July 2011

As of July 2010, 43% of S&P 500 companies have separate CEO and chairman positions, but only about half of those companies have an independent chair.  The debate about the value of having an independent chair continues, including through shareholder proposals.
 
Only a small percentage of the proposals submitted to vote succeed, and usually by narrow margins.  In 2001, only 4 (about 17% of the total) passed, none of the 45 proposals in 2010 received sufficient majority support, and 4 in 2009 (about 10% of the total) and about 5% of the over 160 proposals from 2005 to 2008, won shareholder approval.  In the instances where the proposals pass, companies generally respond promptly.  Looking at 2009 results, Bank of America lost an unusual binding bylaw proposal and appointed a new independent chair.  Weyerhaeuser also elected an independent chair at its annual meeting. 

In recent years, many boards with executive chairman have appointed lead directors to provide countervailing independent board leadership.  Having a lead director with specified responsibilities is one of the factors that could lead ISS to recommend against a shareholder proposal calling for an independent chairman.  Evidencing their view that stock price is tied to board structure, another required factor for this ISS policy and one that cannot be as easily managed by companies, is the requirement that a company's total shareholder return exceeds peers (as defined by ISS).
 
It has been reported that over 50% of S&P 500 companies now have lead directors.  Unfortunately, the absence of clear distinctions between the use of the terms "presiding" director vs. "lead" director means little discernible correlation between the presence of a lead director and the voting results of these shareholder proposals.  Some presiding directors only lead executive sessions, as required by the NYSE, while others have similar responsibilities as directors designated as "lead directors."  There is also a range of duties among those named as lead directors. 

Although the board had a lead director, in 2011 Moody's lost the shareholder proposal (56% in support).  At Vornado Realty Trust, where the company had a separate, but non-independent, chairman, the proposal received slightly above 50%.  The recent requirement by the SEC that companies with combined CEO and chair positions also indicate whether there is a lead director, may have caused some change in roles. 

There are slight variations among the proposals.  While much less common, some shareholder proposals ask for the designation of a lead director rather than an independent chair.  This season, the SEC staff determined a proposal seeking a lead director was sufficiently duplicative with another proposal calling for an independent chair, so that only one needed to be presented in the proxy.  Some companies that already have independent chairmen, such as Whole Foods, received proposals asking that the structure be made permanent. 

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The DC Circuit's vacating of the SEC's proxy access rule has wider applications for the possible challenge of regulations under the Dodd Frank Act on the grounds that they fail to analyze the economic impact.  Even though we all know that the DC circuit is especially hard on the SEC,  other agencies could also find themselves in a similar position given the fact that the speed of deadlines under the Dodd Frank Act has essentially forced a very minimal economic review of hundreds of regulations.  The court's view that the SEC  "inconsistently and opportunistically framed the costs and benefits of the rule; failed adequately to quantify the certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments; contradicted itself; and failed to respond to substantial problems raised by commenters" is a warning shot across the bow of Dodd Frank implementation.

Contact Margaret Tahyar.

A unanimous D.C. Circuit panel this morning invalidated Rule 14a-11 as "arbitrary and capricious", ruling that the SEC had failed to consider the potential costs and other impacts of the rule.  This outcome was fairly predictable given the composition of the panel that decided the case, but even so the scathing and dismissive tone of the opinion is remarkable.  The panel essentially swallowed the Business Roundtable and Chamber of Commerce arguments hook, line and sinker, even to the point of second guessing which academic studies the Commission should have relied upon and which it should have disregarded.

Where do we go from here?  Barring intervention from the Supreme Court, the decision sends the SEC back to square one: a dispiriting prospect, given that the subtext of the opinion is that this panel at least would have thrown out pretty much anything that the SEC might have put forth.  It's also hard to imagine the current Congress coming up with a statutory solution.  This means that the initiative on this subject may be back with companies and shareholders, where it arguably should have been all along.

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As a result of targeted activism in the last few years, more than half of the S&P 500 companies now allow shareholders to call special meetings.  The number of shareholder proposals relating to special meetings declined this year, to 28 in 2011 from 54 in 2009. 

The decline can be attributed in part to companies submitting management proposals in order to exclude the shareholder proposals from their proxy statements.   Shareholder proposals generally seek the ability of 10% or more shareholders to call special meetings, but if companies include a management proposal giving shareholders the same right, but at a different ownership level (for example, 40% for EMC and 25% for Weyerhaeuser), then the SEC staff permits the shareholder proposal to be excluded from a company's proxy statement on the basis that the company is submitting a conflicting proposal under Rule 14a-8(i)(9).

