Proxy Access Efforts Starting Slow

Mandatory proxy access is dead for now, and so far this proxy season attempts by shareholders to obtain the right to nominate directors on the proxy statement at individual companies haven't fared well.

As of May 11, only three proxy-access votes had made it to annual meetings, and none of them passed. In April, a binding proxy access proposal at Wells Fargo from Norges Bank Investment Management (NBIM), a Norwegian government pension fund, fell short with only one-third of shareholders giving their support.  The other two did worse. Less than 14 percent of shareholders voted for access at Ferro Corp. during its April 26 annual meeting, and only 21 percent went for a similar proposal at KSWon May 5.

Many shareholders seem to be taking a wait-and-see approach to proxy access. A tally by proxy advisory firm ISS lists only 22 companies that faced them so far this year.

That a far cry from proxy access at all companies that was written into the Dodd-Frank Act, but was eventually dropped after the U.S. Court of Appeals for the District of Columbia ruled that the SEC hadn't provided a reasonable economic impact on the change. The SEC chose not to challenge the court's decision and, in April, its chairman, Mary Schapiro, told a House oversight panel that resource constraints made tackling a new proxy access rule unlikely for the foreseeable future.

The court's decision to kill off Rule 14a-11, however, left intact a Rule 14a-8 amendment for shareholder proposals, sometimes called private ordering of proxy access. It allows shareholders, starting with this year's annual meetings, to propose bylaw amendments, via proxy, that guide the nomination of board candidates via proxy materials.

The bulk of proxy access proposals this season have come from what might be called “the usual suspects”—well-known activist shareholders (some often described as “corporate gadflies”), unions, and pension funds.

Ken Steiner, an activist retail investor spearheaded proposals for Textron, Bank of America, Medtronic, Forest Laboratories, Sprint Nextel, Ferro Corp., and MEMC Electronic Materials. NBIM took on the fight at Charles Schwab, Wells Fargo, Western Union, Staples, Pioneer Natural Resources, and CME Group. And Jim McRitchie, an influential corporate governance advocate who maintains the Website CorpGov.net, submitted proposals for Goldman Sachs and Dell.

Many of the proposals have been non-binding and seek board nomination privileges for investors who have owned 1 percent of company shares for at least two years, or any coalition of 100 or more investors who each own at least $2,000 in market value of company shares for one year. That formula comes from a model resolution created by United States Proxy Exchange (USPX), a coalition activist. In March, USPX amended its model proposal, lowering the required number of investors to 50.

NBIM's binding proposals (for Charles Schwab, Wells Fargo, Staples, Pioneer Natural Resources, and CME Group) sought a 1 percent ownership stake for at least one year, with a 25 percent cap on board seats.

Nabors Industries and Chesapeake Energy were presented with a 3 percent threshold for at least three years, with a 25 percent cap on board seats.

Proxy Access Defense Strategies

“I think the ones that have gone to a vote so far have had about the level of support you might expect for a first year governance proposal,” says David Lynn, co-chair of the public companies and securities practice with the law firm of Morrison Foerster.

After the SEC adopted rules that initially seemed to pave the way for mandatory access, “there were certainly some companies that went out and did things to their bylaws just to make it a little bit tougher to get a nominee up,” he says. Now, there is more of a wait-and-see approach and “taking the temperature of the shareholders who put these proposals up and then seeing where to go from there” rather than “preemptively adopting hurdles” before there is a viable proxy access threat.

“Certainly people have been focused on this from general interest level,” Lynn says of this year's slate of proxy access proposals. “But I have not seen a lot of focus at an ‘I need to do something' level. If you already have a pretty good governance profile in the sense that you don't have a classified board, you have majority voting, and you have all the favorite checklist items for institutional investors and proxy advisers, you are pretty unlikely to get a lot of pressure on proxy access. In fact, some have been resolved by negotiations to implement some of those changes other than access.”

Nevertheless, a common strategy thus far for companies looking to avoid a private ordering vote has been to fire away objections to the SEC and hope for a no-action determination that lets them keep it off the proxy statement.

“They are throwing everything but the kitchen sink at us,” says McRitchie, the shareholder activist.

Whereas the typical no action request is usually only a page or two, the documents being filed in these efforts have been lengthy and detailed. Filings by Textron and Bank of America were each almost  20 pages long; Sprint Nextel's was nearly 30 pages.

In several cases, companies have been successful at gaining permission from the SEC to ignore the proxy access proposals. A March 7 ruling upheld Textron's contention that an access resolution violated a Rule 14a-8(c) prohibition on submitting multiple proposals.

Sprint Nextel, Chiquita Brands, Staples, and MEMC Electronic Materials successfully argued that proposals were “vague or indefinite,” particularly because they failed to adequately describe eligibility requirements and, instead, merely referenced SEC Rule 14a-8(b). The SEC said many shareholders “may not be familiar with the requirements and would not be able to determine the requirements based on the language of the proposal.”

“We are trying to get a feel for what will go through the no-action process. Then, we'll be submitting many more proposals, probably next year or the year after.”

—Jim McRitchie,

Corporate Governance Advocate,

CorpGov.net

Companies have also successfully petitioned the SEC to exclude shareholder proposals on the basis that they would violate state laws that apply to them. For example, a constraint on the director selection process is considered “unreasonable” and in violation of Delaware law.

