October 15, 2009
The current economic and regulatory landscape poses unprecedented challenges for public companies and their boards of directors. They are facing scrutiny from shareholders, Congress, regulators and the public, and new proposals to address the causes of the financial crisis have been emerging on almost a daily basis for over a year now.
Many of these proposals remain under consideration at a time when calendar-year companies are beginning preparations for the 2010 proxy season, complicating the planning process. The uncertainty of the current environment means that, with respect to many issues–such as the SEC’s proxy access proposals–companies and their boards find themselves in a "wait and see" mode. Directors should remain informed during this time as new developments occur, and they should be prepared to respond at an accelerated pace. To assist boards in addressing the potential changes that lie ahead, this memorandum outlines key issues for directors to consider over the coming months.
1. Executive Summary
As discussed in more detail below, as boards prepare for the potential changes that lie ahead, there are a number of key areas to consider. These include:
a. Director Elections. Boards and companies should take a holistic approach to the director election process, considering the potential impact that the loss of broker discretionary votes will have on director elections at the upcoming annual meeting, as well as the effect of majority voting, "notice and access" (also known as "e-proxy"), and expected voting recommendations of the major proxy advisory firms.
b. Executive Compensation Practices and Disclosures. Boards and compensation committees should evaluate their companies’ compensation practices and policies in light of the current environment, including the strong possibility of federal legislation requiring an advisory vote on executive compensation, or "say on pay." For the 2010 proxy season, new required disclosures are anticipated relating to the risks created by employee compensation plans and the use of compensation consultants. In view of these considerations, companies should assess their compensation disclosures, with particular focus on the Compensation Discussion & Analysis. In addition, boards and compensation committees should be aware of executive compensation practices that institutional investors and proxy advisory firms frown upon (such as tax gross-ups) and those that they advocate, such as "hold-through-retirement" provisions and "clawback" policies.
c. Board Leadership. Boards and companies should expect a continued spotlight on the issue of board leadership in the coming months. In anticipation of new required proxy disclosures about board leadership structure, boards should consider why their current leadership structure is appropriate. At companies that combine the positions of chair and CEO, consideration should be given to what, if any, steps should be taken to enhance the independent leadership of the board. In addition, the board should consider this issue as part of the succession planning process.
d. Risk Oversight. Boards and companies should consider whether the board has the appropriate structure and processes in place for overseeing the major risks facing the company. The board should be comfortable that it understands these risks and how the risks relate to the company’s business and strategy. Boards, and those who advise them, should think carefully about how the board is spending its time and see that the board has adequate time to address critical issues such as strategy and risk.
e. Shareholder Engagement. Boards should be attentive to what their companies are doing to engage shareholders and recognize that, more than in the past, directors may need to play a greater role in reaching out to shareholders. Initiating a dialogue before a major issue arises helps build a relationship so that the company is not approaching a major shareholder for the first time to talk about a critical subject.
f. Shareholder Proposals for the 2010 Proxy Season. For the 2010 proxy season, we expect that shareholder proposals seeking the appointment of an independent chair and proposals seeking an advisory vote on executive compensation will continue to be popular. In addition, executive compensation in general is likely to be a frequent subject of shareholder proposals. Finally, shareholders’ ability to call special meetings and supermajority voting provisions also are likely to be focal points in the next proxy season.
2. Director Elections
Boards and companies should consider the impact that the loss of broker discretionary votes, and other relevant developments, may have on the election of directors at their next annual meetings.
A. Loss of Broker Discretionary Votes
The 2010 proxy season will be the first with no broker discretionary votes in uncontested director elections. As a result of changes to NYSE Rule 452 (the "broker vote rule") that take effect January 1, 2010, brokers that do not receive specific voting instructions from customers that hold their shares in "street name" will not be able to vote those shares in director elections at a company’s annual meeting. The rule in effect in past years and through the end of 2009 gives brokers discretion to vote uninstructed customer shares in uncontested elections, and historically, brokers have cast these votes largely in favor of company nominees.
