On October 26, the SEC proposed changes to the proxy rules that will require participants — both management and dissidents — to provide shareholders with a universal proxy card in a contested election. The SEC’s proposal is designed to permit shareholders voting by proxy to vote for the combination of shareholder and management nominees that they believe best serve their interests, as they would if they were present and voting in person at a meeting. Under current SEC rules and state corporation laws, as well as due to technical developments in the way public company shares are voted, it can be difficult for shareholders voting by proxy to split their ticket and they often are forced to choose between the competing issuer and dissident slates.
Institutional investors and shareholder advocates have been lobbying the SEC to facilitate the use of universal proxy cards in contested elections for many years. Corporations have generally been less supportive of universal proxy cards, often citing practical concerns regarding voting mechanics as well as strategic reluctance to include dissident nominees in company proxy materials. There are pros and cons of universal proxy cards for both sides and the proposed rules would likely have a mixed impact. What we have observed from the limited use of universal proxies in the U.S. is that the voting mechanics are relatively unproven and untested, the cards have been prone to shareholder errors in voting and invalidation of votes and the chance of one or more dissident directors being elected has been enhanced.
The SEC’s proposed rules attempt to address some of the procedural and technical issues with universal proxy cards. However, the adoption of universal proxy cards raises fundamental corporate governance questions, some of which the SEC raises for comment in its proposing release:
- Will universal proxy cards have an impact on the number of dissident nominees elected?
- Will the frequency of contested elections increase?
- How would an increase in elected dissident nominees impact board effectiveness and, ultimately, shareholder value?
The upcoming change in the administration casts doubt on whether this rule making will move forward; universal proxy cards could very well fall to the bottom of the SEC’s priorities list in 2017. However, as the issues have been debated, constituents have agreed on one point — that in any amendments to the proxy rules the “devil will be in the details.” The proposed rules provide some answers and raise some new questions, which we explore below.
Summary of the SEC’s Proposed Rules
The SEC’s proposed changes would establish new procedures for soliciting proxies, preparing and using proxy cards and disseminating information about director nominees in contested elections. The rules would apply to all non-exempt solicitations for contested elections other than those involving registered investment companies and business development companies.
Important provisions of the proposed rules include:
- Universal proxy cards will be mandatory in most contested elections, including partial and full slate contests;
- Each soliciting party would distribute its own proxy card. Proxy cards would be subject to content, format and presentation requirements to ensure that candidates are presented in a “clear” and “impartial” manner, although the management and dissident proxy cards would not need to be identical;
- Dissident shareholders would be subject to new notice and filing requirements, including to (i) provide companies with notice of their intent to solicit proxies and the names of their nominees no later than 60 days prior to the anniversary of the prior year’s annual meeting, and (ii) file its proxy statement by the later of 25 days before the meeting date or 5 calendar dates after the registrant files its proxy statement;
- Registrants would be required to provide dissidents the names of their nominees no later than 50 calendar days prior to the anniversary of the prior year’s annual meeting;
- Dissident shareholders would be required to solicit only a portion of the company’s shareholders representing at least a majority of the company’s voting power;
- The “bona fide nominee” rule would require bona fide board nominees to consent to being named in any proxy statement relating to the upcoming election of directors; and
- The short slate rules would be eliminated as no longer necessary.
Answers and Questions Raised by the Proposed Rules
Will universal proxy cards make it easier for dissidents to gain board seats?
In a rulemaking petition to the SEC, CII stated that “whether universal proxies would result in election of more shareowner or company nominees is unclear and should be irrelevant.” Of course it is not irrelevant to companies and shareholders who are determining the composition of a company’s board in a proxy fight. We anticipate that use of universal proxy cards will result in a small number of dissident nominees (e.g., one or two nominees) being elected to the board of a target company more frequently. Shareholders are often more willing to support one or two dissident directors, as opposed to a larger minority or majority slate, if they believe that the company needs to head in a new direction. On the other hand, in some contests management could win one or two seats that they may otherwise have lost because shareholders supported change and voted on only the dissident’s card. The net result will be more mixed voting outcomes.
Will proxy advisory firm voting recommendations or negotiations with dissidents be impacted?
The recommendations of proxy advisory firms can be highly influential in contested elections. Because shareholders generally cannot split their vote on two separate cards, ISS and Glass Lewis currently cannot effectively recommend a vote for nominees they support on management’s card when they are recommending for one or more dissident nominees. This either/or dichotomy can pose a dilemma for companies when considering whether to settle with a dissident or bring the contest to a vote. If universal proxy cards are mandated, this dilemma will be eliminated. In some instances, this could incentivize companies to take the contest to a vote, rather than reach a settlement, if they believe their outcome will be the same or better than in a negotiated settlement. However, as the recent uptick in settlements indicates, companies are often unwilling to face the public distraction, expense and risks associated with a contested election and the increased prospect of losing one or two board seats to dissidents in an election process that uses universal proxies could push companies to more settlements.
