Where will 452 lead N&A?

After a stormy beginning, notice and access seemed to have finally found its groove. Many companies realized that while the savings to be had were not necessarily earth-shattering – and yes, the drop in retail participation was worrisome – delivering proxy materials electronically still made good business and ecological sense.

With changes to Rule 452 making the election of directors no longer a routine matter voted at the broker’s discretion, some corporate secretaries are now doing an about-face on notice and access. At the same time, they’re scrambling to rethink their entire proxy strategies in light of what seems certain to be a depressed retail vote in spring 2010.

‘Retail holders tend to be very supportive of management on the election of directors, but they just don’t vote in large numbers,’ says Paul Schulman, executive managing director of the Altman Group, a proxy solicitation firm based in Manhattan. He points out that the growing popularity of notice and access has meant retail vote levels, which have historically been quite low, have fallen farther still – and the elimination of the broker discretionary vote means these numbers will almost certainly drop further.

Adding to the sense of skittishness on the part of companies are other changes looming on the proxy horizon. ‘Institutions are becoming much tougher on their criteria for voting for directors,’ notes Schulman. ‘In the past, the routine vote has helped protect directors, in some cases from significant withhold votes. With the discretionary vote gone, however, directors are losing that protection.’

Rachel Posner, senior managing director and general counsel at Georgeson, adds: ‘Companies are definitely concerned about the elimination of Rule 452, and those that aren’t concerned don’t necessarily understand the ramifications of it.’

The most obvious dividing line between companies that are extremely concerned and those that are nonchalant is relative levels of retail ownership. ‘For companies with a 10 percent or even 20 percent retail base, the effects will not be so dramatic,’ says Abigail Jones, vice president of compliance and corporate secretary at Questar Corporation. With approximately 20 percent retail ownership, Questar doesn’t plan on jettisoning notice and access, but it is considering stratifying its approach to e-delivery.

A range of issues

Beyond retail ownership, companies are weighing various factors before deciding the fate of notice and access, or e-proxy. Key questions include whether a company has a majority voting standard, whether its directors are vulnerable to withhold votes because of compensation or other controversial issues, and whether the policies of major institutional holders place a company’s directors in jeopardy.

At present there’s no clear answer for how to proceed with so many question marks, stresses Jones. ‘Each company is going to have to look at this issue on a case-by-case basis and determine whether notice and access makes sense, depending on how a whole range of things fit together,’ she points out.

Posner agrees. The proxy landscape, she says, is ‘like an ecosystem – one slight change can cause ripples everywhere else.’

Johnson & Johnson has not used e-proxy in the past and won’t begin doing so this year, maintains Doug Chia, senior counsel and assistant corporate secretary. ‘The elimination of 452 is enough of a factor for us to believe this is not the year to be experimenting with notice and access, whether stratified or not,’ he explains.

Chia says companies that have already gone the e-proxy route may find it more difficult to pull back now. ‘Once you save that kind of money from the budget, it’s hard to go back and spend it again,’ he says. And according to Chuck Callan, senior vice president of regulatory affairs at Broadridge, the number of notice and access users rose sharply in the past year: from July 1, 2007 to June 30, 2008, there were 653 e-proxy users; from July 1, 2008 to June 30, 2009, there were 1,363. The fate of notice and access may hinge on how much money was ultimately saved. At many companies, says Posner, it simply wasn’t the cure-all everyone expected.

A 2009 survey by the National Investor Relations Institute and the Society of Corporate Secretaries and Governance Professionals bears this out: 33 percent of respondents who used notice and access for the first time in 2009 spent between 75 percent and 99 percent of the prior year’s budget, and 16 percent saved nothing at all. What’s more, 8 percent of respondents actually saw their costs increase.

The dollars and cents of e-proxy constitute only one issue, though. Another is understanding a firm’s shareholder base and how its voting patterns will be affected by electronic delivery. For instance, Jones says Questar has done e-proxy from the first year it was able to and has reaped ‘significant savings’. She is, however, concerned about statistics indicating that retail voting may drop by 50 percent or more since the elimination of the broker discretionary vote. ‘I wouldn’t say it’s the death knell of notice and access, but it’s going to cause people to look at notice and access far more carefully,’ she says. This proxy season she’s considering a stratified approach to electronic delivery – an approach that had been gaining in popularity even before the changes to Rule 452.

Understanding your audience

Dannette Smith, corporate secretary at UnitedHealth Group, predicts that changes to Rule 452 won’t wreak particular havoc on her company given that its shares are around 90 percent institutionally held. What’s more, she estimates that broker non-votes accounted for just 8 percent of the overall vote last year. 

Smith finds that her company can stratify e-proxy and still save a considerable amount of money. UnitedHealth sent any shareholders who had voted by phone or proxy in either of the last two years a paper mailing. In 2009 UnitedHealth had approximately 275,000 retail holders; of those, 48,000 – or 17 percent – received a full package mailing, says Smith. By designing e-proxy this way, UnitedHealth avoided any drop-off in the retail vote.

Smith also points out that the question of whether a company has a majority-voting standard – and precisely how that standard is structured – can prove critical. UnitedHealth changed to majority voting two years ago, but the company’s articles state that the majority to be achieved is the majority of the votes cast. That means the broker non-vote comes out of both the numerator and the denominator of the voting equation, lessening the overall effect. When Smith recalculated last year’s votes by removing the broker non-vote, the difference came to less than 1 percent, she says. ‘The repeal of 452 shines a spotlight on the fact that you really have to know your shareholder base,’ she adds.

Companies must also identify which brokers their retail shareholders used and how these brokers dealt with Rule 452 during the past few years, when the elimination of the broker vote seemed inevitable. During this time, some brokers voluntarily stopped voting their clients’ shares, while others chose to vote retail shares proportionately.