Because this rule change addresses the conduct of brokers, it affects voting at both NYSE- and NASDAQ-listed companies. The loss of broker votes could affect the outcome of director elections, particularly at companies with majority voting, and at mid- and small-cap companies, which tend to have more retail shareholders. With the assistance of their proxy solicitors, companies should do modeling, using 2009 voting results, to assess the anticipated impact of not having broker votes. In evaluating the extent of this impact, companies should take a holistic approach, considering the collective effect of no broker votes, majority voting, "notice and access" (also known as "e-proxy"), and expected voting recommendations of the major proxy advisory firms. Companies also should evaluate whether any of their directors are potentially vulnerable to "vote no" campaigns.
At companies with a majority voting standard, the loss of broker votes will not result in increased votes "against" directors, but it could lower the percentage of votes that are cast "for" directors. A similar result could occur at companies that have retained plurality voting but adopted a director resignation policy requiring that their board members tender a resignation if they do not receive a majority of "for" votes. In either case, the impact of no broker votes will depend on the composition of a company’s shareholder base and, specifically, the percentage of institutional versus retail ownership. Some companies, particularly those with larger retail ownership, may need to consider enhancing their investor communication strategies to encourage retail shareholders to provide their brokers with voting instructions. This is particularly true for companies that opt to use e-proxy to distribute their annual meeting materials because e-proxy has reduced retail shareholder voting levels. Companies that are considering whether to adopt majority voting, or use e-proxy, may wish to defer doing so until after the 2010 proxy season so they have an opportunity to assess what, if any, impact the loss of broker votes has on director elections.
B. Expected Disclosures about Director Qualifications
Boards and companies should expect that the backgrounds of director nominees will receive greater scrutiny due to anticipated new disclosures required in the proxy statement. In July, the SEC proposed rules that would require companies to provide proxy disclosure, for each director and nominee, about the particular experience, qualifications, attributes and skills that qualify the director to serve on the board and each board committee where the director serves. It is anticipated that final rules will be in place for the 2010 proxy season. Directors can expect additional questions about their qualifications in company D&O questionnaires. Companies should expect to devote additional time to gathering information, and preparing disclosures, about their directors’ qualifications and backgrounds. These disclosures also may become a focal point for the proxy advisory firms in formulating recommendations about how shareholders should vote on particular nominees.
The SEC’s proposed director qualification disclosures are just one component of an increasing focus on board composition and the director nominations process that has emerged in recent years. During this time, boards and their nominating/governance committees have become increasingly deliberate in assessing board composition and seeking director candidates who possess relevant expertise. At the same time, institutional investors increasingly are looking for evidence that a board is evaluating its evolving needs, assessing the effectiveness and contributions of existing directors and making changes when appropriate. Boards and nominating/governance committees now routinely engage in a process of considering the background and expertise of existing directors and the specific needs of the board when seeking new board members. They also are conducting targeted efforts to identify and recruit individuals who have specific qualifications identified through this process. In deciding whether to recommend incumbent directors for renomination, nominating/governance committees are taking a critical look at the skills and contributions that individuals directors bring to the board. In addition, some boards are conducting more formal individual director evaluations outside of the annual renomination process. Boards and nominating/governance committees should periodically evaluate their board membership criteria, as well as their processes for identifying and evaluating director candidates and for evaluating incumbent directors, whether in connection with the renomination process or otherwise.
C. Impact of Proxy Advisory Firm Recommendations
Companies also need to look carefully at whether the major proxy advisory firms, RiskMetrics Group and Glass Lewis, are likely to recommend "against" or "withhold" votes with respect to their director nominees. Both firms update their proxy voting policies annually, usually around November. RiskMetrics Group and Glass Lewis typically recommend "against" or "withhold" votes with respect to directors who do not meet the firms’ own independence standards–which are stricter in some cases than those of the major stock exchanges–if these directors serve on any of the three "key" committees (audit, compensation and nominating/governance). Both firms also generally issue "against" or "withhold" recommendations on compensation committee members where a company has certain pay practices that the firms view negatively.
