6.4 Recent Changes to the Proxy Solicitation Process

For publicly traded companies, the annual meeting and proxy solicitation process has historically involved tried-and-true solicitation methods, generally without concern with the potential voting outcome. As a result, annual meetings have been somewhat boring with few investors and others attending. Recent trends and changes to the proxy rules, however, along with rule changes by the SEC and the New York Stock Exchange and an increase in shareholder activism, have changed the mechanics and dynamics for proxy solicitations and have turned what used to be a perfunctory proxy solicitation into a much more complicated process. Some of the recent changes have been:

• "Notice and Access." In recent years the SEC has amended the proxy rules to allow issuers to choose largely to forgo printing and mailing paper sets of proxy materials (notice of meeting/proxy statement, proxy card, and "glossy" annual report to shareholders) and instead direct shareholders to proxy materials available on their Internet websites. While this method of proxy solicitation has resulted in potential cost savings, it has also lowered the cost barriers for activists to wage a proxy battle. In many cases, this method of proxy solicitation has also decreased the voting by retail (household) shareholders.

• Activist Hedge Funds and Institutional Investors. Hedge funds and institutional investors have become increasingly emboldened in recent years in their attempts to tell companies how to improve their business, and to seek one or more seats on the board (For example, Carl Icahn, or Relational Investors LLC, successfully secured a seat on Home Depot's board of directors). In addition, institutions are becoming increasingly vocal in advocating for or against candidates in director elections (For example, H&R Block lost three board seats to Breeden Partners, L.P. after five proxy advisors combined to recommend the opposing fund's slate).

• Majority Voting. Many companies have adopted changes to their charters, bylaws or corporate governance policies to now require director nominees to receive a majority (more than half) of votes cast at the annual meeting in order to be elected. In the past, most directors were elected through a plurality voting systems. Plurality voting refers to the largest number of votes received by one candidate (or any proposal in a referendum) out of the entire group of candidates. Plurality occurs when one candidate receives the most votes but not necessarily more than half of the votes. Thus, for example, if a director is running unopposed, even getting one vote would result in that director being elected.

• Classified v. Annual Election of Directors: Historically, many public companies elected their directors for terms such as three years. In these cases, one-third of the board of director members were elected each year for a three-year term. Having staggered elections of directors was known as having a classified board. In recent years, both shareholder proxy advisory firms and activist shareholders have pushed to have all directors elected each year in annual elections. Having a classified board was seen as a defense mechanism against firm takeover and was not believed to be in the best interest of shareholders. Most companies have now moved to annual elections for all directors, making the director elections must more important than in the past.

• Scrutiny of Executive Compensation. With the increased attention on executive and director compensation from the press and institutional holders, no item on a proxy ballot (including director elections) can any longer be considered "routine." Front-page coverage of director and CEO pay and shareholder concerns about pay corresponding to performance are forcing many companies to reach out to shareholders in order to convince them not only to approve their incentive and compensation plans, but to support all of management's initiatives.

• Changes to NYSE Rule 452. The NYSE amended Rule 452 to reclassify uncontested director elections from "routine" matters on which brokers and banks had the right to vote all "unvoted" shares held in brokerage accounts, to be deemed a "non-routine" matter. This required brokers and banks to obtain voting instructions from beneficial owners in order to vote unvoted shares. Historically, these broker votes have almost always been voted in favor of management nominees. Because of this rule change, companies may have to aggressively increase their solicitation efforts to secure enough votes for their director nominees particularly where majority voting has been adopted.

With these and other changes, the proxy solicitation process requires strategic thinking by company managements and boards about proxy ballot items. Without discretionary broker voting generally less than half of "street name" retail investors actually vote on management ballot items. Companies must assess what additional efforts may need to be expended in soliciting proxies for their annual meeting in order to garner sufficient votes. This requires companies to know the profiles of their shareholders.

These changes also make use a proxy solicitor's services much more important. A proxy solicitor can monitor proxy matters on a year-round basis and collaborate to design an effective proxy solicitation strategy.

In this new environment, it is important that companies know exactly who their shareholders are and that they mix and match the available methods of solicitation to reach those shareholders. The amended proxy rules permit companies to use the notice and access [Internet] model to solicit proxies from some shareholders, and the full set of materials delivery model for others. Companies can break down the method of distribution of proxy materials in several ways. For example, companies may choose to provide "notice and access" to institutional shareholders who are likely to vote under this method, while providing full paper delivery to targeted shareholders, and providing "notice and access" to small shareholders who historically have not voted.

In today's environment it is also very important to engage major shareholders throughout the year in productive dialog. Activist pressures generally come without warning. Whether the issue is a potential slate of one or more opposing director nominees, a shareholder proposal contrary to what the board of directors believes is productive to the company, or expected opposition to one or more management proposals, management generally is never completely prepared for opposition votes or opposition solicitations. By engaging major shareholders in a dialogue throughout the year companies can let their major shareholders know who the members of management and the board of directors are and what their vision for the company is, all within the confines of acceptable public disclosures. It is also important to be in contact with the executives within the institutional holders who are responsible for voting proxies - these are different executives from the analysts and other financial executives within the same institutions.

Proxy Advisory Firms

Now that you understand the proxy solicitation process, we will take a deeper dive into both proxy advisory (sometimes called shareholder advisory firms or proxy firms) and activist investors. Both proxy advisory firms and activist investments have become very prominent players in the corporate landscape in recent years.

A proxy advisory firm is a firm hired by shareholders of public companies (usually large institutional investors) to recommend and sometimes cast proxy statement votes on their behalf. The top two proxy firms in the United States are Institutional Shareholder Services (ISS) and Glass, Lewis & Co. Additional U.S. proxy advisory firms include Egan-Jones Proxy Services, Marco Consulting Group, ProxyTell and C&W Investment Group.

By some accounts, ISS advised half of the common stock in the world as of 2010. Some proxy firms play the role of proxy advisor, in which they simply advise their clients on how to vote. A potential conflict of interest identified by the Government Accountability Office is that some proxy firms do business with both issuers and investors. Although proxy advisory firms are most active in USA, other countries such as Canada and India now have institutionally backed voting/proxy advisory firms.

When corporate shareholders vote at annual meetings or on a big decision — be it a merger with another firm or an adversarial slate of directors — they often take advice from these advisory firms. Both ISS and Glass Lewis publish their independent analysis and voting recommendations for every public company each year. For example, in 2012, ISS recommended a negative "say on pay" vote for Walt Disney Co. ISS based its recommendation on its belief that CEO Robert Iger's performance didn't justify his compensation, valued at $31.4 million in the year ended Oct. 1. Disney countered by saying that ISS "offhandedly and improperly dismissed the board's well considered judgment" regarding executive compensation.