Minimizing the impact

Once the company knows its precise situation, it can try to partially rebuild any losses in the retail vote through a shareholder outreach program. A good program, says Posner, hinges on distinctively designed and written proxy packages and a first-rate website. Companies may want to send shareholders reminder letters or buck slips to increase the vote, or they might make solicitation phone calls to their larger retail shareholders, reminding them of deadlines and explaining how they can vote online or by phone.

Another step is making directors more distinctive and memorable for shareholders. On December 16, 2009, the SEC amended its governance disclosure requirements. Public companies are now required to disclose the specific experience, qualifications, attributes and skills of each director and board nominee. In other words, the SEC wants shareholders to know why a company deems a specific individual worthy of occupying a board seat.

Sylvia Groves, principal and founder of GG Consulting in Calgary and former assistant secretary and governance officer at Canadian energy company Nexen, applauds the move. ‘With retail shareholders, you want to give them something short and sweet,’ she explains. ‘I can see why investors aren’t voting – too often, the names are meaningless to them. It could be the names of 10 al-Qaeda members and they wouldn’t know the difference. If you don’t give them some sense of context, there’s simply no way you’re going to get those votes in.’

When it comes to reaching retail investors, technology may save the day. Chia points out that Johnson & Johnson is experimenting with social media, specifically by stressing the importance of proxy voting on the corporate blog. Meanwhile, Broadridge has launched two new online products to enhance shareholder engagement, says Callan. At its November 2009 annual meeting, Broadridge hosted an electronic shareholder forum for validated investors and even held its annual meeting virtually, allowing shareholders to vote their proxies online and in real time.

Darrell Heaps, CEO of Q4 Web Systems in Toronto, points out that today’s retail investors conduct 85 percent of their research online. He also says that, as of March 2009, two thirds of the online population visited social networks and blogs on a daily basis. ‘If someone is using the web to do research, he/she is likely participating in some form of social network like Facebook or Twitter,’ he notes. ‘If you know your shareholders are online and using social media, our advice is to fish where the fish are. There’s an opportunity for a company to get in front of shareholders by putting content and information into the same channels.’

That said, even the most cutting-edge technology will only boost participation so much. ‘You can try to educate and convince people to vote until the cows come home, but it might not happen,’ says Chia. He points out that, even in presidential elections, voter participation hovers at around 50 percent. ‘With a get-out-the-vote campaign, you have to be realistic,’ he adds. ‘It’s hard to get people off the couch to vote if they don’t feel they have anything vested.’

Preparing your directors

The demise of the broker vote is spurring companies to look long and hard at their directors in an effort to foresee any potential problems that might crop up during an election campaign. Schulman notes that proxy solicitors are increasingly being asked to conduct director vulnerability assessments so that companies aren’t blindsided by a ‘vote no’ campaign. The numbers suggest this concern is well founded: as of September 23, 2009, RiskMetrics reports that 93 directors at 50 US companies had received majority dissent, relative to just 32 directors at 17 companies who failed to achieve majority support in 2008.

Encore Bancshares, which has a relatively small shareholder base and has shied away from notice and access, is actively educating its directors on what to expect in a post-Rule 452 world, says Rhonda Carroll, senior vice president, corporate secretary and chief compliance officer at Encore. ‘Our directors are used to getting a high percentage of support and, while I don’t expect any of them not to get elected, they may get a lower percentage of votes than they’re accustomed to.’

Using a PowerPoint presentation, Carroll showed the directors where Encore’s votes typically come from and how things might change this year once the discretionary vote is gone. She believes that prepping the board is essential. ‘You can deal with pretty much anything, but you really don’t want to surprise your directors,’ she warns.

Chia agrees. ‘Any board member paying attention will see that what’s expected these days has changed dramatically from two years ago,’ he says. ‘They’re looking to us to give some kind of expert opinion in terms of what they can expect.’

A director who fails to be reelected – or is elected only by the slimmest of margins – might trip off other problems by signaling to activist investors that the company has an Achilles’ heel, says Schulman. At the same time, candidates might feel less than enthusiastic about joining a board where future colleagues had been subjected to the humiliation of nearly losing an election. Groves believes this spring’s proxy results could provide a wake-up call about shareholder outreach. ‘It won’t take many cases of a director not getting the vote to open people’s eyes,’ she says.

Changes on the horizon

Jones points out that if the retail vote diminishes, the institutional vote carries more weight than ever. For this reason, she’s focusing her attention on RiskMetrics, Glass Lewis and the other shareholder advisory services, which often shape the hot-button issues in a given proxy season. Chia recommends cementing shareholder relationships early because once RiskMetrics or Glass Lewis has issued an opinion, it’s usually too late to change minds. ‘When recommendations come out from RiskMetrics and Glass Lewis, the votes move very quickly,’ he cautions.

In addition, companies need to watch all possible changes to ‘proxy plumbing’ and non-objecting beneficial owner/objecting beneficial owner status that might affect how proxies are voted. Smith is keeping a close eye on a proposal that would allow shareholders conducting a ‘vote no’ campaign to distribute copies of the proxy card to other shareholders, for example. Were this to be permitted, she asserts, ‘there would be a further shift in power toward shareholders who want to unseat the board.’

Chia predicts that the next six to 18 months will resemble the time period when Sarbanes-Oxley unfolded. ‘If you look at what Congress and the SEC have passed in the wake of the financial meltdown, this is a moment when people are collectively saying, We have to make major adjustments – and companies will have to figure out how to deal with all this change.’

Smith encourages corporate secretaries to view the myriad changes taking place within the proxy process holistically. ‘Each change on its own may not seem that big,’ she concludes, ‘but put them together and the effects can be dramatic.’