(Editor’s Note: This post is based on a Sullivan & Cromwell LLP client memorandum.)

On October 27, 2009, the SEC’s Division of Corporation Finance issued a Staff Legal Bulletin changing prior guidance on the application of Rule 14a-8(i)(7), and expanding the scope of matters that the Division considers permissible subjects for shareholder proposals in company proxy statements. Rule 14a-8(i)(7) permits a company to exclude a shareholder proposal from the company’s proxy statement insofar as the proposal deals with a matter relating to the company’s ordinary business operations.

In the Staff Legal Bulletin, the Division reverses its prior positions that proposals relating to environmental, financial or health risks and proposals related to CEO succession planning may be excluded under Rule 14a-8(i)(7). The Division’s action met with approval from environmental activists who have long sought to include shareholder proposals related to climate change issues in corporate proxy statements.

The Division also clarified that both companies and shareholder proponents may alert the Division in advance of their intent to submit correspondence in connection with a no-action letter request under Rule 14a-8.

…continue reading: SEC Reverses Position on Rules for Excluding Shareholder Proposals

On October 21, 2009 The Altman Group submitted a proposal to the SEC titled Practical Solutions To Improve The Proxy Voting System (available here).

Effective January 1, 2010 brokerage firms will no longer be able to vote for non-responding clients with regard to uncontested elections of directors as a result of the SEC’s recent approval of Amended NYSE Rule 452. Also, for many years corporations have complained about a lack of access to the names of all of their beneficial owners. Finding ways to deal effectively with these issues is now of significant importance to public companies of all sizes.

Our proposal to the SEC suggests certain reforms to the proxy voting system. Among the key issues which we propose the SEC take action on are the following 5 points:

• 1. First and foremost, a new methodology called ABO (i.e., All Beneficial Owners) should replace the current NOBO/OBO mechanism which has existed for 25 years, at least with regard to record dates for annual or special meetings.
• 2. The SEC should seek to authorize the establishment of a second mail and tabulation methodology, one that would give companies the ability (using the names available under ABO) to choose a different vendor to take responsibility for the mailing and tabulation process, while retaining the option to use the current Broadridge system. This new option would be akin to the way most companies currently use their transfer agent to mail and tabulate the votes of registered owners.
• 3. The SEC should require the NYSE to implement as quickly as possible a robust investor education program to try and ameliorate at least some of the impact resulting from the loss of broker voting on non-contested director elections under Amended NYSE Rule 452.
• 4. The SEC should amend Rule 13(f) so that information reported by institutions reflects both shares owned and also voting rights after taking into account loans and other transactions that alter such rights. We also suggest shortening the reporting period for 13(f) information to 15 days from 45 days after the end of a calendar quarter and reducing from 20 to 10 business days the pre-notification of a company’s annual meeting record date.
• 5. The SEC should establish new procedures to deal with issues like “empty voting” and the use of derivative positions to alter voting rights.

(Editor’s Note: This post comes to us from John Mark Zeberkiewicz and Joseph L. Christensen of Richards, Layton & Finger, P.A.)

The SEC recently announced that it would delay voting on the adoption of its mandatory proxy access regime to consider the comments and feedback it received in response to its proposed Rule 14a-11. Meanwhile, at the state level, corporate practitioners are closely following whether (and, if so, in what form) Delaware corporations will voluntarily adopt proxy access bylaws pursuant to the recent amendments to the DGCL. In a brief article appearing in the latest issue of The Review of Securities & Commodities Regulation, we compare Delaware’s approach of authorizing corporations to adopt narrowly tailored proxy access bylaws to the SEC’s approach of prescribing a generally applicable proxy access rule. We illustrate the differences between the two approaches by describing a model proxy access bylaw adopted under the DGCL and pointing out various ways in which that model bylaw could be modified to meet the needs of a particular corporation. Some highlights of the model bylaw are as follows:

