SEC Publishes for Comment Proposed Amendment to NYSE Rule to Eliminate Broker Discretionary Voting in Uncontested Director Elections

March 13, 2009

The Securities and Exchange Commission ("SEC") recently published for comment a proposed amendment to New York Stock Exchange LLC ("NYSE") Rule 452, Giving Proxies by Member Organizations, that would limit the ability of brokers to cast discretionary votes in uncontested director elections.  The result could be significant for many issuers, especially those that have adopted a majority voting standard in uncontested director elections.  Because Rule 452 applies to brokers, the proposed amendment, if adopted, will impact not only issuers listed on the NYSE, but also issuers listed on other exchanges such as NASDAQ.  Set forth below is a summary of the proposed amendment, as well as practical considerations for issuers and others to weigh in commenting on the proposed amendment.

The proposed amendment to Rule 452 must be approved by the SEC before it takes effect and is subject to a public comment period.  The SEC has requested that comments on the proposed amendment be received by March 27, 2009.  Under Section 19(b)(2) of the Securities Exchange Act of 1934, the SEC is required to approve the rule change or institute proceedings to determine whether the proposed rule change should be disapproved within 35 days of its publication in the Federal Register, or such longer period, up to 90 days, as the SEC determines to be appropriate, or as to which the NYSE consents. 

The proposed amendment is available at
http://www.sec.gov/rules/sro/nyse/2009/34-59464.pdf.

The complete NYSE rule filing is available on the NYSE website.

NYSE Rule 452

Background

The NYSE first adopted a rule akin to the current Rule 452 in 1937.  The rule, commonly known as the "Ten Day Rule," permitted brokers to vote stock registered in their names, regardless of whether the stock was in their possession or control, if the beneficial owner of the stock did not give voting instructions at least ten days prior to the stockholder meeting.  The Ten Day Rule did not apply to authorizations for a merger, consolidation or dissolution or for the reclassification of any outstanding security.  Although the NYSE proxy rules have been revised numerous times since the adoption of the Ten Day Rule, the basic principles of the rule have remained largely the same. 

Under current rules, brokers are required to deliver proxy materials to beneficial owners and request that the beneficial owners provide voting instructions.  If brokers do not receive voting instructions by the tenth day preceding an issuer’s scheduled stockholder meeting, the current iteration of the Ten Day Rule, Rule 452, allows brokers to exercise discretionary voting authority and thus vote on certain matters the NYSE considers "routine."  Uncontested director elections currently are considered to be "routine" matters on which brokers are permitted to cast discretionary votes.  In contrast, brokers are not permitted to vote on "non-routine" matters without receiving instructions from the beneficial owners.  Rule 452 currently lists 18 items that are considered "non-routine," including matters involving an election contest or any matter that may affect substantially the rights or privileges of stockholders. 

NYSE Working Group 

In April 2005, the NYSE created a Proxy Working Group to review the NYSE rules governing the proxy voting process, with particular focus on Rule 452.  The Working Group included representatives from a number of different constituencies, including issuers, NYSE member organizations, the legal community, institutional investors and individual investors.  The Working Group issued its report and recommendations in June 2006.[1]  Among the Working Group’s recommendations was that the NYSE amend Rule 452 to make uncontested elections of directors a "non-routine" matter, thereby eliminating brokers’ ability to vote in uncontested director elections without instructions from beneficial owners.  The Working Group’s reasons for this recommendation included its belief that "the election of directors can no longer be perceived as a ‘routine’ matter in the life of a corporation" and the fact that the primary way director accountability is achieved is through the director election process.  The Working Group also recommended that the NYSE work with the SEC and issuers to develop a "significant investor education effort" to inform investors about the proxy process and the importance of voting, noting that such an effort was a "critical component" of any amendment to Rule 452 that would make uncontested director elections a "non-routine" matter.  In addition, the Working Group recommended that the NYSE support a review by the SEC of its stockholder communications rules to consider how to improve communications between issuers and beneficial owners. 