During the 2009 proxy season, there was a significant increase in the number of directors who failed to win majority support (up from 32 directors in 2008 to 93 in 2009), as well as an increase in the number of "against" or "withhold" votes that directors received, according to RiskMetrics Group. The most common situations where directors faced opposition in 2009 involved: (a) non-independent directors serving on key committees; (b) directors being "overboarded"–that is, serving on outside boards in excess of limits set by RiskMetrics Group; (c) companies taking "unilateral" actions without shareholder approval, such as adopting poison pills or conducting option exchanges; and (d) companies not implementing shareholder proposals that received majority votes in prior years.
Without the broker vote, votes from institutional shareholders may have a greater impact than in prior years, increasing the influence of proxy voting recommendations, particularly where a company’s institutional shareholders adhere closely to these recommendations. In addition, the voting recommendations of the proxy advisory firms are likely to have a greater impact at companies with a significant institutional shareholder base. Companies should analyze their institutional shareholder base to assess how closely different institutions follow these voting recommendations and reach out to these institutions as appropriate (see section 6 below on "Shareholder Engagement").
D. Proxy Access
Boards and companies should continue to monitor developments with respect to the SEC’s proxy access proposals. The SEC will not consider final rules on proxy access until early 2010, so final rules will not be in place for the main 2010 proxy season. In a recent speech, Commissioner Elisse Walter stated that the SEC continues to consider comments on the proposals and that the comment letters raised a number of issues related to the workability of various aspects of the proposed rules. Although it is widely expected that the SEC ultimately will adopt some form of proxy access, it is unclear whether that will include a mandatory federal proxy access right, a regime that allows proxy access proposals under the SEC’s shareholder proposal rules, or some combination of the two, such as a mandatory federal regime that companies can opt out of based on a shareholder vote. Depending on the rules ultimately adopted by the SEC, many companies may need to amend their bylaw provisions regarding director nominations.
3. Executive Compensation
Boards and compensation committees should evaluate their companies’ compensation practices and policies in light of the current environment, where executive pay practices continue to face heightened scrutiny and public anger. In addition, new disclosures are likely for the 2010 proxy season, and Congress is widely expected to enact some form of "say on pay" legislation in the coming months. In evaluating their policies and practices, boards and compensation committees should assess not only the amount and form of compensation paid to the company’s executives, the risks created by compensation policies and practices, and other substantive aspects of the company’s compensation programs, but also matters relevant to the compensation decision making process, such as the role of compensation consultants.
A. Anticipated New Disclosures for the 2010 Proxy Season
In July, the SEC published rule proposals that would require companies to discuss and analyze in the compensation discussion and analysis ("CD&A") section of their proxy statements their overall compensation policies and practices for employees generally, including non-executive officers, if the risks arising from the incentives created by these policies and practices could have a material effect on the company as a whole. The SEC has stated that its current rules already require CD&A disclosure to the extent that these risk considerations are a material aspect of the company’s compensation policies or decisions for named executive officers. The SEC proposal is not clear on exactly the type of disclosure the SEC is seeking, although the SEC has stated that it believes this disclosure will "help investors identify whether the company has established a system of incentives that can lead to excessive or inappropriate risk taking by employees." With some form of final rule likely to apply for the 2010 proxy season, it will be necessary to brief the compensation committee before that time about whether any non-executive compensation policies may incentivize conduct that could contribute materially to a company’s business risks, and management will need to review the policies in order to make that assessment. In addition, the compensation committee should be comfortable that it understands any significant risks that may result from incentives created by compensation policies and decisions applicable to named executive officers and other senior executives.
