The Shareholder Voting Process American Bar Association Committee on Federal Regulation of Securities

Transcription

1 The Shareholder Voting Process American Bar Association Committee on Federal Regulation of Securities Robert Todd Lang (Chair) Weil, Gotshal & Manges LLP David Drake Georgeson Inc. Patrick S. McGurn Institutional Shareholder Services Henry T.C. Hu University of Texas Law School Robert L. Messineo Weil, Gotshal & Manges LLP December 2, 2006

2 Table of Contents 1. Panel Outline 2. A Hypothetical Short Slate Contest 3. Current Developments Affecting Shareholder Voting Robert Todd Lang and Robert L. Messineo 4. Empty Voting and Hidden (Morphable) Ownership: Taxonomy, Implications, and Reforms Henry T.C. Hu and Bernard Black Annual Corporate Governance Review (Preliminary Copy) Georgeson Inc. 6. Biographies of Panelists

3 The Shareholder Voting Process American Bar Association Committee on Federal Regulation of Securities December 2, 2006 The Program Will Consist of the Following Presentations I. Overview and Introduction (Robert Todd Lang) II. III. IV. A Proxy Solicitor s Perspective (David Drake) A Proxy Advisor s Perspective (Patrick S. McGurn) Hedge Funds and the Vote Buying Phenomenon (Prof. Henry T.C. Hu) V. A Legal Perspective (Robert L. Messineo) VI. The Panel Discussion will concern the accompanying hypothetical.

4 A Hypothetical Short Slate Contest XYZ Corp. is a well-established company that manufactures and markets a diversity of consumer products. It is incorporated in Delaware and listed on the NYSE. For several years XYZ s stock market performance in comparison to companies in its industry and to general market indicies has been modestly below average. XYZ s chief executive was elected within the past year, following the retirement of his predecessor at the time of the last annual meeting of shareholders, two years before normal retirement age. This former CEO had been at XYZ s helm for seven years and had led it to develop or acquire several of its diverse product lines. The current CEO has been an executive at XYZ for most of his career. XYZ has an 11-member board, which is not classified. The board includes the CEO and chief operating officer, who has also spent most of his career at XYZ. All the other members of XYZ s board are independent directors as determined under NYSE listing standards. One director is the former chief executive (now retired) of a company acquired by XYZ four years ago, who, together with family trusts, owns about 2% of XYZ s shares. No other board member owns more than 1/10 of 1% of XYZ s shares. XYZ s governance guidelines require that at least 3/4 of its directors be independent. At XYZ s last annual meeting of shareholders, a majority of the shares voted were cast in favor of shareholder proposals that XYZ adopt majority voting in the election of directors and that XYZ redeem its poison pill and not adopt another without shareholder approval. Each proposal was made by a different pension fund, which had been a frequent advocate of such proposals. XYZ s board has amended its by-laws, effective for its upcoming annual meeting, to provide for majority voting in the election of directors, except in the case of a contested election, where the traditional plurality vote standard will apply. The by-law provides that an election will be considered contested if there are more nominees for election than positions to be filled, unless the Nominating and Governance Committee determines before the election day that the majority standard shall apply to a nominee. XYZ s poison pill will expire in a year and a half. XYZ s has not redeemed its poison pill but has announced that, if it adopts a new poison pill the board will at the next annual meeting submit it for a shareholder vote and, if a majority of the shareholders voting do not approve of it, will consider and announce within 60 days whether or not it will it continue the new poison pill in effect or redeem it. When XYZ disclosed the retirement package of the former CEO, there was considerable publicity about how generous it was and criticism about it from several commentators and some institutional and other shareholders. In particular, the same pension fund that had submitted the majority vote proposal was vocal in criticizing the package. This pension fund, which has been a long-time holder of XYZ shares, primarily through an indexed portfolio, timely submitted to XYZ s Nominating and Governance Committee two candidates for consideration as nominees of the Board for election as directors at the upcoming annual shareholder meeting, recommending that at least one of them be added to XYZ s Compensation Committee. Each nominee has prior experience as a director of at least one S&P 500 company, has no association with the pension fund and

5 satisfies all of the bright line tests of the NYSE s director independence standards. The Nominating and Governance Committee interviews each of these candidates, but decides not to nominate either of them. Beryl Ridge, a hedge fund, owns slightly more than 5% of XYZ s shares, which it has acquired over the past year. This hedge fund, like some other hedge funds with less than 5% of XYZ s shares, are aware of sophisticated vote buying techniques. As stated in its Schedule 13D, Beryl Ridge considers XYZ an underperforming company and attributes this to poor management. It believes XYZ s business strategy has been flawed and that it should sell several specified divisions and use the proceeds to buy back its shares. Beryl Ridge controls a company that is in a similar line of business as one of these divisions and is expected to be a likely bidder for that division were it put up for sale. In its Schedule 13D, Beryl Ridge states that it has no plan to exercise control over XYZ or engage in any transaction with XYZ. XYZ s CEO has made it known that he thinks Beryl Ridge s criticism misplaced, as he believes that he has put in place business plans that will produce greater synergies and profits from XYZ s diverse product lines. Beryl Ridge timely submitted three individuals to XYZ s Nominating and Governance Committee for consideration as nominees of the Board for election at the upcoming annual shareholders meeting. All three candidates have experience as directors of public companies and would qualify as an independent director under the bright line tests of NYSE s listing standards. Two have no relationship at all with Beryl Ridge; the third is the retired head of a boutique investment banking firm who is a member of Beryl Ridge s advisory committee and has $250,000 invested in Beryl Ridge but plays no role in its management and has no other relationship with Beryl Ridge. Beryl Ridge discussed these candidates before submitting them with the two pension funds that had made shareholder proposals at XYZ s last annual shareholders meeting to see if the pension funds considered them qualified candidates. These pension funds expressed no objection to these candidates. The Nominating and Governance Committee met with the three candidates but declined to nominate any of them. It advised Beryl Ridge that, among other things, it would not consider the three to qualify as independent directors because of their association with Beryl Ridge, given its announced positions regarding XYZ. Beryl Ridge has timely nominated these three individuals for election as directors of XYZ at its upcoming annual meeting. XYZ has just released its proxy statement and the board s nominees are the 11 incumbents. Beryl Ridge has distributed a proxy statement in favor of its nominees, in which it states that it will support the election of six of the Board s nominees; it opposes the reelection of the three members of XYZ s compensation committee and takes no position on the reelection of the CEO and COO. The same proposal about XYZ s poison pill included in the previous year s proxy statement is also to be voted on at the meeting. Beryl Ridge and its nominees have expressed their support for this proposal. The pension fund sponsoring the proposal has announced its support for the Beryl Ridge nominees. Beryl Ridge has asked the Nominating and Governance Committee to treat the election of the eight Board nominees that it is not opposing as noncontested, so that the majority vote standard will apply to their election. 2

6 CURRENT DEVELOPMENTS AFFECTING SHAREHOLDER VOTING Robert Todd Lang Robert L. Messineo Prepared for The Shareholder Voting Process Program American Bar Association Committee on Federal Regulation of Securities December 2, 2006 A variety of developments in the processes by which shareholders exercise their voting franchise are converging to produce a significant change in the shareholder role in corporate governance. The role of shareholders in the selection of directors, the other matters on which shareholders vote, the number of contested votes, the process by which corporations communicate with shareholders and shareholders communicate with each other and the process by which shareholder voting positions are formed have all evolved in recent years. Several trends and pending legal and regulatory initiatives portend further changes in these areas. While some of these may be seen as incremental changes, collectively they may lead to more profound alteration in the relationship between directors and shareholders. For example, the traditional plurality vote standard for the election of directors appears to be giving away to a majority vote standard (of one form or another), listing standards now require shareholder approval for almost any use of equity in employee compensation, contested votes have increased materially in the form of vote no and withhold vote campaigns and short slate election contests, and institutional shareholders are paying a new level of attention to how they make their voting decisions. Vote buying has become an important aspect of contested elections. 1 Shareholders have available to them more information than ever before to consider in making their voting decisions, as corporations are required to provide greater detail about executive compensation, director independence and the director nomination process and third party sources provide governance ratings and proxy voting advice. Pending Securities and Exchange Commission rule proposals promise to bring the Internet revolution to proxy communications. Discretionary voting by brokers on routine director elections may end in Shareholder access to corporate proxy materials has become a central issue in discussions about proxy regulation, the federal-state jurisdictional spheres and corporate governance reform. Copyright 2006 by Robert Todd Lang and Robert L. Messineo. This paper discusses developments through October Messrs. Lang and Messineo are partners, directly or through a professional corporation, of Weil, Gotshal & Manges LLP, resident in its New York office They gratefully acknowledge the assistance of William P. Welty, an attorney at Weil, Gotshal & Manges LLP, in the preparation of this article. Mr. Lang is Co-Chair and Mr. Messineo is a member of the Task Force on Shareholder Proposals of the ABA s Committee on Federal Regulation of Securities, the work of which is discussed in this paper. All views expressed herein are solely those of the authors. NY2:\ \13\109HG13!.DOC\

7 Managements and independent directors need to take into account these developments as they consider the nominees the board will present for election and what other matters they will present for a shareholder vote and whether and how they will attain the votes they need. The same considerations apply to shareholder initiatives. This paper provides an overview of some of the current key legal and regulatory developments in this area. Table of Contents Page Director Selection Reform 2 Background and Overview 2 Shareholder Proposals Regarding Majority Voting 4 Institutional Investor Policies 5 Voluntary Corporate Initiatives 7 Statutory Changes 9 Shareholder Access 11 Withhold Vote and Short Slate Campaigns 15 Internet Proxy Solicitation 17 Discretionary Voting By Brokers 18 The Role of the Limited Solicitation Exemption 20 Conclusion 23 Background and Overview Director Selection Reform Director selection reform has been a prominent corporate governance issue since April 2003 when the Securities and Exchange Commission directed its staff to conduct a study of current proxy regulations and to develop possible changes to improve corporate democracy, including possible changes regarding procedures for the election of corporate directors. 2 This study led to a number of changes in the SEC s disclosure requirements regarding the director nomination process that went into effect in These changes reinforced New York Stock Exchange and Nasdaq Stock Market listing standards that mandated, starting generally with the 2004 annual shareholder meeting season, that (with modest exceptions) independent directors control the selection of the board s nominees. 4 The study also led to the SEC s October 2003 proposal to provide shareholders, for the first time, a limited right of access to corporate proxy machinery for the election of directors. 5 In 2005, it became clear that the SEC s access proposal had not attracted the support needed for so significant a change in the director selection process. Based on suggestions made in the debate on the access proposal, attention turned from the director nomination process to the director election requirements established under state corporation law. Traditionally, corporate directors were elected under a plurality vote requirement where only votes for have legal significance. Among all the nominees for the available board positions, those who receive the highest number of votes in favor of their election are elected, regardless of the number of votes 2

