control, because portions of their holdings are on loan or voting authority is maintained by the beneficial owners. A proper share- holder-profile assessment must evaluate voting power in addition to investment power.
3. Prepare Voting Assessments
Management should be charged with gaining clarity on the outcome of the director election before proxy materials are finalized. Analyzing potential opposition to specific director nominees will provide the foundation to develop and implement an effective proxy-solicitation strategy. It also will allow management and the Board, in advance of the actual solicitation, to assess the risks of a contentious campaign.
4. Establish Relationships with Voting Contacts at Major Institutions
Off-season dialogue and meetings with voting decision-makers are essential to convincing institutions to take back control of their voting responsibilities and to appreciate your company’s specific circumstances. Direct discussions also create an environment more conducive to thoughtful and reasoned decision-making—keys to achieving success in the proxy arena. We recognize that reaching out to institutional shareholders can be challenging and time- consuming, but these efforts can determine the outcome of director elections and many other proposals.
5. Reach Out to Individual Investors
Evaluate the costs and benefits of an aggressive solicitation of individuals to help recoup votes lost due to this rule change. While this type of campaign can be expensive, a consistent effort to reach individual investors can reap meaningful returns that can make the difference between success and failure in a contentious situation, especially for companies with significant individual holdings.
The most effective proxy solicitations include early preparation, a sound strategic plan, and well-coordinated execution. As a director, it is critical that you ensure that management develops and maintains an effective plan for facing the unprecedented proxy and corporate governance challenges that lie ahead.
Thomas Ball and William Ultan are senior managing directors at Morrow & Co. Contact them at tomball@morrowco.com and wultan@morrowco.com or 203.658.9400.