• Granting the proxy access right to the stockholder or group with the greatest holdings (14a-11 grants the right based on a first-in-time system)
• Requiring the stockholder proponent (and each member of a group) to continue to hold shares through the date of the meeting
• Prohibiting the stockholder proponent (and each member of a group) from materially increasing its ownership stake for a specified period
• Excluding nominations from proponents whose nominees have failed to gain substantial support in prior elections
• Requiring a stockholder nominee to submit a conditional resignation that would become effective upon a finding that information included in the proponent’s nomination request, or information furnished by the proponent and included in the proxy statement, was false or misleading
• Requiring proponents to indemnify the corporation against any liability, loss or damage arising out of a stockholder nomination submitted pursuant to the bylaw

The article is available here and the model bylaw (with annotations explaining ways in which various provisions may be modified) is available here.

(Editor’s Note: This post is based on an article by Professor Hamermesh in the Widener Institute of Delaware Corporate and Business Law)

In a very interesting opinion on a matter of first impression, Vice Chancellor John Noble has indicated that the refusal of a board of directors to accept the resignation of a director who fails to obtain a majority vote under a “Pfizer-style” majority vote resignation policy is largely immune from judicial review.

The case – City of Westland Police & Fire Retirement System v. Axcelis Technologies, Inc., decided September 29, 2009 – involved something of a collateral issue: namely, whether to permit inspection of documents relating to the board’s decision to reject the proffered resignations of three directors.  In rejecting that demand, however, the court suggested that such a rejection would not ultimately be tested under standards of judicial review more demanding than the business judgment rule.  For reasons explained below, I question whether that degree of deference should prevail as a general rule, especially in the situation where the majority voting rule exists as a requirement in the bylaws, rather than only as a matter of board policy.

The three directors in question, while elected by the required plurality vote as specified in Axcelis’ bylaws, did not receive a majority of votes cast at Axcelis’ 2008 annual meeting.  (The opinion suggests that this shortfall resulted from an ISS recommendation based on the 7-member board’s refusal to support a proposal to dismantle the board’s classified structure).  As a result, and as mandated by a governance policy adopted by the board of directors (a so-called Pfizer type policy), those three individuals were required to submit their resignations.  Under the policy, however, the board of directors had the discretion to reject the resignations.  In announcing the board’s rejection of the three directors’ policy-mandated resignations, Axcelis referred to the experience of the directors, their membership on key committees, and the anticipated need to supervise negotiations with a potential bidder for the company.

Over six months after the annual meeting, and after a very disappointing outcome of the bidding negotiations, the stockholder plaintiff made a formal demand to inspect documents, mostly relating to the board’s dealings with and evaluation of a potential bidder’s acquisition proposals.  The demand also included the following two categories:

6. All minutes of agendas for meetings (including all draft minutes and exhibits to such minutes and agendas) of the Board at which the Board discussed, considered or was presented with information concerning or related to the Board’s decision not to accept the resignations of Directors Stephen R. Hardis, R. John Fletcher, and H. Brian Thompson.

7. All documents reviewed considered, or produced by the Board in connection with the Board’s decision not to accept the resignations of Directors Stephen R. Hardis, R. John Fletcher, and H. Brian Thompson.

The stated purpose for this inspection was apparently to investigate possible waste or mismanagement, a traditionally accepted basis for inspection under Section 220 of the Delaware General Corporation Law.  Under settled Delaware law, all the plaintiff had to proffer to become entitled to the inspection demanded was “some evidence to suggest a credible basis from which [this Court] can infer that mismanagement, waste, or wrongdoing may have occurred.” And as the Vice Chancellor acknowledged, this evidentiary requirement has accurately been described as “‘the lowest possible burden of proof’ in Delaware jurisprudence.”

…continue reading: Delaware Decision Defers to Retention of Directors Under a “Majority Vote Resignation Policy”

(Editor’s Note: This post is based on a Sullivan & Cromwell LLP client memorandum.)