8 withheld with respect to their election. The possibility was raised that by changing their certificates or articles of incorporation (or, where permitted by state law as in Delaware, their bylaws) corporations could instead require that a director nominee receive a majority of the votes cast in order to be elected. Some of the leading institutional investors quickly endorsed the concept. Since that time, a number of issues associated with a change to a majority vote standard for the election of directors have been identified and analyzed and various ways of dealing with these issues have emerged. Shareholder proposals, initiatives by boards of directors and legislative changes have all been involved. Under the most commonly discussed majority vote requirement, a director nominee would not be elected if fewer votes were cast in favor of his or her election than were withheld from his or her election. The practical effect would be that nominees of the board of directors would no longer be assured election where no alternative nomination has been made and an election contest has not been conducted. Change to a majority vote system would give the expression of shareholder dissatisfaction by the withholding of votes from a nominee greater significance than under the plurality vote system. This new significance of withheld votes would not only determine whether a nominee ultimately achieved election, but would also effectively increase the influence that shareholders (particularly large shareholders or organized groups of shareholders) would have on the nomination process of boards of directors. A majority vote requirement necessarily raises the possibility that failed elections could occur situations where seats on the board would not be filled by an election because no nominee receives the requisite majority vote. The possibility of a failed election adds a degree of uncertainty to the director election process. This uncertainty is somewhat mitigated by provisions of every state s corporation law to the effect that an incumbent director remains in office until his or her successor is elected and qualifies (the so-called holdover director rule ). Consequently, if a failed election did occur, the incumbent, whether or not the nominee, would remain on the board (subject to his or her resignation or, where permitted by law and the company s articles or certificate of incorporation and bylaws, removal from office by an additional vote of the shareholders). While it mitigates the uncertainty attendant on a failed election, the holdover director rule qualifies the impact of a change to a majority vote standard. While some argue that failed elections would be a rare phenomenon, others point out that there is no experience in the U.S. with the matter. The recent history of withhold vote campaigns suggests that, under a majority vote system, failed elections might occur with some frequency. In any event, the effect of, and possible changes to, the holdover director rule soon came to be recognized as an integral part of the discussion of majority voting. Modification of the operation of the holdover director rule so as to permit the replacement of an incumbent director who did not receive the requisite majority vote was soon suggested and, as discussed below, a few different approaches to the issues posed by the holdover director rule have developed. Institutional investor interest in majority voting in the election of directors matured during 2005 into shareholder initiatives seeking the adoption of majority vote requirements, a review of institutional investor voting policies concerning director election provisions and the development by Institutional Shareholder Services ( ISS ) and other proxy advisory firms of policies for voting on majority vote proposals. Starting in 2005, a significant number of companies, recognizing the shareholder interest in director selection reform, addressed the matter on their own initiative by adopting policies, as part of their boards governance guidelines, to 3

9 require that, while plurality voting will continue to apply as the legal requirement for the election of their directors, a director must submit his or her resignation for consideration by the board of directors if he or she does not receive a majority of the votes cast with respect to his or her election ( majority vote director resignation policies ) A few companies went further and changed their director election requirements from a plurality to a majority vote. The results of voting during the 2006 proxy season on shareholder proposals seeking majority voting in the election of directors and the initiatives and responses undertaken by companies with regard to majority voting indicate that majority voting in the election of directors may in the next few years become common practice rather than the exception among widely held companies. In the same period, there have also been significant developments in the law relating to director selection. In 2005, a Task Force of the American Bar Association Committee on Corporate Laws undertook to consider the issues that would be raised by a change from the traditional plurality vote requirement in the context of possible changes in the Model Business Corporation Act (the Model Act ), on which the corporate law of a majority of the states are based. In June 2005, it issued for comment a Discussion Paper in which it identified several alternatives to plurality voting. 6 After considering a wide range of comments 7 and issuing a preliminary report regarding specific changes in the Model Act that it was considering, 8 in June 2006 the ABA Committee released its final report, adopting amendments to the Model Act. 9 The ABA Committee concluded that the substance of the Model Act s existing director election provisions, which establish a plurality vote requirement absent contrary provisions in the articles of incorporation, should continue. However, the ABA Committee did approve specific changes to provisions of the Model Act in order to facilitate action by corporations with respect to their director election requirements, including provisions that would allow a publicly-held corporation, by unilateral action of its board of directors or its shareholders, to opt in to a specified modified majority vote requirement. In addition, Delaware and California each amended its corporation statute to facilitate the ability of corporations and their shareholders to fashion their director election requirements, including the adoption of majority voting. Shareholder Proposals Regarding Majority Voting Numerous companies have received shareholder proposals under SEC Rule 14a-8 seeking a vote at their annual shareholders meeting favoring a change to a majority vote requirement for the election of their directors. More than 60 such proposals came to a vote during the 2005 proxy season and 84 during the first half of 2006; with at least 12 more reportedly scheduled for a vote over the rest of the year. 10 ISS has reported that through August, 36 of the 2006 proposals received the support of a majority of the shares voted and the average vote of shareholders for such proposals was 47.7% for the first six months of In two instances, Marriott International, Inc. and Host Hotels & Resorts Inc., the board of directors supported a shareholder-submitted majority voting proposal, resulting in shareholder support greater than 95% for the proposals. 12 Most of the majority voting proposals have been precatory in nature, recommending that the board of directors take appropriate action to adopt a majority vote requirement. In a few instances, binding bylaw amendments, which would mandate such a vote to achieve election, were proposed. (Changes in director election requirements can in some states, notably including Delaware, be made through bylaw amendments that may be adopted by shareholders unilaterally, thereby making a mandatory shareholder proposal permissible under state law.) 4

10 In several no-action letters issued in 2005, the SEC staff refused to allow the omission under Rule 14a-8 of precatory shareholder proposals recommending that the board of directors act to adopt a majority vote requirement. In doing so, the SEC staff rejected arguments that such a proposal falls within Rule 14a-8(i)(8) s exclusion of any proposal that relates to election for membership on the company s board (and certain other grounds peculiar to the circumstances), without explaining why, in the past, it had permitted similar proposals to be excluded or providing any other explanation for its position. 13 In January 2006, the SEC staff refused to allow the omission of such a proposal as already substantially implemented under Rule 14a-8(i)(10) where a company has adopted a majority vote director resignation policy. 14 Similarly, in a no-action letter issued to Honeywell International Inc. in January 2006, the SEC staff refused to allow the omission under Rule 14a-8 of a binding shareholder proposal to amend Honeywell s bylaws to establish a majority vote requirement. In doing so, the SEC staff rejected Honeywell s argument that the mandatory bylaw amendment proposal fell within Rule 14a-8(i)(10) s exclusion of a proposal that the company has already substantially implemented Honeywell had argued that the director resignation policy adopted by its board compared favorably with the proposed mandatory bylaw amendment, as (among other things) it more directly addressed the holdover director situation. The SEC staff apparently has not yet issued a no-action letter addressing the status of a mandatory majority voting proposal where a company has argued that Rule 14a-8(i)(8) s exclusion of a proposal that relates to election for membership on the company s board is applicable. In the 2005 and 2006 proxy seasons, shareholders voted on several binding proposals to institute majority voting. In 2005, a binding majority voting proposal was submitted to Paychex Inc. under Rule 14a-8 by the American Federation of State, County and Municipal Employees pension fund ( AFSCME ). Paychex did not seek to exclude the AFSCME proposal, which simply substituted reference to a majority for the existing reference in the company s bylaws to a plurality vote requirement for director election. Paychex s board recommended a vote against the proposal, criticizing it as incomplete in that it does not address what would occur if a candidate did not receive a majority vote and would likely result in unintended consequences that do not benefit stockholders, noting specifically that it could result in a holdover director situation. At Paychex s October 2005 annual meeting, the proposal received the favorable vote of approximately 18% of the votes cast. 16 In 2006, AFSCME submitted binding majority voting proposals to Qwest Communications International Inc., Honeywell International Inc. and Wells Fargo & Company, which came to a vote at their annual meetings. 17 In each case, the target company s board of directors recommended that shareholders vote against the binding majority voting proposals. 18 At Honeywell and Wells Fargo, the majority voting proposals failed to secure a majority of votes cast on the proposal, garnering approximately 49% and 39% of the vote, respectively. At Qwest, the majority voting proposal received support from almost 54% of its stockholders, however Qwest s charter required the support of at least 80% of the outstanding common stock to adopt the proposal, and consequently, the proposal was not adopted. Institutional Investor Policies As shareholder proposals seeking majority voting have become common, institutional investors and proxy advisory firms have developed positions concerning changes in the traditional system of election of directors by plurality vote. Many submitted comments to the 5

11 ABA committee favoring changes in the Model Act to provide for majority voting. Several institutional investors, including the California Public Employees Retirement System and Teachers Insurance and Annuity Association-College Retirement Equities Fund 19 have adopted policies supporting most such proposals. The Council of Institutional Investors has adopted a policy that directors should be elected by a majority of the votes cast unless the company is precluded from doing so under state law. In the latter circumstance, directors should be asked to tender their resignations in the event that the number of votes withheld is greater than the number of votes cast in favor of the candidate. In early 2006, the Council of Institutional Investors sent letters to 1,500 of the largest U.S. publicly-owned companies urging them to adopt a majority vote requirement in the election of directors. The Council of Institutional Investors favors a majority vote requirement providing means for a vote against a nominee and recognizes that, in the event of a failed election, some provision for holdover directors may be appropriate to provide board continuity for a period while the situation is addressed. 20 The International Corporate Governance Network, an association of major international institutional investors and investment advisers, has also endorsed majority voting. 21 ISS, a leading proxy advisory firm to institutional investors including mutual funds, has endorsed majority voting in the election of directors, referring to it as being at the top of the unfinished agenda of corporate governance reform. 22 ISS has stated that the current plurality standard creates a flawed accountability mechanism because directors do not face elections with consequences, even if they fail to win a majority of votes cast. Majority voting will make director elections meaningful and provide a new level of accountability in corporate boardrooms. 23 ISS recommended an amendment to the Model Act to make a majority vote requirement the Model Act s default rule for the election of directors of publicly-held corporations. It suggested a modification of the holdover director rule so that a failed election would end a director s term unless the result would be to leave the company without a majority of independent directors or fewer than three independent directors such that it would be unable to comply with listing standards and other legal requirements. ISS also proposed that 10% or 15% of the shareholders be provided the right to call a special shareholders meeting to fill a position left vacant as a result of a failed election and urged elimination of broker discretionary voting on the election of directors. 24 ISS has pointed out that the operation of the holdover director rule is an impediment to full implementation of the majority vote system and that majority vote director resignation policies provide only a partial step toward true majority voting, which it has referred to as the gold standard by which all other election reform alternatives should be judged. 25 In its 2006 proxy voting guidelines, ISS continued its policy of generally supporting majority vote proposals, while providing some additional specification about its policy. 26 ISS will recommend a vote FOR reasonably crafted shareholder proposals calling for directors to be elected with an affirmative majority of votes cast and/or the elimination of the plurality standard for electing directors (including binding resolutions requesting that the board amend the company s bylaws), provided the proposal includes a carve-out for a plurality voting standard when there are more director nominees than board seats (e.g., contested elections). 6