The SEC’s July rule proposals also included proposed new disclosures relating to compensation consultants. Motivated by concerns that consultants’ relationships with management may compromise the independence of the advice they provide compensation committees, several institutional investors have called for the elimination of these potential conflicts while others have called for increased disclosure of consultants’ services. The SEC’s proposed rules would require companies to provide enhanced disclosure of potential conflicts of interest involving compensation consultants that provide advice to the board or compensation committee regarding executive or director compensation if the consultants also provide other services to the company. Specifically, if a compensation consultant that "played a role" in determining or recommending the amount or form of executive and director compensation provides additional services to a company, the company would have to disclose: (1) the additional services that the consultant provides; (2) the aggregate fees paid for work related to determining or recommending executive and director compensation and for all additional services; (3) whether management had a role in the decision to engage the consultant for the additional services; and (4) whether the board or compensation committee approved all of the additional services.
In addition, there is legislation pending in Congress on this subject. In July, the House of Representatives approved the Corporate and Financial Institution Compensation Fairness Act of 2009, which would require that any compensation consultants or other similar advisors to the compensation committees of listed companies meet independence standards to be developed by the SEC. Moreover, on an annual basis, companies would have to disclose in their proxy statements whether or not they retained an independent compensation consultant. A second piece of legislation would direct the SEC to adopt rules requiring that any consultants retained to advise on executive compensation be independent.
B. Say on Pay
Boards and compensation committees should prepare for the strong possibility that federal law will soon require public companies to give their shareholders an advisory vote on executive compensation, also known as "say on pay." The Corporate and Financial Institution Compensation Fairness Act, which passed the House of Representatives in July, contains a provision mandating say on pay votes at public companies but with an implementation schedule that would delay its effectiveness until after the main 2010 proxy season. However, we understand that supporters of say on pay are urging the Senate to act on this legislation or on stand-alone say on pay legislation before Congress recesses in December, and are advocating for any legislation on this subject to require say on pay votes at all 2010 annual meetings. In the meantime, companies that have received majority or high votes on say on pay shareholder proposals should be preparing to address say on pay now, as they are likely to face pressure from institutional investors to act voluntarily. Whether or not they already have received a say on pay shareholder proposal, companies should assess their compensation practices and compensation disclosures, with a particular focus on the CD&A. Revisions that may be appropriate due to the prospect of say on pay include reorganization of the CD&A to highlight the connection between performance and specific pay decisions, enhanced disclosure of performance measures and "total compensation" calculations, and more informative explanations of benchmarking standards and of the bases for significant compensation decisions.
Since 2007, shareholder proposals requesting that companies provide for an annual advisory vote on executive compensation have become increasingly popular and have received high votes. Moreover, in the past two years, at least 21 additional companies, including Intel Corp., Motorola Inc. and Verizon Communications Inc., have agreed to hold an advisory vote on executive compensation, either voluntarily undertaking to provide for these votes or doing so in response to shareholder proposals. In addition, approximately 400 companies that received funds under the Troubled Asset Relief Program ("TARP") were required by law to hold a say on pay vote at shareholder meetings held in 2009. In 2009, company-sponsored say on pay votes have reflected high support for the companies’ executive compensation programs, with approximately 87.5% of votes cast at 136 meetings for which results are available. Notably, although RiskMetrics Group recommended votes against the companies in a number of instances, there has yet to be a majority vote against a company.
Some companies have taken different approaches to soliciting shareholder input on executive compensation. A number of companies, including Ingersoll Rand Co. Ltd. and Pfizer Inc., have held meetings with their large shareholders to discuss governance issues, including executive compensation. In April 2009, Schering-Plough Corp. submitted a survey to its shareholders to obtain their views on a variety of compensation issues. In addition, some shareholders have advocated an alternative to annual advisory votes on executive compensation, with the Carpenters Union Pension Trust submitting shareholder proposals calling for an advisory vote on executive compensation once every three years and additional steps designed to provide greater meaning to and feedback from the process. Recently, Microsoft Corporation announced that it would hold an advisory vote on executive compensation once every three years, beginning with its annual meeting this November, while Prudential Financial, Inc. has decided to provide shareholders with a say on pay every other year starting in 2010.
In addition to reviewing their compensation practices and disclosures, companies that have not done so already should be prepared to engage with shareholders that raise concerns about executive compensation issues. That way, a dialogue will already be underway in the event that say on pay legislation becomes a reality, facilitating the process of seeking shareholder support for a favorable vote. Depending on the circumstances, it may be appropriate to involve the chair and/or other members of the compensation committee in these discussions (see section 6 below on "Shareholder Engagement").