The SEC has proposed to amend the Internet proxy delivery rules in order to increase retail shareholder participation in the proxy voting process and to improve the notice and access model. The proposed amendments would:

• provide flexibility regarding the format and content of the Notice of Internet Availability of Proxy Materials;
• permit issuers and other soliciting persons to accompany the Notice of Internet Availability of Proxy Materials with an explanation of the process of receiving and reviewing proxy materials and voting; and
• permit a soliciting person other than the issuer to use the notice and access model and send its Notice of Internet Availability for Proxy Materials by the later of
  • 40 days before the shareholders meeting, or
  • the date on which the soliciting person files its definitive proxy statement if the soliciting person’s preliminary proxy statement is filed within 10 days of the issuer’s filing of its definitive proxy statement.

The SEC is providing an abbreviated comment period with comments due by November 20, 2009.

…continue reading: Proxy Solicitation Through the Internet

(Editor’s Note: This post is based on a Gibson, Dunn & Crutcher LLP memorandum by Amy Goodman and Gillian McPhee.)

The current economic and regulatory landscape poses unprecedented challenges for public companies and their boards of directors.  They are facing scrutiny from shareholders, Congress, regulators and the public, and new proposals to address the causes of the financial crisis have been emerging on almost a daily basis for over a year now.

Many of these proposals remain under consideration at a time when calendar-year companies are beginning preparations for the 2010 proxy season, complicating the planning process.  The uncertainty of the current environment means that, with respect to many issues–such as the SEC’s proxy access proposals–companies and their boards find themselves in a “wait and see” mode.  Directors should remain informed during this time as new developments occur, and they should be prepared to respond at an accelerated pace.  To assist boards in addressing the potential changes that lie ahead, this memorandum outlines key issues for directors to consider over the coming months.

1.  Executive Summary

As discussed in more detail below, as boards prepare for the potential changes that lie ahead, there are a number of key areas to consider.  These include:

a. Director Elections.  Boards and companies should take a holistic approach to the director election process, considering the potential impact that the loss of broker discretionary votes will have on director elections at the upcoming annual meeting, as well as the effect of majority voting, “notice and access” (also known as “e-proxy”), and expected voting recommendations of the major proxy advisory firms.

b. Executive Compensation Practices and Disclosures.  Boards and compensation committees should evaluate their companies’ compensation practices and policies in light of the current environment, including the strong possibility of federal legislation requiring an advisory vote on executive compensation, or “say on pay.”  For the 2010 proxy season, new required disclosures are anticipated relating to the risks created by employee compensation plans and the use of compensation consultants.  In view of these considerations, companies should assess their compensation disclosures, with particular focus on the Compensation Discussion & Analysis.  In addition, boards and compensation committees should be aware of executive compensation practices that institutional investors and proxy advisory firms frown upon (such as tax gross-ups) and those that they advocate, such as “hold-through-retirement” provisions and “clawback” policies.

c. Board Leadership.  Boards and companies should expect a continued spotlight on the issue of board leadership in the coming months.  In anticipation of new required proxy disclosures about board leadership structure, boards should consider why their current leadership structure is appropriate.  At companies that combine the positions of chair and CEO, consideration should be given to what, if any, steps should be taken to enhance the independent leadership of the board.  In addition, the board should consider this issue as part of the succession planning process.

d. Risk Oversight.  Boards and companies should consider whether the board has the appropriate structure and processes in place for overseeing the major risks facing the company.  The board should be comfortable that it understands these risks and how the risks relate to the company’s business and strategy.  Boards, and those who advise them, should think carefully about how the board is spending its time and see that the board has adequate time to address critical issues such as strategy and risk.
e. Shareholder Engagement.  Boards should be attentive to what their companies are doing to engage shareholders and recognize that, more than in the past, directors may need to play a greater role in reaching out to shareholders.  Initiating a dialogue before a major issue arises helps build a relationship so that the company is not approaching a major shareholder for the first time to talk about a critical subject.

f. Shareholder Proposals for the 2010 Proxy Season.  For the 2010 proxy season, we expect that shareholder proposals seeking the appointment of an independent chair and proposals seeking an advisory vote on executive compensation will continue to be popular.  In addition, executive compensation in general is likely to be a frequent subject of shareholder proposals.  Finally, shareholders’ ability to call special meetings and supermajority voting provisions also are likely to be focal points in the next proxy season.

