The U.S. Securities and Exchange Commission’s recently finalized rule requiring a universal proxy card (UPC) in all contested director elections is expected to affect the way future proxy contests and board elections are strategized and conducted.
To better understand what the UPC means for boards and nominating committees, Julie Daum, leader of Spencer Stuart's North American Board Practice, recently hosted a virtual discussion featuring:
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Benjamin Colton, Global Head of Asset Stewardship, State Street Global Advisors
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Derek Zaba, Partner and Co-Chair of Sidley’s Shareholder Activism Practice
- Ann Yerger, Adviser in Spencer Stuart's North American Board Practice
Panelists shared the following observations about the potential impact of the new rule, which was effective Sept. 1, 2022:
1) Director elections may be more “personal”
Before the rule change, shareholders voting by proxy generally had to vote for one slate or the other but could not mix directors from different slates. According to Zaba, under this system, investors first decided whether they supported management’s vision for the company or the shareholder’s before considering individual candidates. As a result, if the shareholder’s nominees won, “You had a clear indication that people made a decision to support the dissident’s thesis,” he said.
With a universal proxy card, however, shareholders may vote for any candidate, and it may be less clear whether they are supporting a specific vision for the company or just prefer the qualifications of certain directors.
“We'll see a situation where the dissident thesis is mostly wrong, maybe a little bit right, but they found a great independent director. And there's somebody with a similar skill set on the board who does not have the resume or come across in the meetings nearly the same,” Zaba said. “Some investors will be very tempted to put that director on the board, and that director’s election may be interpreted as some sort of a mandate for a dissident platform but that really isn't what the majority of shareholders supported.”
State Street will continue to ground its voting decisions on its evaluation of long-term strategic vision. Barring a history of governance failures, if it agrees with management’s plan, State Street will defer to the nominating/governance committee and its nominations, said Colton. “It is the job of the nom/gov committee to properly vet and determine which directors are best placed,” he said. “It's not our job as investors to replicate the work that's already been done by the nom/gov committee.”
2) Settlement fever may intensify
Few challenges culminate in a proxy contest. More often, a settlement is negotiated. Zaba believes the universal proxy rule change is likely to encourage investors challenging management to seek more board seats than in the past, under the assumption that boards will be uncomfortable with the increased uncertainty and more willing to settle. Zaba expressed a fear “that activists will increase their demands and basically not be willing to take some of the same settlements that they were willing to take before,” he said.
Colton agreed. “I fear that one of the unintended consequences is, indeed, an increase in settlements. The other thing that we're concerned about in terms of settlements is it disenfranchises the voice of long-term shareholders. We do prefer when situations go to the vote rather than having these settlements.”
3) Proxy adviser influence may increase
Another potential outcome of the UPC is that proxy advisers may increase their influence. “The bigger institutions generally have teams that make their own decisions. But there's a lot of smaller institutions, and they can make up to 20 percent of a company’s share base,” said Zaba. “You'll see a lot of these smaller institutions relying on the proxy advisers because they're frankly in a better position to evaluate individual director nominees. They've spoken to these folks.”
Yerger agreed, noting that shareholders will now be able to execute recommendations by proxy advisers to split their vote between management and investor slates, which they could not do before unless voting in person.
Preparing for the rule change: what boards can do
The jury is out on the impact of the UPC, but in light of some of the more likely outcomes, nom/gov committees and individual directors can take some actions now.
Review bylaws. Nominating/governance committees should review advance notice and other bylaw provisions to ensure orderly processes. Changes could include setting requirements for inclusion on a universal proxy card or requiring shareholder candidates to be interviewed by the nom/gov committee, according to Zaba.
Know your investors. “Every board needs to know who their shareholders are,” said Yerger. “They need to understand that different investors have different structures for proxy voting. Boards should understand these differences and engage strategically with portfolio managers and the stewardship teams.” And investors want to hear proactively from companies ― before they are facing a challenge.
“I think ‘sunny day engagement’ is incredibly important,” added Colton. “Even if we're not taking the meeting, we are tracking which companies reach out every year. So, even though we haven't taken a meeting, we know they're open to engagement. That's incredibly important.”
And, in an environment in which directors will increasingly be evaluated individually, directors may benefit from engaging with shareholders, especially when there isn’t a specific issue on the table. “I do think it will be more important for directors to be part of those direct engagements with investors. Having those discussions and being known and developing those relationships is going to be more important because these contests are going to be more personal,” Zaba said.
Focus on board refreshment. Nominating/governance committees should pay even more attention to board refreshment, director skill sets and related disclosures. “It’s going to be particularly important to be much more focused and thoughtful about how [boards] are doing their board assessments and board refreshment processes,” Zaba said. Committees may even want to take the extra step of looking at the board from an activist perspective, considering the types of skills they might put forth based on their thesis for the company.
Provide credible, proactive shareholder communication. Nom/gov committees should think about the narrative being publicly provided about the board composition. “Ensure disclosures are useful,” said Yerger. Board matrices in which every director checks every box are generally not considered meaningful, so practices such as carefully defining what experience qualifies for different categories or limiting the number of categories directors may select can help enhance matrix disclosures.
It also will be important for individual directors to be able to articulate the value they bring to the board. Said Colton: “When you're joining a board, when you're on a board, it's even more important to think of exactly how you would articulate your value ― not only in terms of the value to the company, but also how it relates to other people on the board.”
Conclusion
It is too soon to know exactly how the UPC will impact director elections, but our panel predicted that boards should prepare for more personal director elections, increased pressure for settlements and growing proxy adviser influence. Preparations may include updating bylaws to minimize the disruption from shareholder slates, understanding the different proxy voting structures of investors and engaging strategically and proactively with investors ― including articulating the value that each director brings to the board.