This now well-recognized method of excluding special meeting shareholder proposals doesn't mean that the same proposal won't continue to be submitted after the company adopts a provision, in an attempt to get the ownership threshold ratcheted down to 10%.  But these proposals can often be defeated at companies that already allow some percentage of shareholders to call special meetings.  This year, most companies where the proposals failed had minimum ownership thresholds at 25% (Citigroup, Goldman Sachs, DuPont and Office Depot) with some higher (Amazon at 30%) or lower (Pepsi at 20%).  At Home Depot, however, the shareholder proposal received majority support although the company already provides the ability of 25% or more shareholders to call special meetings. 

The coalescence around these preferred ownership percentages by shareholders do not seem to result from individual analysis of a particular companies' holdings, but rather seems to reflect a "one-size-fits-all" approach.  Almost all shareholder proposals seek the right to call special meetings at ownership levels of 10% or more, even at companies like Wal-Mart which has more than 40% insider control.  Verizon implemented a bit of a creative approach by providing the threshold at 10% for a single shareholder, or 25% ownership for multiple shareholders.

While companies are rightly concerned about adopting provisions that may result in significant board and management time and expense, it may be worth noting that special meeting provisions generally include necessary procedural safeguards and qualifications to minimize those costs.  The requirements include certain notice and possibly certifications for shareholders, and restrictions on the time period and manner for calling special meetings, especially if another annual or special meeting covering the same subject matter has just passed or is upcoming in the near future.  In fact, the ISS 2011-2012 policy survey inquires about a fairly recent phenomenon that it declares only a “handful” of companies have adopted:  the requirement that the ownership threshold be held in a net-long position.

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As is their customary timing, on Friday afternoon the SEC issued several updated CD&I interpretations of particular interest to the governance community:

 

–Information About Non-Continuing Directors.  The SEC clarified a previous CD&I regarding disclosure of certain biographical information, under Item 401(a) and Item 401(e), about directors whose terms of office will not continue after the annual meeting.  Both requirements may be omitted so long as a company provides its Part III of Form 10-K information by incorporating from the proxy statement, and the company files its proxy statement within 120 days after its fiscal year-end.  This means most public companies would not have to provide this disclosure.  (116.10 of the Regulation S-K CD&Is)

 

–Use of Non-GAAP Information in Proxy Statements.  The SEC indicated that non-GAAP financial information that does not relate to pay target levels, but is included in the CD&A or other parts of the proxy statement, are subject to the non-GAAP rules under Regulation G and Item 10(e).  The rules provide a specific exemption for disclosure of target levels that are non-GAAP financial measures.  As part of the increased effort to demonstrate the connection between pay and performance, companies are more frequently referring to corporate financial data, including non-GAAP financial information, in their discussion of executive compensation.

 

However, for purposes of pay-related disclosure only, a company can include the required GAAP reconciliation and other information in an annex to the proxy statement, so long as the company includes a prominent cross-reference.  Alternatively, the company can provide a prominent cross-reference to the pages of the Form 10-K that contain the required disclosures, if the non-GAAP financial measures are the same as those included in the Form 10-K, and the Form 10-K incorporates the proxy statement's Item 402 disclosure as part of its Part III information.  It appears that an attached annex or Form 10-K are the only options, and it would not be sufficient to instead cite to a website where the reconciliation is posted. (118.08 of the Regulation S-K CD&Is and Item 108.01 of the Non-GAAP Financial Measures CD&Is)

 

–Broker Non-Votes in Frequency Vote Disclosure.  The SEC confirmed the disclosure of the number of broker non-votes for the advisory vote on the frequency of say-on-pay is voluntary, not required, under Item 5.07(b) of Form 8-K.  (121A.03 of the Form 8-K CD&Is)

 

Relevant links below:

 

Regulation S-K: http://www.sec.gov/divisions/corpfin/guidance/regs-kinterp.htm

 

Exchange Act Form 8-K: http://www.sec.gov/divisions/corpfin/guidance/8-kinterp.htm

 

Non-GAAP Financial Measures: http://www.sec.gov/divisions/corpfin/guidance/nongaapinterp.htm

 

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With the vast majority of this year’s annual shareholder meetings for U.S. public companies behind us (at least for those with calendar-year fiscal years), we wanted to update the findings that we shared in our last post on the subject.  As of the end of last week, 1,193 large accelerated filers had reported the voting results from their shareholder meetings.

Regarding approval of “say-on-pay”:

Large Accelerated Filers by Say-on-Pay Vote (as of July 1, 2011)
90-100% Approval	791
80-89% Approval	195
70-79% Approval	97
60-69% Approval	55
50-59% Approval	29
40-49% Approval	16
30-39% Approval	9
20-29% Approval	1
0-19% Approval	0
Total	1,193

 

 

 

 

 

 

 

 

 

 

 

 

 

Generally, approval for say-on-pay votes has remained high as the season has progressed, and the average say-on-pay result for all large accelerated filers is 89%.  Similar to what we reported at the height of the proxy season, less than 18% of large accelerated filers reported say-on-pay results below the 80% approval level, and less than 10% reported results below the 70% approval level.

