It is no secret that shareholders of public companies are restive and increasingly are doing something about it. This growing involvement has been fueled by outrage over overpaid, under-performing executives and the corporate scandals of recent years, among other factors. Hedge funds are also increasingly more active in their investments, and are pushing management to make rapid changes.
Most influential, perhaps, has been the growing importance of Institutional Shareholder Services Inc. (ISS), which reviews the proxy statements for many public corporations and makes recommendations to ISS clients on how to vote on matters presented at stockholder meetings. ISS reportedly counts more than 2,300 institutional investors as clients, who in turn manage trillions of dollars in investment assets – so its opinion matters.
ISS has stated, “[i]f the majority of shareholders have indicated they desire a particular governance change, the board should support the proposal in question,” regardless of whether the board agrees with the proposal. Indeed, ISS recommends voting against the re-election of any director nominees who have either ignored a shareholder proposal that has been approved by a majority of the votes cast for two consecutive years or ignored a shareholder proposal approved by a majority of the outstanding shares. This withhold vote policy is intended to make it more difficult for boards to resist a popular proposal, even if the directors do not consider it to be in the best interest of the company.
The majority voting movement has the potential to change dramatically how boards react to the threat of such withhold voting campaigns. Until recently, almost all public companies elected directors using a plurality voting standard. Now, more than 60 percent of the larger public companies have adopted some form of majority voting, with many more expected to do so before the close of the 2008 proxy season.
Under plurality voting, the nominees with the greatest number of “for” votes are elected, which in an uncontested election means that even one “for” vote secures a win. For example, Section 1758 of the Pennsylvania Business Corporation Law (BCL) states: “[t]he candidates for election as directors receiving the highest number of votes from [the eligible voting shares] shall be elected.” By contrast, under majority voting, nominees are only elected if they receive a majority of votes cast, with some variations discussed below.
The advantage of plurality voting is that it ensures that a company is able to elect a full board. But it does run counter to our traditional conception of how elections should work. Even if 80 percent of the vote were withheld for a candidate, she would still be elected, so long as no one else receives more “for” votes. This system largely discounts shareholder votes and perpetuates the incumbent directors unless someone is willing to take the time, trouble and expense of running an opposition candidate. Plurality voting also has the effect of undermining the ISS withhold vote policy mentioned above by making such withheld votes irrelevant. However, under a majority voting regime the cost of ignoring shareholder proxy proposals would significantly increase.
Variations of Voting Standards
There have been several modifications of the voting standard in the evolution of the majority voting movement. The earliest of these was the eponymously named “Pfizer” voting policy, which was incorporated into that company’s corporate governance guidelines. The Pfizer policy did not change the plurality election standard, but instead required any nominee receiving a greater number of “withhold” than “for” votes in an uncontested election to submit her resignation, which could be accepted by the board in its discretion. Many companies adopted similar policies. It was easy to adopt, but as its critics pointed out, it could also easily be eliminated or waived.
The Securities and Exchange Commission, however, has taken the position that adopting such a policy does not permit a company, under the SEC proxy rules, to exclude from its proxy statement a shareholder proposal to amend its bylaws to adopt majority voting. In the SEC’s view, such a governance policy does not “substantially implement” a proposal that majority voting be part of the company’s bylaws, which is the relevant standard for whether such proposals may be omitted.
The second principal voting standard is known as the “plurality-plus” standard, which also retains the plurality voting standard, but includes an express director resignation provision in the company’s bylaws, not merely in its governance policies. This means that a nominee who fails to receive a majority of votes is required to submit her resignation, or, under a Delaware variation, an incumbent nominee is required, before the election, to submit an irrevocable resignation that becomes effective upon failing to receive a majority of the votes cast and acceptance of the board.
The alternative to plurality-plus is a true majority voting standard. Under majority voting, a nominee is not elected unless she receives more “for” votes than “against” votes. The consequence of adopting a majority vote standard is straightforward for new nominees; they are not seated on the board if they do not receive a majority “for” vote. State director holdover laws, however, still can cause inconsistent results for incumbent directors who are not re-elected.
Under the holdover rules, a sitting director continues to serve until her successor is elected and qualified, allowing a losing director to remain in office indefinitely, so long as her replacement is not elected. True majority vote standards address holdover directors by coupling the majority vote rule with a mandatory resignation requirement similar to the requirement in the plurality-plus standard.
Resignation, Holdover Laws
Some companies have strengthened mandatory resignation bylaws, curtailing a board’s discretion to accept or reject a resignation by requiring that the board accept a director’s resignation upon failure to receive a majority vote, absent a “compelling reason” not to do so. But most companies have permitted boards to consider all relevant factors, including the following: shareholders’ stated reasons for the “withhold” or “against” votes; whether the underlying cause is curable; the director’s length of service, qualifications and contributions; overall composition of the board and whether accepting a resignation would cause failure to meet SEC or stock exchange requirements; availability of other qualified candidates; and whether acceptance of the resignation would trigger breaches of any contracts.
