June 2012

This is the first in a series of posts to discuss shareholder proposals during the 2012 proxy season.

The march towards board declassification showed no signs of slowing down in the 2012 proxy season. Of the 45 precatory shareholder declassification proposals that had gone to a vote as of mid-June, 40 of such proposals passed with an average support of 89% of the votes cast. This shows an increase in support of shareholder declassification proposals over the previous proxy season, in which  declassification proposals passed with average support of 77% of votes cast. For the proposals that failed, the average support was 43.7% (excluding a failed proposal at Hospitality Properties Trust, which garnered the support of 90% of votes cast but failed to get the requisite 75% of outstanding shares.) 

The number of shareholder declassification proposals might have been even higher had an additional 44 companies receiving such shareholder proposals not negotiated agreements to offer management proposals to declassify their boards, according to a report by the Harvard Law School Shareholder Rights Project (SRP). All the management proposals regarding declassification received resounding support of votes cast, but some nevertheless failed at companies, such as Alcoa and Charles Schwab, which require votes of more than 80% of the outstanding shares.

According to the ISS, only one-third of all S&P 500 companies have staggered boards, as compared with over half of the mid-cap and small-cap companies. Notwithstanding this gap, the activist focus continues to be on the large-cap companies. Approximately three-quarters of the shareholder declassification proposals this season were filed at large-cap companies, many of them proposed by institutional investors who were advised by the SRP. 

Today, the SEC rules on the independence of compensation committees and advisers were published in the Federal Register. As we described in our memo, the listing exchanges have 90 days to propose implementation, and then a year from today to finalize the standards with approval from the SEC.

Since those are the outside dates, the listing exchanges can act much sooner. Depending in part on the comments received on the proposed standards, final standards may be adopted in time to apply to the 2013 annual meeting. We hope that the transition period for compensation committee independence standards will accommodate the fact that many boards evaluate director independence months before proxy statements are issued with related independence disclosure. Companies and boards will need sufficient time to modify their processes to evaluate additional independence factors required, or possibly even change the composition of their compensation committee.

In terms of compensation adviser independence, since there is no public disclosure required, the rules may not be affected by the proxy season (and proxy statement) timing. The importance in this case is for the listing exchanges to provide sufficient transition periods for companies to gather the necessary information and the compensation committee to examine the required factors. Companies will also need to consider whether their governance documents, including committee charters, should be modified to reflect the new rules.

As a reference, in a rule filing on April 2003, NYSE allowed companies 18 months following SEC approval to comply with the requirement to have a majority of independent directors (classified boards had 30 months if the affected director was not up for election). By the time the SEC approved those and other governance rules for NYSE and Nasdaq in November 2003, the implementation schedule had been revised to apply to the following year's annual meeting.

While proxy season has ended for most companies, there are a number of governance matters worth keeping an eye on during the summer months:

SEC Rulemaking.  The SEC website noting upcoming Dodd-Frank activity still indicates a number of actions slated before the end of June, including proposing rules regarding disclosure of pay-for-performance, pay ratios, hedging by employees and directors and recovery of executive compensation. It was recently updated to reflect the adoption of final rules on compensation committees and advisers, which we discussed here. As we are in the last week of June, it is likely that the Commission will again delay the actions into the next time period – July to December 2012. Watch for the SEC Sunshine Act meeting notices that usually come out on Wednesdays regarding Commission discussions of proposed or final rules, as summer is traditionally an active month for SEC rulemaking. 

NYSE and Nasdaq Listing Standards.  The SEC final rules on compensation committees and compensation advisers gave the listing exchanges wide latitude in proposing standards of implementation, including the possibility of imposing additional prohibitions or other restrictions. The exchanges have 90 days from the time the rules are published in the Federal Register, and the proposed standards are subject to public comment. 

ISS Policy Survey.  Last year, ISS released its policy survey to its client institutions and corporate issuers in early July. The survey forms the basis for possible changes to ISS policies with respect to voting recommendations on such matters as director elections, say-on-pay and shareholder proposals. 