12 However, ISS will consider recommending AGAINST a shareholder proposal if the company has adopted formal corporate governance principles that present a meaningful alternative to the majority voting standard and provide an adequate response to both new nominees as well as incumbent nominees who fail to receive a majority of votes cast. ISS s policy further calls for the company to articulate to shareholders why [its] alternative to a full majority threshold voting standard is the best structure at this time for demonstrating accountability to shareholders. ISS has noted that even the most robust director resignation policy leaves the power in the hands of the board to make a determination on the status of a director who fails to win shareholders support and that the burden of proof is on the board to explain and justify its procedures against the goal of greater boardroom accountability. ISS has stated that it will also evaluate the company s history of accountability to shareholders in its governance structure and in its actions. In particular, ISS will consider a classified board structure or a history of ignoring majority-supported shareholder proposals when deciding if a company s policies are sufficient to justify ISS not supporting a majority vote proposal. ISS also has announced that it will not consult with boards seeking to develop alternatives to majority vote requirements. 27 During the 2006 proxy season, with one exception, ISS supported all shareholder proposals seeking majority voting (where the proposal provided for a contested election exception). ISS is still formulating its proxy voting policies for the 2007 proxy season, which are expected to be released later this year, but its strong support for majority voting seems unlikely to change. Other proxy advisory services have also indicated their general support of majority vote proposals, but have not made public further information on their policies. Voluntary Corporate Initiatives Beginning in 2005, as a result of the increased public attention being given to director selection, many companies initiated changes in their director election requirements. Two different approaches to effectuating these changes have emerged a majority of companies, while retaining the traditional plurality vote standard for the election of directors, have adopted policies requiring a director to resign if he or she did not receive the requisite majority vote on his or her election, while a smaller number have amended their bylaws to institute a majority vote requirement for the election of directors. Pfizer Inc. acted first, on June 23, 2005, announcing a change in the corporate governance principles adopted by its board to include a policy providing as follows: Any nominee for Director who receives a greater number of votes withheld from his or her election than votes for such election shall tender his or her resignation for consideration by the Corporate Governance Committee. The Corporate Governance Committee shall recommend to the Board the action to be taken with respect to such resignation. 7

13 Pfizer has since modified its guideline to clarify that it only applies where the election is uncontested and to add several procedural requirements, including a requirement that a decision on a resignation be made within 90 days and that only directors who are not required to tender their resignations will participate in the decision about whether or not to accept a resignation. 28 Following Pfizer s action, since June 2005 more than 140 companies, including The Walt Disney Company, Time Warner Inc., Microsoft Corporation and General Electric Company, have announced that their boards of directors adopted similar majority vote director resignation policies. 29 While there are certain variations among these policies, 30 in each case they call for a director to submit his or her resignation from the board (even though he or she would have achieved election by virtue of satisfying an unchanged plurality vote election requirement) if the number of votes withheld from his or her election exceeds the number of votes received for his or her election, applying a majority of votes cast standard. In each instance, the resignation requirement only applies in the case of an uncontested election. In August 2005, Office Depot, Inc. and Circuit City, Inc. both adopted voting policies regarding director resignations but opted for voting standards which differed substantially from the Pfizer model. The boards of directors of Office Depot and Circuit City adopted policies to provide for the submission of a resignation, subject to the board s acceptance, of a nominee who received withheld votes of greater than 50% of the outstanding shares, opting for a majority of the outstanding shares standard, rather than a majority of votes cast standard. 31 In 2005 and 2006, several companies amended their bylaws to require a majority vote in the election of directors. Automatic Data Processing, Inc. did so in August 2005 with respect to non-contested elections: 32 The directors shall be elected by the vote of the majority of the shares represented in person or by proxy at any meeting for the election of directors at which a quorum is present, provided that if the number of nominees exceeds the number of directors to be elected, the directors shall be elected by the vote of a plurality of the shares represented in person or by proxy at any such meeting. Intel Corporation did so in January Intel s bylaws now require a majority vote for the election of directors, except in cases where there are more nominees than board positions, where a plurality vote requirement will continue to apply. This bylaw addresses additional procedural matters, providing that the requisite majority vote shall be calculated based on a majority of votes cast for or against a nominee and that, if an incumbent director is not elected as a result of the majority vote requirement, he or she shall offer to tender his or her resignation to the board. This offer shall be considered by the Corporate Governance and Nominating Committee, which shall make a recommendation to the full board on whether or not to accept the resignation or to take other action, so that a decision on the matter (in which such director shall not participate) is made within 90 days after certification of the election results. Since January 2006, more than 40 companies have reportedly adopted a majority vote requirement for the election of directors, in most cases applicable only in a non-contested election. 33 8

14 Statutory Changes On August 1, 2006, two amendments to the Delaware General Corporation Law (the DGCL ) concerning director selection became effective. One was an addition to Section 141(b) of the DGCL confirming that a director s resignation, if it so states, will become effective at a future specified date or upon the occurrence of a future event, rather than at the time of delivery. It also provides that A resignation which is conditioned upon the director failing to receive a specified vote for reelection as a director may provide that it is irrevocable. This provision, comparable to a revision of the Model Act adopted by the ABA Committee, facilitates the operation of a majority vote / director resignation policy. It addresses the concern that, even though a board of directors has adopted such a policy and even if a director has submitted a conditional resignation in accordance with the policy, the policy may not be enforceable and the resignation may not be given effect under Delaware law if the director, as a fiduciary for the corporation, concludes that giving effect to it would not be in the best interests of the corporation and revokes it. The second amendment modified Section 216 of the DGCL to provide that A bylaw amendment adopted by stockholders which specifies the votes that shall be necessary for the election of directors shall not be further amended or repealed by the board of directors. On January 1, 2007, an amendment to the California Corporations Code will go into effect which will give corporations with stock listed on the New York Stock Exchange, the Nasdaq Stock Market or the American Stock Exchange the ability to change their certificates of incorporation or bylaws to provide for a majority vote requirement for the election of directors. A bylaw provision of this nature may be adopted by action of the shareholders alone. The California amendments also address the holdover director rule by providing that, if a director of a company that has adopted such a majority vote requirement fails to be elected by approval of the shareholders in an uncontested election, then the term of such director would end on the earlier of (a) 90 days after the voting results are determined or (b) the date on which such company s board of directors selects a person to fill the office. Under California law, approval of the shareholders occurs when a proposal is approved or ratified by the affirmative vote of a majority of the shares represented and voting at a duly held meeting at which a quorum is present (which shares voting affirmatively also constitute at least a majority of the required quorum). In June 2006, the ABA Committee announced final amendments to the Model Act s director election provisions, concluding that the traditional plurality vote requirement should remain as the Model Act s default rule. The ABA Committee reached this conclusion primarily based on the judgment that the many problems that could be created as a result of a failed election make a majority vote requirement (and the other alternative voting standards the Committee had considered) inappropriate for application to corporations universally, that is, without providing an opportunity for the board of directors to consider the corporation s circumstances. The ABA Committee did, however, make changes to the Model Act to facilitate private ordering by corporations of their director election requirements, with the intent of enhancing the ability of the board of directors and shareholders to develop the director election requirements best suited for the circumstances of the particular corporation. Specifically, the ABA Committee amended the Model Act in three areas. First, it implemented a change to permit corporations by provisions in their articles of incorporation to modify the holdover director rule. By doing so, a corporation would have the flexibility to 9

15 address what many have perceived as a problem in having a holdover director in the event of a failed election under a majority vote requirement (or other requirement that is more stringent than the traditional plurality vote requirement). The second change confirmed the effectiveness of conditional director resignations, specifically allowing a resignation to be conditional or effective at a future date and provided that a resignation conditioned upon failing to receive a specified vote for election will be irrevocable if it so provides. As discussed above regarding the comparable amendment of the Delaware corporation statute, this change reinforces the effectiveness of majority vote director resignation policies. Finally, an entirely new provision of the Model Act allows publicly-held companies not having cumulative voting in the election of their directors, by amendment of their bylaws unilaterally approved by their board of directors or their shareholders, to elect to have a modified majority vote system apply to the election of their directors. Under these provisions, a plurality vote would suffice to elect a director, but additional requirements would apply to the election. In addition to voting for the election as a director of a nominee, as currently provided, shareholders would be specifically allowed to vote against a nominee or to abstain from voting with respect to the election of a director, in effect displacing the more ambiguous withhold vote instructions otherwise provided by the proxy rules. 34 If a nominee is elected by reason of receiving for votes representing a plurality of the votes cast for the board position but less than a majority of the votes cast for and against his or her election, the nominee would only serve as a director for a maximum of 90 days after the certification of the election results, unless the board of directors within such period selects the nominee to fill the board position. At any time during the 90-day period, the board could make such selection or could select any other qualified individual to fill the board position held by such director. In the latter case, the director s term of office would automatically end upon the board s action selecting another individual to fill such board position, even though such action occurred before the 90-day period elapsed. 35 If the board did not select such director or another individual for such board position within the 90-day period, such director s term of office would then automatically end, creating a vacancy on the board of directors. These provisions operate as a modification of the holdover director rule by ending a holdover director s term of office. A resulting board vacancy could be filled in the same manner as any other vacancy, that is, by vote of the shareholders or, if the articles of incorporation so provide, by the board of directors; alternatively, the board position could be eliminated by reducing the size of the board (by action of the board of directors or the shareholders, as provided in the articles of incorporation and bylaws). Generally, in practice the modified majority vote system would not apply to a contested election. 36 Although amendments to the Model Act have generally been influential in shaping the evolution of the corporation statutes of many states, each state must consider, through its own legislative process, whether to revise its corporation statute to conform to an amendment made to the Model Act. Accordingly, many corporations, shareholders and boards of directors do not currently have and may not have for some time the additional flexibility to implement a private ordering of their director election requirements that the recent Model Act amendments provide. 10

16 Shareholder Access In October 2003, the SEC proposed certain changes to the proxy rules that would have required a company, under certain circumstances and subject to certain limitations, to include in its proxy materials, as distributed to all shareholders, specified information (including a supporting statement of up to 500 words) about one, two or three shareholder nominees (depending on the size of the board) and also to provide on the proxy card a means to vote on such nominees. 37 The proposed rule regarding shareholder access attracted significant attention from both activist investors and public companies; hundreds of comment letters were received by the Commission on the proposal. Among the comments received by the SEC, several questioned whether the SEC has the statutory authority to require companies to provide their shareholders with access to company proxy materials with respect to the election of directors, inasmuch as the election of directors is a central corporate governance matter traditionally regulated by state corporation law. 38 Generally, shareholders have no independent right as a matter of state law to use of a corporation s proxy materials, which are considered a company asset over which the board of directors has authority. While as a practical matter Rule 14a-8 has long operated as a limited qualification on the control over company proxy materials given to boards of directors by state law, the Commission s access proposal raised substantially different considerations than those historically raised by Rule 14a-8 proposals. This position is based on the 1990 decision of the Court of Appeals for the District of Columbia Circuit in The Business Roundtable v. Securities and Exchange Commission, 39 which established that the SEC did not have authority to mandate listing standards requiring that voting rights be allocated on a one share / one vote basis, inasmuch as voting rights involve a fundamental area of state corporate law that Congress had not preempted. The court specifically found that the SEC did not derive the necessary authority by implication from its authority under Section 14 of the Securities Exchange Act of 1934, as amended, to regulate proxy solicitations. By 2005, the SEC s access proposal had failed to attract the support needed for so significant a change in the director selection process and, as indicated above, director selection reform efforts turned to focus on the adoption of a majority vote standard in the election of directors. While the SEC was still considering its access proposal, some shareholders pursued access to the proxy materials of individual companies by submitting shareholder proposals under Rule 14a-8 urging adoption of access provisions, often on terms similar to those proposed by the SEC. Companies, however, were generally successful in excluding these proposals from their proxy materials pursuant to Rule 14a-8(i)(8) on the grounds that such proposals related to the election of directors, so these proposals did not come to a vote during the 2004 through 2006 proxy seasons. However, on September 5, 2006, the United States Court of Appeals for the Second Circuit issued an opinion, AFSCME Pension Plan vs. American International Group, Inc., 40 which upheld a challenge to the position that an access proposal could be excluded under Rule 14a-8(i)(8) as relating to the election of directors. At issue in AFSCME was a shareholder proposal requesting that American International Group ( AIG ) include shareholder-nominated candidates for election to the board of directors in the company s proxy materials, essentially in the same circumstances in which access would be required to be provided under the then- 11

