Corporate Governance

Broker Non-Voting and the SEC: The Incumbent Advantage

By J. Robert Brown

It took the SEC until July 2009 to authorize the proposed amendment to NYSE Rule 452 to designate uncontested elections to the board as a non-routine matter (thereby preventing brokers from voting uninstructed shares held by beneficial owners on the matter).  The matter had languished for years, with the original proposal filed back in October 2006.  The SEC has issued the release that accompanied its approval (by a 3-2 vote) of amendment.

Rule 452 is set up to allow for voting of any shares where instructions have not been received within ten days of the meeting.  The Rule includes a list of items, however, that are outside this right to vote.  Among other things, Rule 452 does not allow discretionary voting on a list of 18 matters, ranging from matters subject to a counter solicitation to appraisals and mergers to the creation of indebtedness or a class of preferred stock.   The provision covered contested elections to the board but not uncontested ones.  Moreover, under a cramped reading of the rule, an effort to defeat a director under a majority vote requirement was not considered a "contest." See NYSE Rule 452.11(2). 

The effect of discretionary voting was to give a decided advantage to incumbents in any uncontested election.  This occurred for two reasons.  First, brokers invariably used the shares to support management.  As the Release obliquely noted:  "In the view of some commenters, brokers tend to vote in accordance with management's recommendation."

Second, the percentage of shares subject to broker control under Rule 452 was significant.  One commentator put the figure at 19%.  In short, the broker no votes could be outcome determinative.  In fact, in the 2004 "just say no" campaign at Disney, Michael Eisner only received a majority because of the discretionary votes cast by brokers.  As the Report of the Working Group for the NYSE that proposed the amendment noted:

• The impact of broker votes on such campaigns can be significant. For example, in the WaltDisney Company's 2004 Annual Meeting, involving one of the best known and organized 'just vote no' campaigns, Disney CEO Michael Eisner was re-elected to the board with 55% of the votes cast, while 45% of the shares voted were 'no' votes. Had broker votes not counted in this election then Mr. Eisner would have received only 45% of the votes in favor of re-election, and a majority of the votes cast, 54%, would have been withheld from him.

In other words, the usually unstated reason to leave Rule 452 alone was to preserve an unfair advantage for incumbents in any uncontested election where a majority vote bylaw was in place. 

The importance of this advantage could be seen by the failure of opponents to aggressively support alternatives.  The most obvious alternative was a system of proportional voting (in fairness, it should be noted that a number of comment letters to the proposal did suggest this as an alternative).  This would entail brokers voting in proportion to the votes cast by street name owners who did return their voting instructions.  Thus, for example, Commissioner Paredes noted the practice.  See Remarks of Commissioner Paredes, July 1, 2009 ("With proportional voting — which some brokers already have implemented — the broker vote mimics the retail shareholder vote even more closely than when the broker votes with management entirely.").   He did not, however, push this as an alternative (in contrast to his negative vote against access where he did push an alternative).

Proportional voting would have solved the quorum issue but also would have removed the incumbent advantage.  In cases where retail investors favored the defeat of a director, proportional voting would continued and even enhanced this result.  With the incumbent management gone, the interest in the alternative also seemed to subside.

Full post as published by The Race to the Bottom on July 23, 2009 (boomark / email).