July 2009 Authors: William Gleeson william.gleeson@klgates.com 206.370.5933 C. Kent Carlson kent.carlson@klgates.com 206.370.6679 Eric Simonson eric.simonson@klgates.com 206.370.7679 Aaron A. Ostrovsky aaron.ostrovsky@klgates.com 206.370.7853 K&L Gates is a global law firm with lawyers in 33 offices located in North America, Europe, Asia and the Middle East, and represents numerous GLOBAL 500, FORTUNE 100, and FTSE 100 corporations, in addition to growth and middle market companies, entrepreneurs, capital market participants and public sector entities. For more information, visit www.klgates.com. New Amendment to NYSE Rule 452 Limits Discretionary Broker Voting in Director Elections Rule 452 of the New York Stock Exchange has been amended to eliminate broker discretionary voting in uncontested elections of directors (the Amendment ). The NYSE proposed the Amendment and the SEC approved it on July 1, 2009. The Amendment applies to the voting of shares held in street name by NYSE members in connection with elections at all public companies. Because NYSE members hold the vast majority of shares held in street name, the Amendment will affect almost all public companies, except investment companies, and not just NYSE-listed companies. The Amendment will be effective for proxy voting for shareholder meetings held on or after January 1, 2010. The Amendment is likely to have its greatest impact on companies with a high percentage of shares held by retail investors (typically smaller companies), especially those companies that use a majority-vote-for-director standard for director elections. Generally speaking, the rate at which smaller companies have adopted a majority vote standard has been much lower than at larger companies. The Commission s release noted that nearly 70% of companies in the S&P 500 have adopted some form of majority voting and the release noted other information from which it could be inferred that only about 10% of the companies from 1001 to 3000 in the Russell 3000 have adopted some form of majority voting for director. What is NYSE Rule 452? Investors can hold shares of record (in their own name) or in street name, that is, in the name of a broker, bank or custodian (collectively for this memo, broker ), in which case the investor is the beneficial, but not the record, owner. It is estimated that approximately 85% of exchange-listed shares are held in street name. Proxy solicitations of beneficial owners are typically made through the broker, which transmits the proxy statement to the beneficial holders. Instead of sending a proxy card, the broker sends to the beneficial holder an instruction sheet which the beneficial holder can return to the broker with voting instructions. Rule 452 comes into play when the beneficial owner does not instruct the broker how to vote the shares. The rule specifies the conditions under which the broker can vote the shares without having received voting instructions from the beneficial owner. Rule 452 allows a broker to vote shares held in street name on routine proposals if the broker s customer, the beneficial owner of the shares, has not provided specific voting instructions to the broker at least ten days before a scheduled meeting. Shares for which no instructions are received are referred to as uninstructed shares. The rule prohibits brokers from voting shares on non-routine proposals, such as a merger or other proposal that would substantially affect the rights or privileges of
the shares, without specific voting instructions from the beneficial owner. Rule 452 is applicable to NYSE members, primarily brokers and banks, and regulates their conduct in voting shares held in street name for customers. Rule 452 regulates the brokers voting of shares of all companies, not just those listed on the NYSE. The rule does not regulate the conduct of companies listed on the NYSE. What Changes Does the Amendment Make Regarding Director Elections? Contested elections. It has long been established under Rule 452 that a contested election of directors is non-routine. A contested election is one in which there is a competing slate of directors and a counter-solicitation opposed by management. In contested elections, brokers cannot vote uninstructed shares. The Amendment does not change broker voting in contested elections. Uncontested elections. In the past, an uncontested election of directors was considered routine under Rule 452 and accordingly brokers could vote uninstructed shares. The Amendment makes an uncontested election non-routine, eliminating brokers ability to vote uninstructed shares in such an instance. Vote no or withhold vote campaigns. The NYSE s long-standing position has been that a just vote no or withhold vote campaign (collectively, Just Vote No Campaigns ) does not transform an election of directors into a contested election. The rationale is that a Just Vote No Campaign does not involve a competing slate of directors or a formal counter-solicitation. In a Just Vote No Campaign, the dissident shareholder seeks to have shareholders either vote against the board s nominees or withhold authority to vote for the board s nominees, but in either case using the company s proxy card. The dissident shareholder engaging in a Just Vote No Campaign does not solicit proxies giving the dissident shareholder the power to vote the shares for a competing slate of directors, which has been the key requirement for classifying an election as non-routine. As a result of the Amendment, elections involving a Just Vote No Campaign are considered nonroutine. Why Did the SEC Approve the Underlying the SEC s approval of the Amendment was the Commission s belief, as expressed in its release approving the Amendment, that The election of directors is not a routine issue for either the corporation or the shareholders; it is a key event in the operation and direction of the corporation and the shareholders exercise of their rights and interests as owners of