17 pending SEC rule proposal. AIG took the position that it could exclude the proposal from the company s proxy materials pursuant to Rule 14a-8(i)(8) because the proposal relates to the election of directors, and sought no-action relief on this basis from the Division of Corporation Finance of the SEC. AIG received a no-action letter which stated that the SEC staff would not recommend enforcement action if AIG did not include the proposal in its proxy materials based on AIG s position that the director election exclusion under Rule 14a-8(i)(8) applied to the proposal. 41 The no-action letter did not state the reason why the staff accepted AIG s position. However, the staff in other contexts had noted that proposals submitted under Rule 14a-8 that would likely result in an election contest would be treated as relating to the election of directors. 42 AFSCME brought an action in the United States District Court for the Southern District of New York seeking to mandate that AIG include the proposal in its proxy materials as properly submitted under Rule 14a-8. The court ruled that the AIG was not required to include the proposal in its proxy materials based on the director election exclusion. 43 On appeal, the Second Circuit determined that, as a matter of administrative procedure, AFSCME s access proposal could not be excluded under Rule 14a-8(i)(8). AFSCME argued that the rule created an exclusion for proposals relating to a particular election but not to proposals that established a process governing elections generally. The court found that language of the rule ambiguous, and so turned to the SEC s interpretation of its rule. AIG, accompanied by the SEC as amicus curiae, argued that shareholder proposals that would result in contested elections were excluded by the provisions of section (i)(8), a position that the SEC had taken in no-action letters for many years. However, the court found that this interpretation was not consistent with the SEC s original interpretation of the director election exclusion provision of the rule when the full Commission last addressed the text of the rule in The court noted that from 1976 to 1990 the SEC had interpreted the rule to exclude only those proposals related to particular elections (e.g., a proposal seeking to further the election of a candidate other than a particular nominee of the board). The SEC s interpretation only began shifting to focus on proposals that would result in an election contest in 1990, a change in interpretation that had not been explained by the Commission or implemented through rulemaking or other formal interpretive procedure (including in the no-action response to AIG). While the court was clear that the policy choice about the categories of shareholder proposals relating to director elections that were excludible under the rule was for the Commission to decide, it concluded that it was appropriate for the SEC s original interpretation to apply with respect to the AFSCME proposal. The court found that the SEC had not given sufficient reasons for its change in interpretation starting in 1990 and, accordingly, the AFSCME proposal had not been properly excluded by AIG. After the AFSCME decision, the status of director selection proposals under Rule 14a-8 has been left in an uncertain state: The SEC has taken the position that precatory majority voting proposals are not excludible (without explaining why such proposal, which necessarily contemplates a solicitation against a board nominee, is not considered to create an election contest) but has not taken a position as to whether a by-law amendment to adopt a majority vote requirement is excludible. The SEC has taken the position that both a precatory proposal and a by-law amendment to establish access is excludible as tending to create an election contest and in its 2003 access proposal specifically proposed amending Rule 14a-8 to permit access proposals made in accordance with its proposed rule (and only such access proposals) to be included under Rule 14a-8. 12

18 On September 7, 2006, the SEC announced that it would address the issues raised by the AFSCME decision. Christopher Cox, Chairman of the SEC, stated, Rule 14a-8, the shareholder proposal rule, provides shareholders important rights in the proxy process. These rights are best secured under consistent national application of Rule 14a-8 to shareholder proposals. Therefore, to provide certainty with regard to shareholder proposals in every judicial circuit, I have directed the staff to prepare recommendations for revisions to Rule 14a-8 that will assure its consistent nationwide application. Following the publication of a proposed amendment and the opportunity for public comment, a final proposal will be considered at an open meeting of the Commission that will be scheduled to allow a final rule to go into effect in time for the 2007 proxy season. 44 The SEC now has this subject on its agenda for an open meeting on December 13, There are problems of an immediate nature to be addressed by the SEC based on the AFSCME decision, as proxy season is fast approaching and companies are likely to be confronted with various shareholder proposals with respect to access in November and December 2006 in light of the 120-day notice period under Rule 14a-8. While further review of the Second Circuit decision has not been sought, it is recognized that other circuits may take a contrary view with regard to the extent of the SEC s administrative authority in applying Rule 14a-8 and it is highly desirable that there be a consistent interpretation of the director election exclusion on a national basis. The Commission faces both substantive issues with respect to the scope and purposes of Rule 14a-8 and issues with respect to its procedures for administering the rule. The SEC s interpretation of the rule s various provisions and exclusions have regularly evolved to adapt to changing circumstances through the no-action letter process provided by sections (j) and (k) of the rule, under which the staff has not always provided reasons for the position it has taken. In addressing the concerns raised by the court in the AFSCME decision, the Commission may consider the procedures it will use in interpreting the rule in the future. Without attempting to predict what action the SEC may take, the following identifies a number of considerations of relevance to the alternative courses of action available to the Commission: (1) The SEC could continue to apply to the director election exclusion in general, and to access proposals in particular, its resulting in a contested election interpretation, consistent with the view it expressed in its proposed access rule. 45 In order to comply with the holding of the AFSCME decision, it could state the reasons for changing its interpretation of the exclusion from that which it provided in This should not prove difficult because the voting process has changed significantly since that time. From its inception, Rule 14a-8 was never intended, and was not designed, to deal with election contests, including in the form of the short slate and withhold vote campaigns which are now in use -- techniques that were unknown in Also, the role of proxy advisors and how voting positions are formed have changed significantly in the last few decades, with the consequence that the voting process in terms of influence and control significantly differs from that which existed in Finally, Internet proxy solicitation is likely to be enabled by the SEC in the near future, further changing the mechanics and economics of proxy solicitation that Rule 14a-8 was in part designed to address. (2) The SEC could reverse its recent policy position concerning the director election exclusion and return to its original 1976 interpretation of the exclusion, at least as pertinent to access proposals. This outcome would likely result in many access proposals of varying kinds being submitted and brought to a vote in the upcoming proxy season, potentially 13

19 producing for companies and shareholders a confusing situation regarding access. In addition, the same considerations concerning the Commission s authority over proxy solicitation and corporate governance based on The Business Roundtable decision that arose with respect to the Commission s 2003 access proposal may apply to a mandate by the Commission that companies make their proxy material available under Rule 14a-8 for access proposals, particularly proposals of a binding nature. This factor was not addressed in the AFSCME decision. (3) The SEC may elect to propose clarifying changes in the language of the director exception exclusion embodying a modified or preexisting policy. This would involve notice of the change and a comment period, with the practical consequence that such change would not be effective in the upcoming proxy season. The SEC would therefore need to consider its position with respect to access proposals submitted for a vote in the upcoming proxy season. It could decline to take a position on the application of the director election exclusion to such proposals during its rulemaking process, leaving companies and shareholder proponents to resolve among themselves or (at least outside of the Second Circuit) in court how such proposals should be treated. Alternatively, it could adopt an interim position on the issue (as described above), stating its reasons so as to comply with the AFSCME decision. Another interim measure may be to permit precatory access proposals to be included in proxy materials under Rule 14a-8 but not permit binding access proposals (those which the proponent seeks to put into effect by a bylaw amendment) on the grounds that such proposals affect corporate governance in ways beyond the scope of Rule 14a-8. The Commission would presumably provide reasons for this distinction, which is one that has been addressed in the past in a limited way in some no-action and interpretive positions. 46 The latter alternative raises a number of issues but as an interim step may be available to the Commission. (4) The SEC could propose a new access rule such as proposed Rule 14a-11 with modifications to attempt to deal with objections to the original proposal. This would raise the same authority issue as raised by the 2003 proposal. The SEC would also need to consider its interim approach to access proposals made under Rule 14a-8 for the 2007 proxy season while it undertook the necessary rulemaking process. Some commentators suggest that the SEC should take advantage of the decision of the court in AFSCME to provide access. 47 The implication is that the court, by declining to permit AIG to exclude the proposal, supports that suggestion. However, the court was explicit as to its neutrality on the subject stating as follows: In deeming proxy access bylaw proposals non-excludable under Rule 14a-8(i)8), we take no side in the policy debate regarding shareholder access to the corporate ballot. There might be perfectly good reasons for permitting companies to exclude proposals like AFSCME s, just as there may well be valid policy reasons for rendering them non-excludable. However, Congress has determined that such issues are appropriately the province of the SEC, not the judiciary

20 Depending on the action taken by the SEC, the authority of the SEC as interpreted under The Business Roundtable decision may be an issue. Given the complexity of the situation, the SEC s action scheduled for December 13 may not provide a definitive outcome with respect to the treatment of access proposals under Rule 14a-8. Withhold Vote and Short Slate Campaigns In the 2004 proxy season withhold vote campaigns began to emerge as an important factor in the election of directors. A number of such campaigns were mounted in the 2005 and 2006 proxy seasons as well. Withhold vote campaigns are a means of expressing dissatisfaction with the board s nominees, often because of objection to particular board practices or polices or as a rejection of the board s overall direction of corporate affairs. Their goal is to send a message to the board of directors and influence the future composition of the board. The target of these campaigns may be only some of the board s nominees or, in cases, may be all the board s nominees. As companies adopt majority vote requirements for the election of their directors, withhold vote campaigns may evolve into against vote campaigns, but the goals and dynamics of these efforts would seemingly remain the same. In some withhold vote campaigns concerted efforts are made through the widespread dissemination of proxy solicitation materials to convince shareholders to withhold their votes from the election of specific nominees or all nominees of the board. These can be high profile efforts. In other cases, widespread solicitation of proxies has not been undertaken but significant shareholders and/or proxy voting advisors have recommended that votes be withheld from certain directors. These efforts tend to be well recognized among institutional shareholders and can result in a substantial number of withheld votes. As discussed below, the limited solicitation exemption of Rule 14a-2(b)(1) may be relied on in the solicitation efforts made in support of these campaigns. In 2004, The Walt Disney Company, Federated Department Stores, Inc., MBNA Corp., Kohl s Corp. and Zimmer Holdings Inc., received withhold vote totals against at least some directors exceeding 30%. 49 In 2005, while the campaigns usually took on a lower profile than in 2004, companies including MCI, Inc., Costco Wholesale Corp., VF Corp., Monsanto Co. and the McGraw-Hill Cos. still received withhold vote totals against at least some directors exceeding 20%, while a director at Alaska Air Group Inc. received 42% withhold votes. 50 In 2006, eight companies received withhold vote totals against at least some directors exceeding 40%, and more than 30 additional companies received withhold vote totals against at least some directors between 20% and 40%. 51 Director independence, financial reporting policies, executive compensation policies and responses to precatory shareholder proposals are all factors that have been identified by institutional investors and proxy advisory firms as important in their determining when to withhold votes from the election of a board nominee. As of September 2006, ISS had made withhold vote recommendations against 15% of the 31,400 corporate directors up for election during the 2006 proxy season. 52 This represents a modest decrease in the number of withhold vote recommendations ISS made in previous years; ISS made withhold vote recommendations against 17% of corporate directors in 2005, 20% in 2004 and 25% in

