United States: NYSE Proposes Amendments to Proxy Voting Rules

In April 2005, the New York Stock Exchange (NYSE) impaneled a special committee, composed of representatives from issuers, brokers, the legal community and institutional and individual investors, to review the NYSE rules regulating the proxy voting process, and, in particular, to review and make recommendations with respect to the NYSE’s proxy rules (Rules 450-460 and Rule 465). The committee, dubbed the NYSE Proxy Working Group, issued its preliminary report on June 5, 2006¹.

The report contained six recommendations, including an amendment to Rule 452 — also called the broker-vote rule or the 10-day rule — to make the election of directors a "non-routine" matter that would eliminate the ability of brokers to vote in uncontested director elections without instructions from beneficial owners of securities held in street name. Since one of the regulatory functions of the NYSE is to govern the relationship between member firm broker-dealers and their customers, this proposed amendment would affect not only the director election process of NYSE-listed companies, but also that of other publicly traded companies.

Under the current NYSE and Securities and Exchange Commission (SEC) proxy rules, public companies, brokers and banks must deliver proxy materials to beneficial owners or registered investment advisers and, in return, request voting instructions regarding matters put to shareholder vote. If voting instructions have not been received by the tenth day preceding the meeting date, then brokers may vote on certain matters deemed "routine" by the NYSE. Routine matters, as currently defined by Rule 452, include an "uncontested" election for a company’s board of directors. Though contested elections are rare², the fact that broker-dealers typically vote with management in director elections increases the likelihood under current Rule 452 that management nominees are elected as directors. The Proxy Working Group determined that the election of directors should no longer be viewed as a "routine" matter and recommended that brokers no longer be permitted to vote uninstructed shares for the election of directors.

On "non-routine" matters, which generally involve a matter that may substantially affect the rights or privileges of stockholders, NYSE rules prohibit brokers from voting without receiving instructions from the beneficial owners. "Non-routine" matters include, among other things, items such as stockholder proposals and mergers or consolidations. Rule 452 was amended in June 2003 to eliminate broker voting on equity compensation plans.

One of the most important results of broker votes of uninstructed shares is their use in establishing a quorum at shareholder meetings. According to estimates provided by the Investor Communications Services Division of Automatic Data Processing, Inc. (ADP), an independent corporation that manages the administrative process of distributing proxy materials and tabulating votes for virtually all brokers and banks, if broker discretionary votes were excluded from the vote tabulation, as many as 20% of NYSE-listed companies may not have been able to achieve a quorum in 2004; this figure could be higher for non-NYSE-listed companies. More generally, ADP estimates that the process by which companies achieve a quorum for ordinary meetings would be considerably more expensive and time consuming if broker discretionary voting were eliminated, and that companies would not know until later in the process whether or not they would be able to achieve a quorum. Given the prohibition on uninstructed broker voting on non-routine matters, the proposed re-classification of director elections from routine to non-routine may have a significant impact on a company’s ability to achieve a quorum at shareholder meetings in which no routine matters are presented. In such a scenario, for example, uninstructed broker votes would not be counted toward determining whether a quorum has been established.

In making its recommendations, the Proxy Working Group recognized that the proposed amendment could significantly impact the director election process and would likely increase the costs of uncontested elections. Issuers may have to spend more money and effort to reach shareholders who previously did not vote. These consequences and costs could fall most dramatically on smaller issuers, who may have a smaller proportion of institutional investors, and other p ublic companies with large percentages of shares held by retail shareholders. Both of these groups of issuers may have greater difficulty contacting previously non-voting or non-instructing shareholders and convincing them to vote in uncontested elections.

It is important to view the recommendations of the Proxy Working Group in light of other proxy reform proposals dotting the corporate governance landscape. The SEC’s proposed amendments to the proxy rules under the Securities Exchange Act of 1934 would permit internet availability of proxy materials and substantially reduce the costs associated with proxy delivery requirements for some classes of issuers³. Similarly, the movement toward a majority-voting standard for director elections is significantly impacted by the proposed amendments to Rule 452. For issuers who have adopted majority-voting rules for director elections, as well as companies that have adopted policies requiring directors to offer their resignation if "withhold" votes outnumber "for" votes, the amended Rule 452 would give shareholders, as a class, increased control over the outcome of director elections by significantly reducing the large block of "for" votes that directors usually receive in uncontested elections. Thus, the relationship between the proposed amendments to Rule 452 and the movement toward majority-voting could increase the power shareholders have over the process of director elections.

In addition to its recommendations regarding an amendment to Rule 452, the Proxy Working Group also recommended changes to Rule 465 relating to the reimbursement of brokers for expenses in connection with communications with beneficial owners of street name securities. This proposal would reduce the potential burden on brokers resulting from amended Rule 452, though it would not offer similar relief to issuers. The Proxy Working Group also recommended that the NYSE:

• take a leading role in efforts to further educate investors about the proxy voting system;

• support efforts to improve the ability of issuers to communicate with beneficial owners;

• continue to evaluate the effectiveness and necessity of broker discretionary voting following the amendment of Rule 452;

• engage an independent third party to analyze and make recommendations regarding the structure and amount of fees paid pursuant to Rule 465; and

• request that the SEC study the role of groups, such as institutional advisory services and proxy voting groups, who make voting recommendations and/or decisions over shares in which they do not own or have an economic interest.

The NYSE Staff seeks comments on the Proxy Working Group’s recommendations from listed companies by the end of June, which it will share with the SEC. After reviewing these comments, the NYSE Board will consider them and any proposed rule changes will then be filed with the SEC; the SEC will then directly solicit additional public comment. Given this timeline, it is possible that any proposed rule changes may be effective in time for the 2007 proxy season.