Say-on-Pay.  The current count is 49 companies with failed votes. June has been a particularly active month, with eventful annual meetings at Nabors and Chesapeake but also with Safety Insurance Group being the first company to fail its vote even after receiving support from ISS. ISS likely recommended in favor of the company because it scored "low concern" on the three quantitative pay-for-performance tests, but shareholders rejected that formulaic approach. Consulting firm Semler Brossy indicates that shareholders may have been concerned about the company's performance and possibly the absence of changes or description of shareholder outreach that might have been expected as a result of the prior year's 67% favorable vote. Interesting events continue to unfold, such as Abercrombie & Fitch announcing changes to CEO compensation immediately after its vote received only 25% in favor. The company indicated that the CEO will forego two semi-annual equity grants that he is entitled to under his employment agreement. As the season winds down, we will begin to see whether there are any lessons to be learned from this second year of experience. 

Shareholder Proposals.  As the overall results of shareholder proposals are tallied, it may be useful to analyze not only the average votes, but also where companies received either much higher or lower support for the proposals that your company may have already received, or may be at risk of seeing for the 2013 meeting. Proposals often also reflect the current governance environment in terms of which practices are becoming more widely adopted by companies and expected by investors as a result of high support, such as board declassification. 

Shareholder and Proxy Advisory Firm Engagement.  The summer months may be an ideal time to reach out to shareholders, and proxy advisory firms if needed, either on specific issues or as a way to make introductions or otherwise keep in contact with those no longer harried by the proxy season. 

The movement toward exclusive forum provisions, which as we recently discussed had been gathering steam over the past couple of years, is under attack and is for the moment, we believe, in retreat.   Although some 200 companies have adopted exclusive forum provisions since 2010, mostly in the form of board-adopted bylaws, recent litigation in Delaware has caused some companies to dismantle these bylaws and numerous others to defer consideration of the issue.

This recent shift illustrates what happens when a small group with strong preferences encounters a large group with less strong ones.  The large group in this case is the companies.  An exclusive forum provision mandating that shareholder litigation take place in Delaware does not eliminate shareholder litigation, but it channels it in a way that can avoid forum shopping and duplicative litigation and enhance predictability, since the Delaware courts handle these sorts of cases for a living.  It is easy to conclude, as many companies have, that this is in the interests of shareholders, but most companies we’ve talked to view these provisions as “nice to have” rather than as a matter of critical importance.

The small group, of course, is the plaintiffs bar, for whom duplicative litigation and forum shopping are a feature rather than a bug, since they magnify uncertainty (and thus settlement value) and may facilitate finding a congenial place to make a fee application.  Faced with a threat to their franchise, the plaintiffs bar determined to act preemptively, and sued about a dozen companies in the Delaware Court of Chancery for adopting exclusive forum bylaws.  Plaintiffs also challenged charter amendment proposals by three companies.  Suing in Delaware was an interesting tactical decision, since Chancery, with its natural interest in upholding the primacy of the Delaware courts, might have been thought to be the court most likely to uphold these provisions.

Faced with this unexpected development, the defendants faced the dilemma of whether to invest time and money defending litigation over a provision that had been promoted as a device to reduce litigation.  Not surprisingly, the great bulk of the companies chose to reverse course, repealing the exclusive forum bylaws provisions and mooting the pending litigation. Two of the three companies whose charter amendment proposals were challenged also withdrew the proposals in response.

Leaving the field of battle may not be for free, however.  The plaintiffs filed fee applications seeking approximately $400,000 in each bylaw case and $500,000 in each charter proposal case.  Ten of the thirteen mooted cases reached settlement agreements earlier this week for undisclosed amounts.  The other three fee petitions remain pending.

This leaves two companies, Chevron and FedEx, continuing to litigate the validity of their bylaws.  Chevron has also been sued in a copycat action in federal court in California, and has moved to stay or dismiss the California action.