21 The level of withheld votes with respect to board nominees (or against votes where majority voting in the election of directors has been adopted) may increase over time. Another development is the increase in short slate campaigns. These occur when a shareholder presents nominees to run against some but not all of the nominees of the board of directors, in contrast to a traditional election contest intended to give the proponent control of the corporation. A 1992 amendment of the proxy rules facilitated short slate campaigns, which were virtually unknown before that time. Previously, if a shareholder proponent presented nominees for only some board seats to be filled at an election, it could only distribute a proxy card providing for a vote for its nominees; it could not list any nominee of the board or another party on its proxy card without the nominee s consent. If a shareholder submitted the proponent s proxy card, it was generally understood to have thereby revoked any prior proxy it issued. This put shareholders in a situation were there was no convenient means for them to vote by proxy with respect to some nominees of a shareholder proponent and some nominees of the board. By permitting a shareholder proponent to distribute proxy cards that provide for a vote with respect both to its nominees and nominees of the board of directors, Rule 14a-4, as amended in 1992, made it feasible to run a short slate contest. 54 However, under this rule, it is up to the proponent to determine if it wishes to provide on its proxy card means for shareholders to vote on the board s nominees for positions for which the proponent does not propose a nominee; the proponent is not required to do so. The 2006 proxy season saw a material increase in the number of proxy contests, including an increase in the number of short slate contests. 55 The proxy contest waged by Nelson Peltz against the board of directors of H.J. Heinz Company received significant attention from the mainstream press, as did Carl Icahn s threat to wage a contest against Time Warner Inc. While in several notable cases, including the Heinz contest, insurgents ultimately won seats on the target s board of directors, a number of target companies avoided a contested election by settling with insurgents, agreeing either to nominate insurgent nominees for election or directly appoint them to the board in exchange for the insurgent s withdrawal from the contest (and sometimes agreeing to pursue particular strategic alternatives as well). Among the companies agreeing to such settlements with insurgents were Time Warner (which agreed to increase a previously announced stock buyback and appoint two new independent directors), Wendy s International (which agreed to appoint three insurgent nominees and spin-off a subsidiary) and Topps (which agreed to add three insurgent nominees to its slate of nominees). 56 A material increase in short slate campaigns is a likely consequence of the current developments in voting systems and processes. Such campaigns can be undertaken for a variety of purposes. For example, activist shareholders who are dissatisfied with the performance of the board, or of specific directors, of a corporation may put forward a short slate of rival nominees. Alternatively, if a shareholder has proposed to the board a candidate for nomination by the board but the candidate is rejected by the board, it may itself nominate the candidate and run a shortslate campaign in support of the candidate. In other cases, hedge funds or other activist shareholders may propose a short slate in an effort to gain more influence over a corporation in support of a specific strategic program such as a divestiture. The proponent is likely to present its nominees as eligible to serve as independent directors. The proponent would be required to prepare and distribute a proxy statement in support of its nominees but it may be possible to run such a campaign effectively at a far more modest cost than in the past, as the adoption of the 16

22 SEC s proposed Internet proxy solicitation rules (discussed below) will likely reduce the costs. While many institutional shareholders may be reluctant to put forward rival nominees of their own, this may not significantly limit the incidence of short slate campaigns. Institutional shareholders may well be willing to support actively a short slate put forward by another shareholder, including by distributing supporting materials themselves. In doing so, the institution may rely on the limited solicitation exemption from the requirement to prepare and distribute a proxy statement, as discussed below. Moreover, under the SEC s proposed rules on use of the Internet in proxy solicitations, such supporting materials may be economically disseminated. It is noteworthy that while this technique would not provide access, it would produce much of the result as the regulatory structure that would have been established by the SEC s proposed access rule. Internet Proxy Solicitation On December 8, 2005, the SEC proposed amendments to its proxy rules that, subject to a notice requirement, would in most circumstances treat the posting of proxy materials on a generally accessable free Internet website as delivery of that material. 57 This Internet access equals delivery system is intended to speed the dissemination of proxy information to shareholders while reducing printing and mailing costs for both companies and those engaging in election contests and other solicitations. In general, the proposed rules would allow companies, shareholders and others soliciting proxies to forego sending a paper copy of their solicitation material to shareholders and instead (i) send a plain English Notice of Internet Availability of Proxy Materials containing (and permitted to contain only) a few specified items of information, including the website address where the solicitation material can be accessed (an Internet Notice ), and (ii) make the solicitation material available on such website not later than the date when the Internet Notice is sent. The Internet Notice must be sent to solicited shareholders at least 30 days before the scheduled date of the shareholders meeting or the earliest date a solicited consent may be given effect. Shareholders would generally have the right, upon request, to receive a paper copy of the solicitation material by mail (or, if they request, an electronic copy by ). However, the proposed rules would exempt a shareholder who does not seek proxy voting authority to send shareholders an Internet Notice. Use of this Internet access equals delivery system would be optional. It could be used as an alternative or in addition to the existing method of printing and mailing proxy materials. It could be used for some or all of a company s shareholder meetings or consent solicitations and for some or all of the proxy materials used in connection with a particular meeting or consent solicitation, except that it is not available for use in a solicitation relating to a business combination. Any corporation law requirements relating to a shareholders meeting or solicitation of consents would nevertheless have to be satisfied, so, for example, a notice of meeting or notice of dissenters rights would still have to be sent to shareholders and, if so required by corporation law, in paper form sent by mail. The proposed rules permit the Internet Notice to include or be accompanied by any notices required by state corporation law. As proposed, the Internet Notice could be sent electronically where the proxy materials to which it relates may be sent electronically under the existing rules. Consequently, it would usually be necessary to mail a paper copy of the Internet Notice to each shareholder who is to be solicited, 17

23 subject to the exceptions discussed below. Filing with the SEC of all proxy materials (including the Internet Notice) will continue to be required not later than the date of first use. The availability of materials on the SEC s EDGAR website is not proposed to be sufficient to satisfy the Internet access equals delivery requirements. The SEC s proposing release makes clear that, to the extent existing rules allow proxy materials to be distributed electronically or made available on an Internet website, this flexibility continues to be available and will continue under the proposed rules. Proxy cards may be completed and submitted by shareholders through Internet facilities. As a general matter, required proxy materials may currently be sent to a shareholder by only where the shareholder s consent has previously been obtained (or in the case of a company s employeeshareholders who have ready access to, and regularly use, , where such consent is implied). Additional proxy materials (i.e., materials other than a proxy statement, a required amendment or supplement thereto and a proxy card), however, apparently may be sent to shareholders without express or implied consent. 58 Under the proposed rules, an Internet Notice could accordingly be sent by where the consent of the receiving shareholder has been obtained or is implied or where the Internet Notice relates only to additional soliciting materials. Thus, a shareholder soliciting other shareholders who is not required to send proxy statements under the limited solicitation exemption provided by Rule 14a-2(b)(1) where the shareholder is expressing a position, but not requesting a proxy would be able to avoid all printing and mailing costs in making its solicitation (except where it receives a request for a paper copy in response to its Internet Notice). (Whether this flexibility would be available to a shareholder for a distribution of additional solicitation materials supporting a withhold vote (or against vote ) campaign will depend on whether the limited solicitation exemption is available. In addition, under the proposed rules, a shareholder may conduct a conditional electronic only solicitation by which it sends shareholders an Internet Notice, but, as specified in such notice, will seek proxy authority only from those shareholders who agree to access electronically the soliciting shareholder s solicitation materials; in such cases, the soliciting shareholder would not be required to provide a written copy of its solicitation material to a requesting shareholder. 59 Discretionary Voting By Brokers On October 24, 2006 the New York Stock Exchange ( NYSE ) filed with the SEC a proposed amendment of NYSE Rule 452 and corresponding NYSE Listed Company Manual Section that will eliminate broker discretionary voting on the election of directors of shares held in client accounts when voting instructions are not provided by the client, the beneficial owner of the shares. 60 The proposed amendment, which is subject to approval by the SEC, will be applicable to proxy voting by SEC member-firm brokers with respect to shareholder meetings held on or after January 1, 2008, except to the extent that a meeting was originally scheduled to be held in 2007 but was adjourned to The NYSE and SEC proxy rules require brokers to deliver to their clients proxy materials for shares held by the brokers (or their nominees) for client accounts and NYSE rules require brokers to solicit their clients voting instructions. NYSE Rule 452, titled Giving Proxies by Member Organizations, allows brokers who have not received voting instructions from the 18

24 beneficial owner of the shares at least 10 days before a scheduled meeting to vote the client s shares on routine matters. Rule 452 currently lists 18 items that are considered non-routine, such as a contest or any matter which may affect substantially the privileges of stockholders. This list was amended in 2003 to include a vote on authorization of any equity compensation plan. 61 On such non-routine matters, brokers are prohibited from voting in the absence of instructions from the beneficial owners (although such shares are counted as present for quorum purposes). Under Rule (2) a contested matter is one that is the subject of a countersolicitation, or is part of a proposal made by a stockholder which is being opposed by management A counter-solicitation with regard to the election of a director has long been interpreted to apply only to a solicitation in favor of the election of an alternative nominee as to whom a proxy statement in favor of his or her election has been distributed. Therefore, most director elections have been considered routine matters and brokers have been allowed to cast discretionary votes on such elections. In casting votes on routine matters, brokers have virtually uniformly voted as recommended by the board of directors, i.e., for its nominees for election as directors. In April 2005, the NYSE created a Proxy Working Group ( PWG ) to review the NYSE rules regulating the proxy voting process. The PWG recommended in a June 2006 report, among other things, amendment of Rule 452 to make the election of directors a non-routine matter and end the ability of brokers to influence the outcome of director elections by voting client shares in the broker s discretion, situations where the broker has no economic interest in the outcome. 62 It reasoned that, even where no alternative nominee is contesting an election, the election of a director is no longer a routine event in the life of a corporation, given the critical role directors play. In addition, the PWG concluded that eliminating broker discretionary voting on the election of directors would promote greater transparency of the election process and better corporate governance. Moreover, it noted that the definition of a contested election has been increasingly questioned, given the rise of withhold vote campaigns. In light of these recommendations and based on its own conclusions, the NYSE proposes to add the election of directors to Rule 452 as a non-routine item, thereby eliminating broker discretionary voting on the election of directors. The PWG s report also recommends improvements in the proxy and shareholder communications process, including a greater ability of companies to communicate directly with the beneficial owners of their shares. Three subcommittees have been established by the PWG to review and make recommendations on (1) improvements in the shareholder communication process, (2) the fees and costs associated with the solicitation of proxies and (3) the education of investors on the importance of participation in the proxy voting process. The PWG s recommendation that the ability of companies to communicate directly with the beneficial owners of their shares be improved seconds concerns expressed by The Business Roundtable, which in 2004 petitioned the SEC to review its rules governing such communications with the view to enabling companies generally to communicate directly with the beneficial owners of their shares. 63 In addition, the PWG recommended that the NYSE request that the SEC study the role of proxy voting advisory services in making decisions over shares in which they do not own or have an economic interest. 19

