December 1, 2011Client Alert

Developments In Securities Law - December 2011



As issuers look ahead to the 2012 proxy season, it is worth reviewing the 2011 season and focusing on a number of new developments for 2012.


Lessons from the 2011 Proxy Season

The 2011 proxy season was less contentious than many had expected. This was due in part to shareholder focus on newly-mandated advisory votes on executive compensation and issuer efforts to understand and address shareholder concerns prior to the vote. The say-on-pay vote provided shareholders with a new opportunity to express their views on issuer pay practices and was associated with a decline in the number of shareholder proposals on compensation matters. In addition, issuers became more proactive by increasing communications and engagements with shareholders on compensation issues in advance of the advisory vote. A review of the 2011 proxy season reveals that:


  • Executive compensation practices received high levels of support from shareholders in the first year of mandatory say-on-pay.
  • Shareholder opposition to director re-election (as indicated by withhold and against votes) declined.
  • Issuer engagement with shareholders on issues of concern to shareholders increased.
  • The trends of implementing greater accountability measures at the board level and eliminating barriers to shareholder action continued.
  • Shareholders showed significant support for proposals on social and environmental issues, signifying the growing value that shareholders place on these issues.  Support for other corporate responsibility proposals also showed continued growth.
  • Proposals to appoint an independent board chair received only average levels of support, with the number of these proposals holding relatively steady year over year, possibly indicating that shareholders believe boards should have discretion regarding the structure of board leadership.
  • Proposals relating to board diversity grew at a relatively fast pace, possibly demonstrating that shareholders want more input on the makeup of the board.


Private Ordering of Proxy Access


Following a decision by the D.C. Circuit Court of Appeals vacating the SEC’s mandatory proxy access rules, the SEC announced in early September 2011 the effectiveness of amendments to Rule 14a-8, which will usher in a new private ordering proxy access regime. These amendments were originally adopted in August 2010 as part of the SEC’s mandatory proxy access rules but had been subject to a stay imposed by the SEC pending resolution of the aforementioned lawsuit. The Rule 14a-8 amendments were not subject to the suit.


Under these Rule 14a-8 amendments, shareholders will generally be permitted to include a proposed bylaw amendment in an issuer’s proxy statement providing for proxy access if (as in Delaware) permitted by state law, or include an advisory, or precatory, proposal requesting that the board take such action. Prior to these amendments, shareholders were not permitted to make proxy access shareholder proposals under Rule 14a-8. In contrast to the stricter eligibility standards of the mandatory proxy access rules (which would have required shareholder(s) seeking to make a proxy access director nomination to have held at least 3% of the issuer’s stock for at least three years), Rule 14a-8 only requires that a proposing shareholder have held at least $2,000 of an issuer’s stock for at least one year. To the extent that issuers adopt proxy access bylaws through this shareholder proposal process, shareholders at these issuers will then be permitted to include their director nominees in the issuer’s proxy statement within the parameters set forth in the bylaws, thereby saving a nominating shareholder the cost of circulating its own proxy statement.


Staff Legal Bulletin No. 14F on Shareholder Proposals


On October 18, 2011, the SEC issued Staff Legal Bulletin No. 14F (the “Bulletin”), giving its views on a number of topics pertaining to shareholder proposals. Although this Bulletin is primarily directed to shareholders submitting proposals under Rule 14a-8, issuers should be aware of the Bulletin, as it may impact their responses to shareholder proposals. 


The main issue addressed by the Bulletin relates to proof of compliance with the share ownership requirement for persons making shareholder proposals. A shareholder making a proposal for inclusion in an issuer's proxy materials generally must have held at least $2,000 in market value of the issuer's stock for at least one year as of the date the shareholder submits the proposal. The question of who is a record holder for these purposes has been a source of considerable uncertainty and a focus of litigation, no-action requests and prior guidance by the SEC’s Division of Corporation Finance (the “Division”).


