For publicly traded companies, the annual meeting and proxy solicitation process has historically involved tried-and-true solicitation methods, generally without concern with the potential voting outcome. Recent trends and changes to the proxy rules, however, along with proposed rule changes by the SEC and the New York Stock Exchange, are changing the mechanics and dynamics for proxy solicitations and could turn what used to be an ordinary proxy solicitation into a potential contest.
Here are the key developments:
"Notice and Access." The SEC has amended the proxy rules to allow issuers to choose largely to forgo printing and mailing paper sets of proxy materials (notice of meeting/proxy statement, proxy card, and "glossy" annual report to shareholders) and instead direct shareholders to proxy materials available on their Internet websites. While this new method of proxy solicitation may result in potential cost savings, it may also lower the cost barriers for activists to wage a proxy battle. It is also unclear whether this method of proxy solicitation may decrease shareholder voting.
Activist Hedge Funds and Institutional Investors. Hedge funds and institutional investors have become increasingly emboldened in recent years in their attempts to tell companies how to improve their business, and to seek one or more seats on the board ( see , e . g ., Carl Icahn, or Relational Investors LLC, which successfully secured a seat on Home Depot's board of directors). In addition, institutions are becoming increasingly vocal in advocating for or against candidates in director elections ( see , e . g ., H&R Block, which lost three board seats to Breeden Partners, L.P. this year after five proxy advisors combined to recommend the opposing fund's slate).
Majority Voting. Many companies have adopted changes to their charters, bylaws or corporate governance policies to now require director nominees to receive a majority of votes cast at the annual meeting in order to be elected. In the past, directors at these companies were elected by a plurality - whoever received the "most" votes, which need not be a majority of the votes cast, was elected. Majority voting provisions can change director elections from a mere formality to a real decision for company shareholders.
Scrutiny of Executive Compensation. With the increased attention on executive and director compensation from the press and institutional holders, no item on a proxy ballot (including director elections) should any longer be considered "routine." Front-page coverage of director and CEO pay and shareholder concerns about pay corresponding with performance are forcing many companies to reach out to shareholders in order to convince them not only to approve their incentive and compensation plans, but to support all of management's initiatives.
Proposed Changes to NYSE Rule 452. In October 2006, the NYSE proposed an amendment to Rule 452 that would reclassify uncontested director elections from "routine" matters on which brokers and banks had the right to vote all "unvoted" shares held in brokerage accounts, to now be deemed a "non-routine" matter. This would require brokers and banks to obtain voting instructions from beneficial owners in order to vote unvoted shares. Historically, these broker votes have almost always been voted in favor of management nominees.
The NYSE has recently indicated that this rule will not be effective for the 2008 proxy season. However, if and when this rule amendment is approved by the SEC, companies may have to aggressively increase their solicitation efforts to secure enough votes for their director nominees particularly where majority voting has been adopted.
SEC's Shareholder Access Proposals. This summer the SEC proposed an amendment to Exchange Act Rule 14a-8 that would enable shareholders who own five percent or more of a company's shares to include in company proxy materials proposals for bylaw amendments relating to the election of directors. This would pave the way for shareholders to make director nominations that would be included in companies' proxy materials. The SEC has also proposed to formalize rules for shareholder "chat rooms."
Other Strategies by Shareholder Activists. Existing rules also provide measures and methods which continue to allow shareholder activists to use inexpensive means to influence proxy election results. First, soliciting persons other than the issuer are not required to furnish a proxy statement to shareholders from whom no actual proxy authority is being sought (such as a "just say no" campaign). Additionally, a soliciting person other than the issuer may elect to solicit only certain shareholders (such as large institutional shareholders who may be more receptive to their message or position), which reduces solicitation costs. Finally, existing SEC proxy rules are not applicable to proxy solicitations of ten or fewer shareholders (which, if limited to the largest institutional holders, may be sufficient to control the outcome). Plainly these existing strategies, when combined with the new and proposed changes to the proxy rules, substantially level the field for any opposition to management slates of directors or management proposals. These factors also require companies to start taking proxy solicitations for annual meetings much more seriously.
