July 25, 2006

The SEC’s New Chief Accountant

Yesterday, SEC Chairman Cox appointed Conrad Hewitt as the SEC’s new Chief Accountant. Hailing from Cox’s home state of California, where he last served as California’s Superintendent of Banking – Conrad has been retired for about 8 years, not typical for a Chief Accountant. Conrad currently serves on several boards and was a managing partner for Ernst & Young for 23 years.

California Senate Amends Its Majority Vote Bill

At the end of June, the California majority vote bill wound its way through the Senate – SB 1207 (Alarcon) – and was amended. This bill would facilitate the ability of listed companies incorporated in California to amend their by-laws or articles to provide for the election of directors by a majority vote. Before amendment, the bill had required use of majority – rather than plurality – voting to elect a director of a publicly-traded, listed California corporation in an uncontested election and would have required an incumbent director who failed to receive a majority vote in an uncontested election to resign within 90 days of the election.

The bill supporters include CalPERS, CalSTRS, AFSCME and SEIU. In opposition to the mandatory requirements are American Electronics Association, California Bankers Association, California Business Roundtable, California Chamber of Commerce, California Hospital Association, the State Bar of California Corporations Committee of the Business Law Section and the United Hospital Association.

The “Skinny” on the California Bill Amendments

Our California law expert, Keith Bishop, provides this analysis: “There is a quite a bit of irony attached to this bill. For better or worse, California’s General Corporation Law has been highly supportive of cumulative voting. In fact, the opportunity to vote cumulatively is mandated for nearly all California corporations and for those foreign corporations that are subject to California’s pseudo-foreign corporation statute (Corporations Code Section 2115). It was many years after the adoption of the CGCL that the legislature finally relented to permit NYSE, AMEX and Nasdaq National Market listed issuers to eliminate cumulative voting.

One consequence of California’s strong attachment to cumulative voting is that the CGCL has carefully drafted provisions regarding the removal of directors. Under Corporations Code Section 303(a), any or all of the directors may be removed without cause by the outstanding shares (i.e., the affirmative vote of a majority of the shares entitled to vote). For example, if a corporation has 100 shares outstanding, removal requires at least 51 affirmative votes. Furthermore, no director may be removed (unless the entire board is removed) if the votes cast against removal or not consenting in writing to removal, would be sufficient to elect the director if voted cumulatively at an election at which the same total number of votes were cast (or if the action is taken by written consent, all shares entitled to vote were voted). While this may sound complicated, the idea is not. Without such a requirement, the holders of a majority block could remove a director elected under cumulative voting. This, of course, would make cumulative voting illusory.

SB 1207 in its current form would gut these protections by allowing a corporation to amend its articles or bylaws such that in uncontested elections “approval of the shareholders” would be required to elect a director. Under the CGCL, “approval of the shareholders” means approved by the affirmative vote of a majority of the shares represented and voting at a duly held meeting at which a quorum is present (which shares voting affirmatively also constitute at least a majority of the required quorum). For example, if a corporation has 100 shares outstanding and 51 are present at a meeting, then a director would need to obtain at least 26 votes to be elected. Thus, directors could be in effect removed by as few as 26% of the shareholders. Further, SB 1207 would allow these changes to the articles of bylaws to be effected by approval of the shareholders rather than approval of the outstanding shares.

Cumulative voting and majority voting are fundamentally incompatible. In fact, Hewlett Packard recently cited cumulative voting as a basis for opposing a stockholder majority vote proposal: “The HP policy also gives stockholders a meaningful role in the director election process without interfering with cumulative voting. The ability to cumulate votes in director elections is universally recognized as protecting stockholder rights. A majority voting standard may raise difficult issues in the context of cumulative voting. While the rules governing plurality voting are well understood, majority voting at companies that have cumulative voting presents technical and legal issues for which there is no precedent. These difficulties have led the American Bar Association Committee on Corporate Laws, the Council of Institutional Investors and the Institutional Shareholder Services Institute for Corporate Governance to indicate that majority voting should not apply to companies that allow cumulative voting. HP’s voting system must be a reliable process for the election of qualified directors to represent the interests of all of our stockholders. In the absence of uniform, workable standards that can be consistently applied by all companies and that take into account the special circumstances of companies with cumulative voting, HP believes it would be inappropriate to adopt a majority voting standard.”

Given the negative impacts of SB 1207 on cumulative voting, I find it ironic that this bill is being sponsored by CalPERS. By statute – Government Code Section 6900 – CalPERS is required to vote its shares to permit or authorize cumulative voting.”