Boards Brace for Regulatory, Shareholder Storms in 2010

A perfect storm of investor anger, regulatory reform, and economic meltdown is hurtling towards the 2010 proxy season—and directors should brace for their own elections to be at the center of the hurricane.

All the chestnuts of shareholder activism from previous years—executive compensation, shareholder votes on pay plans, majority election for directors, calls for independent board chairmen—will once again top activists’ agenda for the coming year. What’s different this year, however, is how shareholders will make their concerns known.

“We’ve finally seen the transition from a referendum or shareholder proposal-based form of activism, to a director election-focused form of activism,” says Pat McGurn, special counsel at RiskMetrics Group. “Even though there will be a significant number of shareholder proposals filed, the big game in town now is the election of directors.”

McGurn

Indeed, McGurn expects more bargaining and spats over director elections in 2010 than all other shareholder resolutions lumped together. The problem will be felt most sharply at small and mid-sized companies, who for the first time will weather an annual meeting season without “broker votes” in director elections. Those votes, cast by broker-dealers when their clients give no instruction on how to vote their shares, have typically been rubber-stamp support for management. The Securities and Exchange Commission and the New York Stock Exchange finally put an end to that power last year.

“We could be looking at hundreds of directors this year not receiving majority support,” McGurn says. Nearly 100 directors failed to receive majority support in 2009, and a large number were “in the red zone” of more than 40 percent withheld or cast against directors, he adds.

McGurn says a failure to act on past shareholder votes in favor of various resolutions will be the major driver of votes against directors now. Companies that don’t require directors to win a majority of ballots cast are also targets of shareholder wrath.

According to RiskMetrics’ 2009 post-season report, 91 directors at 49 companies failed to receive majority support. None resigned (all of the companies had a plurality voting standard for director elections), and few were at large-cap companies.

“The lion’s share of our negative recommendations are at mid-cap and small-cap companies where the penetration of majority voting … has been lower,” McGurn says. “The question is whether activists will complete the process of pushing majority voting down to those companies.”

Durkin

The United Brotherhood of Carpenters, long a proponent of more shareholder-friendly policies, plans to submit roughly 80 proposals for majority-vote thresholds in director elections, targeting the remaining S&P 500 companies that haven’t adopted such standards yet, according to union spokesman Ed Durkin.

Amalgamated Bank’s LongView Funds will also continue to press for majority voting at companies that haven’t adopted it, according to outside counsel Con Hitchcock. “We’re looking hard at mid-cap and small-cap companies in the portfolio,” he says.

Hitchcock says Amalgamated expects to submit proposals to provide for shareholder votes on “golden coffin” death benefit agreements, a crusade it launched last year.

Pay Plans

Smith

Shareholder advisory votes on executive compensation will continue to be a primary concern, as investors file proposals building on their success from 2009 and await Congressional action to make such votes mandatory. “We’re keeping that in front of companies,” says Timothy Smith, senior vice president at Walden Asset Management.

The House passed legislation in July that would require all public companies to hold annual say-on-pay votes. The Senate must still approve the measure, and the Securities and Exchange Commission is also expected to approve its own say-on-pay mandate sometime soon. (Recipients of government bailout funds must already provide the votes.) The state of Delaware has also amended its corporation law to allow such votes as well.

Average support for say-on-pay grew to 46 percent in 2009, up roughly 4 percent over 2008, according to RiskMetrics. The resolutions received majority support at 22 firms.

“Given the virtual inevitability of legislative action, that could jump to over 50 percent next year,” McGurn says. He believes some companies that got majority support on shareholder resolution may put a management proposal on the ballot to avoid negative votes against their board members. And several dozen companies have proposed offering the votes voluntarily, although only a handful have let shareholders cast ballots so far.

A RISKY PROPOSAL

Below is an excerpt from a recent SEC legal bulletin explaining the agency's logic in deciding when a company can or cannot omit a shareholder proposal pertaining to risk assessments from the proxy statement.

Over the past decade, we have received numerous no-action requests from companies seeking to exclude proposals relating to environmental, financial or health risks under Rule 14a-8(i)(7). As we explained in SLB No. 14C, in analyzing such requests, we have sought to determine whether the proposal and supporting statement as a whole relate to the company engaging in an evaluation of risk, which is a matter we have viewed as relating to a company's ordinary business operations. To the extent that a proposal and supporting statement have focused on a company engaging in an internal assessment of the risks and liabilities that the company faces as a result of its operations, we have permitted companies to exclude these proposals under Rule 14a-8(i)(7) as relating to an evaluation of risk. To the extent that a proposal and supporting statement have focused on a company minimizing or eliminating operations that may adversely affect the environment or the public's health, we have not permitted companies to exclude these proposals under Rule 14a-8(i)(7).

We have recently witnessed a marked increase in the number of no-action requests in which companies seek to exclude proposals as relating to an evaluation of risk. In these requests, companies have frequently argued that proposals that do not explicitly request an evaluation of risk are nonetheless excludable under Rule 14a-8(i)(7) because they would require the company to engage in risk assessment.

