Corporate Governance

Regime Change and the SEC's Corporate Governance Agenda: #8 Broker Votes and Directors

By J. Robert Brown

Another area of necessary reform concerns NYSE Rule 452, the so called ten day rule. First adopted in 1937, the rule permits brokers to vote uninstructed shares, but not for controversial matters. Approximately 19% of votes cast at a shareholder meeting are from brokers. See Roundtable Discussion on Proxy Voting, Securities and Exchange Commission, Thursday, May 24, 2007 (statement by Rob O’Connor, managing director, Morgan Stanley).   Without the rule, companies would have a substantially more difficult time meeting quorum requirements and obtaining mandatory thresholds on uncontroversial matters if brokers could not vote the shares. See Licht v. Storage Technology, 2005 Del. Ch. Lexis 64, n. 8 (Del. Ch. May 6, 2005)(Broker non-votes "may be counted for purposes of establishing a quorum").

Because brokers may not cast uninstructed shares on controversial matters, most issues of importance to shareholders remain uninfluenced by these votes.  There is, however, one significant exception.  The provision applies to any matter that is "the subject of a counter-solicitation, or is part of a proposal made by a stockholder which is being opposed by management (i.e., a contest)" but does not apply to the unopposed election of directors.

The latter omission has been the source of controversy. As public companies increasingly opt for majority vote provisions for the election of directors and shareholder activists push "just say no" campaigns, the ability of brokers to vote shares in uncontested elections for the board increasingly interjects them into a highly controversial environment. The NYSE formed the Proxy Working Group to consider the matter. The Group issued a report on June 5, 2006 with a series of recommendations. Most noticeably, as the report noted, Rule 452 should be amended to define as controversial the election of directors.

• The Working Group believes that the election of directors can no longer be considered a “routine” event in the life of a corporation. Directors have authority over the most fundamental issues of corporate governance today, while investors, regulators, courts, and others have all recognized the critical role directors play in the life of a corporation. Because shareholder voting for directors is a critical component of good corporate governance, the Working Group considered recommending the elimination of Rule 452 in its entirety. However, as described in more detail below, the Working Group concluded that Rule 452 continues to have an important role in the proxy process today, particularly with respect to allowing issuers to achieve a quorum for regular meetings. Accordingly, the Working Group recommends that even where an election of directors is not contested, Rule 452 should be amended so that the election of directors should not be considered “routine” and brokers should no longer be permitted to vote the shares of beneficial owners who do not give specific voting instructions.

The NYSE approved the recommendations, including the changes to Rule 452, and on October 24, 2006, sent them off to the Commission with the expectation that the amendments would be in place in time for the 2008 proxy season. The proposal conceded that the change could increase costs ("For example, it is likely to increase the costs of uncontested elections, as issuers will have to spend more money and effort to reach shareholders who previously did not vote.") but nonetheless noted that "the election of a director, even where the election is uncontested, is not a routine event in the life of a corporation."  In response to criticism from the Investment Company Institute, the NYSE amended the proposal to exempt companies registered under the Investment Company Act of 1940, allowing brokers to vote for uncontested elections to the board of mutual funds.

The response from the Commission has been deafening silence.  Given the growing importance of shareholder voting for directors, the reform is a necessary one. The Division of Corporation Finance should be instructed to issue the proposed change for notice and comment as soon as possible.

The reform should, however, be accompanied by reform of the Shareholder Communication Rules.  As brokers receive less voting rights, companies have an incentive to communicate with beneficial owners to encourage them to instruct the shares so that they will be voted at the meeting.

Full post as published by The Race to the Bottom on December 31, 2008 (boomark / email).