On July 1, 2009, the Securities and Exchange Commission (SEC), in a 3-to-2 vote, approved a proposed amendment to New York Stock Exchange (NYSE) Rule 452 that will prohibit discretionary broker voting in director elections. [1] The rule change will likely have a significant impact on public companies in the 2010 proxy season, including:

• increased costs for shareholder communication and proxy solicitation for companies with a large retail shareholder base;
• difficulty in achieving a quorum; and
• an increased number of "vote no" or "withhold vote" campaigns against company director nominees and a greater likelihood of success for such campaigns.

This Update summarizes the amendment and its implications and provides practical tips.

The Amendment Affects All Public Companies Beginning in 2010

The amendment will apply to all shareholder meetings held on or after January 1, 2010. [2] Although Rule 452 is an NYSE rule, it applies broadly to all public companies [3] because it governs all NYSE member brokers, regardless of the exchange on which an issuer's stock is listed.

Current Rule 452 Allows Brokers to Vote Uninstructed Shares in Director Elections

Under the current Rule 452, a broker can vote shares without instruction from the beneficial owner of the shares, i.e., the broker's customer, for certain proxy matters as long as the beneficial owner did not provide voting instructions at least ten days prior to the shareholder meeting.  Brokers can only vote these "uninstructed" shares on matters classified as "routine" matters.  While the NYSE does not define "routine" matters, Rule 452 lists 18 examples of nonroutine matters, which includes contested elections of directors.  Uncontested director elections, even those that are the subject of "vote no" or "withhold vote" campaigns, have been considered "routine" for purposes of Rule 452.

Amended Rule 452 Will Define Director Elections as Nonroutine Matters

The amendment will add uncontested director elections to the list of nonroutine matters.  As a result, brokers will be prohibited from voting on the election of directors, whether contested or uncontested, absent specific instructions from the beneficial owners of the shares. 

Elimination of Discretionary Voting in Director Elections Will Have Significant Implications

The NYSE's discretionary voting rule has taken on increased significance in recent years for several reasons.  The number of shares held by brokers in "street name" has grown from less than 30% in 1976 up to estimates as high as 85% of exchange-traded shares.  Historically, there has been low participation by retail investors in matters submitted to a shareholder vote, which has been further depressed in many instances by the e-proxy notice and access rules.  Finally, brokers have traditionally voted with management, although recently some brokers have exercised their discretion to vote uninstructed shares on a proportional basis with directed votes.  In light of this combination of factors, the elimination of broker discretionary voting in uncontested director elections will likely present several new challenges to public companies in the 2010 proxy season.

• Costs May Increase Due to Additional Shareholder Communication.  Companies will have to spend more on shareholder outreach and proxy solicitation efforts to secure votes from retail investors.  Smaller companies, which typically have a higher proportion of retail shareholders, will be affected disproportionately.  While the NYSE and the SEC have said they plan to increase the amount of investor education in this area, much of this burden will fall on companies.
• A Quorum May Be Difficult to Obtain.  Companies often achieved a quorum at annual meetings based on the number of votes cast in uncontested director elections.  Under the amendment, some companies may have problems achieving a quorum to conduct business at annual meetings if not enough director votes are cast and the agenda for the meeting does not include at least one "routine" matter.
• "Vote No" Campaigns May Increase.  The number of "vote no" and "withhold vote" campaigns will probably increase as a result of the amendment.  Without the significant number of broker votes in uncontested director elections supporting management's director slate, these campaigns are more likely to succeed.
• Institutional Investors and Proxy Advisory Firms May Have Increased Influence.  Because the elimination of broker discretionary voting will diminish retail shareholder voting, the voting power of institutional investors, including hedge funds, and the influence of shareholder activists and minority shareholders will be enhanced.  In addition, the influence of the proxy advisory firms on which many institutional investors rely may also increase.  In the order approving the amendment, the SEC noted the concern expressed by several commentators about the degree of influence that proxy advisory firms have in corporate elections, and said that it would be considering the use of proxy advisory services, and whether that use should be further regulated, in its examination of broader proxy issues.
• The Adverse Impact on Retail Shareholder Voting May Be Compounded by E-Proxy Notice and Access.  It has been reported that companies relying on the notice and access delivery method under the e-proxy rules experienced a 50% fall off in the retail vote.  The elimination of broker discretionary voting in uncontested director elections is expected to further exacerbate this trend.
• Majority Voting Standards May Be More Difficult to Achieve.  Approximately 50% of the S&P 500 companies have implemented majority voting for director elections and another approximately 20% have adopted a policy requiring a director who does not receive majority support to submit a resignation.  The plurality voting standard is still the standard at a substantial majority of smaller companies.  The elimination of broker discretionary voting may make it more difficult for companies with a majority voting standard, or a plurality voting standard that is coupled with a resignation policy, to obtain a majority vote of shares for the company's director nominees.

Additional Information

This Update provides only a summary of the amendment. You can find a copy of the full text of the SEC order at http://www.sec.gov/rules/sro/nyse/2009/34-60215.pdf. 

[1] The amendment stems from recommendations of the Proxy Working Group (PWG), which was formed by the NYSE in 2005 to review its rules regarding the proxy voting process.  Opposing SEC commissioners and many companies and commentators urged the SEC to delay implementation of the amendment to Rule 452 until a series of related issues involving the proxy voting process raised by the PWG and others have been resolved, including the current difficulties companies have in communicating with shareholders, the impact of e-proxy notice and access rules in depressing the retail vote, the influence of proxy advisory firms, and the impact of "over-voting" and "under-voting" by brokers.  The SEC said that it did not believe the concerns expressed merited a delay in implementing the amendment, but stated that it would continue to examine broader proxy issues.

[2] The amendment will not apply to meetings originally scheduled to be held in 2009 if properly adjourned to a date after January 1, 2010.

[3] The amendment will not apply to companies registered under the Investment Company Act of 1940.