Based on our experience in reviewing these requests, we are concerned that our application of the analytical framework discussed in SLB No. 14C may have resulted in the unwarranted exclusion of proposals that relate to the evaluation of risk but that focus on significant policy issues. Indeed, as most corporate decisions involve some evaluation of risk, the evaluation of risk should not be viewed as an end in itself, but rather, as a means to an end. In addition, we have become increasingly cognizant that the adequacy of risk management and oversight can have major consequences for a company and its shareholders. Accordingly, we have reexamined the analysis that we have used for risk proposals, and upon reexamination, we believe that there is a more appropriate framework to apply for analyzing these proposals.

On a going-forward basis, rather than focusing on whether a proposal and supporting statement relate to the company engaging in an evaluation of risk, we will instead focus on the subject matter to which the risk pertains or that gives rise to the risk. The fact that a proposal would require an evaluation of risk will not be dispositive of whether the proposal may be excluded under Rule 14a-8(i)(7). Instead, similar to the way in which we analyze proposals asking for the preparation of a report, the formation of a committee or the inclusion of disclosure in a Commission-prescribed document—where we look to the underlying subject matter of the report, committee or disclosure to determine whether the proposal relates to ordinary business—we will consider whether the underlying subject matter of the risk evaluation involves a matter of ordinary business to the company. In those cases in which a proposal’s underlying subject matter transcends the day-to-day business matters of the company and raises policy issues so significant that it would be appropriate for a shareholder vote, the proposal generally will not be excludable under Rule 14a-8(i)(7) as long as a sufficient nexus exists between the nature of the proposal and the company. Conversely, in those cases in which a proposal’s underlying subject matter involves an ordinary business matter to the company, the proposal generally will be excludable under Rule 14a-8(i)(7). In determining whether the subject matter raises significant policy issues and has a sufficient nexus to the company, as described above, we will apply the same standards that we apply to other types of proposals under Rule 14a-8(i)(7).

In addition, we note that there is widespread recognition that the board’s role in the oversight of a company’s management of risk is a significant policy matter regarding the governance of the corporation. In light of this recognition, a proposal that focuses on the board’s role in the oversight of a company’s management of risk may transcend the day-to-day business matters of a company and raise policy issues so significant that it would be appropriate for a shareholder vote.

Source

SEC Staff Legal Bulletin (Oct. 27, 2009).

Durkin says UBC may refile its triennial say-on-pay proposal, although no final decision had been made at press-time. That idea would require a vote on compensation plans every three years, plus another vote on yearly and long-term incentive plans and post-employment pay which shareholders would decide annually. UBC filed 20 such proposals in 2009, but withdrew most of them to focus on lobbying efforts.

That aside, UBC is also drafting a set of executive compensation principles it will convey to 75 to 100 companies. The union will request time with each to discuss if and how it incorporates those principles, Durkin says.

Performance Matters

The AFL-CIO also plans to unveil new proposals this season, mostly dealing with the roles directors should (or should not) play on boards and other reforms to sharpen the focus of compensation plans.

One resolution will call for a handful of companies to adopt a policy that bars active or retired CEOs from serving on their compensation committee. That proposal targets S&P 500 companies where the CEO is also the chairman, where performance was poor both in absolute terms and relative to peers, and where two or more CEOs serve on the compensation committee.

“All too often, CEOs pick other CEOs who won’t object to their pay to sit on the compensation committee,” says Vineeta Anand, chief research analyst for the AFL-CIO’s Office of Investment.

Another proposal will squeeze banks and other recipients of government bailout money: If those funds haven’t been repaid to the government yet, the company would need to tell shareholders about any executive compensation over $500,000, the limit of what bailout recipients can count as deductible to the company.

The AFL-CIO will also re-file a proposal calling for companies to separate their CEO and chairman roles. In 2009, shareholder resolutions seeking independent board chairs averaged 36.3 percent support in the United States, up from 29.8 percent in 2008, according to RiskMetrics.

McGurn says those proposals are being discussed by independent directors themselves, who increasingly see separate roles as a best practice, and something the government will probably mandate anyway. “The voices in the current debate … have made this a topic of debate in boardrooms, not just something that’s being pushed by activists,” he says.

The American Federation of State, County, and Municipal Employees, long a source of stress for corporations during proxy season, also says executive compensation will be its main focus again this year.

Ferlauto

Rich Ferlauto, former director of pension and benefit policy at the AFSCME, says the structure of executive pay will again be its main focus.

The AFSCME will re-file proposals calling for companies to require executives to hold most of their equity compensation through retirement. It will also re-file proposals that attempt to roll back compensation programs shareholders dislike, such as tax gross-ups and golden coffins, says Richard Ferlauto, the AFSCME’s director of pension and benefit policy. (Ferlauto himself will be starting a job at the SEC’s Office of Investor Education this year.)

The AFSCME also plans to file at least a half-dozen proposals calling for companies to reimburse shareholders for at least some of the expenses in a proxy fight, similar to an amendment adopted in October by HealthSouth.

“Since the SEC won’t have adopted rule-making that allows proxy-access proposals on the ballot for next season, we see solicitation reimbursement as a proxy for proxy access,” Ferlauto says.