…continue reading: Considerations for Public Company Directors in the Current Environment

(Editor’s Note: This post comes to us from Jie Cai and Ralph Walkling of Drexel University.)

In our forthcoming Journal of Financial and Quantitative Analysis paper, Shareholders’ Say on Pay: Does it Create Value?, we investigate whether allowing shareholder votes on executive compensation increases shareholder wealth. We perform three experiments to examine this issue. In our primary experiment, we examine the market reaction to the passage of the House of Representatives “Say on Pay Bill”, which was passed on April 20, 2007 by a 2-1 margin. In our second experiment, we examine the shareholder sponsored say-on-pay proposals targeting individual companies. In our third experiment, we ask whether shareholder votes are related to excess CEO compensation when they are asked to approve equity-based compensation plans.

Our primary experiment examines the stock price reaction of 1,270 of the largest corporations in the United States on the day the bill passed the House. The passage of the Say-on-Pay Bill might not be surprising to the market since Democrats were in control of the House. However, its 2-1 margin (269 positive votes vs. 134 votes against) was a surprise, as well as the fact that 55 Republican Congressmen also supported the Bill. We find a more favorable market reaction to the bill for firms that overpay their CEOs and for firms that have low pay-for-performance. Additionally, we find that the positive stock price reaction is more pronounced for firms with relatively weak, but not the weakest governance. These firms are likely to benefit from better compensation design if they implement such improvements under shareholder pressure. Conversely, firms with the weakest governance may not respond to advisory shareholder votes at all. Finally, market reaction is more favorable for firms that have higher activist shareholder ownership as well as firms that have previously responded to shareholder dissatisfaction as expressed in director elections.

In our second experiment, we use a sample of 113 say-on-pay shareholder proposals between 2006 and 2008 to examine shareholder-sponsored say-on-pay proposals targeting individual companies. We find that the companies targeted are not ones likely to benefit from say-on-pay. On average, the CEOs of these firms are not overpaid. Moreover, targeted firms have similar performance and governance as typical firms. Activist shareholders appear to target large firms. In addition, most of these proposals are sponsored by labor unions with very small stock holdings in the companies targeted. The stock prices of targeted firms react negatively to the announcement of union-initiated proposals and these proposals receive lower support from other shareholders. Finally, when shareholders vote down these proposals, the stock prices of targeted firms react positively, and the reaction is higher when more shareholders vote against the proposals.

In our third experiment, we examine shareholder votes concerning management proposals for approval of incentive compensation (mostly equity-based compensation plans). Using a sample of 2,511 management-sponsored compensation proposals voted on at 1,853 shareholder meetings during the 2003-2008 period, we find that shareholder support for such proposals is lower when abnormal CEO compensation is high and CEO pay-for-performance sensitivity is low.

Taken together, our evidence suggests that say-on-pay may benefit firms with questionable compensation practices but can hurt firms targeted by special interests. Thus, with say-on-pay it is not the case that one size fits all. The full paper is available for download here.

In light of the intense current debate regarding the SEC’s proposed proxy access reforms, the Harvard Law School Program on Corporate Covernance this week hosted a roundtable on the proposed reforms. The Roundtable brought together prominent participants in the debate – representing a range of perspectives and experiences – for a day of discussion on the subject.

The two morning sessions, chaired by Professor Robert Clark, focused on the question of whether the SEC should provide an access regime, or whether it should leave the adoption of access arrangements, if any, to private ordering on a company-by-company basis. The third session, chaired by Professor Howell Jackson, focused on on how a proxy access regime should be designed, assuming the SEC were to adopt such an access regime. The final session, chaired by Professor Lucian Bebchuk, went beyond proxy access and focused on whether there are any further changes to the arrangements governing corporate elections that should be considered.