Adoption of director resignation policies is complicated by state laws that differ regarding the legality of requiring directors to resign. In Pennsylvania and many other states where there is no statutory provision authorizing mandatory resignations, there is significant uncertainty over the enforceability of such a rule in light of conflicting but similar director removal statutes, and a real risk that a director could revoke a resignation.
Some companies have limited the terms of directors to immediately after, or within 30 days of, the annual meeting, instead of the more traditional “until their successors are elected.” Of course, this risks having an incomplete board of directors. The approach taken by many states, including Delaware, avoids this risk. In Delaware, the state corporation law has been amended to expressly authorize irrevocable resignations contingent upon failing to be elected by a specified vote. This makes it possible to combine a true majority vote standard with mandatory contingent director resignations, effective if the director fails to receive a majority of the votes cast and the board accepts the resignation.
Similarly, the American Bar Association’s committee on corporate law has modified the default plurality voting standard in the Model Business Corporation Act (MBCA) to enable the functional equivalent of a majority vote standard. Although the MBCA did not move to a true majority voting standard, the amendments allow a company’s board or shareholders to adopt a bylaw which limits the holdover period of any director who receives more “withhold” votes than “for” in an uncontested election to the earlier of 90 days from the vote, or as soon as the board finds a replacement. The amendments also allow companies to eliminate the holdover rule entirely, and to require directors to submit irrevocable resignations contingent upon the failure to obtain a majority vote. States that traditionally follow the MBCA are generally expected to adopt these recent amendments.
Majority Vote in Pa.
Pennsylvania continues to mandate a plurality voting standard and holdover rule as the default for director elections unless the company’s articles of incorporation otherwise provide, according to BCL Section 1758. Unlike Delaware, where the voting standard can be changed in the bylaws, in Pennsylvania such a change, and a revision of the holdover rule, can be effected only by including the provisions in the company’s articles of incorporation. This is an important distinction because, although the bylaws may be amended directly by the shareholders through a proxy proposal and vote, an articles amendment for a Pennsylvania public company must also be approved by the board of directors.
Moreover, public company shareholders may not propose amendments to the articles, pursuant to BCL Section 2535. This means that although a stockholder of a Delaware company may submit a majority voting proposal for inclusion in the company’s proxy statement that, if adopted, is binding and effective, this is not the case in Pennsylvania. In Pennsylvania, such proposals may only be non-binding, or precatory. And, as noted above, the Pennsylvania BCL also does not authorize irrevocable director resignations, leaving some uncertainty as to their enforceability. Nonetheless, many Pennsylvania corporations have adopted some version of mandatory advance resignation.
It is expected that many more companies will implement some revision to their plurality voting regimes by the end of the 2008 proxy season, either voluntarily or in reaction to a shareholder initiative. Although most companies that made revisions to their voting systems initially did so using a variation of the “Pfizer policy,” this approach has become less attractive in light of the SEC’s position that such a policy does not foreclose a stockholder proposal to include majority voting as a bylaw or charter provision.
In jurisdictions that do not allow true majority voting, the decision is whether to couple a plurality voting standard with either a mandatory resignation bylaw or a provision that shortens or eliminates the holdover period for directors who do not receive more “for” votes than “withhold” votes. Where true majority voting is permitted, as is the case in Pennsylvania and Delaware, there is little difference between adopting that standard and adopting the plurality-plus standard, including the mandatory director resignation bylaw.
In most instances, corporations will prefer to adopt their own rules, rather than be forced to accept a shareholder proposed and approved version. In many jurisdictions, including Delaware, the shareholders have the right directly to amend the bylaws without prior board approval. In these jurisdictions, if the board acts first, it can adopt a version of the standard of its own choosing and be more certain that it is well designed and effective. Importantly in Delaware, if the board acts first to amend the bylaws, it can retain the flexibility to subsequently modify the standard; if the shareholders enact a bylaw relating to votes necessary for director election, however, such a bylaw may not be modified by the board.
This is not true in Pennsylvania, where changes would have to be effected by an amendment to the articles of incorporation. And, even in Pennsylvania, there is a risk that a shareholder could propose a binding bylaw amendment to require mandatory director resignation upon failing to achieve a majority of “for” votes. Although the enforceability of such a provision remains unclear, companies may not want to become the test case for the issue.
As the majority voting movement sweeps through public companies, we can expect ISS and others to use the power provided by their “withhold” votes to seek greater influence with boards, and to force greater receptivity to their proposals on topics ranging from executive compensation and anti-takeover measures to environmental concerns. This may put directors in the difficult position of having to choose between rejecting a proposal they believe is not in the corporation’s best interests, and risking the loss of a board seat. Activist investors call this increased accountability. But there is also another, less pleasant name for it.
Annapurna Singh and Eric Marr assisted with the preparation of this article. F. DOUGLAS RAYMOND chairs the corporate and securities group at Drinker Biddle & Reath. He can be contacted by e-mailing Doug.Raymond@dbr.com