Proposed Amendment

The NYSE first filed with the SEC a proposed amendment to Rule 452 in October 2006, but the SEC never published it for comment.  In response to concerns expressed by the investment company community, the NYSE amended the rule filing in May 2007 to provide that the proposed amendment to Rule 452 is not applicable to companies registered under the Investment Company Act of 1940.  The recently proposed amendment to Rule 452 follows the recommendation of the NYSE Working Group to make uncontested elections of directors a "non-routine" matter, meaning that brokers could not vote on such matters absent specific instructions from their clients.  Thus, the amendment to Rule 452 would eliminate broker discretionary voting in uncontested director elections. 

If adopted by the SEC, the proposed amendment will be applicable to proxy voting for stockholder meetings held on or after January 1, 2010.  However, if the proposed amendment is not approved by the SEC until after August 31, 2009, the effective date will be delayed until a date which is at least four months after the approval date and which does not fall within the first six months of the calendar year.  In any case, the proposed amendment will not apply to a stockholder meeting that was originally scheduled to be held prior to the effective date but was properly adjourned to a date on or after the effective date.

Alternatives

Critics of Rule 452 object to the rule because they assert that it allows persons without an economic interest in an issuer to vote on corporate matters and, at least until recently, because brokers typically have voted uninstructed shares in accordance with the recommendations of an issuer’s board of directors.  However, in recent years, we understand that some brokers have implemented policies whereby they will not vote shares as to which they have not received voting instructions.  In addition, a number of brokers have implemented proportional voting on "routine" matters, whereby the brokers will vote uninstructed shares in the same proportion as those shares for which they received voting instructions from their other retail stockholders.  The NYSE Proxy Working Group considered the alternative of proportional voting and concluded at the time that, although a proportional voting system was "somewhat attractive," it was not the "optimum result."  In an addendum to the Working Group’s report released in August 2007,[2] the Working Group stated that it planned to review the experiences of brokers who have implemented proportional voting to determine whether proportional voting is a viable alternative. 

The addendum to the Working Group’s report also discussed a new proposal developed by Working Group member Stephen Norman called Client Directed Voting.  Under Client Directed Voting, when an investor opens a brokerage account, the investor would be allowed (but not required) to provide a "good until cancelled" instruction on matters to be voted on at companies in which they own stock.  Investors would be permitted to elect whether to always (i) vote in accordance with the board’s recommendation, (ii) vote against the board’s recommendation, (iii) abstain from voting, or (iv) vote proportionally with the broker’s retail clients’ instructed votes on the same issue.  At the time of any proxy solicitation, each investor would receive a notice from their broker reminding the investor of their standing instructions and how those instructions would be implemented with respect to the upcoming vote.  Investors would then have the ability to override their standard instructions by providing specific voting instructions.  The Working Group stated in the addendum that it would continue to evaluate the advantages and disadvantages of Client Directed Voting in light of its recommendation to amend Rule 452.

Issues to Consider

The proposed amendment to Rule 452 to eliminate broker discretionary voting in uncontested director elections is likely to have a significant impact on issuers by increasing the cost of uncontested director elections, as issuers will need to expend more resources—financial and otherwise—reaching out to stockholders who previously did not vote.  Moreover, eliminating broker discretionary voting in uncontested director elections is likely to adversely impact stockholders’ exercise of their rights, as discussed further below.  Thus, when determining whether to comment on the proposed amendment to Rule 452, issuers and others should keep in mind the following considerations:

• Stockholder Communications.  The elimination of broker discretionary voting in uncontested director elections would greatly increase issuers’ need to communicate with beneficial owners who hold their shares in "street name" (meaning through brokers, banks or their depositories) about the importance of voting in director elections.  A potential roadblock is that the lists of such stockholders are maintained by brokers and banks and not by issuers.  Issuers are permitted by SEC rules to request the names of such stockholders from the brokers and banks, but stockholders may choose whether or not they wish to have their names and addresses disclosed to issuers.  Stockholders who object to being contacted by issuers are called "Objecting Beneficial Owners" ("OBOs"), and stockholders who do not object are called "Non-Objecting Beneficial Owners" ("NOBOs").  The existence of the OBO/NOBO distinction under SEC rules would present a significant obstacle for issuers attempting to reach out to their stockholders about the importance of voting in director elections.  In this regard, as mentioned above, the NYSE Proxy Working Group recommended a reexamination by the SEC of its rules regarding stockholder communications.  
• Stockholder Education.  As mentioned above, the Working Group stated that as a "critical and integral" part of its proposal to amend Rule 452, the NYSE should play a leading role in undertaking a substantial investor education effort to inform investors about the proxy voting process. Research conducted on behalf of the Working Group concluded that there is a general lack of stockholder understanding of the proxy voting process.  According to the research, approximately 37% of stockholders appear to be aware that if they do not vote their proxy on "routine" matters, their shares may be voted by their brokers in their discretion, and 27% of stockholders appear to be aware that when brokers exercise their discretion in voting on such matters, they typically vote in accordance with the recommendations of the issuer’s board of directors. 

