Memo to the Board of Directors: Preparing for 2013
By Frank Aquila, Krishna Veeraraghavan, and Marc Morgenthau, Sullivan & Cromwell LLP’s
As 2012 draws to a close, now is an opportune time for boards of directors to reflect on the most recent proxy season as they prepare for 2013. While shareholder proposals in the 2012 proxy season included political and social concerns, compensation-related issues, and other nongovernance items, this article focuses on four key corporate governance items that boards of directors should consider now as they prepare for the 2013 proxy season.
Lead Director Versus Independent Chair
Directors of corporations that have substituted the appointment of a lead independent director in place of separating the roles of CEO and chairman of the board should consider reviewing the language used to describe the lead director’s duties. ISS recommends that shareholders vote in favor of proposals to separate the roles of CEO and chairman unless the company in question satisfies certain governance requirements, including all of ISS’s lead director criteria, which require that the designated lead director:
- be elected by and from the independent board members;
- serve a minimum term of one year;
- have clearly delineated and comprehensive duties and rights that should include:
- presiding at all meetings of the board at which the chairman is not present, including executive sessions of the independent directors;
- serving as a liaison between the chairman and the independent directors;
- approving information sent to the board;
- approving meeting agendas for the board;
- approving meeting schedules to ensure that there is sufficient time for discussion of all agenda items;
- having the authority to call meetings of the independent directors; and
- if requested by major shareholders, ensuring that he or she is available for consultation and direct communication.1
Prior to the 2012 proxy season, in determining whether to recommend that shareholders vote for or against policies providing for the appointment of a lead director, ISS focused on the substance of the corporation’s policy for the appointment and duties of the lead director, rather than on whether the exact language used in the policy was consistent with the language promulgated by ISS in its guidelines.
In the 2012 proxy season, ISS followed a different approach and took issue with a number of corporations’ policies on the basis of the language used to describe the duties of the lead director. For example, ISS no longer considers companies granting a lead director the responsibility to consult or review board materials to be in compliance with its policy that the lead director have the authority to “approve” such materials.
Based on this change in practice, boards that have adopted lead director policies should review the precise wording of the policies and consider rewording the description of the duties to more closely align with the ISS guideline language.
Ability to Call Special Meetings
Along with efforts to declassify boards of directors and permit shareholders to act by written consent (discussed below), an area of focus for proxy advisory firms and activist shareholders has been advocating for proposals that permit shareholders to call special meetings, and boards are advised to be prepared with a management proposal regarding the ability of shareholders to call special meetings.
A management proposal can serve as the basis for excluding a shareholder proposal from the company’s proxy pursuant to SEC Rule 14a-8(i)(9), which allows a company to exclude shareholder proposals that conflict with management proposals, and can be drafted to incorporate critical protective features that most shareholder proposals lack. However, if a board determines to put forth a management proposal too late in the process, it could be difficult to solicit the requisite input from significant shareholders and proxy and legal advisors.
Thus, whether or not a corporation is expecting to receive a shareholder proposal regarding the ability of shareholders to call special meetings, it may be advisable to give advance thought to the contours of the management proposal so that the company can react quickly in the event that such a proposal is received.
ISS recommends that shareholders vote in favor of proposals that provide shareholders with the ability to call special meetings, taking into account a number of factors, including:
- shareholders’ current right to call special meetings;
- minimum ownership thresholds necessary to call special meetings;
- the inclusion of exclusionary or prohibitive language;
- investor ownership structure; and
- shareholder support of, and management’s response to, previous shareholder proposals.2
On the question of the percentage of the corporation’s outstanding shares that should be required to participate in the request that the corporation convene a special meeting, ISS policy indicates a preference for a 10 percent threshold, which is consistent with many recent shareholder proposals. Many companies and shareholders regard a higher threshold, as high as 25 percent, as being more appropriate.
In addition, ownership may be defined to include only “record” ownership (as opposed to beneficial ownership) and to incorporate a “net long ownership” concept, which accounts for short-positions and the use of derivative instruments that reduce economic exposure. Shareholders can also be required to provide disclosure regarding their short-positions and any hedging transactions that may impact their economic exposure.
Another procedural feature to consider is to require shareholders to hold their shares for a minimum period of time before being able to submit a request to convene a special meeting. Separately, a company can set blackout periods during which a special meeting will not be convened (e.g., within a period of time before or after the annual meeting).
An important corollary issue boards of directors should consider is whether the right to call special meetings should be included in the company’s charter, bylaws, or both. A bylaw amendment can be implemented without delay and without the need for a shareholder vote. A charter amendment requires shareholder approval.
Provisions included in the charter are less subject to change, as both board and shareholder approval would be required for a subsequent charter amendment. One approach is to include key provisions, such as a minimum ownership threshold, in a charter amendment but to include other provisions in the bylaws so that the board retains greater flexibility to modify them in the future.