the corporation. From this principle and taking note of the fact that there is concern that brokers typically support management disproportionately over dissidents, it follows, according to the release, that the Amendment should better enfranchise shareholders by taking voting decisions away from brokers who have no economic interest in the company. The SEC reasoned that eliminating voting by those with no economic interest should enhance corporate governance and accountability to shareholders. The SEC noted that in certain Just Vote No Campaigns, presumably in elections requiring a majority of votes cast, it appeared that broker discretionary voting for the management slate has made the difference and allowed directors subject to these campaigns to be elected. It further noted that even in situations where broker discretionary voting did not change the result of an election, the typically disproportionate support of management could create a perception that a candidate or group of candidates has greater support than would be the case without broker discretionary voting. This can lead to a failure to understand that the directors suffer from a lack of substantial support and that in turn can inappropriately affect decisions of the board and shareholders. July 2009 2
Is There an Exemption from the Voting in director elections for registered investment companies is exempt from the Amendment. Brokers can continue to treat elections at registered investment companies as routine and vote uninstructed shares. The SEC rejected exemptions for smaller issuers, business development companies, and master limited partnerships. The Commission recognizes that small issuers could face similar concerns as registered investment companies, but refused to exempt them from the Amendment because of the unique regulatory scheme governing investment companies. What is the Effect on Non-NYSE Members? Rule 452 affects proxy voting by members of the NYSE, who account for the vast majority of shares held in street name. However, there are brokers who are not members of the NYSE. AMEX Rule 577 is applicable to AMEX members and historically has substantially mirrored Rule 452. It can be expected that AMEX will file for a rule change similar to the Amendment. In any case, an AMEX member that is also a NYSE member is subject to Rule 452. NASD Rule 2260 does not permit broker voting except in accordance with the rules of an exchange of which the brokers are members. FINRA members are subject to Rule 2260 and the Rule requires that the brokers send beneficial owners a proxy card as opposed to an instruction sheet. However, a FINRA member that is also a NYSE member is subject to Rule 452. What will be the Impact of the The Amendment is likely to have its greatest impact on companies with a high percentage of shares held by retail investors. Retail investors who hold shares of record vote at rates significantly below institutional shareholders. Similarly, retail investors who hold shares in street name provide voting instructions to the broker at rates significantly below institutional shareholders. Companies that have a large percentage of retail record or beneficial shareholders would likely include smaller companies, which typically having a smaller proportion of institutional investors. Just Vote No Campaigns. The Amendment could have a significant impact on the frequency and effectiveness of Just Vote No Campaigns. Majority-Vote-For-Director Elections. The impact may be most pronounced at companies having a majority-vote-for-director election standard. The typical provision requiring a majority vote requires that a director receive a majority of votes cast to be elected. Under Rule 452 before the Amendment, a broker could vote uninstructed shares and they would be votes cast. After the Amendment, uninstructed shares cannot be votes cast. Traditionally, broker discretionary votes have been voted heavily in favor of the board s nominees, making it easier to achieve a majority vote. The Amendment is likely to enhance the effectiveness of Just Vote No Campaigns in the context of a majority-vote-for-director provision and could lead to the defeat of the board s nominees and this in turn could lead to an increase in the frequency of Just Vote No Campaigns. In its release approving the Amendment, the SEC downplayed the significance of the Amendment on elections requiring a majority vote, noting that one study found that only 2 nominees out of 2,718 failed to receive a majority vote without broker discretionary voting. Nevertheless, the Commission did concede the Amendment may make it somewhat more difficult for a director in a majority vote company to survive a just vote no or similar campaign. Plurality Elections. The Amendment could also have a significant impact on Just Vote No Campaigns even where the election standard is a plurality of the votes cast. While the Just Vote No Campaigns would not lead to the defeat of the board s nominees, the Amendment could July 2009 3
lead to embarrassing situations where the board nominees do not receive a majority of the votes cast or, even if they do, the majority is small. Quorum at Shareholder Meetings. A quorum at a shareholder meeting is established by the presence of shares eligible to vote, whether in person or by proxy. Shares are considered present where a broker votes a customer s shares pursuant to a proxy and the only matter voted on in the proxy is voted pursuant to broker discretionary voting. Thus, where the only matter to be voted on was an uncontested election of directors, the broker could vote because the matter was routine and the voted shares would be deemed present. After the Amendment, if the only matter to be voted on is an uncontested election, the broker cannot vote the customer s shares and such shares are not present for quorum purposes. It is likely that companies will put more routine proposals on their proxy cards (such as the ratification of auditors) in