2014 Canadian proxy primer

Canadian board members have learned anything in recent years it is that when things change, they change fast. Spurred by a slew of high-profile proxy contests (along with a surge in more discreet approaches to corporate transformation), boards are discovering that the once ‘clubby’ atmosphere within the Canadian corporate establishment has swiftly given way to a new era of activism, with formerly inert institutional investors now much more disposed to question both performance and governance issues.

‘Pershing Square’s successful proxy battle with Canadian Pacific in 2012 was a watershed,’ says Glenn Keeling, executive vice president of CST Phoenix Advisors. ‘It was a very public demonstration that shareholders are no longer willing to simply vote with their feet. They know their rights and have seen how activism can positively affect performance. Directors are waking up to the reality that they are vulnerable, that no company is immune from increasingly sophisticated activism and that there is a desperate need to be better prepared.’

The first step toward such preparedness is staying connected with the investor community. Traditionally this has been accomplished largely through the investor relations (IR) function – but traditional IR is no longer enough. ‘It used to be that someone in the IR group occasionally contacted shareholders to get a feel for their concerns and sentiment,’ says Brad Allen, founder of Branav Shareholder Advisory Services. ‘Those days are gone. Directors are realizing this is a key strategic risk area and are actively looking for more effective ways to obtain independent feedback from investors on governance issues, strategy and performance.’

Learning to listen

To spur more dialogue, companies are experimenting with new ways of consulting with shareholders, including surveys, board blogs, governance-related conference calls and investor roadshows that include board representation. Still, despite a clearly vested interest in knowing first-hand what investors think, and despite the growing institutional clamor for more engagement, Allen believes few boards have yet to aggressively take up the challenge. ‘Real engagement is best done face to face,’ he says.

Allen thinks concerns about directors selectively disclosing information are unwarranted as ‘board members are generally too smart for that. More to the point, when they do engage in face-to-face communication, they aren’t there to talk; they’re there to listen. It’s about boards demonstrating an ongoing interest in investor concerns and willingness to give them due consideration.’

How far a board wants to take engagement depends on individual company circumstances, but there is no doubt the role of corporate secretary is taking on increasing importance. ‘Corporate secretaries are a corporation’s eyes and ears on the shareholder community’s governance agenda,’ says Carol Hansell, founding partner of law firm Hansell. ‘They possess an enormous amount of knowledge about the players, emerging trends and hot-button issues that could affect a shareholder vote. They need to be working closely with IR and searching for more effective ways of bringing that information before management and the board.’

Thwarting the ambush

In the search for solutions to shareholder activism, more and more Canadian companies are tweaking their corporate organizations with bylaw provisions intended to thwart sneak attacks. Among these are the adoption of advance notice requirements and enhanced quorum bylaws in the case of director nominations by shareholders. Following a judicial green light in 2012, hundreds of Canadian companies – mostly smaller issuers in the oil & gas sector – have adopted advance notice provisions, and observers fully expect the trend to continue in 2014.

‘Until a couple of years ago, you could count on one hand the number of Canadian companies that had adopted advance notice provisions,’ says Andrew MacDougall, a partner at law firm Osler Hoskin & Harcourt. ‘Last year the floodgates opened and now it’s become common practice.’

MacDougall says that when they are properly drafted, advance notice provisions have not proven controversial among either shareholders or proxy advisers. ‘If you add so many bells and whistles that it significantly impedes the nomination of a director, you won’t fit within ISS or Glass Lewis guidelines and it will be harder to get shareholder support,’ he explains. ‘Aside from that, these provisions aren’t really a problem. Shareholders understand the concept is to allow everyone to make an informed decision with no last-minute surprises.’

A complementary but perhaps less well-known governance tool is the enhanced quorum bylaw. As developed, where a change in the majority of the board is at stake, it requires that the normal quorum of a company (which can be set as low as 10 percent) be bumped up to 50 percent of the issued and outstanding shares. Failure to meet the quorum requirement results in a meeting adjournment lasting as long as two months, during which time the company and activist shareholders are expected to get their message out to a broad group of shareholders.

‘It basically buys the company time to respond and formulate a strategy if taken by surprise,’ says Allen. ‘Companies can institute it as a bylaw subject to subsequent affirmation at the next shareholder meeting.’

Room for disagreement

Companies should be aware, however, that ISS won’t see eye to eye with them on this. Holding that all matters voted on at shareholder meetings are of equal importance, ISS’ new policy explicitly states that it will not support bylaws that establish a different quorum for meetings where half or more of incumbent directors may be replaced.

‘How much influence ISS has with your company’s shareholders will determine how hard you have to work to get [an enhanced quorum bylaw] passed,’ comments Allen. ‘But if a company can state its case cogently to key shareholders, it doesn’t matter what ISS says.’

Still, while useful in preventing an ambush, none of these tools can ultimately defeat a truly dedicated activist. David Salmon, senior vice president at Laurel Hill Advisory Group, says boards must acknowledge shareholder needs and be proactive in addressing expectations. He points to the conceptual interplay of director accountability, independence and engagement as a defining element in 2014’s proxy season and beyond.

‘Tactical defenses won’t suppress the overall level of activism,’ says Salmon. ‘We expect it to grow this year and in the future. That’s because investors want to see higher standards at the boards of companies in which they invest. If boards aren’t prepared for sufficient engagement, questions about independence and accountability can only grow.’

That sort of uncertainty, when combined with poor corporate performance, tends to engender conflict, notes Salmon. ‘And in today’s world, no company or board can afford to head into proxy season without the maximum possible trust and goodwill of shareholders.’