Regardless of how the board chooses to proceed, shareholders may subsequently propose to reduce the minimum ownership threshold, but such proposals have generally received less support than proposals for the right to call special meetings in the first instance.
Shareholder Action By Written Consent
In the 2012 proxy season, shareholders submitted a number of proposals seeking the right to act by written consent, which generally received strong shareholder support. Proxy advisory firms and shareholders have sought the implementation of the right to act by written consent as part of the same corporate governance trend driving proposals for rights to call special meetings. Directors anticipating that they may receive a shareholder proposal requesting the right to act by written consent should consider their best course of action taking into account any existing or contemplated rights for shareholders to call special meetings.
Granting shareholders the right to call a special meeting rather than the right to act by written consent may offer several advantages and may satisfy the underlying governance concerns driving the shareholder proposals. In particular, the right to call a special meeting may provide shareholders with a means to effect corporate actions between annual meetings in a more orderly and less coercive manner than action by written consent, with better notice and disclosure requirements and allowing for more planning and predictability.
ISS generally recommends that shareholders vote in favor of proposals that provide shareholders with the right to take action by written consent, but recommends a case-by-case vote on proposals to act by written consent if the following criteria are satisfied:
- a right for shareholders to call special meetings at a 10 percent threshold without restrictions on agenda items or the number of shareholders who can group together to reach the 10 percent threshold and with only reasonable limits on when a meeting can be called (no greater than 30 days after the last annual meeting and no greater than 90 days prior to the next annual meeting);
- a majority vote standard in uncontested director election;
- no nonshareholder-approved poison pill; and
- an annually elected board.
ISS suggests that shareholders consider a number of factors when considering a proposal to grant shareholders the right to act by written consent, including:
- shareholders’ current right to act by written consent;
- the consent threshold;
- the inclusion of exclusionary or prohibitive language;
- investor ownership structure; and
- shareholder support of, and management’s response to, previous shareholder proposals.3
The considerations that apply with respect to setting a minimum ownership threshold to initiate a consent solicitation are generally the same as those discussed above with respect to shareholders’ right to call special meetings.
Of equal importance to the minimum ownership threshold are certain procedural elements designed to provide for an orderly consent solicitation process. The corporation can require that notice be given to the board ahead of any action by written consent so that the board has an opportunity to set a record date for determining the shareholders entitled to take part in the action by written consent. Setting a record date, rather than relying on the corporate law default record date, which in Delaware is the first date on which a signed written consent is delivered to the corporation, helps ensure that there is a known and predictable timeline for the consent solicitation.
The board may wish to require the disclosure of information with respect to the shareholders initiating the consent solicitation and may require them to solicit the consent of all of the corporation’s shareholders in accordance with the SEC’s proxy rules.
Although the proposed SEC Rule 14a-11 mandating proxy access was vacated by the U.S. Court of Appeals for the D.C. Circuit in July 2011, the related amendments to the shareholder proposal Rule 14a-8(i)(8) permitting shareholders to make proposals related to election or nomination procedures of companies survived. As a result, the 2012 proxy season was the first year that shareholders submitted proxy access proposals under Rule 14a-8.
Proxy access refers generally to the ability of shareholders to include information about shareholder-nominated nominees for director to be included in the corporation’s proxy statement and proxy card. The ability to do so significantly reduces the costs for shareholders to create and distribute soliciting materials for their nominees by causing the corporation to do so on their behalf.
Like the right to call special meetings, proxy access bylaws are likely to become a focus of proxy advisory firms and shareholders as ways to enhance the right of shareholders to participate in and exercise control over the corporation’s affairs. While there is little value in boards adopting proxy access bylaws in advance of receiving a shareholder proposal, it is nevertheless time well spent for boards to discuss features of a proxy access bylaw they would find acceptable. The most obvious provision is the requisite ownership level for a shareholder to include nominees in the company’s proxy statement.
Proxy access proposals received during the 2012 proxy season ranged between 1 percent and 3 percent, with only proposals at the 3 percent level receiving significant support. Relatedly, corporations should consider whether to include a net long ownership definition to ensure the applicable shareholders have sufficient economic exposure in the shares owned. Other provisions to consider include establishing a deadline for receipt of nominations by the company, eligibility requirements for nominees, and required information about the nominees and the nominating party.
As boards of directors look forward to the 2013 proxy season, it is important that they review the proposals received by companies in their sector during the 2012 proxy season and prepare accordingly. The proposals discussed in this note are likely to continue to be submitted by activist shareholders, and supported by proxy advisory firms, so directors will be well served to consider responses to such proposals in advance or, better yet, take action now that might preempt any need to respond.
Frank Aquila and Krishna Veeraraghavan are partners, and Marc Morgenthau is an associate, at Sullivan & Cromwell LLP’s New York office. This article is based on a memo entitled “2012 Proxy Season Review” published by Sullivan & Cromwell LLP.
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