C. Scrutiny of Specific Pay Practices
As the preparation of 2010 proxy disclosures gets underway, boards also need to be cognizant of the policies that the major proxy advisory firms apply in assessing companies’ executive compensation practices. In particular, RiskMetrics annually updates its list of "poor compensation practices," which it uses in recommending whether shareholders should vote "against" or "withhold" voting authority from compensation committee members and in some cases the entire board. RiskMetrics may recommend "against" or "withhold" votes on compensation committee members if a company implemented an option repricing without shareholder approval or, absent certain undertakings, if the committee approved an arrangement or employment agreement during the past year that provides for grossing up "golden parachute" taxes. Other practices that, depending on the circumstances, may draw negative voting recommendations from RiskMetrics include "excessive" severance arrangements, tax gross-ups on perquisites for named executive officers, and paying dividends or dividend equivalents on unearned performance awards. In addition, we anticipate that shareholders will be focusing on whether compensation committees take into account gains accrued on equity awards that were granted during the down market, and that union pension funds and others will be closely scrutinizing whether large bonuses are awarded at companies that implemented broad layoffs. Boards and compensation committees should evaluate whether their companies have any of the practices that RiskMetrics has identified and determine if the practices remain appropriate.
D. "Hold-‘Til/Through-Retirement" Provisions and "Clawback" Policies
Boards and companies also should be aware of compensation "reforms" that are a particular focus for shareholders and activists, including "hold-through-retirement" provisions and "clawback" policies.
1. "Hold-‘Til/Through-Retirement" Provisions
Initially, shareholder activists sought to require senior executive officers to retain substantial amounts of their equity in a company until they left the company–so-called "hold-‘til-retirement" requirements. More recently, the focus has shifted to "hold-through-retirement" requirements, which would require stock ownership for one or two years following an executive’s separation. These requirements are designed to align the interests of executives with those of shareholders, to discourage executives from taking unnecessary or excessive risks shortly before their retirement in order to maximize short-term stock returns to the detriment of long-term value, and to promote long-term succession planning. While "hold-through-retirement" requirements reflect some of the same policies underlying traditional stock ownership guidelines/requirements, their advocates do not view stock ownership requirements as an acceptable substitute.
In 2009 to date, shareholders submitted 17 hold-through-retirement shareholder proposals, and 14 of these proposals were voted on by shareholders or are pending. The majority of these proposals were submitted by the American Federation of State, County and Municipal Employees ("AFSCME") Employees Pension Plan and requested that the compensation committee adopt a policy requiring senior executive officers to retain a "significant percentage" of shares acquired through equity compensation programs until two years after their departure from the company. The shareholder proposals further recommended that the compensation committee adopt a percentage not lower than 75% of net after-tax shares, and that the policy address the permissibility of hedging and other transactions that are not sales but reduce the risk of loss to executives. Hold-through-retirement shareholder proposals received average support of 26.3% of votes cast at 12 meetings for which results are available, with RiskMetrics Group taking a case-by-case approach when formulating voting recommendations on the proposals.
2. "Clawback" Policies
"Clawback" policies are policies providing for the recoupment of bonuses and other incentive compensation payments made to individuals (usually senior executives) based on financial results that are later found to be inaccurate or based on individuals’ failure to comply with certain aspects of their employment agreements, such as non-compete and no-solicitation clauses. Since 2004, shareholders have submitted a total of 35 shareholder proposals requesting that companies adopt clawback policies. Nearly half of the companies that received these proposals previously had restated their financial results. The popularity of clawback shareholder proposals peaked in 2006 and 2007, and since then, there has been a decrease in both the number of and the average support for these proposals. This decrease is likely due to the increase in the number of companies that voluntarily have adopted clawback policies. A Fall 2008 survey by Equilar, Inc. indicates that among Fortune 100 companies, the prevalence of disclosed clawback policies increased from 17.6% in 2006 to 42.1% in 2007 to 64.2% in 2008. A June 2008 survey of approximately 2,100 companies from The Corporate Library found that approximately 300 companies had clawback provisions, compared to only 14 companies that had disclosed the existence of these provisions in the four years prior to the survey. The Shareholder Empowerment Act of 2009, introduced in June in the House of Representatives, would require public companies to adopt clawback policies to recoup performance-based compensation paid based on inaccurate financial results.