The Program on Corporate Governance will be issuing a transcript of the Roundtable’s proceedings later on; a link to the transcript will be posted on the Forum.

…continue reading: Harvard’s Proxy Access Roundtable

(Editor’s Note: This post comes to us from Paul Fischer of Pennsylvania State University, Jeffrey Gramlich of the University of Southern Maine and Copenhagen Business School, Brian Miller of Indiana University, and Hal White of the University of Michigan.)

In our forthcoming Journal of Accounting and Economics paper Investor Perceptions of Board Performance: Evidence from Uncontested Director Elections, we investigate whether uncontested elections serve as meaningful polls reflecting investor perceptions of board performance. Our paper is motivated in part by the general perception that many director elections are meaningless charades of shareholder democracy due to the lack of contested elections, coupled with the widespread use of plurality voting rules.

We construct approval measures using director vote tallies for a sample of S&P 500 firms from 2000-2004, and find evidence consistent with these measures reflecting investor perceptions of board performance. In particular, we examine the relation between the approval measures and the stock price response to a change in the most focal member of the board, the CEO. We find that higher (lower) approval is associated with lower (higher) stock price reactions to subsequent announcements of management turnovers. We also show that the approval measures predict uncertain future events expected to be associated with board performance. Specifically, we find that firms with low board approval are associated with a higher likelihood of CEO turnover, greater board turnover, lower CEO compensation, fewer and better received acquisitions, and more and better received divestitures subsequent to the vote.

We also assess whether the approval measures are incrementally informative to traditional metrics of board performance, such as stock returns and return on assets. In particular, we find that the information content in the vote approval measures is largely unaffected by the inclusion of controls for traditional metrics of board performance. Hence, the vote approval metrics are uniquely meaningful measures of board performance. As such, our approval measures can be used to complement existing governance measures, such as the Gompers, Ishii, and Metrick (2003) index, which focus primarily on governance structures as opposed to the performance of the individuals operating within those structures. Overall, our findings suggest uncontested votes do reflect investor perceptions in spite of a number of countervailing forces, including the lack of diligent voting by all shareholders.

The full paper is available for download here.

(Editor’s Note: This post comes is based on a Davis Polk & Wardwell LLP client memorandum by Phillip R. Mills, Francis S. Currie, Linda Chatman Thomsen, Ning Chiu and Robert L.D. Colby)

A broad cross section of commenters is encouraging the Securities and Exchange Commission (the “SEC”) to take a cautious approach with its latest proposal to allow shareholders to solicit votes for their director candidates through corporate proxy statements. [1]

The SEC received over 520 comment letters to date recommending a host of modifications to its proposal for uniform mandatory proxy access. Some commenters, including members of the investor community, have expressed concerns about the desirability of any uniform mandatory proxy access rule. Significant investor constituencies have also expressed concern about a possible compromise being advocated by companies and their representatives: deferring adoption of a uniform mandatory proxy access rule and instead allowing shareholders to propose bylaw amendments permitting proxy access through the existing shareholder proposal process. That compromise does have institutional investor support, however, with one leading investor recommending raising the ownership threshold for shareholder proxy access bylaw amendments to 5%.

In 2003 and 2007, the SEC proposed different rules to give shareholders greater access to a company’s annual proxy materials to nominate candidates for election as directors. In response to those rule proposals and investor concerns, states and corporations have taken steps to allow for proxy access and expanded shareholder influence in director elections. In addition to greater adoption of majority voting standards, states such as Delaware have recently adopted laws specifically permitting proxy access and proxy solicitation expense reimbursement bylaws. In response to a perceived need for greater director accountability arising out of the recent financial crisis, the SEC released its latest proposal that would mandate a uniform federal access right to a company’s proxy materials for shareholders who meet minimum holding period and ownership threshold criteria.

…continue reading: SEC Urged to Defer Adopting Proxy Access Rules