Investors are using proxy access proposals to gain negotiating leverage.
This year’s proxy season kicks off a new era in shareholder-management relations thanks to the new proxy access rule. While the impacts this year are likely to be small, ‘several years from now many if not most companies will have proxy access procedures,’ and proxy access ‘will be viewed as a good corporate governance practice,’ predicts Edward Smith, a partner at law firm Chadbourne & Parke.
Smith and Amy Borrus, deputy director of the Council of Institutional Investors, have similar views about the coming proxy season. Neither thinks many proposals will be submitted. As to the kinds of companies that will be targeted by investors, Borrus explains, ‘Investors will select companies with severe issues, from performance shortcomings to governance concerns.’ Generally speaking, she continues, investors will target ‘boards that have been chronically unresponsive to shareowner concerns and/or have authorized executive pay that is significantly out of whack with company performance over multiple years.’
As a specific example of something that might trigger governance concern, Borrus offers the failure of a company ‘to adopt actions recommended in shareowner proposals, particularly proposals that passed two or more years in a row’. Smith also suggests that ‘big-name and very visible companies’ could be targeted. ‘Size and notoriety would be the drivers,’ he says.
Rules of engagement
Still, analysts can’t assume that even egregious governance problems alone will get a company targeted. Borrus points out that an investor must weigh whether ‘enough significant investors at a target company are likely to support a proxy access proposal’. Filers are likely to have had some communication with other investors to get an idea of whether a proposal has a chance of passing or not.
Smith details the two types of proposals companies might face – precatory and binding – along with who might submit which, and why. ‘Precatory proposals ask the board to take such action as may be necessary to allow proxy access, such as amending the bylaws,’ he explains. ‘This approach will be favored by individual activist stockholders because the language of the proposal can be standardized and submitted to multiple companies.’ Beyond the standardization advantage of precatory proposals, Smith notes that binding proposals involve particular challenges.
‘A binding proposal would directly amend the company’s bylaws, and so would need to be customized to those bylaws,’ Smith says. ‘In addition to that substantive challenge, stockholders seeking to offer customized, binding proposals face a procedural limit: the 500-word count.’ Under this rule, proponents only have 500 words for both their proposals and their supporting statements. Smith believes ‘bylaw amending proposals would likely use up lots of words’, leaving few words to make a case to vote for the proposal.
First filers
By mid-December, 15 proxy access proposals had been reported, all precatory. Activist shareholder Kenneth Steiner had submitted five, targeting Textron, MEMC Electronic Materials, Bank of America, Sprint Nextel and Ferro. Norges Bank Investment Management, which manages the Norwegian Government Pension Fund, submitted six targeting Wells Fargo, Charles Schwab, Western Union, Staples, Pioneer Natural Resources and CME Group. Amalgamated Bank filed a proposal against Hewlett-Packard; activist James McRitchie filed a proposal against Goldman Sachs; and activist John Chevedden filed a proposal against Chiquita Brands International. Also, an investor coalition of nine public pension funds that collectively owns 1.78 million shares of Nabors Industries valued at over $31.7 million filed a proxy access proposal.
According to the website Dodd-Frank.com, during the first week of January, Textron and Wells Fargo became the first targeted companies to file a no-action request with the SEC in order to get a shareholder proposal seeking a proxy access bylaw omitted. Textron has offered several very technical arguments to exclude the proposal filed against it, while Wells Fargo is seeking to omit a portion of the proposal because of ‘false or misleading’ information.
The relatively low number of proposals is not surprising given that the rule is new and took effect not long before the deadline for submitting proposals for the spring proxy season. As Smith explains, ‘The deadline for proxy proposal submission is 120 days before the company’s proxy materials were mailed for the prior year’s annual meeting.’ For companies that have synched their fiscal year with the calendar year and hold their meetings in April and early May, the deadline passed in early December.
Nevertheless, in late November there was still ‘ongoing discussion at US pension funds’ about submitting proposals, according to Borrus.