How do shareholders feel about these provisions?  The evidence is inconclusive.  Of the five exclusive forum provisions that were to have been on the ballot in 2012, two were approved, two were withdrawn and one voted down.  In addition, shareholder proposals seeking to remove exclusive forum provisions at two companies (including Chevron) failed to pass.  While labor unions and other shareholder groups traditionally aligned with the plaintiffs bar will invariably oppose exclusive forum provisions, the voice of the majority of institutional shareholders has not yet been heard clearly.

Now that adopting an exclusive forum bylaw has turned out not to be costless, we expect most companies to wait for guidance from the Court of Chancery before taking further action in this area.

Yesterday marked an active day on the corporate governance front. First, the U.K. Government announced “a far reaching package of reform to strengthen the hand of shareholders to challenge excessive pay.” The hallmark of this package is a binding shareholder vote on prospective compensation and exit payments. Other elements include a continued shareholder advisory say-on-pay vote, as well as enhanced disclosure regarding actual amounts of remuneration paid during the prior year.

Second, the SEC finalized its rule requiring listing standards for compensation committees and their advisers, as required by the Dodd-Frank Act. The final rules largely adopt the SEC’s proposed approach, which in turn closely follows the original statutory language. However, there are a few changes, such as narrowing the disclosure requirement regarding compensation consultants, which many had complained as overly extensive. In any event, there is much more to come, as the exchanges must now propose listing standards on several key elements within 90 days of the SEC rule’s publication in the Federal Register, and it is conceivable that they may expand beyond the limited statutory language. There may also be practical implications for companies in terms of possible committee charter amendments and procedures for the committee to consider adviser independence and consultant conflicts.

We will be summarizing both developments in further detail, but wanted to alert our readers in the interest of time.

Being an election year, it’s no surprise that the most prolific type of shareholder proposal this season asked for disclosure and oversight of political contributions and lobbying expenses.  ISS reports that over 100 such proposals were filed. The proposal generally averages far less than overwhelming support, not even 30% as of the end of May.  However, WellCare recently became the first company in 2012 to receive 53% in favor of the proposal (without counting abstentions), an increase from 43% in the prior year.  Similar proposals also received more than 40% support at five other companies, including Coventry Health Care Inc. (49%) and Anadarko Petroleum Corp. (47%).

According to a profile on WellCare published by the Center for Political Accountability, 90 companies in the S&P 500, including more than half of the S&P 100, have committed to disclose their political spending and oversight of such activities.  The disclosure sought by proponents of these proposals are complex.  Many activists say it is insufficient to include only direct contributions to candidates, parties and committees.  They also want companies to report the dues and other payments made to trade associations and other tax-exempt groups that are used for political purposes, which is broadly defined.  The need to highlight those particular expenses is often difficult for companies, but as one example, AFSCME praises Coca Cola for its disclosure on the amounts and percentages of the portion of dues it pays to national trade associations that are used for lobbying expenditures. 

ISS began to recognize companies' efforts and revised its policy for this season by making voting recommendations on a case-by-case basis, depending in part on a company's existing disclosure of policies and oversight mechanisms related to its direct political contributions and payments to trade associations or other groups that may be used for political purposes and any recent significant controversies, fines, or litigation pertaining to the company's political contributions or political activities.  In practice, ISS did not automatically recommend in favor these proposals, and therefore may have contributed to the generally low level of votes in support.

Some are urging the SEC to get involved.  In 2011, a group of law professors petitioned the SEC for rulemaking mandating political contributions disclosure data, indicating that public investors have become increasingly interested in receiving information about corporate political spending and citing companies' voluntary reports as evidence of responses to such interest.  The petition states that the disclosure is "important for the operation of corporate accountability mechanisms."  A few months later, SEC Commissioner Luis Aguilar, referring to the rulemaking petition, voiced his support for SEC rulemaking since “investors are not receiving adequate disclosure, and as the investor’s advocate, the commission should act swiftly to rectify the situation.”

