Over the past 12 months, the world of corporate governance for U.S.-listed companies has changed rapidly as the various regulatory bodies looked to create better investor safeguards in the wake of the unprecedented collapse of the global financial markets in 2009. As a result, directors of these companies will now be operating in a dramatically different – and much more difficult – working environment, particularly around the annual proxy season.
In just the past year, corporate boards have had to contend with such new governance challenges as:
- “Just Vote No” campaigns. These campaigns involve applying pressure on an issuer by encouraging fellow shareholders to vote against a corporate proposal or withhold votes from an incumbent director. Similar campaigns have been waged to defeat the quorum for meetings when it appears likely that shareholders would not have had an opportunity to express their views.
- Elimination of broker voting in uncontested elections. This change has likely received the most discussion in boardrooms, as companies try to understand the potential ramifications of discontinuing the practice of brokers voting on behalf of their clients and, in most cases, casting their votes in favor of management. The elimination of broker voting has ended the implied “automatic support” for management proposals, which is proving troublesome at companies with majority voting rules.
- Real-time reporting of vote results. The Securities and Exchange Commission (SEC) approved amendments to Form 8-K that require companies to disclose the results of a shareholder vote within four business days after the end of the meeting at which a vote is held. This change requires that issues directly impacting shareholder interest, such as the election of directors, changes in shareholder rights, investments or divestments, be reported in a timely manner and replaces the requirement to disclose voting results in Forms 10-K and 10-Q, which often are filed months after the relevant meeting.
- Enhanced discussion of risk surrounding oversight, compensation practices and climate change. New disclosure rules require companies to clearly explain the relationship of compensation policies and practices, as well as potential climate change impacts, to risk management. In particular, the discussion of compensation should be designed to help investors determine whether a company has incentivized excessive or inappropriate risk-taking by employees. Additionally, the new rules require companies to expand their disclosure to include a discussion on the board’s overall role in the oversight of risk such as how it administers the function and the effect it has on the board’s leadership structure.
- Discussion of board diversity. Another new disclosure requirement calls for companies to outline whether, and if so how, a nominating committee considers and defines diversity in identifying nominees for director positions. If the nominating committee or board has a policy with regard to the consideration of diversity in identifying director nominees, the final rules require disclosure of how this policy is implemented and how the nominating committee or board assesses the effectiveness of its policy.
- Discussion of management succession planning. More and more emphasis is now being placed on the outlook for companies’ future leadership teams. While investors are not necessarily looking for names of specific individuals, they are increasingly asking for more visibility into the process the board uses in preparing for an eventual leadership transition.
- Enhanced disclosure of board members’ past affiliations and involvement in litigation.As shareholders continue to increase their scrutiny of directors, reviewing past relationships and legal battles is becoming a more significant part of their standard due diligence process. Companies must disclose any directorships at public companies and registered investment companies that directors or director nominees held at any time during the previous five years. Further, companies must disclose legal proceedings, such as SEC securities fraud enforcement actions, against the director or nominee, going back 10 years instead of the current five years. The list of legal proceedings included in this disclosure has also been expanded.
- Greater transparency about board members’ experience, qualifications, attributes and skills (also referred to as EQAS).This new disclosure is designed to enhance the standard biographical information typically included in a company’s proxy statement to help investors understand why the company’s slate of directors was selected to serve on the board, as well as how their individual experiences and qualifications will assist the management team in executing the company’s long-range strategic plan and governance needs. Over the past year, this expanded content has proven to be a critical piece of a company’s proxy materials, particularly in those instances where the company is promoting a management slate of nominees over shareholder-nominated individuals.
- Enhanced disclosure of a board’s rationale for adopting a particular leadership structure.This disclosure is intended to provide further transparency for how the board functions, and the relationship between the board and senior management. As such, it requires a company to explain why it has chosen to combine or separate the CEO and board chairman position, which has become a major “flashpoint” for governance rating agencies and activist investors. Companies now have to provide greater transparency and strategic rationale for choosing a particular board leadership structure, including a detailed explanation of the role of the lead director (if the company has one).
And 2010 was just the beginning of the change. In 2011, public companies will be required to submit a “say-on-pay” proposal to their shareholders. Thus, the “rules of engagement” for public companies and their boards will be further altered by this regulatory change, coupled with the looming proxy access change (which may encourage more shareholder proposals in 2011), the SEC’s recently proposed new “Whistleblower Bounty Program” (under which individuals would be entitled to 10 to 30 percent of any financial penalty imposed upon a publicly traded company as a result of their anonymous SEC notification of perceived corporate malfeasance), current trends in shareholder activism and a healthier financial landscape.
