On May 23, 2007, the New York Stock Exchange (NYSE) revised a previously proposed amendment to Rule 452 ("Giving Proxies by Member Organizations"), the NYSE rule that governs when brokers may submit proxies without having received voting instructions from their clients. The proposed amendment would prohibit brokers from exercising "discretionary" proxy authority with respect to uncontested director elections, a change that many fear would be particularly burdensome for mutual funds. The revised proposal would exempt registered investment companies, including both mutual funds and closed-end funds, from this rule change.
Current Rule 452
Rule 452, as currently in effect, permits members of the NYSE to execute and return proxy statements with respect to "routine" shareholder proposals when beneficial owners of shares have not provided specific voting instructions to the broker at least 10 days before a scheduled meeting.
Rule 452 lists, by way of example, eighteen "non-routine" matters (e.g., proposals subject to counter solicitations, proposals relating to mergers, proposals changing the terms of existing stock, etc.). In these instances, a member may not submit a proxy without first receiving shareholder instruction. At present, an uncontested election of directors is generally considered to be routine for purposes of Rule 452. Accordingly, brokers are permitted to authorize proxies on behalf of shares held by their clients who do not provide timely voting instructions.
NYSE Review of Proxy Voting Rules
In April 2005, the NYSE created a Proxy Working Group to review the NYSE rules regulating the proxy voting process, with a particular emphasis on Rule 452. On June 5, 2006, after meetings with a number of interested groups (including the Council of Institutional Investors, the Investment Company Institute and the Securities Industry Association), the Proxy Working Group to the NYSE issued a report and recommendations.
In its report, the Proxy Working Group concluded that "shareholder voting for directors is a critical component of good corporate governance" and that the election of directors should no longer be considered to be "routine." Among its recommendations, the Proxy Working Group proposed that Rule 452 be amended to classify the election of directors as a "non-routine" matter. If adopted, the amendment would eliminate the ability of brokers to exercise "discretionary" voting for the election of directors.
The Proxy Working Groups report acknowledged that this change could increase the cost of director elections, requiring that more time and money be devoted to contacting shareholders. Nonetheless, the Proxy Working Group determined that the election of directors (even in uncontested elections) is not a "routine" matter and that the additional costs and burdens are outweighed by the benefits of better shareholder representation in elections.1
On October 24, 2006, the NYSE filed with the Securities and Exchange Commission (SEC) a proposed amendment to Rule 452 (and corresponding changes to Section 4.02.08 of the NYSE Listed Company Manual) to implement the recommendation of the Proxy Working Group. As initially proposed, the amendment would apply equally to shareholder solicitations by mutual funds and by operating companies.
Effect on Mutual Funds
Prior to and after the NYSE filed its proposed amendment to Rule 452, the Investment Company Institute (ICI) led the charge in opposing the elimination of discretionary voting by brokers in connection with the election of directors of mutual fund companies, arguing that the proposed amendment would have a disproportionately burdensome effect on mutual funds. In letters and presentations to the NYSE (and, later, to the SEC), the ICI explained that mutual funds have a considerably higher retail shareholder base than operating companies and, even under current proxy voting rules, often find it difficult to establish quorums at shareholder meetings.
The ICI contended that the NYSE had not undertaken a meaningful cost/benefit analysis. Elimination of discretionary voting on director elections would be expected to result in additional proxy solicitation costs and adjournments of meetings, without there being any material counterbalancing benefit to fund shareholders. An ICI report estimated that proxy costs would double, causing fund expense ratios to rise by approximately 1 to 2 basis points. Additionally, the election of new directors could be delayed by several months.
May 2007 Revision to Proposed Amendment
As noted above, on May 23, 2007, the NYSE filed a revised proposal to amend Rule 452. In its filing, the NYSE reported that the Proxy Working Group had considered the materials provided by the ICI and other representatives of investment companies. In particular, the Proxy Working Group focused on the disparate impact that the previously proposed amendment would have on mutual funds. The Proxy Working Group also recognized that, unlike operating companies, registered investment companies are subject to additional regulation under the Investment Company Act (e.g., the requirement that shareholders approve changes in fundamental investment policies).
Accordingly, the NYSE has revised its proposed amendments to Rule 452. As currently proposed, the amendment would still add "the election of directors" to the list of "non-routine" matters, but would provide that this change not be applicable to companies registered under the Investment Company Act.
If approved, the proposed amendments will be applicable to proxy voting for shareholder meetings held on or after January 1, 2008, except to the extent that a meeting was originally scheduled to be held in 2007 but was adjourned to 2008.
1 During the Proxy Working Group’s review of Rule 452, the NYSE took action to further tighten the availability of discretionary voting. In September 2005, the NYSE reversed a previous interpretation of Rule 452, relating to the approval of investment advisory contracts for which shareholder approval is required under the Investment Company Act of 1940, as amended. As of September 2005, such proposals are now deemed to be "non-routine" matters for purposes of Rule 452.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.