One interesting question is whether proxy advisory firms will consider directors on an individual basis and recommend voting for a dissident nominee who they believe to be highly qualified in lieu of a sitting director they do not support, such as a long-tenured director or a director they believe to have independence issues, in a situation where they do not support the dissident’s arguments for change. We believe this is unlikely and that they would continue to support management’s slate but the universal proxy card would result in unprecedented a la carte voting options and potentially give dissidents more leverage to push board refreshment as its own end.
Will investors be confused by universal proxies? What happens if a shareholder does not record their voting instructions properly?
The proposed rules require that universal proxy cards clearly distinguish between management and dissident nominees and that they disclose (i) the maximum number of nominees for which authority to vote can be granted, and (ii) the treatment of a proxy executed in a manner that grants authority to vote for more, or fewer, nominees than the number of directors being elected, or does not grant authority to vote for any nominees. This disclosure could provide useful guidance for shareholders. We also anticipate that for online voting, Broadridge and other service providers can develop mechanisms that prevent certain shareholder errors, such as checking 11 names when there are only 10 board seats. However, if a physical proxy card is delivered with this type of over-voting error it will likely be thrown out.
Under the proposed rules, there could also be situations where investors receive differing or confusing proxy cards. For example, if a dissident changed its nominees or abandoned its solicitation after the company had disseminated a universal proxy card including the names of the dissident’s directors, the company could, but would not be required to, circulate a new card. In addition, the proposed amendments to the bona fide nominee definition would permit proponents to include the names of some or all of the registrant’s nominees on its proxy card even when the proponent is not nominating its own candidates. For example, if the proponent had a corporate governance proposal, it could use its proxy card to recommend the election of some, but not all, management nominees. In the proposing release, the SEC argues that this is not problematic because shareholders could vote for all director nominees on management’s proxy card. However, it is likely that some shareholders would incorrectly believe that director nominees listed on the proponent’s card supported the proponent’s proposal or that some shareholders would vote only on the proponent’s card, without realizing the company’s card included additional voting options, resulting in under-voting for directors and perhaps other proposals on the ballot.
What about retail shareholders?
Under the proposed rules, dissidents are required to solicit only holders representing at least a majority of the voting powers of shares entitled to vote on the election of directors. Larger institutional holders are more likely to be included in the dissident’s solicitation and are better equipped to access and analyze electronic proxy materials. Smaller shareholders are more likely to receive a company’s universal proxy card listing dissident nominees without the accompanying information contained in the dissident’s proxy materials. As noted by Commissioner Piwowar in statements at the SEC’s opening meeting, this should present a somewhat existential dilemma for the SEC whose mission is to protect all shareholders. And more practically speaking, while all proxy materials relating to the contested election would be available online, our experience demonstrates that retail holders who do not receive paper copies of proxy materials are much less likely to vote in elections.
Will costs of contested solicitations rise?
Companies must include the names of dissident nominees on their proxy card, however they will not be required to bear the burden of delivering other dissident proxy materials to shareholders as some had feared. Dissidents would incur the costs of developing their own proxy materials, but the burden is limited by the requirement that dissidents only solicit a portion of shareholders. While companies are becoming more diligent with off-season shareholder engagement, the costs of shareholder outreach and negotiations in terms of time and money expended and management distraction can be significant. Any increase in activist activity would result in an increase in costs to targeted companies and, ultimately, their shareholders.
Will tactics for vote “against” campaigns be influenced?
Under the proposed rules, a dissident shareholder could use its proxy card to wage a vote “against” campaign. As noted above, the proposed amendments to the bona fide nominee definition would permit proponents to include the names of some or all of the registrant’s nominees on its proxy card even when the proponent is not nominating its own candidates. Under the SEC’s short slate rule, which is proposed to be eliminated, dissident shareholders may not use the short slate rule for solicitation in a vote “against” campaign.
How do universal proxy cards relate to proxy access?
Some constituents have conflated universal proxy cards with proxy access. As the SEC outlines in the adopting release, they are different in several important aspects, including that using a universal proxy card would not require a company to include in its proxy statement any information about the dissident shareholder or its nominees and that dissidents would still bear the burden and costs of preparing and filing their own proxy materials. Prevailing wisdom has been that the adoption of proxy access may be much ado about nothing in the respect that activist shareholders such as hedge funds and active money managers are unlikely to use proxy access and that other shareholders would likely only do so in limited situations. On November 9, National Fuel Gas Company became the first company to receive notification of a proxy access nominee, submitted by GAMCO Asset Management Inc., a fund run by Mario Gabelli, and certain affiliates. This raises the specter that certain long-term activists will use proxy access to seek limited board representation or perhaps leverage settlement discussions. The success of this and any other proxy access nominees submitted in 2017 will be closely watched. A requirement for mandatory universal proxy cards could, in a more direct and immediate manner, impact how activist campaigns and proxy fights are conducted.