SEC posts release approving amendment to NYSE Rule 452 eliminating broker discretionary voting for directors

By Cydney Posner

The rule change will be effective for shareholder meetings held on or after January 1, 2010 (except to the extent that a meeting was originally scheduled to be held prior to that date but was properly adjourned to a date on or after it). The NYSE rule change will add the "election of directors" to the list of enumerated non-routine items for which a member generally may not give a proxy to vote without instructions from the beneficial owner. (The change would not apply to investment companies registered under the 1940 Act.)

Currently, Rule 452 allows a broker to vote in his discretion on "routine" proposals if the beneficial owner of the shares has not provided specific voting instructions to the broker at least 10 days before a scheduled meeting. Brokers may not vote without instruction on matters determined to be non-routine. "Non-routine" matters are generally those involving a contest or a matter that may substantially affect the rights or privileges of shareholders, such as mergers or shareholder proposals. Among the matters defined as "routine" under the current Rule is an "uncontested" election for a company's board of directors. With the increasing proportion of shares now held in street name, the impact of the broker vote on the election of directors has become increasingly significant. Moreover, NYSE has not viewed elections subject to "vote no" campaigns to be election contests within the meaning of Rule 452 and has taken the position that these elections are eligible for broker discretionary voting. NYSE's interpretation of "uncontested election" has recently been called into question as an increasing number of proxy campaigns have targeted the election of directors without a formal contest and a competing slate of nominees. In 2006, the NYSE's Proxy Working Group issued a report recommending that, in light of the importance of directors to a corporation, Rule 452 be amended to make the election of directors ineligible for broker discretionary voting, whether the election is contested or uncontested. Following the recommendation, NYSE proposed the change.

Interestingly, most of the commenters on the proposal neither explicitly supported nor opposed the proposal, but rather expressed concerns with the proposal and urged that the SEC not take action on the proposal at this time. Many of these commenters believed that the proposal should not be viewed in isolation, but should be considered by the SEC as part of a comprehensive review of the proxy voting and shareholder communication system, including issues regarding the distortion of the shareholder voting process resulting from stock lending and financial derivatives as well as the impact of over-voting and under-voting. Commenters also highlighted as a likely result of the rule change increases in the cost of achieving a quorum at shareholder meetings, particularly for smaller issuers and especially in light of lower retail participation. Some commenters also raised the concern that the proposal would make it especially difficult for companies that have adopted a majority vote standard for the election of directors to obtain adequate votes to overcome a "vote no" campaign by activist shareholders, thus disproportionately empowering minority shareholder groups. Some commenters also expressed the concern that the change could disenfranchise individual shareholders, who may assume that brokers would vote on their behalf if they did not vote. Commenters also believed that the rule change would shift voting power toward special interest groups wishing to use minority stock positions to pursue their own special interests and non-investment objectives, increase the influence of proxy advisory firms or shift disproportionate weight to institutional investors and increase power in the hands of the few shareholders who vote. Suggestions were made to examine as alternatives to the rule change either proportional voting (broker voting in proportion to directed votes by other customers of the broker) or client-directed voting (broker voting consistent with standing customer directors).

While acknowledging that many proxy plumbing issues are currently under review, the SEC contended that it would not be appropriate to delay action on the NYSE's proposal pending consideration of these other complex proxy issues; issues relating to the potential regulation of proxy advisory services and the impact of derivatives and share lending on voting will be considered by the SEC in the context of broader proxy issues, but should not preclude adoption of this rule change. Similarly, the SEC believes that the quorum issue can be easily addressed by adding a routine proposal, such as ratification of auditors, to the meeting agenda and doubts that, to the extent there are issues regarding establishing a quorum, "having uninstructed votes cast on the election of a director by broker-dealers who lack the shareholders' economic interests in the corporation is the appropriate way to address the issue." Concerns regarding the influence of institutions and special interests were similarly dispatched. With regard to majority voting concerns, the SEC cited statistics showing that the change was unlikely to have a major impact. The SEC also seems to have agreed with some commenters that broker votes can improperly skew the results and that the change would enfranchise retail voters, not disenfranchise them, especially if investor education efforts are pursued. Suggestions to consider either proportional voting or client-directed voting were not endorsed by the SEC and viewed as potentially distortive or based on inadequate information.

The SEC concluded that the rule change is reasonable and consistent with purposes of the Act, "particularly given the large proportion of shares that today are held in street name, the importance of corporate governance and accountability expressed through the election process, and the concern that the broker vote could potentially distort election results." The SEC concurs with NYSE that the "election of directors is not a 'routine' issue for either the corporation or the shareholders; it is a key event in the operation and direction of the corporation and the shareholders' exercise of their rights and interests as the owners of the corporation" and believes that the "most fundamental way in which shareholders can ensure that directors remain accountable to them for the directors' performance of [their] critical duties is through the director election process." Accordingly, the SEC believes that the rule change "should better enfranchise shareholders by helping assure that votes on matters as critical as the election of directors are determined by those with an economic interest in the company, rather than the broker who has no such economic interest, and also should enhance corporate governance and accountability to shareholders."

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