25 As discussed in the PWG report, the proposed change in broker discretionary voting could have significant impact on the director election process, including: increased costs to listed companies as a result of the additional time and money that will be spent to reach shareholders who previously did not vote; enhanced ability of special interest groups and other shareholders with a particular agenda to influence and challenge an incumbent board at the expense of smaller shareholders; and an increased burden on smaller listed companies whose shareholder body includes a smaller proportion of institutional investors and/or that have greater difficulty in contacting shareholders and convincing them to vote in uncontested elections. The Role of the Limited Solicitation Exemption In the emerging environment for shareholder voting several unresolved issues arise under the federal securities laws. In significant part, the solicitation activities undertaken by investors seeking to influence the composition and policies of a company s board of directors proceed under the limited solicitation exemption from the disclosure requirements of the proxy rules. 64 This exemption which in recent years has been used by shareholders in connection with withhold vote campaigns allows a person, other than the company and its affiliates and associates, to advocate how shareholders should vote on a matter without having to prepare and distribute a proxy statement. Among the key conditions for reliance on the exemption is that the person not be required to file a beneficial ownership report on Schedule 13D or, if such a filing is required, that the person does not disclose in the report an intent to engage in a control transaction or a contested solicitation for the election of directors (as it is required to do if it has such intent) and does not reserve the right to engage in such activity. The limited solicitation exemption was adopted in 1992 so that institutional investors would be free to express publicly their views about how they vote their shares, provided that they do not engage in control activities or transactions in which they have a substantial interest and do not seek proxy voting authority, which was then the recognized means for investors to seek to influence the control of companies. 65 Given the broad reach historically given to the concept of proxy solicitation, any public expression of views about a matter that was subject to a vote by a shareholder could have been considered to require the preparation and filing of a proxy statement. This was considered an unnecessary burden and cost, and an unwise restriction, on the ability of shareholders to exercise their franchise and, indeed, worked against responsible exercises of the shareholders franchise and informed voting decisions. The limited solicitation exemption was designed to remedy this problem. 66 However, in today s environment, where the line should be drawn between activity as to which no additional disclosure is warranted and activity as to which shareholders should receive additional information is unclear. The operation of the limited solicitation exemption across today s spectrum of activities is uncertain and how the current exemption applies depends on seemingly subtle factors and is highly dependent on the facts and circumstances in which the activities are undertaken. 20

26 At the time that the limited solicitation exemption was adopted, concern was expressed about the possible need for greater transparency as to the vote formation process. 67 The point was made that there was a risk that significant shareholders would have the opportunity to meet, as in the proverbial smoke-filled room, and, while not seeking proxy authority from each other, concur on common or parallel voting positions on the election of directors or with respect to specific proposals. Such common or parallel voting positions might be determinative of the outcome of the vote on a matter. In short, proxy authority is not the only means of enlisting shareholder support which in turn may affect influence and control. Whether a complete exemption from the proxy statement disclosure requirements of the proxy rules was warranted in such circumstances was considered. It was assumed that there would be no specific agreement or commitment among the participants as to how they would vote, such that a group for purposes of Section 13(d) would not be formed and no Section 13(d) reporting obligation (for example, about the extent of the participants interest in and their plans respecting the company) would be triggered. Moreover, the participants would have a natural interest in letting other shareholders and the market know of the voting position they were taking, at least where their position was in opposition to the recommendation of the board of directors. The desirability of letting significant shareholders interact in determining their voting positions and letting other shareholders know of their conclusions was, in the context of the time, considered to outweigh the risk of not imposing any proxy statement disclosure requirements. However, the presumption underlying the exemption was that such shareholder activity would not involve the exercise of control over a company or of influence over the control of company affairs. Given the ways shareholder voting can now influence companies, this presumption requires reexamination. To use an antitrust law analogy, the question is whether at some point the conscious parallelism that may result from activities of this nature ripens into collective action that warrant disclosure of the kind customarily required of participants in election contests. Under the limited solicitation exemption, this judgment revolves around whether the participants have a Schedule 13D reporting obligation, including by reason of having formed a Section 13(d) group, and intend to influence control of the company. In such event, enhanced disclosure obligations would apply (both under Schedule 13D and by reason of the inapplicability of the exemption, such that the participant would be required to prepare a proxy statement if it were to seek to solicit on a matter). In some circumstances, other issues could also arise. In connection with the election of directors, concerted support for a nominee can raise issues of deputization. 68 There may, in addition, be questions as to the affiliate status of shareholders who lead an initiative that gives them an influence over control of the company, affecting their ability to sell their shares without restriction or registration under the Securities Act of 1933, as amended. 69 A Schedule 13G filer, as long as it is not affiliated with a company, is ordinarily entitled to benefit of the limited solicitation exemption. Under Rule 14a-2(b)(1), a Schedule 13D filer loses the exemption when there is disclosure pursuant to the Schedule of an intent, or reservation of a right, to engage in a control transaction or any contested solicitation for the election of directors. 70 When the SEC amended its beneficial ownership reporting rules in 1998 to (among other things) permit a less than 20% beneficial owner to file a Schedule 13G report in lieu of a Schedule 13D report, it discussed whether and when sponsorship or solicitation in support of a Rule 14a-8 proposal would be considered to involve a control intent that would make Schedule 13G and the limited solicitation exemption unavailable to a 5%+ shareowner or shareowner 21

27 group. While recognizing that whether or not a person has a control intent would normally be determined based upon the specific facts and circumstances accompanying the solicitation and the vote, the SEC did comment in its adopting release that most solicitations in support of a proposal specifically calling for a change in the control of a company (e.g., a proposal to seek a buyer for the company or a contested election of directors ) would clearly have the effect or purpose of changing or influencing control. 71 This commentary seemingly was intended to correspond to the wording of the limited solicitation exemption (which had been adopted six years earlier), which makes the exemption unavailable to a 5%+ shareowner intending or reserving the right to engage in any contested solicitation for the election of directors. A contested solicitation may be a broader range of activity than a traditional contested election in the sense that an alternative slate of nominees is put forward in opposition to the nominees of the board. 72 Moreover, soliciting against or withhold votes on the election of a director is activity comparable to soliciting in favor of the revocation of a proxy already granted to the incumbent board, which is an action specifically not permitted under the limited solicitation exemption. The SEC concluded that the filing status of institutional investors which engaged in proxy solicitations with regard to shareholder proposals would be based on the purpose and effect of the type of proposal and related soliciting activity, and set forth some factors that it considered relevant in making such a determination. 73 There is a question as to whether, or in what circumstances, a withhold vote (or against vote ) campaign will constitute a contested solicitation for the election of directors. Whether a majority vote or a plurality vote requirement applies to the election of a director may affect this determination. Where the solicitation is in the context of a majority vote election requirement, such that the consequence of an against vote can directly affect the composition of the board of directors, the circumstances may be considered different from a withhold vote solicitation under a plurality vote regime, where the consequence is only an expression of shareholder dissatisfaction. In a situation where a majority vote requirement applies, a shareholder or shareholder group that has 5% or greater beneficial ownership of the company who campaigns against the election of a board nominee might no longer be eligible for the limited solicitation exemption (and would most likely also become ineligible to submit a short form report of its beneficial ownership on Schedule 13G) because such efforts might be considered a disqualifying contested solicitation or considered a disqualifying effort to influence control of the corporation. In the context of a withhold vote or against vote campaign, the SEC s facts and circumstances test concerning availability of the limited solicitation exception might include the number of incumbent directors who are subject to the campaign, the goals of the campaign and the significance of the voting block actively supporting the campaign, particularly in the future environment in which a smaller percentage of shares may vote as a result of the elimination of broker discretionary voting in the election of directors. Disqualification seems more likely where a majority vote requirement applies: the solicitation of a vote against, or to withhold a vote from, a nominee is more likely to be influential (perhaps as a practical matter determinative) as to the board s composition, with greater potential impact on control of the corporation. 74 It seems that soliciting votes against the election of particular directors under a majority vote system would involve a contested solicitation inasmuch as it would convert a non-contested solicitation by the incumbent board into a contested solicitation over the election of a board nominee. In any event, a widespread campaign to solicit votes against a nominee would likely involve an effort to influence control, inasmuch as the campaign would presumably be based on criticism of some action or policy of the incumbent board or of 22

28 one or more of the board s nominees and, thus, constitute an effort to bring about a change in the incumbent board s policies, practices or composition. Thus, the current and pending changes in shareholder voting processes raise new disclosure issues for the companies, shareholders and the Commission to consider. Conclusion It is clear from the foregoing, as well as other developments beyond the scope of this paper (such as vote buying ), that significant changes to the shareholder voting process have already occurred and are ongoing. Accordingly, future proposals for regulatory and other changes to the shareholder voting process should take into account the combined effects, both formally and in practice, of these developments. 23

29 ENDNOTES 1 Vote buying is beyond the scope of this article but concerning the subject see Henry T.C. Hu and Bernard Black, Empty Voting and Hidden (Morphable) Ownership: Taxonomy, Implications, and Reforms, 61 BUSINESS LAWYER 1011 (2006). 2 SEC Press Release (April 14, 2003). 3 Disclosure Regarding Nominating Committee Functions and Communications Between Security Holders and Boards of Directors, Exchange Act Release No (November 24, 2003) 4 NASD and NYSE Rulemaking: Relating to Corporate Governance, Exchange Act Release No (November 4, 2003). 5 Proposed Rule: Security Holder Director Nominations, Exchange Act Release No (October 14, 2003). This proposal was discussed in a October 28, 2003 Memorandum to Clients and Friends, available on the website of Weil, Gotshal & Manges LLP, at < cesstoproxymats.pdf>. 6 Committee on Corporate Laws, Section of Business Law, American Bar Association, Discussion Paper on Voting By Shareholders for the Election of Directors (June 22, 2005), available at < (The Chairman of the Task Force and Committee, E. Norman Veasey, formerly Chief Justice of the Supreme Court of Delaware, is a member of Weil, Gotshal & Manges LLP.) 7 Comments were received from institutional and other investors, companies, investor groups and others, including ISS and the Task Force on Shareholder Proposals of the ABA Committee on Federal Regulation of Securities, which discussed proxy solicitation and disclosure considerations under the federal securities laws that would be implicated by a change from the traditional plurality vote requirement. The comment letters received on the Discussion Paper are available at < (Two members of this firm participated in the Task Force that commented on the Discussion Paper.) 8 Committee on Corporate Laws, Section of Business Law, American Bar Association, Preliminary Report of the Committee on Corporate Laws on Voting By Shareholders For the Election of Directors (January 17, 2006), available at < 9 Press Release, Committee on Corporate Laws, Section of Business Law, American Bar Association (June 20, 2006), available at < 10 See ISS, 2006 Postseason Report (2006), at 16, available at < 11 Id. 12 Id. For the respective proposals and board recommendations, see Proxy Statement on Schedule 14A, filed by Marriott International, Inc. on March 22, 2006 and Proxy Statement on Schedule 14A, filed by Host Hotels & Resorts, Inc. on April 21, For the respective voting results, see Quarterly Report on Form 10-Q for the quarterly period ended June 16, 2006, filed by Marriott International, Inc. on July 19, 2006 and Quarterly Report on Form 10-Q for the quarterly period ended June 16, 2006, filed by Host Hotels & Resorts, Inc. on July 24, Marriott International s Board of Directors subsequently approved a bylaw amendment adopting a majority of votes cast standard for the election of directors in uncontested elections. Pursuant to the bylaw amendment, if a nominee already serving as director does not receive a majority of votes cast, such director must offer to tender his or her resignation to the board of directors, and following a review by the nominating and corporate governance 24