Since investor dissatisfaction drives proxy access proposals, ‘as a general matter, companies should be meeting with key stockholders to discuss their views on important investor concerns, such as compensation and corporate governance policies,’ Smith counsels. But if management won’t do this, or such dialogue isn’t enough to prevent a proposal from being submitted, what’s a company that gets a proxy access proposal to do? Smith explains that under the SEC’s rule, a company has numerous procedural and substantive grounds for keeping a proxy access proposal out of its proxy materials, but each option has its pros and cons.
More to come
According to Smith it is likely that a higher number of proxy access proposals will be submitted for the fall proxy season, and by the spring of 2013 it’s possible even more could be filed. Over the next several years Smith expects the proxy access process to evolve, with the key trend being how many of the ‘constraints built into [the now-invalidated SEC universal proxy access rule] get adopted in some form’. He offers several examples of issues that need to be addressed: ‘What will the qualifying thresholds be, such as the amount of stock ownership required and the length of the holding period? For how many of the open seats can an investor submit candidates? If multiple stockholders submit different nominees, which nomination will receive priority? Will the stockholder have to certify that it is not seeking a change of control?’
The entire proxy access issue is a bit of a red herring, however, as both Borrus and Smith agree that what’s really at stake is negotiating leverage. ‘I think this rule is less about contested elections than it is about getting a stockholder’s representative on the board,’ says Smith. ‘If a stockholder really wants to change control of the company, he or she will run his or her own proxy.’
Borrus agrees. ‘The real value of a proxy access proposal is that it is leverage in getting the board to act in ways that will enhance shareowner value,’ she emphasizes. ‘Filing a proxy access proposal is a last-resort measure. It should be a wake-up call to the board.’
Options when faced with a proxy access proposal
Edward Smith, a partner with Chadbourne & Parke, suggests numerous options companies can take if faced with a proxy access proposal:
1. Exclude the proposal on one of the eligibility grounds – for example, to make a proposal the stockholder ‘must hold $2,000 or 1 percent of the stock for the preceding year’.
2. Attempt to negotiate with the proponent about the proposal. Perhaps the proponent would withdraw the proposal if the company granted some other corporate governance change.
3. Include the proposal in the company’s proxy statement, recommend against it, and hope stockholders don’t adopt it.
4. Negotiate changes to make the proposal acceptable, include the amended proposal in the proxy statement and recommend its adoption. An example would be a proposal that allowed a stockholder owning one percent to nominate, and the board could say, ‘If you change that to 2 percent, we’ll include it and recommend its adoption.’
5. Include the company’s own proxy access proposal and seek to exclude the stockholder’s as conflicting with it. The risk with this option is that the company must obtain an SEC no-action letter to exclude the proposal, and before agreeing, the SEC will review both proposals to see how real the conflict is.
6. Unilaterally amend the company’s bylaws to include proxy access and then seek to exclude the stockholder proposal on the grounds that the company has already implemented the proposal. Again, the risk is that the unilateral amendment and the shareholder proposal may be sufficiently different that the SEC doesn’t agree that the proposal has been substantially implemented. For example, perhaps the company allows shareholders owning 5 percent to nominate, but the shareholder asks for a 1 percent threshold – is that substantially implemented or not?
Don’t expect 2012 proposals to be withdrawn
Francis Byrd, pictured left, senior vice president and corporate governance risk practice leader at Laurel Hill Advisory Group, says that since investors are anxious to see what the law will allow, companies shouldn’t expect many proxy access proposals to be withdrawn. He believes early filers are more likely to force a vote than negotiate a solution because they are passionate about the issue and want to see proxy access established as an undisputed right of investors.
Byrd believes that individual investors like Steiner, McRitchie and Chevedden are unlikely to negotiate because ‘they believe this is a right that the shareholders should have irrespective of the performance of the company’.
Since shareholders in Europe and around the world already have proxy access, Byrd says Norges Bank is unlikely to withdraw its proposals because it feels America is out of step. ‘I don’t think European shareholders are going to negotiate what they consider to be a right that they’re fighting for,’ he states.
Given that there may be strong support for the proposal, Byrd’s advice to companies that may be targeted this year and next is: ‘You have to start thinking about what you’re going to give up if you want these people to go away and you want your proposal to pass.’ In most cases investors want to have one of their people named to the board, but for companies with particularly bad governance records, it may take additional changes to compensation plans or governance practices to make a proposal go away.