The SEC did, however, dispute assertions by Charles Schwab, Wells Fargo, and Western Union that NMIM's proposal was “false or materially misleading,” writing that there was no evidence to support those claims.

Another option for companies is to fight fire with fire and draft access bylaws of their own, with higher thresholds for ownership periods and amounts, limiting access to only the largest shareholders.

For example, Amalgamated Bank agreed to withdraw its access proposal when Hewlett Packard agreed to include one for a shareholder vote at its 2013 annual meeting. The bylaw revision, if voted in, would grant shareholders who own at least 3 percent of company shares for at least three years the ability to nominate up to 20 percent of the company's directors.

“At this point they are just putting up the barricades and hoping they hold,” says McRitchie. “Once the barricades come crashing down, that is when you will see the counter proposals. He says the counter proposals of 3 percent ownership for three years or even as high as 5 percent ownership for five years aren't acceptable to most shareholders.

USPX UPDATED PROXY MODEL

Below is the updated proxy access proposal for USPX.

WHEREAS, This is a standard "proxy access" proposal, as described inhttp://proxyexchange.org/standard_004.pdf. *** Opening statement may be customized for

individual companies' specific circumstances by adding additional words. Be sure not to exceed

the SEC's 500 word maximum for the entire proposal. ***

RESOLVED, Shareowners ask our board, to the fullest extent permitted by law, to amend our

governing documents to allow shareowners to make board nominations as follows:

1. The Company proxy statement, form of proxy, and voting instruction forms shall include,

listed with the board's nominees, alphabetically by last name, nominees of:

a. Any party of one or more shareowners that has collectively held, continuously for two

years, one percent of the Company's securities eligible to vote for the election of directors,

and/or

b. Any party of shareowners of whom 50 or more have each held continuously for one year a

number of shares of the Company's stock that, at some point within the preceding 60 days,

was worth at least $2,000.

2. Any such party may make one nomination or, if greater, a number of nominations equal to 12%

of the current number of board members, rounding down.

3. For any board election, no shareowner may be a member of more than one such nominating

party. Board members and officers of the Company may not be members of any such party.

4. Parties nominating under 1(a) may collectively, and parties nominating under 1(b) may

collectively, make nominations numbering up to 24% of the company's board of directors. If

either group should exceed its 24% limit, opportunities to nominate shall be distributed among

parties in that group as evenly as possible. If necessary, preference among 1(a) nominators will be

shown to those holding the greatest number of the Company's shares for at least two years, and

preference among 1(b) nominators will be shown to those with the greatest number who have

each held continuously for one year a number of shares of the Company's stock that, at some

point within the preceding 60 days, was worth at least $2,000.

5. All board candidates and members originally nominated under these provisions shall be

afforded treatment equivalent, to the fullest extent possible, to that of the board's nominees.

Should the board determine that aspects of such treatment cannot be equivalent, the board shall

establish and make public procedures reasonably designed to ensure that such differences are

both fair and necessary. Nominees may include in the proxy statement a 500 word supporting

statement.

6. Each proxy statement or special meeting notice to elect board members shall include

instructions for nominating under these provisions, fully explaining all legal requirements for

nominators and nominees under federal law, state law and the company's governing documents.

Source: USPX.

This year's proxy access fights aren't so much about scoring wins as setting the stage for future successes, he says.

“We put out the Cadillac model first, to see what would happen and now we will tweak it and resubmit,” McRitchie says of himself and other shareholder activists. “We are trying to get a feel for what will go through the no-action process. Then, we'll be submitting many more proposals, probably next year or the year after.”

McRitchie says that many of the proposals included too much, making them easier targets for SEC no-action letters.  “If I was to do it all over again, I would be submitting 10 different models to 10 different companies instead of the same model to five different companies.”

 “Eventually, we will come to a proxy access proposal that passes the SEC's test and then it will be a matter of getting it through ISS and CalPERS and the other folks who count.”

As shareholder activists work to refine proxy access proposals, companies are working on mounting a better defense against them. In a research paper, J. W. Verret, assistant professor of law at Georgetown University, proposed various defensive strategies that might be attempted by companies.

 “If the hostile takeover period of the mid-1980s is any indication, corporate lawyers will innovate to meet a demand for defensive measures,” he wrote.

One of his strategies is similar to a defense used during the hostile takeover period: the poison pill. Verret suggests that incumbent directors could submit non-rescindable resignations contingent on the election of a nominee who was not approved by the nominating committee of the board of directors.

“A failure to maintain a working quorum of the board could result in failure to meet default provisions, stock exchange listing requirements, ability to certify required SEC filings, and a variety of other disastrous consequences,” he writes. “And it is precisely the prospect of such dire results that gives his scorched-earth defensive tactic its strategic relevance. Because it would mean that contested solicitation could literally destroy the corporation, it would quell the shareholder electorate's appetite for such a result.”

Boards also might consider adopting a policy that will indemnify, advance legal expenses, and purchase D&O insurance coverage only for those who were approved by the nominating committee of the board in advance of a contested election.

Another tactic Verret suggests is for boards to make dividends contingent on the election of only those approved by the nominating committee of the board. Among the reasons this tactic could be effective, he says, is that institutional investors, subject to ERISA, could view giving up dividends in exchange for the “uncertain benefits from a new slate” as putting their fiduciary responsibility for a prudent investor standard at risk.