A lot has already been written about the controversy surrounding Chesapeake's governance and its annual meeting taking place today, but since it is unusual for shareholders to litigate in order to delay an annual meeting with routine ballot items, the court order on the preliminary injunction request gives some insight on the standard.

Chesapeake originally filed a preliminary proxy on April 20th that included information regarding the CEO's now well-known interest in certain company transactions and related loans. The SEC conducted a review of the proxy after media inquiry highlighted those transactions. The company issued a final version to shareholders on May 11th. Plaintiffs later asserted that defendants failed to disclose material information necessary to allow shareholders to cast a fully informed vote and asked the Court to enjoin the meeting until the disclosure is revised. The plaintiffs alleged that the voting items impacted by the lack of disclosure include the re-election of two directors, an amendment to the equity plan and the approval of the performance goals for a new cash-based plan. The plaintiffs did not reference the advisory vote on executive compensation.

The Court determined that the plaintiffs did not met their burden of showing irreparable injury, because the plaintiffs have an adequate remedy if the injunction is denied. Namely, if the plaintiffs ultimately prove proxy violations, the Court can void the shareholders’ vote on the voting items related to that material information and order that those voting items be resubmitted to the shareholders, especially as the voting items at issue "do not involve complex business transactions."  The Court also noted that the director elections were not contested, and that some weight should be given to the SEC's review and clearance of the proxy when deciding on the matter. 

There may never be a need to consider whether to void at least some of the votes, since reports today indicate that the two directors received less than majority support (about 26-27% in support) and have tendered their resignations under a newly adopted majority voting policy. The say-on-pay vote fared even worse, and received only 20% in support. 

In the first win of its kind, a majority of shareholders at Nabors Industries voted in favor of a proposal for the right of shareholders owning 3% or more for at least three years to nominate directors on a company's ballot, for up to 25% of the board. The thresholds are the same as those previously adopted by the SEC, which was later struck down by the courts. The shareholder proposal was submitted by a group of New York City Pension Funds led by the City Comptroller of New York, and co-sponsored by similar funds in five other states. The company confirmed news reports that the proposal has passed, but has made no public announcement about the specific vote results.

Nabors had been criticized for their executive compensation practices last year, which entitled the then-CEO to a cash bonus of 10% of any amount of the company’s cash flow that exceeded 10% of average shareholder equity. In addition, a $100 million award was triggered when the CEO relinquished his title but did not leave the company. The outcry resulted in a failed say-on-pay vote. The company also announced an SEC investigation into its disclosure of aircraft perks after the Wall Street Journal reported that flight logs showed many flights to the CEO's homes that did not appear to be reported in the proxy statement. 

While claiming that proxy access is a basic shareholder right in an exempt filing, the proponents also cited several issues that they argued made proxy access particularly compelling at Nabors, including the $100 million award (which the CEO later waived), related party transactions with board members and the absence of majority voting. A later filing quoted from ISS and Glass Lewis reports in support of the proposal. 

While much of the attention on proxy access proposals this season has been on the versions proposed by U.S. Proxy Exchange and Norges Bank since they put forth the bulk of the proposals, it was always questionable whether they would succeed, given that their low thresholds likely caused institutional investors to question their reasonableness. In addition, the SEC staff permitted the exclusion of several proposals.

Instead of peppering the landscape with proposals, seasoned shareholder proponents like the City Comptroller targeted only a few companies that have been criticized for perceived governance issues. It now appears that their strategy has succeeded, as Hewlett-Packard previously negotiated to include proxy access and the proposal won at Nabors. The next proposal of this kind to be voted on is at Chesapeake Energy's annual meeting this Friday, but given that their recent governance changes included the ability of two shareholders to name directors to the board, the concept of proxy access seemed to have already taken effect. 

