February 16, 2010

RiskMetrics’ FAQs on SEC’s New Disclosure Requirements

Last week, RiskMetrics posted three FAQs to address how their voting policies apply to the SEC’s new rules. These FAQs address:

– What will RiskMetrics be looking for in the new disclosure requirement on risks raised by compensation programs? In particular, how will RMG react to non-disclosure?

– How will RMG analyze compensation consultant fee disclosures? Will RMG apply some type of formula where concerns will be raised if fees for other services exceed fees for compensation consulting?

– Regarding the new disclosures on director qualifications, diversity policies, and board leadership and oversight of risk management, what are RMG’s views and the prospects for related voting recommendations?

In his “Proxy Disclosure Blog,” Mark Borges discusses these new FAQs.

Delaware Chancery Court’s Groundbreaking Decision: “Brokers” as Recordholders

Here is some news from John Grossbauer of Potter Anderson:

Last Tuesday, Delaware Vice Chancellor Laster delivered a potentially important opinion in Kurz v. Holbrook. In it, VC Laster finds valid consents delivered without the consenting party having obtained an omnibus proxy from DTC. The Vice Chancellor held this did not invalidate the consents, because the Cede breakdown is part of the stocklist for Section 219 purposes. In other words, brokers are now “record holders” of Delaware corporations for all purposes. This has potentially significant consequences for consent practice and compliance with notice requirements.

He also invalidates a bylaw that purported to reduce the size of the board and to call a special meeting to elect the single remaining common director, finding this would not comport with any of the valid methods for ending the term of an incumbent director. He does say that a bylaw that would reduce the size of the board at an annual meeting could effectively end the term of directors not reelected at that meeting.

We are posting memos analyzing this opinion in our “Stockholder Lists” Practice Area.

Showdown Over Special Meetings

Below is some recent commentary from RiskMetrics’ Ted Allen:

More than a dozen U.S. companies plan to offer management proposals this year to give shareholders the right to call special meetings. While one might expect that investors would welcome these reforms, shareholder activists are crying foul because these management bylaw (or charter amendment) proposals have higher ownership thresholds than those that many investors say they prefer.

In virtually all of these cases, the companies are acting in response to a recently filed shareholder proposal that requests a 10 percent (of outstanding shares) threshold, and/or a similar investor resolution that received majority support in 2009. Most of the companies are seeking a 25 percent threshold, although a few issuers have proposed different percentages such as Honeywell International (20 percent), and Medco Health Solutions (40 percent).

Companies have offered various arguments in support of a 25 percent threshold. Some issuers point out that 25 percent is more appropriate for their circumstances because there are several institutions that own more than 5 percent of their shares. They contend that a higher threshold would deter nuisance requests and force a hedge fund to seek broader support before requiring a company to incur the expense of holding a special meeting.

However, most shareholders won’t have an opportunity this year to choose between the competing thresholds because many issuers are obtaining permission from the staff of Securities and Exchange Commission’s Corporation Finance Division to omit the investor resolutions. In their no-action requests, the companies are successfully citing SEC Rule 14a-8 (i)(9), which bars a shareholder proposal that would directly conflict with a management resolution that the company plans to present at the same meeting.

Under that rule, an investor resolution may be excluded if it and the management agenda item present “alternative and conflicting decisions for shareholders.” In a 1998 rulemaking release, the SEC explained that the proposals don’t have to be “identical in scope or focus” for a company to exclude the shareholder resolution.

Among the companies that have successfully used the (i)(9) argument recently to exclude special meeting proposals are: CVS Caremark, Medco, Honeywell, NiSource, Baker Hughes, Becton Dickinson & Co., Eastman Chemical, and Safeway. In addition, Time Warner, Genzyme, Bristol-Myers Squibb, International Paper, Pinnacle West Capital, and Liz Claiborne Inc. have filed similar no-action requests to exclude proposals with a 10 percent threshold, according to investors.

Meanwhile, AT&T is trying to exclude a 10 percent special meeting resolution under a different SEC rule–14a-8(i)(10)–by arguing that it has “substantially implemented” that proposal. The company’s board approved a 15 percent bylaw on Dec. 18.