Technically, the record holder of most public company shares is Cede & Co., the nominee of The Depository Trust Company (“DTC”). The actual public shareholders are beneficial owners of an interest in DTC’s holdings, through a securities intermediary that is a participant in the DTC system. In certain cases, a beneficial owner of an issuer’s shares may have engaged an introducing broker to purchase securities and the introducing broker will have engaged a clearing broker to execute the purchase. The introducing broker is typically not a DTC participant and the clearing broker typically is. The Division previously required issuers to accept proof of ownership letters from introducing brokers for Rule 14a-8 purposes, even where the broker was not a DTC participant. In this situation, the issuer is not able to verify the positions against its own or its transfer agent’s records or against DTC’s listing of securities positions. In the Bulletin, the Division reversed its prior position and takes the view that for Rule 14a-8(b)(2)(i) purposes, only DTC participants should be viewed as record holders of securities that are deposited at DTC. The Division stated that the transparency of DTC participants’ positions in an issuer’s securities will provide greater certainty to beneficial owners and to issuers that proof of ownership has been established. The Division reiterated its view that Rule 14a-8(b)(2)(i) does not require a shareholder to obtain proof of ownership from DTC or Cede & Co.


ISS Voting Policies


As preparations are made for the 2012 proxy season, it is important to be mindful of changes that proxy advisors are making to their voting policies. Institutional Shareholders Services (“ISS”) recently released its draft policy changes for 2012, which include significant revisions to its methodology for evaluating management say-on-pay proposals. Issuers should consider the proposed updates, including any impact they may have on the expected level of support for the nominated directors or the issuer’s say-on-pay proposal in 2012.


A number of the changes ISS is making address criticisms raised by companies during the 2011 proxy season over ISS’s current methodology. This consisted of screening out firms whose one- and three-year total shareholder returns were below the peer group median, and then examining the issuer’s pay practices and trends, such as whether or not the CEO’s pay increased in the past year. ISS’s proposed changes attempt to give a more realistic appraisal of long-term pay and performance alignment.


Audit Firm Rotation


In the wake of the financial crisis, regulators and shareholder activists alike have been revisiting the issue of auditor independence with a view towards requiring issuers to periodically rotate their outside audit firms.


An August 2011 concept release by the Public Company Accounting Oversight Board (“PCAOB”) proposes mandatory term limits for corporate auditors in order to enhance their objectivity and professional skepticism. Although the Sarbanes-Oxley Act (“SOX”) requires registered public accounting firms to rotate the lead and concurring partners on an engagement every five years, PCAOB inspections have found audit deficiencies during the eight years since SOX was adopted. In weighing an appropriate auditor term, PCAOB notes that the average tenure for audit firms is 28 years at the 100 largest U.S. companies (based on market capitalization) and 21 years at the 500 largest U.S. companies.


Critics have long questioned whether mandatory audit firm rotation would be a practical or cost-effective way to strengthen auditor independence. Although PCAOB is moving slowly on mandatory auditor rotation, issuers would be well advised to weigh in on its release since shareholder activists are likely to continue raising the matter through annual meeting resolutions.


Establishing Quorum by Including Routine Matters


As way of reminder, a change to NYSE Rule 452 in January 2010 increased the difficulty in obtaining a quorum at a shareholders’ meeting. Under the rule change, brokers for investors who do not provide voting instructions are no longer able to cast discretionary votes in uncontested director elections. Prior to the change, uncontested director elections were considered “routine” matters, and shares held in street name could be voted by brokers, at their discretion, if the beneficial owners failed to instruct the brokers how to vote. Under the new rule all director elections, including uncontested elections, are characterized as “non-routine.” As a result, if uninstructed brokers do not vote because all matters presented to the shareholders are non-routine, shares held in street name will not be treated as present for quorum purposes.  Broker non-votes are only counted toward a quorum if stockholders will be voting on a routine matter. Achieving a quorum for any matter brought forth at a shareholders’ meeting (including a “routine” matter) results in a quorum for the entire meeting. The solution then is to include at least one routine matter (such as independent auditor ratification) on the meeting agenda so that broker discretionary votes will count for at least one matter and a quorum can be achieved.

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