In this regard, we offer several key recommendations to consider in preparing for the 2011 proxy season:
- Know your shareholder base. Determine whether a majority of your shares are held by institutional investors or retail shareholders. Determine whether your larger institutional holders develop their own proxy voting guidelines or whether they follow the recommendations of a proxy advisory firm. Finally, determine how often they engage with companies and on what types of voting issues. Without a working knowledge of the voting trends and policies of your shareholder base, it is impossible to predict whether a proposal will garner majority support.
- Engage shareholders early. One of the more common misconceptions among companies is that their day-to-day institutional contacts (including analysts and portfolio managers) have significant input in voting proxies. While that may be the case in some instances, particularly in the case of mergers and acquisitions and proxy contests, many institutions have established proxy voting or governance departments. If a company does not have an existing relationship with a proxy decision maker at an institution, it is vital to develop those relationships. Furthermore, to the extent you are aware of a problematic issue on the ballot, it is best to engage with institutions to gauge their stance on the matter. Early engagement can save a company time and energy required to fix the problem during the course of a solicitation. Finally, if your company does have a meaningful percentage of its common stock held by retail investors, make an effort to reach these investors long before you need their support – whether it be dedicated content for retail investors on the IR portion of your website, a quarterly update that is mailed with dividend checks (if applicable), social media tools, or the distribution of key trade media or business media coverage, among other things.
- Build relationships with proxy advisory firms. Establishing productive and ongoing relationships with the key proxy advisory firms, such as Proxy Governance, Glass Lewis and RiskMetrics, will likely serve the company well over the long term. Companies should also consider scheduling a meeting with the RiskMetrics analyst who will be making the recommendation on the action items at the annual meeting. Bear in mind, however, that these meetings are granted at the analyst’s discretion and there is no obligation – implied or otherwise – to meet with management to discuss the various items on its proxy ballot. Furthermore, during the busy proxy season, these meetings usually occur only by phone to allow the analyst to facilitate as many meetings as possible. Although there is no guarantee that a discussion will result in a favorable recommendation, it will at least provide the company with the ability to refine and sharpen any governance message. RiskMetrics typically releases its voting recommendation reports about two weeks before the company’s annual meeting.
- Engage a proxy solicitor.These solicitation firms can greatly assist your efforts in the proxy solicitation process. A proxy solicitor will: (i) use its market intelligence and research to help companies predict possible vote outcomes, as well as help to develop a concerted and proactive shareholder outreach strategy designed to invest time wisely by focusing on those shareholders legitimately “on the fence” regarding particular proxy items; (ii) help identify a decision maker within an institution if the company does not already have a relationship with that individual; (iii) analyze whether a retail shareholder campaign is needed in the event of a close vote and, if so, help to shape the components of that campaign; and (iv) assist companies and their outside advisers in understanding the voting policies of the various proxy advisory firms.
- Keep the entire team updated. It is imperative to keep management and the board apprised of key developments and findings. Both groups must have a clear understanding of where the company’s institutional holders stand on current and looming issues. Likewise, they should be alerted to any major changes in the shareholder base and the underlying factors driving those shifts, as well as any inquiries received or expressions of interest (e.g., attending conference calls, requesting one-on-one meetings with management at industry conferences, etc.) from known activist funds. Similarly, they should also be briefed regularly – as part of the investor relations update – on important regulatory changes and the impact of these changes on the organization, especially those that may put the company at risk.
- Expect more shareholder activism. With valuations still well below expectations for most publicly traded companies, coupled with the recovering financial condition of many hedge funds and activist investors, it would be prudent to expect these recent and expected governance changes will increase the likelihood of your company finding itself “in the crosshairs” of an activist campaign. Among other things, the enhanced disclosure requirements around board structure, board member background and qualifications, and executive compensation will be under close scrutiny by activist shareholders looking for vulnerabilities to exploit and leverage. Likewise, a company’s sustainable practices and best efforts to mitigate its impact on the environment could also come under greater examination in the United States as investment funds with particular social agendas become more active and vocal during the annual proxy season.
- Be prepared. Finally, long before a proxy fight arises, companies and their directors should have a well-thought-out and documented rationale for their strategic decisions and governance policies and practices – from board composition to board structure, from executive compensation packages to risk management oversight protocols. By doing this work in advance of any potential conflict, a company (and its external advisers) can more quickly and accurately respond should a challenge arise.
About the Authors: Robert G. Berick is senior managing director of Dix & Eaton, a communications firm with specialized expertise in investor relations. Rachel L. Posner is senior managing director and general counsel of Georgeson, a world leader in proxy solicitation.