Below are some suggestions to address in this new environment:
Have a Strategy. Today's proxy environment requires strategic thinking about proxy ballot items. Without discretionary broker voting generally less than half of "street name" retail investors actually vote on management ballot items. Companies will need to assess what additional efforts may need to be expended in soliciting proxies for their annual meeting in order to garner sufficient votes. This requires companies to know the profiles of their shareholders.
Consider Using a Proxy Solicitor. Distribution and post-mailing solicitation are now merely one aspect of a proxy solicitor's services. A proxy solicitor can monitor proxy matters on a year-round basis and collaborate to design an effective proxy solicitation strategy. The need for such a strategy generally arises when you least expect it.
Make Every Vote Count. Work closely with officers, directors and company plans to make sure all shares are voted. Use additional solicitation efforts such as mailings and telephone calls to encourage participation.
Effectively Use "Notice and Access." With the new proxy amendments, companies have a potentially lower cost alternative to traditional printing and mailing of proxy materials.
These amendments establish a "universal" system which provides two options to deliver proxy materials to shareholders (other than for business combination transactions). Under the "notice and access" model, companies may furnish proxy materials to shareholders by posting them on an Internet website and notifying shareholders of the online availability of the proxy materials. Under the "full set delivery" model, companies can rely on traditional means of proxy delivery by sending a full set of proxy materials to shareholders, but with the additional requirement that companies also provide shareholders with notice of the online availability of the proxy materials and post the proxy materials on a publicly accessible website. These requirements apply to large accelerated filers after January 1, 2008, and to non-large accelerated filers, registered investment companies and soliciting persons other than the issuer after January 1, 2009.
Intermediaries (such as brokerages) who are required to deliver proxy materials to the "street name" beneficial holders may follow the "notice and access" model only if the issuer requests it to do so and, in such cases, must follow that model. An issuer or other soliciting person relying on the notice and access model must provide the intermediary with all information necessary for the intermediary to prepare its own notice in sufficient time for the intermediary to send the notice to beneficial owners. The intermediary's notice to beneficial owners likewise must be sent at least 40 days prior to the meeting, which means the company will need to provide the intermediary all requisite information in advance of this 40 day time period (generally 5-7 days in advance).
These time periods may be earlier than many public companies have traditionally made proxy materials available.
Companies must also wait 10 days after delivering notice to shareholders before sending them a printed proxy card (however, a company is required to provide a means to vote - other than a printed proxy card - immediately upon posting its proxy materials on its website, such as through Internet voting or telephone voting). In order to meet this stepped-up deadline, companies may have to adjust their annual meeting timelines to ensure that key dates, such as broker search notices, auditor signoff on audited financial statements, audit committee meeting to approve audited financials, etc., all occur by the new deadlines.
Companies using the notice and access model need to make sure that the websites that contain their proxy materials are user-friendly and easily navigable, or they will risk scaring off shareholders who try to access proxy materials online and be forced to send those shareholders full paper sets of proxy materials (at first class rates).
While the new notice and access model may appear to be an attractive alternative, the revisions to the proxy rules come at a time when more companies are feeling more pressure than ever to effectively solicit proxies. For some companies, the cost/benefit analysis may suggest that continuing the traditional full delivery approach better ensures a successful proxy solicitation.
Know Your Audience: Mix and Match the Two Methods. The amended proxy rules permit companies to use the notice and access model to solicit proxies from some shareholders, and the full set delivery model for others. Companies can break down the method of distribution of proxy materials in several ways. For example, companies may choose to provide "notice and access" to institutional shareholders who are likely to vote under this method, while providing full paper delivery to targeted shareholders, and providing "notice and access" to small shareholders who historically have not voted.
Engage Throughout The Year in Productive Dialog with Your Major Shareholders. Activist pressures generally come without warning. Whether the issue is a potential slate of one or more opposing director nominees, a shareholder proposal contrary to what the board of directors believes is productive to the company, or expected opposition to one or more management proposals, management generally is not completely prepared for opposition votes or opposition solicitations.
With the changes and proposed changes in proxy rules, combined with increased shareholder activism, it is important for management to engage its major shareholders in a dialogue throughout the year. It is important to let your major holders know who you are and what your vision for the company is, all within the confines of your public disclosures. It is also important to be in contact with the executives within your institutional holders who are responsible for voting proxies - these are different executives from the analysts and other financial executives within the same institutions.
Published October 1, 2007.