It is an unusual annual meeting where Justin Timberlake acts as the Master of Ceremonies and Taylor Swift, Celine Dion, Lionel Ritchie and others perform for over 14,000, mostly employees, in attendance. But the focus at Wal-Mart’s meeting was clouded by recent allegations of FCPA violations, as evidenced in the annual meeting results announced today. 

Since slightly more than half of the shares are held by insiders, the opposition by more than 15% to the re-election of former CEO H. Lee Scott is not insignificant. ISS also recommended against current CEO Michael Duke, chairman Robson Walton and audit committee chair Christopher Williams, with those three directors receiving about 13% negative votes. Perhaps as a testament to ISS influence, the remaining directors emerged unscathed with at least 93% in support, even though CalPERS campaigned against the re-election of nine directors, the City Comptroller of New York targeted five directors and Glass Lewis also recommended against additional directors. 

In other director news today, Chesapeake Energy announced in advance of its annual meeting on Friday that it will change the composition of its board after reaching agreement with Southeastern Asset Management and Carl Icahn to add four new independent directors to replace four existing directors who plan to resign, and appoint a new independent chairman upon the retirement of a fifth existing director. It is unclear whether this development affects the hearing scheduled to take place in Oklahoma federal court on a preliminary injunction to delay the meeting until more information is made available about the related party transactions and perks involving the company's CEO. The plaintiffs argued that they needed more details to make informed voting decisions about director elections and the vote on executive compensation. 

Even with director elections in the news, ISS reports that the average vote for directors were 95.5% as of late May. Only 7 out of 5,7000 directors have failed to win majority support, and for all the same reasons as in prior years – attendance issues, adoption of poison pills without shareholder approval and failure to implement shareholder proposals that received majority of votes from shareholders. Most of those directors remain on their boards due to plurality voting structures.

The U.S. Chamber of Commerce recently sent a letter to the SEC asking the regulator to "monitor the activities" of Glass Lewis, questioning whether the proxy advisory firm's recent vote recommendations for the 2012 Canadian Pacific Railway meeting was influenced by its parent company, the Ontario Teachers' Pension Board. The letter pointed out that the Ontario Teachers' opposition to the board of directors of Canadian Pacific Railway was followed by Glass Lewis issuing a recommendation that shareholders vote for the alternative slate of directors. The Chamber questions the "tangible conflicts of interest in the operation of proxy advisory firms."

Glass Lewis issued a press release refuting the Chamber's assertions. In a fairly defensive statement, Glass Lewis' first response, although not pertinent to the issue, is that it does not offer consulting services to public companies or their directors. Glass Lewis noted that it fully disclosed the potential conflict on the front cover of the relevant research report that Ontario Teachers has a stake in Canadian Pacific (although the excerpt of the cover did not indicate Ontario Teachers' position) and that the timing of the report was driven by meetings with the company and dissidents. In addition, Glass Lewis also emphasized that it recommended for seven of the company's nominees while Ontario Teachers voted against all of them, and highlighted two incidents where the firm's recommendations differed from Ontario Teachers' votes in the last two years. 

The Nasdaq Stock Market has proposed to broaden the exception (in Rules 5605(c)(2)(B), 5605(d)(3) and 5605(e)(3)) that allows one non-independent director to serve on a company’s audit, compensation or nomination committee under “exceptional and limited circumstances” for a maximum of two years if the board determines that it is in the best interests of the company and its shareholders. Under the existing rules, a company may not use the exception if the director is currently an officer or employee of the company or has a family member who is an officer or employee of the company. 

The proposed rules would continue to prohibit the use of the exception for family members of executive employees but would not prohibit the use of the exception if the director is a family member of a non-executive employee. The proposal attempts to harmonize the exception with the director independence rules generally, which do not disqualify a director from being considered independent based on a familial relationship with a non-executive officer. As before, a listed company that relies on the exception must comply with the relevant disclosure requirements. 

The SEC is soliciting comments on the proposal. Comments are due within 21 days from the date the proposal is published in the federal register (which is expected shortly).

Read the proposed rule change.