30 committee, the board of directors must accept or reject the resignation. Marriott International retained plurality voting for contested elections, where the number of nominees exceeds the number of seats available. See Current Report on Form 8-K, filed by Marriott International, Inc. on August 22, The Board of Directors of Host Hotels & Resorts does not appear to have acted with respect to majority voting at this time. 13 See, e.g., JPMorgan Chase & Co., SEC No-Action Letter, 2005 SEC No-Act. LEXIS 254 (February 22, 2005); Time Warner Inc., SEC No-Action Letter, 2005 SEC No-Act. LEXIS 267 (February 17, 2005); Citigroup Inc., SEC No-Action Letter, 2005 SEC No-Act. LEXIS 242 (February 14, 2005). In similar contexts (such as proposals to provide shareholder access to company proxy material for shareholder nominees) the SEC staff for many years has taken the position that proposals that would tend to lead to contested elections may be excluded as relating to the election of board members. Regarding the staff s position in this regard over the years, see SECURITIES LAW TECHNIQUES (2006 Ed.) 53.06[d][i] (A.A. Sommer, Jr., Gen. Ed ). Recent development concerning this position are discussed below. 14 Hewlett Packard Company, SEC No-Action Letter, 2006 SEC No-Act. LEXIS 6 (January 5, 2006). 15 Honeywell International Inc., SEC No-Action Letter, 2006 SEC No-Act. LEXIS 69 (January 20, 2006). 16 For the voting results, see Quarterly Report on Form 10-Q for the quarterly period ended November 30, 2005, filed by Paychex Inc. on December 21, Season Rundown: AFSCME 2006 Proxy Season Review, available at < 18 For the respective proposals and board recommendations, see Proxy Statement on Schedule 14A, filed by Qwest Communications International Inc. on March 30, 2006, Proxy Statement on Schedule 14A, filed by Honeywell International Inc. on March 13, 2006, and Proxy Statement on Schedule 14A, filed by Wells Fargo & Company on March 17, For the respective voting results, see Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2006, filed by Qwest Communications International Inc. on August 1, 2006, Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2006, filed by Honeywell International Inc. on July 21, 2006, and Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2006, filed by Wells Fargo & Company on August 3, California Public Employees Retirement System, Press Release, March 14, 2005, available at < Teachers Insurance and Annuity Association College Retirement Equities Fund has indicated its support for majority voting in the election of directors, see ISS, 2005 Postseason Report (2005), but not yet issued a formal statement of its voting policies on proposals concerning the subject. See TIAA-CREF, Policy Statement on Corporate Governance, available at < (last accessed January 12, 2005). 20 Council of Institutional Investors, Council Policies, available at < see also CII s comments on the Discussion Paper, available at < 21 See Comment Letter of the International Corporate Governance Network, dated August 17, 2005, on the Discussion Paper, available at < 22 See ISS, Majority Voting in Director Elections From the Symbolic to the Democratic at 1 (2005). 23 ISS, Majority Elections: Questions and Answers on ISS 2006 Voting Policy (Dec. 2005), available at < 24 See Comment Letter of ISS, dated August 15, 2005, on the Discussion Paper, available at < 25 ISS, Majority Elections: Questions and Answers on ISS 2006 Voting Policy (Dec. 2005). 25

31 26 ISS, U.S Proxy Voting Guidelines Summary, available at < see also ISS, U.S Corporate Governance Policy 2006 Updates, available at < ISS voting guidelines for the 2007 proxy season are scheduled for release in mid-november ISS, Majority Elections: Questions and Answers on ISS 2006 Voting Policy (Dec. 2005). 28 The current Pfizer governance guideline provides: In an uncontested election, any nominee for Director who receives a greater number of votes withheld from his or her election than votes for such election (a Majority Withheld Vote ) shall promptly tender his or her resignation following certification of the shareholder vote. The Corporate Governance Committee shall consider the resignation offer and recommend to the Board whether to accept it. The Board will act on the Corporate Governance Committee s recommendation within 90 days following certification of the shareholder vote. Thereafter, the Board will promptly disclose their decision whether to accept the Director s resignation offer (and the reasons for rejecting the resignation offer, if applicable) in a press release to be disseminated in the manner that Company press releases typically are distributed. Any Director who tenders his or her resignation pursuant to this provision shall not participate in the Corporate Governance Committee recommendation or Board action regarding whether to accept the resignation offer. However, if each member of the Corporate Governance Committee received a Majority Withheld Vote at the same election, then the independent Directors who did not receive a Majority Withheld Vote shall appoint a committee amongst themselves to consider the resignation offers and recommend to the Board whether to accept them. However, if the only Directors who did not receive a Majority Withheld Vote in the same election constitute three or fewer Directors, all Directors may participate in the action regarding whether to accept the resignation offers. 29 See ISS, 2006 Postseason Report (2006), at 16. See also Thaddeus C. Kopinski, Will Investors Choose Majority Vote or Pfizer?, available at < 30 For example, the GE guideline states that Absent a compelling reason for the director to remain on the Board and public disclosure of that reason, the Board shall accept the resignation. 31 Circuit City s policy provides that Any Director nominee in an uncontested election for whom greater than 50% of the outstanding shares are withheld from his or her election shall tender his or her resignation for consideration by the Nominating and Governance Committee. The Nominating and Governance Committee shall recommend to the Board the action to be taken with respect to such resignation. See Circuit City Stores, Inc. Board of Directors Practices and Policies, available at < (see Policy #19). See also Office Depot, Inc. Corporate Governance Guidelines, available at < (see Guideline #5). 32 ISS, 2006 Postseason Report (2006), at 16. See footnote 33 regarding the shares present standard used in the Automatic Data Processing provision. A few other companies had earlier taken similar action. In May 2005, Dillard s Inc. announced that its Board of Directors had amended its bylaws to require a majority vote in the election of its directors. See Current Report on Form 8-K, filed by Dillard s Inc. on May 21, Also, in May 2005, N- Viro International Corp. announced that its board of directors had amended its by-laws to provide for majority voting in the election of directors, subject to shareholder approval at its upcoming annual meeting of an amendment of its certificate of incorporation it recommended to eliminate the plurality vote requirement contained in its 26

32 certificate of incorporation. The amendment was approved at that meeting by an overwhelming favorable shareholder vote. See Current Report on Form 8-K filed by N-Viro International Corp. on May 13, In both cases, the bylaw provision is applicable regardless of the number of nominees. Lockheed Martin Corporation has for many years had such a provision in its by-laws. See Quarterly Report on Form 10-Q for the quarter ended June 28, 1993, Exhibit 3, filed by Lockheed Martin Corporation. 33 ISS, 2006 Postseason Report (2006), at 16. Most of these provisions require for election a majority of the votes cast for or against the director. It should be noted that under Delaware law (DGCL 216), absent contrary provisions in the certificate of incorporation or by-laws, shareholder action, other than with respect to the election of directors, is by majority of the votes of the shares present at a meeting and entitled to vote, a quorum being present and with regard to the election of directors a plurality of the shares present at the meeting and entitled to vote. Delaware recognizes a difference between shares present and votes cast in regard to the treatment of abstentions and so-called broker non-votes. Accordingly, it is important in crafting a majority vote requirement for the election of directors of a Delaware corporation to consider how abstentions and broker non-votes should be treated and whether the requisite majority is to be of votes cast for or against the director (and, if so, to specify this) or whether the traditional Delaware shares present formulation should apply. 34 Under Rule 14a-4, a form of proxy must provide for a shareholder to withhold its vote from the election of a director nominee, unless the law under which the company is organized permits a vote against the election of a director, in which case the form of proxy must provide means for a shareholder to vote against the nominee s election. States whose corporations law is based on the Model Act, as well as Delaware, New York and most other states, currently do not permit a vote against the election of a nominee as a director. 35 In the former case, the selection would be treated as though it constituted the filling of a vacancy, with the result that the director s term of office would extend until the next annual meeting of shareholders (even if the articles of incorporation provided for a board of directors have staggered multi-year terms of office such that the director would normally have had a longer term in office) and (as provided by the holdover director rule, unless that rule had been modified by a provision in the certificate of incorporation) until the election of his or her successor. 36 Under the newly-adopted provisions of the Model Act, modified majority voting would not apply if (a) at the expiration of time fixed under an advance notice bylaw to nominate a director, or (b) if there is no such advance notice bylaw, at a time fixed by the board of directors which is not more than 14 days before notice of a stockholder meeting is provided, there are more candidates for election than the number of directors to be elected. However, if a company did not have an advance notice bylaw and an insurgent nominated a candidate after the time fixed by the board of directors pursuant to the rule, modified majority voting would continue to apply even though there was an election contest. See Press Release, Committee on Corporate Laws, Section of Business Law, American Bar Association (June 20, 2006), available at < 37 Subject to certain limitations, the new shareholder access rule would have required a company to include in its proxy materials, as distributed to all shareholders, specified information (including a supporting statement of up to 500 words) about one, two or three shareholder nominees (one if the board has eight or fewer members, two if more than eight and three if 20 or more) and also to provide on the proxy card a means for voting on nominees. However, these requirements would only be applicable if one of two triggering events had occurred: (a) a shareholder vote in favor (as determined by a majority of the votes cast) of a shareholder proposal to the effect that the nomination procedure specified by the proposed rule be adopted by the company, where such an opt-in proposal was submitted in accordance with Rule 14a-8, by a shareholder who at the time was, and for at least the previous year had been, the owner of more than 1% of the voting stock or (b) action by shareholders representing at least 35% of the votes cast at an annual meeting for the election of directors withholding authority to vote in favor of the election of any nominee of the board, except where the election was a contested one or was one as to which the proposed shareholder nomination procedure applied (i.e., as to which a triggering event had already occurred). 38 See, e.g., the Comment Letter of the ABA Task Force on Shareholder Proposals, on the SEC s access proposal (January 7, 2004), available at < 27