The special meeting proposals are part of a successful multi-year campaign by Nick Rossi, William Steiner, and other retail investors affiliated with John Chevedden, a long-time shareholder activist based in southern California. Overall, 31 special meeting proposals filed by investors received majority support in 2009, according to RiskMetrics Group data. Of the 14 companies that so far have sought to exclude proposals under Rule 14a-8 (i)(9), 10 had special meeting proposals that earned majority support last year.

Until last year, not many companies had tried to use (i)(9) to knock out shareholder proposals. In the past, companies often have responded to broadly supported shareholder resolutions by adopting governance policies or bylaws (that may be more restrictive on investors) and then arguing under Rule 14a-8 (i)(10) that they had “substantially implemented” those proposals. However, corporate lawyers shifted their strategy last season after the SEC staff rejected (i)(10) arguments by AMN Healthcare, Allegheny Energy, and Becton Dickinson to exclude special meeting proposals. After switching to (i)(9) arguments later in the proposal filing season, lawyers for H.J. Heinz, International Paper, and EMC successfully won no-action relief.

In letters to the SEC opposing the recent wave of no-action requests, Chevedden argues that the management and shareholder proposals do not directly conflict because they would allow investors to choose between two different thresholds. “Management should not be allowed to short-circuit that sort of dialogue between shareholders and the board by letting a defensive maneuver trap an otherwise legitimate shareholder proposal,” he wrote in a Dec. 30 letter in response to Medco’s no-action petition.

He also complains that the SEC staff is allowing companies to mislead investors, who may logically assume that the management proposal will enhance their rights. “When shareholders are given the ‘opportunity’ to vote on a weak management version of this topic in order to prevent them from voting on a stronger shareholder proposal on the same topic, the shareholders who learn of this context may view this as a subtraction from their rights,” he wrote in a Dec. 18 letter on Medco’s no-action request.

Chevedden contends that some companies (where the board may adopt bylaws without shareholder consent) are holding unnecessary investor votes on special meeting bylaws just to thwart the 10 percent proposals filed by investors. He also expresses concern that companies will be able to avoid votes on future investor resolutions on special meetings by offering management proposals with different (such as 35 or 50 percent) percentages each year.

Cornish Hitchcock, a Washington-based attorney who represents the Amalgamated Bank and other labor investors in no-action matters, said the volume of exclusion requests under (i)(9) this season has been a “little surprising.” He recalled that the SEC staff has rejected a few no-action petitions based on that provision, such as last year when the staff concluded that a retail investor’s “say on pay” proposal at Bank of America did not directly conflict with the company’s federally mandated advisory vote, because the shareholder resolution sought an advisory vote every year.”Some clarification [from the SEC staff] would be useful about what companies can and cannot do under (i)(9),” Hitchcock said.

So far, the SEC staff has not provided a detailed explanation on how it is interpreting Rule 14a-8(i)(9) this season. In ruling on no-action requests, the agency staff typically issues a one-page memorandum stating whether it concurs with any of the issuer’s arguments. Chevedden and his fellow investors have asked the SEC staff to reconsider its rulings on the CVS, Medco, Honeywell, and Safeway no-action petitions. On Dec. 22, the staff rejected his request to reverse its Becton Dickinson decision.

It remains to be seen how institutional investors will react to the companies that have proposed a 25 percent threshold for special meetings in response to majority-supported 10 percent provisions. Based on responses to a recent policy survey, RiskMetrics’ institutional investor clients were divided over what shareholders should do. Of the approximately 100 institutions that responded, just 33.7 percent of endorsed the management approach by saying they would support the management proposal and not withhold support from directors.

However, a majority of the respondents indicated that there should be some negative consequences for management, but they split over how to express their concern: 34.7 percent said they would oppose the management proposal and the board; 16.3 percent said they would support the management proposal but oppose the board; and 15.3 percent said they would oppose the management proposal but support the board.

– Broc Romanek