RiskMetrics Group takes a case-by-case approach when formulating voting recommendations on clawback shareholder proposals, considering whether a company has a clawback policy, whether the policy substantially addresses the concerns in the proposal and whether the company has a history of restatements or other financial problems. According to its 2009 proxy voting policies, RiskMetrics Group has determined that the clawback provisions applicable to companies that received funds under TARP represent the new "best practice" in the area. Recipients of these funds must seek recovery from certain senior executives of any bonus or incentive compensation paid to them that was based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria, even when there is no misconduct. Thus, going forward, RiskMetrics Group is likely to support a clawback shareholder proposal if the provisions of a company’s current policy do not align with those applicable to TARP recipients. Glass Lewis also takes a case-by-case approach and considers a variety of factors, including whether a company has adopted a clawback policy. It generally recommends votes "against" clawback shareholder proposals when the company’s policy covers the proposal’s major tenets.
4. Board Leadership
Boards and companies should expect a continued spotlight on the issue of board leadership in the months ahead.
It is now common practice for larger companies to have a lead/presiding director in order to provide independent leadership for the board, but shareholder activists and some governance experts increasingly are calling for the appointment of an independent chair. For example, in March, the Chairman’s Forum, organized by Yale University’s Millstein Center for Corporate Governance and Performance, issued a policy briefing arguing in favor of independent chairs and specifically calling on all North American companies to adopt an independent chair, effective upon the succession of an existing combined chair/CEO. Although the number of companies with independent chairs has gone up in the past several years, the majority practice among U.S. companies remains a combined chair/CEO. According to RiskMetrics Group data, as of August 1, 2009, 53.6% of S&P 1500 companies had a combined chair/CEO, while 21.1% had a fully independent chair, and 22.7% had a separate chair who was not independent due to current or past employment by or other affiliation with the company. Larger companies are more likely than smaller or mid-cap companies to combine the positions.
In July, the SEC issued proposed rules, expected to be in place for the 2010 proxy season, that would require companies to provide disclosure in their proxy statements about their leadership structures. This disclosure would include information about whether a company separates or combines the roles of the chair and CEO, whether the company has a lead director and why the company believes that its leadership structure is appropriate for it. Notably, in proposing the rules, the SEC acknowledged that different leadership structures may be suitable for different companies and that the proposed disclosure is not intended to influence a company’s decision about its board leadership structure. Congress also has taken an interest in the issue of board leadership. The Shareholder Bill of Rights Act of 2009, introduced in May in the Senate, and the Shareholder Empowerment Act (discussed above), would direct the SEC to adopt rules mandating that all public companies have an independent chair.
Independent board leadership has been a popular topic for shareholder proposals in recent years. Given the success of these proposals in the past year, we expect that the number of shareholder proposals seeking an independent board chair will increase during the 2010 proxy season, including binding proposals that would amend companies’ bylaws and thus mandate an independent chair structure. In 2009, both Exxon Mobil Corporation and Bank of America Corporation received binding bylaw proposals, and Bank of America appointed an independent chair after the proposal passed by a narrow margin. RiskMetrics Group generally recommends a vote "for" independent chair shareholder proposals unless a company meets a number of criteria, including having a lead/presiding director with duties specified by RiskMetrics Group, not exhibiting sustained "poor total shareholder return performance," and not having experienced other governance issues. Over the past several years, RiskMetrics has tightened its voting policy on these proposals and we expect that, in the coming year, it may move toward recommending a vote "for" all independent chair proposals unless a company has an independent chair.