order to assure that there will be broker discretionary voting on at least one matter at the meeting and the customer shares can be deemed present for quorum purposes. What are the Challenges Created by the The SEC s position is that the Amendment will better enfranchise shareholders. It is well documented that the voting rates of retail shareholders can be quite low. Some companies have relied on broker discretionary voting to establish quorums and to provide support for the board s nominees for directors. Before the Amendment, brokers could use their discretion in voting the shares of customer/beneficial owners in elections if the beneficial owners did not provide instruction as to how to vote. That solution, however, had, in the SEC s view, undesirable consequences: broker discretionary voting resulted in voting decisions being made by brokers having no economic interest in those shares and this in turn could have a distorting effect on elections in general and especially those involving Just Vote No Campaigns. The Commission s action eliminates those undesirable consequences. To make up for the lost broker discretionary votes, companies will have to increase voting rates for retail shareholders. This may not be an easy task. Not only are voting rates by retail shareholders low, but surveys show that most retail shareholders who own shares held in street name do not understand that brokers have had the power to, and did, vote uninstructed shares. The problem is particularly acute in the area of investment companies, where 98% of the shares are held by retail investors and the low level of participation by retail investors is more likely to result in the failure to obtain a quorum. As for a solution to the problem of low participation in elections by retail investors, the SEC said only that it encourages [brokers] to implement an investor education effort to inform investors about [the Amendment], the proxy voting process, and the importance of voting. In the near term, it is likely that many companies will have to step up efforts to increase voting by retail shareholders, efforts that are likely to increase the costs of the proxy process, perhaps significantly. Were there Alternative Approaches that the SEC Rejected? There were other possible approaches to the concerns that the Commission identified, but none of these approaches were included in the Amendment. These approaches would have taken discretion on how to vote away from the broker but assure that the shares are voted. These included: Proportional Voting. Beginning in 2007, at least ten of the largest brokers, representing more than 40% of the market, have instituted proportional voting policies for voting uninstructed shares. Those brokers vote uninstructed shares in the same proportion as the actual retail vote of shares for which instructions are received. Client Directed Voting. When an investor opens a brokerage account, the investor would be allowed (but not required) to provide a "good until cancelled" instruction on matters to be voted on at companies in which they own July 2009 4
stock. Investors would be permitted to elect whether to always (i) vote in accordance with the board s recommendation, (ii) vote against the board s recommendation, (iii) abstain from voting, or (iv) vote proportionally with the broker s retail clients instructed votes on the same issue. At the time of any proxy solicitation, each investor would receive a notice from their broker reminding the investor of their standing instructions and how those instructions would be implemented with respect to the upcoming vote. Investors would then have the ability to override their standard instructions by providing specific voting instructions. Redefining the term Contested Election. Issues relating to Just Vote No Campaigns could be resolved by defining elections involving Just Vote No Campaigns as contested elections for purposes of Rule 452. Such a change would not address the fact that, in uncontested elections brokers without an economic interest would make voting decisions and, given the fact that broker discretionary voting disproportionately favors management, such voting could create misperceptions as to the level of support directors enjoy. Anchorage Austin Beijing Berlin Boston Charlotte Chicago Dallas Dubai Fort Worth Frankfurt Harrisburg Hong Kong London Los Angeles Miami Newark New York Orange County Palo Alto Paris Pittsburgh Portland Raleigh Research Triangle Park San Diego San Francisco Seattle Shanghai Singapore Spokane/Coeur d Alene Taipei Washington, D.C. K&L Gates is a global law firm with lawyers in 33 offices located in North America, Europe, Asia and the Middle East, and represents numerous GLOBAL 500, FORTUNE 100, and FTSE 100 corporations, in addition to growth and middle market companies, entrepreneurs, capital market participants and public sector entities. For more information, visit www.klgates.com. K&L Gates comprises multiple affiliated partnerships: a limited liability partnership with the full name K&L Gates LLP qualified in Delaware and maintaining offices throughout the U.S., in Berlin and Frankfurt, Germany, in Beijing (K&L Gates LLP Beijing Representative Office), in Dubai, U.A.E., in Shanghai (K&L Gates LLP Shanghai Representative Office), and in Singapore (K&L Gates LLP Singapore Representative Office); a limited liability partnership (also named K&L Gates LLP) incorporated in England and maintaining offices in London and Paris; a Taiwan general partnership (K&L Gates) maintaining an office in Taipei; and a Hong Kong general partnership (K&L Gates, Solicitors) maintaining an office in Hong Kong. K&L Gates maintains appropriate registrations in the jurisdictions in which its offices are located. A list of the partners in each entity is available for inspection at any K&L Gates office. This publication is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer. 2009 K&L Gates LLP. All Rights Reserved. July 2009 5