A total of 25 large accelerated filers have lost their say-on-pay votes, and all of them received “against” recommendations from ISS.  To date, large accelerated filers with “against” recommendations have averaged 64% approval, while those with “for” recommendations have averaged 92% approval. – interestingly, these approval levels have been remarkably stable and are, in fact, identical to those we reported in our last post.  We believe the total number of public companies, including large accelerated filers, that have lost their say-on-pay votes is 37.

On the “say-when-on-pay” front, shareholders at 1,076 large accelerated filers voted in favor of an annual frequency (i.e., over 90% of all large accelerated filers).  Although votes for triennial have occurred with slightly greater frequency as the annual meeting season has progressed, only around 27% of all large accelerated filers that recommended a triennial frequency have had their recommendation endorsed by shareholders, and, in the great bulk of these cases, the triennial vote was supported by a controlling or at least very substantial insider shareholder.  The companies that managed to get a triennial vote, without insider support, included Bancorpsouth, Crocs, Linn Energy, Inc., Markel Corporation, SCANA Corporation and United Parcel Service.

Over 63% of the companies that have reported the results of their annual meetings have already adopted a say-on-pay frequency, and in 749 of 752 instances, the board of directors went with the recommendation of shareholders.  Curiously, in two of the three other instances (namely, Crocs and Green Mountain Coffee Roasters), a shareholder vote in favor of a triennial frequency has nonetheless resulted in the company adopting an annual frequency.  In the third, shareholders who voted in favor of an annual frequency saw the company (Annaly Capital Management) adopt a triennial frequency, which is what the board had originally recommended to its shareholders.  It remains to be seen what pressure, if any, companies that buck the stated preference of shareholders come under.

Contact Kyoko Takahashi Lin.

Proposals to elect directors by a majority vote fared well this season, averaging 56.6% at 31 companies as of early June.  This was the topic with the most number of submissions, as Carpenters, CalPERS and other proponents sent over 80 shareholder proposals to companies, almost twice as many as in 2010.  Activists were angered by the fact that the requirement for all public companies to adopt majority voting was dropped from the final version of the Dodd-Frank Act.  Many companies decided to proceed with implementation and negotiate for withdrawal of the proposal rather than putting it to a shareholder vote.

Analysis of the voting results for the shareholder proposals that ended up in proxy statements is complicated by the fact that the term "majority voting" is often used to include both: (a) policies in corporate governance principles that continue to retain plurality voting but require a director that received more "withhold" rather than "for" votes to submit his or her resignation (sometimes known as a "director resignation policy") and (b) majority voting standards in charters or bylaws that also demand the same type of director resignation, but triggered by whether the director received more "against" rather than "for" votes.   Both standards need the additional step of a director offering to resign based on the election results because of state law holdover statutes that severely restrict the involuntary removal of a director, regardless of the amount of votes cast.  Both standards also provide boards with ample discretion to accept or reject a director's offer of resignation.

Shareholder proposals request that the charter or bylaws require majority voting, as activists consider director resignation policies in governance principles to be merely symbolic resolutions that are legally unenforceable and easily changed by later board decision without public fanfare.  However, most shareholder proposals fail to pass if a company maintains plurality voting but has a director resignation policy in place, given the similar effect of adopting majority voting in charters or bylaws.  During this season, more than 85% of the companies where the proposal was not approved already had a director resignation policy, including at Caterpillar, Baker Hughes, Duke Energy and Kellogg.

As expected then, the proposals succeeded at over 90% of the companies without a director resignation policy, most notably this season at Apple.  CalPERS campaigned for  the proposal, declaring:  “We’re asking for an election, not a coronation of the board.”  Apple argued that the adoption of majority voting would harm the company given the unusual complexity of California state law, which requires not only the affirmative vote of a majority of the shares but also the affirmative vote of more than half of the shares required for a quorum.  In addition, under California's mandatory termination law, a director’s term in office would simply end 90 days after failing to receive the requisite votes.  Apple's explanations, however, went unappreciated by the more than 73% of its shareholders that supported the proposal, signifying a major win for CalPERS. 

Two other companies, Qualcomm and BB&T Corporation, failed to convince shareholders that they had adequate substitutions in place.  Their policies require only board review if a director receives more "withhold" rather than "for" votes, without triggering director resignation.

Even companies with director resignation policies will often agree to adopt majority voting without putting the shareholder proposal to a vote, as Pepsi did this year.  Companies that need charter amendments to implement majority voting must include a management proposal asking for shareholder support, which were overwhelmingly supported. 

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