In anticipation of the SEC’s expected new disclosures for the 2010 proxy season, boards should consider the reasons why their current leadership structure is appropriate. At companies that combine the positions of chair and CEO, consideration should be given to what, if any steps, should be taken to enhance the independent leadership of the board. In addition, as part of the succession planning process, the board or responsible committee should look ahead and consider what leadership structure may be appropriate in the future.
5. Risk Oversight
In the wake of the financial crisis, there has been increasing focus on how companies address risk assessment and management. Many boards have been considering how to address their risk management oversight responsibilities most effectively, including whether to allocate risk oversight responsibilities to the audit committee, a separate risk committee and/or the board as a whole. In this regard, boards and companies should consider whether the board has the appropriate structure and processes in place for overseeing the major risks facing the company. Boards should be comfortable that they understand these risks, as well as the company’s business and strategy and how these relate to risk.
In July, the SEC proposed rules that would require companies to provide disclosure in their proxy statements about the board’s role in the company’s risk management process, including: (a) how the board implements and oversees its risk management function, whether through the board as a whole or through a committee, such as the audit committee; (b) whether the persons who oversee risk management report directly to the board as a whole, to a committee such as the audit committee, or to one of the board’s other standing committees; and (c) whether and how the board, or board committee, monitors risk. We expect some form of these rules to be in place for the 2010 proxy season. In addition, the Shareholder Bill of Rights Act (discussed above) would direct the SEC to adopt rules requiring the establishment of a separate risk committee.
The vast majority of companies address risk through their audit committees, presumably because NYSE rules require audit committees to discuss risk assessment and risk management policies, although the rules also clarify that the audit committee need not be the sole body responsible for risk oversight. Some companies address risk through one or more other committees–including, in a minority of cases, through a separate risk committee. Delegation to other committees can avoid overburdening the audit committee in light of the significant responsibilities audit committees face in the post-Sarbanes-Oxley environment. It also enables the board to draw on the input of other board committees that may be relevant to the company’s particular risks and can elevate the visibility of the board’s oversight of risk to management and shareholders. Finally, risk issues are inherently tied to corporate strategy and the company’s business plan, which most companies deal with at the full board, not committee, level. For this reason, some companies address risk oversight only at the full board level, while others see that there are frequent reports to the full board on the issue by management and the responsible board committee(s).
Whatever oversight structure a board adopts, it should be one that enables the board to remain informed about, and understand, all of the major risks facing the company and the steps the company is taking to manage those risks. In addition, the board should understand the structure it has implemented–specifically, who, among the full board and various committees, is responsible for overseeing what risks–and be comfortable that the oversight system provides appropriate coverage of all major risks. Directors also should be comfortable that they understand how the company’s risks fit within the "big picture"–specifically, that they understand how these risks relate to the company’s business and strategy, and more fundamentally, that they understand the business and strategy itself. Boards, and those who advise them, should think carefully about how the board is spending its time and see that the board has adequate time to address critical issues such as strategy and risk. To the extent that directors would benefit from "deeper dives" into particular areas, boards should consider devoting a portion of the time allocated for ongoing director education to helping directors obtain a greater understanding of the company’s business and strategy, as well as associated risks.
6. Shareholder Engagement
A critical component of addressing many of the issues discussed above is effective shareholder engagement. This means that companies should make good investor relations and "good listening" a priority, so that engagement with shareholders happens on ongoing basis. Boards should be attentive to what their companies are doing in this area and recognize that, more than in the past, directors may need to play a greater role in reaching out to shareholders. Board-level involvement in shareholder engagement can generate goodwill and avoid a situation where shareholder exposure to the board and its work is limited to the annual meeting context.
Effective shareholder engagement can help companies educate shareholders and other stakeholders about what the board does and the nature of the board’s oversight role. The board should consider what the company is doing to communicate effectively and regularly with shareholders, the business press and analysts about the company’s business and strategy, including the role that the board plays in overseeing these critical areas. The current environment also presents an opportunity for companies to be proactive in discussing the steps they are taking to manage risk and the board’s role in overseeing this process.