  Based on these statistics, amending Rule 452 to eliminate broker discretionary voting in uncontested director elections would be counter to the assumptions of a significant percentage of stockholders.  Accordingly, amending Rule 452 without a corresponding widespread effort to educate investors about the practical implications of the amendment could significantly impact stockholders’ exercise of their rights, as many stockholders likely will continue believing that even if they do not provide voting instructions, their brokers will vote on their behalf.  Just as issuers and the SEC are concerned that the "notice and access" form of electronic proxy delivery (e-proxy) has resulted in lower retail investor participation in the stockholder franchise,[3] eliminating discretionary voting will disenfranchise those retail investors who may not be providing voting instructions in the expectation that their brokers will vote for them.  At the same time, issuers could, in the absence of discretionary voting in uncontested elections, reconsider the manner in which they take advantage of the cost savings and reduced environmental impact that can be generated through notice and access in order to increase the possibility of receiving an affirmative response from stockholders.    

• Majority Voting.  In recent years there has been a growing trend towards issuers adopting a majority voting standard in uncontested director elections.  The loss of broker votes could mean the loss of a significant block of votes "for" the board of directors’ nominees, which in turn could make it more difficult for directors to achieve the majority support needed for election. 
• Proxy Advisory Firms.  The loss of the broker discretionary vote in uncontested director elections could increase the influence of the voting recommendations of proxy advisory firms such as RiskMetrics Group, Inc., Glass Lewis & Co., LLC and Proxy Governance, Inc. on the outcome of director elections.  This is especially relevant given proxy advisory firms’ heightened scrutiny of issuers’ corporate governance and executive compensation practices, which has recently lead to such proxy advisory firms issuing more withhold or against vote recommendations for issuers’ director nominees. 
• "Vote No" Campaigns.  The proposed amendment to Rule 452 could increase the frequency of "vote no" campaigns against directors.  If brokers no longer have the ability to cast discretionary votes in uncontested director elections, "vote no" campaigns led by stockholder activists would likely have greater influence on the outcome of director elections. 
• Achieving Quorum.  Broker voting traditionally has played an important role in allowing issuers to achieve quorum for stockholder meetings.  This is because broker votes are counted for purposes of achieving a quorum even with respect to "non-routine" matters on which brokers are not entitled to vote.  In other words, if a broker votes a stockholders’ shares on one "routine" item on an issuer’s ballot (such as auditor ratification), the shares are considered present for the purposes of establishing a quorum with respect to all matters that are up for a vote at the stockholder meeting.  The loss of the broker discretionary vote in uncontested director elections could result in quorum problems at companies that do not have at least one routine item on their ballot, such as auditor ratification.

Conclusion

In light of the important issues raised by the proposed amendment to Rule 452, interested parties should consider commenting on the proposed rule amendment.  Interested parties also should consider requesting that the SEC extend the rulemaking period so that appropriate consideration can be given to the important issues raised by the proposed amendment. 

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:  

John F. Olson (202-955-8522, [email protected])
Brian J. Lane (202-887-3646, [email protected])
Ronald O.  Mueller (202-955-8671, [email protected])
Amy L. Goodman, (202-955-8653, [email protected])
Gillian McPhee (202-955-8230, [email protected])
Elizabeth A.  Ising (202-955-8287, [email protected])

© 2009 Gibson, Dunn & Crutcher LLP

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