33 39 The Business Roundtable v. Securities and Exchange Commission, 905 F.2d 406 (D.C. 1990). 40 AFSCME Pension Plan vs. American International Group, Inc., 462 F.3d 121 (2d Cir. 2006). 41 American International Group, Inc., SEC No-Action Letter, 2005 SEC No-Act. LEXIS 235 (February 14, 2005). 42 See Proposed Rule: Security Holder Director Nominations, Exchange Act Release No (October 14, 2003). The proposed shareholder access rules would have amended Rule 14a-8(i)(8) to prohibit a company from excluding a shareholder proposal that would subject such company to the shareholder access rules (i.e., shareholder access proposals would no longer be excludible under Rule 14a8(i)(8)). See also General Motors Corporation, SEC No-Action Letter, 2005 SEC No-Act. LEXIS 309 (February 28, 2005). In the no-action letter issued to GM, the SEC staff indicates that the interpretative changes with respect to Rule 14a-8(i)(8) that were necessitated by the proposed shareholder access rule were no longer necessary given the passage of time and indicates that the SEC staff had reverted to its prior view that such proposals could be excluded pursuant to Rule 14a-8(i)(8). 43 AFSCME Pension Plan vs. American International Group, Inc., 361 F. Supp. 2d 344 (S.D.N.Y. 2005). The District Court after reviewing the SEC s 1976 release and subsequent no-action letters, found that AFSCME s proposal both related to an election and was likely to cause an election contest, and denied AFSCME s motion for a preliminary injunction. 44 SEC Press Release (September 7, 2006). 45 See supra note The SEC has not taken a definitive position on when a bylaw amendment proposal can be excluded under Rule 14a-8, finding significant uncertainty in the state law provisions governing the matters that may be regulated by bylaws. See, e.g., Massey Energy Company, SEC No-Action Letter, 2004 SEC No-Act LEXIS 414 (March 1, 2004); Verizon Communications, Inc., SEC No-Action Letter, 2004 SEC No-Act LEXIS 140 (Feb. 2, 2004); Sears, Roebuck and Co., SEC No-Action Letter, 2004 SEC No-Act LEXIS 163 (January 27, 2004) (all stating that the staff is unable to conclude that the proposed bylaw amendment is not a proper subject for shareholder action); Toys R Us, Inc., SEC No-Action Letter, 2002 SEC No-Act LEXIS 571 (April 9, 2002) (finding some basis for the view that a bylaw amendment can be excluded as violating state corporation law); The Quaker Oats Company, SEC No- Action Letter, 1999 SEC No-Act. LEXIS 417 (April 6, 1999); Community Bancshares, Inc., SEC No-Action Letter, 1999 SEC No-Act. LEXIS 426 (March 15, 1999); Eastern Enterprises, SEC No-Action Letter,1999 SEC No-Act. LEXIS 270 (February 17, 1999); SECURITIES LAW TECHNIQUES 53.06[2][b] (A.A. Sommer, Jr. ed.). 47 See, e.g., Letter from James P. Hoffa, General President, International Brotherhood of Teamsters to Christopher Cox, Chairman, Securities and Exchange Commission (September 27, 2006) (available at Letter from Rob Feckner, President, CalPERS Board of Administration to Christopher Cox, Chairman, Securities and Exchange Commission (September 13, 2006) (available at But see Letter from Steve Odland, Chairman, Corporate Governance Task Force, Business Roundtable to Christopher Cox, Chairman, Securities and Exchange Commission (September 29, 2006) (available at 48 See AFSCME at See ISS, 2004 Postseason Report: A New Corporate Governance World: From Confrontation to Constructive Dialogue (2004), available at < 50 See ISS, 2005 Postseason Report (2005), available at < 51 ISS, 2006 Postseason Report (2006), at

34 52 ISS, 2006 Postseason Report (2006), at ISS, 2005 Postseason Report (2005). 54 Rule 14a-4(d). See Regulation of Communications Among Shareholders, Exchange Act Release No (October 16, 1992). 55 ISS, 2006 Postseason Report (2006), at See Richard Siklos and Andrew Ross Sorkin, Time Warner and Icahn Reach a Settlement, N.Y. TIMES, February 18, 2006, at C1, Current Report on Form 8-K, filed by Wendy s International, Inc. on March 10, 2006 and Current Report on Form 8-K, filed by The Topps Company, Inc. on August 1, Internet Availability of Proxy Materials, Exchange Act Release No (December 8, 2005). 58 See, with respect to current requirements concerning electronic delivery of proxy material, Use of Electronic Media for Delivery Purposes, Exchange Act Release No (October 6, 1995) and Use of Electronic Media, Exchange Act Release No (April 28, 2000). 59 Under the proposed rules, a company would not be able to conduct a conditional electronic only solicitation and so would always be required to provide a written copy of its solicitation material to a shareholder requesting such. The proposing release explains that it would be impractical for a company to do a conditional electronic only solicitation because the company would be obligated to provide an information statement complying with Regulation 14C to any shareholder to which it did not send a proxy card because the shareholder had not agreed to access the company s proxy materials electronically. See note 28 and the related text of the SEC s proposing release and proposed rule 14a-3(g)(8). 60 Available at < 61 Order Approving NYSE and Nasdaq Proposed Rule Changes and Nasdaq Amendment No. 1 and Notice of Filing and Order Granting Accelerated Approval to NYSE Amendments No. 1 and 2 and Nasdaq Amendments No. 2 and 3 Thereto Relating to Equity Compensation Plans, Exchange Act Release No (June 30, 2003). 62 Report and Recommendations of the Proxy Working Group to the New York Stock Exchange (June 5, 2006), available at < 63 The Business Roundtable requested that the SEC thoroughly examine the process by which companies communicate with their shareholders, stating its belief that there are numerous inefficiencies in the system which hamper effective communication. See Request for Rulemaking Concerning Shareholder Communications (April 12, 2004), at 64 Rule 14a-2(b)(1). 65 Regulation of Communications Among Shareholders, Exchange Act Release No , (Oct. 22, 1992). 66 Id. at The adopting release noted that Many corporate commenters argued that absent a filing obligation in connection with all communications among shareholders, the reforms would further the disturbing trend toward the determination of the outcome of shareholder voting by secret back-room lobbying of and negotiations with institutional investors, rather than in open and public proxy campaigns. Id. at 16, citing a comment letter submitted by The Business Roundtable, dated September 18,

35 68 Deputization can be used to establish Section 16(b) liability for a shareholder who is not a director but who is closely associated with a shareholder. See Blau v. Lehman, 368 U.S. 402 (1962), Feder v. Martin Marietta, 406 F.2d 260 (2d Cir. 1969); 3 LOUIS LOSS & JOEL SELIGMAN, SECURITIES REGULATION, (3d ed. 1999)( The big question [with regard to liability for short swing trading] is whether one who deputizes another to be a director is a director and, if so, what is involved to deputize a director ). 69 Such shareholders may be deemed affiliates and consequently restricted from reselling their shares. See Rule 144(a)(1); Rule 405; 5 LOSS, supra note 68, at 1518 ( Because the Commission staff is concerned with control groups, not merely control persons, an individual s holdings of far less than a 10 percent stock interest will not discourage the staff from considering him or her to be an affiliate if his or her family or other allied persons holds a control block in aggregate ). Under some circumstances, a director designated by a shareholder for election and holding office could be deemed to have the requisite relationship with the shareholder to cause the shareholder to be considered an affiliate of the company. 70 Rule 14a-2(b)(1). Additionally, pursuant to Rule 14a-6(g), a person who owns more than $5,000,000 of the class of securities which is subject to the solicitation shall file a Notice of Exempt Solicitation (Rule 14a-103) and shall attach as an exhibit all written solicitation materials. Speeches and oral solicitations are excluded from the requirement. Presumably, a person includes a group. 71 Amendments to Beneficial Ownership Reporting Requirements, Exchange Act Release No (January 12, 1998) at 34 (emphasis added). It should be noted that this disqualification is not triggered only by an intent to exercise actual control but also by an intent to influence control. 72 Efforts to change the composition of a corporation s board have generally been considered to constitute efforts to exercise control over a corporation. See, e.g., SECURITIES LAW TECHNIQUES (2006 Ed.) (A.A. Sommer, Jr., Gen. Ed., ). In recently proposing a limited right of shareholder access to company proxy material under a new Rule 14a-11, the SEC seemingly confirmed this, inasmuch as it sought as part of such proposal to create an additional exemption from the requirement to prepare and distribute a proxy statement and from most other proxy rules requirements for solicitations by qualified shareholders who nominated candidates under Rule 14a- 11; otherwise, that proposed rule would have been of limited practical utility for a person or group beneficially owning 5% or more of a corporation s shares. Nevertheless, there is some uncertainty as to the disclosures required of a 5% or greater beneficial owner in relation to voting on the election of directors, even if such an owner has the ability to affect significantly the board s composition. In Edelson v. Ch ien, 405 F.3d 620 (7th Cir. 2005), the court rejected a private cause of action for violation of Section 13(d) of the Securities Exchange Act of 1934, as amended, against the beneficial owner of more than 16% of a company s shares, who was also chairman of the company s board of directors, premised on his failure to file a Schedule 13D report in place of the Schedule 13G he had on file when he decided not to vote for the reelection of two nominees of the board, even though he, as a director, had voted in favor of their nomination. (The company was organized in the Cayman Islands and a majority vote requirement applied to the election of its directors, whose term ended upon the vote being held.) The nominees were independent directors and constituted a majority of the company s audit committee and had disagreed with, and apparently effectively blocked, a proposal advocated by the beneficial owner that the company acquire a large portion of his stock. The court, rejecting an interpretation urged by the SEC as amicus curiae, ruled that, even if such owner s vote was intended to and had the effect to determining the board s composition, the owner had not at any proximate time to the vote acquired any shares and could not be said to have acquired his shares years earlier with such purpose and, accordingly, was not required under Section 13(d) to disclose his intentions regarding his voting on the election of directors. The court ruled that Section 13(d) s disclosure obligations only apply where a 5% or greater beneficial owner has or is engaged in the rapid acquisition of a substantial block of shares, as by a tender offer or comparable acquisitive activity. In its amicus curiae brief the SEC argued that a 5% or greater beneficial owner becomes ineligible to file a Schedule 13G report, and is required to file a Schedule 13D and disclose therein a control intent (presumably including an intent to change the board s composition, the only controlrelated activity at issue in that case), at any time it holds shares with such intent, regardless of whether it acquired any shares with such intent and even though no control transaction, including an election contest, is then pending. On the basis of the SEC s position expressed in that brief, the limited solicitation exemption under the proxy rules would likely not be available to a shareholder with such an intent. 30

36 73 See Amendments to Beneficial Ownership Reporting Requirements, Exchange Act Release No (January 12, 1998) at The factors set forth by the SEC as relevant in such an analysis were: (1) Does the filing person purchase securities in the ordinary course of business and by its nature does not seek to acquire control of companies? (2) Was the proposal submitted or solicitation undertaken based upon the filing person's investment policies regarding good corporate governance for all the filer's portfolio companies, rather than to foster a control transaction for the particular company? (3) Was the proposal submitted, or solicitation commenced, under circumstances where, given the subject matter of the particular proposal, it is likely to have the effect of facilitating a change of control of that particular company by another person or group (for example, the submission of a proposal to eliminate a staggered board that may facilitate a non-management solicitation, even by an unrelated third party)? (4) Did the filing person commence an independent solicitation, exempt or otherwise, in favor of a proposal (the mere submission of a proposal under Rule 14a-8, without any independent soliciting activity, would be less likely to have a disqualifying purpose or effect)? (5) Was the activity undertaken in opposition to a proposal put forth by management for shareholder approval, rather than in support of a proposal submitted by the filing person or some other shareholder? 74 See ABA Task Force on Shareholder Proposals, Comment Letter dated April 15, 2005 on the Discussion Paper at page18, available at < 31

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