Looking ahead to the upcoming annual meeting, the board should be comfortable that the company knows its shareholder base and that the company is anticipating areas of potential shareholder concern and how to address them. The company should have an understanding of what proportion of its shareholders are institutional as opposed to retail, who the largest shareholders are and how long they have held the company’s stock. In the case of institutional shareholders, it is important to know how closely these shareholders follow the recommendations of the major proxy advisory firms. For those holders that take these recommendations into account but do a case-by-case analysis in making voting decisions, outreach may be helpful in order to avoid a negative vote on a director or a shareholder proposal.
In addition, the board should consider the company’s strategies for engaging, or enhancing engagement, with its largest shareholders. Shareholder outreach can be important to convey the company’s views and may be helpful in preventing shareholder proposals or obtaining withdrawal of a proposal that has already been submitted. In this regard, it is important to recognize that proxy voting decisions at institutional shareholders often are not handled or influenced by the portfolio managers and analysts with whom management engages at industry conferences and during earning calls, but instead are often handled by separate personnel at the institution. Initiating a dialogue before a major issue arises helps build a relationship so that the company is not approaching a major shareholder for the first time to broach a critical subject. Where shareholders express concerns about particular issues, such as board leadership or executive compensation, it may be appropriate for board members–such as the relevant committee chair or committee members–to participate in the dialogue with shareholders. This sends a message that individuals at the highest levels within the company take shareholder concerns seriously and helps to reinforce shareholder confidence in the directors.
In communicating with shareholders, directors and companies should strive for transparency while at the same time being sensitive to confidentiality concerns. At a recent meeting of the SEC’s newly constituted Investor Advisory Committee, there was some consensus that the SEC should issue guidance clarifying that dialogue between boards and shareholders on corporate governance matters is acceptable under Regulation Fair Disclosure, which prohibits the selective disclosure of material nonpublic information. In addition, directors should take care to maintain the confidentiality of board deliberations and keep in mind that any written communications between themselves, and with management, may be discoverable in litigation.
7. Anticipated Shareholder Proposals for 2010
For the 2010 proxy season, as discussed above, we expect that shareholder proposals seeking the appointment of an independent chair and proposals seeking an advisory vote on executive compensation will continue to be popular. Executive compensation in general is likely to be a frequent subject of shareholder proposals, which we anticipate will address a range of compensation issues including hold-through-retirement requirements (discussed above). In addition, now that a "critical mass" of large companies has adopted majority voting in uncontested directors elections, shareholders will increasingly be directing majority voting shareholder proposals to mid-cap and smaller companies, where plurality voting continues to be the norm.
Two other anticipated focal points for shareholder proposals in 2010 are shareholders’ ability to call special meetings and supermajority voting provisions. During the past three years, an increasing number of companies have received shareholder proposals addressing the ability of shareholders to call special meetings. Depending on the company, these proposals generally seek to amend the bylaws either to allow shareholders to call special meetings or to reduce the stock ownership threshold required to call a special meeting. The stock ownership threshold for calling special meetings has declined over time, so that in 2009, nearly all of the special meeting shareholder proposals sought a threshold of 10%. In 2009, special meeting shareholder proposals received average support of slightly more than 50% of the votes cast, and whether a company already permitted shareholders to call special meetings at a stock ownership threshold higher than 10% does not appear to have affected the levels of support that proposals received.
During the past several years, shareholder proposals requesting that boards of directors take the steps necessary to remove supermajority voting requirements also have been popular. Even companies without supermajority voting provisions in their charters or bylaws have received these proposals where there are default supermajority voting provisions in the applicable state law. RiskMetrics Group and Glass Lewis generally support shareholder proposals to lower supermajority voting requirements, and companies that receive a supermajority voting shareholder proposal can expect strong support (in the 60% range) for the proposal.
Gibson, Dunn & Crutcher’s Securities Regulation and Corporate Governance Practice Group is available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work, or any of the following in the firm’s Washington, D.C. office:
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