Market Digest

Last week, the SEC amended NYSE rules to eliminate broker discretionary voting in director elections, approving a reform proposal that is unanimously expected to increase the power of institutional investors–and activist shareholders, specifically–in influencing corporate affairs through “withhold vote” campaigns.

In addition to expressing their concern about the rise in activist power, those who opposed the amendment argue that, due to the frequent disenfranchisement of retail investors, eliminating discretionary voting will make it more difficult to establish a quorum at annual meetings and could raise solicitation costs.

“To assist companies facing these concerns, The Conference Board recommends that senior executives and board members assess the impact of the new rule on future annual meetings, especially in light of factors such as the size of the company’s retail shareholder base, equity holdings by activists, and recent election results,” says Matteo Tonello, Associate Director, Corporate Governance at The Conference Board. In particular, companies should consider:

• Analyzing historical shareholder trends and monitoring future extraordinary voting patterns, possibly with the assistance of specialized services (such as securities surveillance reports or Wall Street-perception audits). This will help anticipate any situation where individual shareholders not voting their shares may magnify the power of short-term, speculative investors and skew election results. If a stock watch service provider is engaged for this purpose, it is good practice to research its reputation and ensure that its means to gather information are proper. In fact, there have been prior incidents when the SEC probed the ethical standards of securities surveillance analysts, who are often compensated by commission.

• Understanding larger investors’ intentions (especially if they have a history of activism) and investigating voting policies by mutual funds and other–more passive–mainstream asset managers holding stock of the company, so as to recognize possible voting alliances with activists. For the same purpose, in the current economic climate, The Conference Board urges companies to regularly communicate–in compliance with Regulation FD and insider trading rules–with the 10 largest institutional shareholders to inform them on the business strategy, including new efforts for improving shareholder value. A company should approach each proxy season with a thorough assessment of the real voting power of dissident institutional shareholders. Such an estimate ultimately allows the company to determine the level of tolerance for inadvertent “no” votes by its retail investors.

• Developing–in collaboration with proxy solicitors and investor relation advisors–a specific strategy to improve external communications on corporate matters, engage retail investors, and ultimately increase voting response. However, since such a strategy  is likely to increase significantly the costs of uncontested elections, The Conference Board recommends that nominating/governance committees closely monitor this use of corporate resources and ensure appropriate safeguards from insider abuses and conflicts of interest. Because brokers remain able to vote uninstructed shares with respect to any “routine” item on the meeting agenda (for example, the ratification of auditors), companies should ensure, at a minimum, that at least one such matter is put to a vote at the meeting.

Before the latest SEC amendment, in any uncontested director election, brokers holding shares in investors’ accounts were permitted to exercise discretionary voting authority on any share for which they had not received voting instructions from the beneficial owner. Brokers have traditionally followed the recommendations of incumbent boards in casting their discretionary votes for uninstructed shares, therefore potentially distorting election outcomes. As a result of the change, since uninstructed votes will be counted as “no” votes, it could become arduous for companies adopting a majority voting standard to attain the vote required to elect a management’s slate of nominees–particularly if there is a large retail investor base or if an activist launches a “just say no” campaign to encourage shareholders to withhold votes for certain directors.

“Over the years, in witnessing the expansion of the shareholder rights movement, The Conference Board has consistently reiterated a position of neutrality and non-advocacy,” adds Tonello. “While acknowledging a body of empirical research that discredits the notion of activism as a monolithic phenomenon driven exclusively by short-term gain seekers, we also recognized the need to assist our member companies by promoting organizational and board practices that would protect them from vulnerabilities and abuses.” This effort is attested, among other things, by the institution of The Conference Board Working Group on Hedge Fund Activism, a diverse group of high-level business leaders, asset managers and governance experts convened to discuss the corporate response to hedge fund activism campaigns. Recommendations issued by the group in September 2008 promote corporate-investor dialogue and outreach plans as a preventive measure against speculative initiatives that could damage long-term value growth strategies.

The rule change is effective for shareholder meetings on or after January 1, 2010 and affects most U.S. public companies, because the restriction applies to all NYSE-registered brokers, irrespective of the exchange on which a company is listed.

Source: The Conference Board