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Implications of the Elimination of Broker Discretionary Voting

by Annette L. Nazareth, Davis Polk & Wardwell,

Friday, July 10, 2009 at 01:13 PM EDT

This post is by my colleagues John H. Butler, Ning Chiu, Nora M. Jordan, Louis L. Goldberg, Kyoko Takahashi Lin, Barbara Nims and Mutya Fonte Harsch.

The SEC recently voted (3-2) to eliminate broker discretionary voting in director elections for meetings held on or after January 1, 2010. Previously, brokers were permitted to vote uninstructed shares in uncontested director elections, which were classified as “routine” under NYSE Rule 452. The rule change, which was adopted as proposed, could make it more difficult for directors to be elected under a majority voting standard, as we discussed in our previous newsflash, SEC Proposes Elimination of Broker Discretionary Vote in Director Elections for 2010.

As a result of this change, the number of votes in favor of board-nominated directors will be reduced, since brokers have typically followed the recommendations of incumbent boards in casting their discretionary votes. Other notable implications include:

• The rule change will affect most U.S. public companies, because the restriction applies to the actions of NYSE-registered brokers, regardless of the exchange on which a company is listed.

• In most cases, the new rule should have little effect on a company’s ability to achieve a quorum, since a broker would continue to be able to return a proxy with a vote on a “routine” item – such as the ratification of auditors.

• Brokers are and will remain unable to vote uninstructed shares in contested elections.

The rule change does not apply to registered investment companies. However, the new rule codifies two previously published interpretations relating to investment companies that do not permit broker discretionary votes (i) for material amendments to investment advisory contracts and (ii) on any proposal to obtain shareholder approval of an investment company’s investment advisory contract with a new investment adviser.

In addition to the discretionary voting changes, the SEC voted unanimously to publish proposals that would require what the SEC considers “better” disclosure of certain compensation- and corporate governance-related matters and would establish rules related to the obligations of TARP recipients to implement say on pay.

• Changes to the Value of Equity Awards in the Summary Compensation Table (“SCT”) and Director Compensation Table (“DCT”). A proposed amendment to Item 402 of Regulation S-K will require that the value of equity awards reported in the SCT and DCT be disclosed at the aggregate grant date fair value of such awards computed in accordance with FAS 123R. This revised valuation requirement replaces currently mandated disclosure in these tables of the annual accounting expense of such equity awards, affecting the total compensation reported and possibly the composition of named executive officers (for example, by neutralizing the impact of retirement eligibility). An important question will be how this change would be implemented in light of the SCT’s coverage of not only the most recent fiscal year but the two prior fiscal years.

• Greater Disclosure on Directors and Director Nominees. A proposed amendment to Item 401 of Regulation S-K will expand the disclosure required with regard to directors and director nominees, requiring disclosure for each person as to the particular experience, qualifications, attributes or skills that make the nominee qualified to serve as a director and as a member of any committee, in light of the company’s business. The proposed amendment will also require disclosure of any directorships at public companies held by each director or nominee at any time during the past five years (instead of that required for only currently held directorships) and lengthen the time for which disclosure of legal proceedings is required from five to 10 years.

• New Disclosure on Board Leadership Structure. Proposed amendments to Item 407 of Regulation S-K and Schedule 14A will require disclosure of a company’s board leadership structure and require a discussion of why the company believes that this board leadership structure is the best structure for the company, including a discussion of whether and why the company has chosen to combine or separate the CEO and board chairperson positions and whether the company has a lead independent director. Further, the proposed amendments will require disclosure about the board’s role in the company’s risk management process and the effect, if any, that this has on the way the company has organized its board leadership structure.

• Expanded CD&A to Include Disclosure of Material Risks Arising from Any Compensation Policy. A proposed amendment to Item 402 of Regulation S-K will broaden the scope of the CD&A to require a discussion and analysis of any compensation policy and overall actual compensation practices for employees generally (not limited to those which pertain to named executive officers), if the risks arising from such policies or practices may have a material effect on the company. The Staff emphasized that this is targeted to elicit information on material risks and does not seek general information on all compensation policies and practices.

• Additional Disclosure on Compensation Consultants. A proposed amendment will require additional disclosure on the fees and services of compensation consultants and their affiliates if they provide both consulting services relating to executive or director compensation and additional services. Disclosure that will be required includes: (i) the additional services provided, (ii) the aggregate fees paid for all additional services, (iii) the aggregate fees paid for work relating to executive and director compensation consulting, (iv) whether the decision to engage the consultant or its affiliates for any other services was recommended or made by management and (v) whether the board or compensation committee has approved these other services.

• Accelerated Reporting of Annual Meeting Voting Results. A proposed amendment adding a new item to Form 8-K will require that annual meeting voting results be reported within four business days of a company’s annual meeting, instead of on Form 10-Q for the quarter.

• Clarifications to Proxy Solicitation Rules. Amendments to the following Exchange Act Rules were also proposed to clarify rules already in place regarding proxy solicitations:

• Exempt Solicitations (14a-2(b)). Proposed amendments will clarify that (i) an unmarked copy of a management proxy card that is requested to be returned directly to management is not a form of revocation that renders the 14a-2(b) exemption unavailable and (ii) substantial interest in the subject matter of the solicitation that would otherwise make the exemption unavailable may be present even if the soliciting party is not a shareholder.

• Requirements of a Proxy (14a-4(d) and 14a-4(e)). Proposed amendments will provide that a soliciting person can “round out” a director short slate with nominees named in a nonmanagement proxy statement in the same manner as already permitted by the rule for nominees named in management’s proxy statement. Further, proposed amendments will clarify that any condition specified by a soliciting party as to when it may not vote shares over which it has received proxy authority must be objectively determinable.

• Solicitation Prior to Furnishing a Proxy Statement (14a-12). Proposed amendments will clarify that information regarding the identity and interests of participants in a solicitation must be available and on file no later than the time shareholders are first solicited.

• Say on Pay for TARP Companies. The SEC will essentially codify the requirements to which most TARP companies were already subject this year. A proposed new Rule 14a-20 and an amendment to Item 20 of Schedule 14A together will clarify how U.S. companies that have received financial assistance under TARP are required to implement their statutory obligations to have an advisory shareholder vote on executive compensation. There were no statements on changing the requirement to file a preliminary proxy statement, as discussed in our newsflash, “Say on Pay” Now a Reality for TARP Participants.

The proposed rules are subject to a 60-day public comment period after their publication in the Federal Register, which is expected shortly. We based this summary on oral discussions at the SEC’s recent open meeting.

This article originally appeared on The Harvard Law School Forum on Corporate Governance and Financial Regulation.