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— Industry Insight —
Recent developments have set the stage for increased effectiveness and expanded use of "just vote no" campaigns in uncontested director elections. In the past, these low-cost campaigns were better suited to shareholders seeking governance reform than those pursuing changes in management or corporate strategy. In 2010, however, just vote no campaigns are likely to be used more frequently, and with greater success, to push for management and strategy changes. In some cases, just vote no campaigns may serve as viable alternatives to "short slate" proxy contests by hedge funds and institutional shareholders. In uncontested director elections, shareholders voting by proxy can either grant authority to vote "for" the board's nominees or to "withhold" voting authority. Just vote no campaigns seek to withhold as many votes as possible from management's board nominees who have been targeted. By achieving a compelling withhold vote, which may be more or less than a majority of the shares voted, the campaign aims to send a strong message to the company's board of directors that shareholders are dissatisfied with some aspect of governance, management or corporate strategy. On the surface, this tactic does not appear particularly threatening to corporate boards and managements. Unlike a short slate proxy contest, where the proponent nominates opposition candidates for a minority of a company's board seats, a just vote no campaign is simply a referendum on management's board nominees, with no guarantee that a successful campaign will result in change. In addition, the longstanding rules and practices that have governed proxy voting in uncontested elections have been biased in favor of management's nominees.
Nonetheless, there is more than anecdotal evidence that just vote no campaigns can lead to corporate change. One recent study, "Do Boards Pay Attention When Institutional Investor Activists 'Just Vote No'?," by Diane Del Guercio, Laura Seery and Tracy Woidtke, found that campaigns motivated by firm performance and strategy concerns, rather than by general governance practices, resulted in boards taking a variety of value-enhancing actions, including replacement of the CEO (in 31% of the target companies studied) and other strategic changes (in 50% of the targeted companies that did not dismiss their CEOs). Just vote no campaigns can be substantially less expensive than a proxy contest, take less time to manage and avoid potential disadvantages of nominating candidates. Because there is no opposition slate, attention remains focused on the concerns motivating the campaign and is not diverted by attacks on the experience and leadership qualities of opposition nominees. In addition, by not proposing a slate, the shareholder leading the fight does not risk subjecting itself to potential restrictions and liabilities that may result if one or more of its nominees are elected to the board, such as trading restrictions, fiduciary duty issues, conflict of interest concerns, and reporting obligations and short-swing profit liability under Section 16 of the Securities Exchange Act of 1934. Starting in 2010, two important developments are likely to increase the potency of just vote no campaigns. First, an amendment to New York Stock Exchange Rule 452, which affects all public companies regardless of the exchange on which they are listed, has leveled the playing field by eliminating the bias in favor of management's board nominees in uncontested elections. And second, today's environment places a much greater emphasis on corporate governance and shareholder democracy, a trend that has only been encouraged by public opinion following this year's massive government bailouts of public companies in the financial and automotive industries. Together, these two developments are likely to lead to higher withhold votes in well-run campaigns and a greater inclination in the boardroom to act on the message that has been sent. Currently, in uncontested director elections, brokers who hold shares for clients are permitted to vote those shares at their own discretion if they do not receive timely voting instructions from their clients. Since many brokers automatically vote these "uninstructed" shares in favor of management's nominees, uncontested elections generally result in an artificially high vote for management's nominees and a correspondingly low withhold vote. At times, broker discretionary voting has been very significant. For example, as a result of the highly successful just vote no campaign against chairman and CEO Michael Eisner at Walt Disney Co.'s 2004 annual meeting, 45% of the votes cast on Eisner's re-election to the board were withhold votes; had broker discretionary voting not been permitted at that time, the withhold vote would have been 54% of the votes cast. For shareholder meetings starting in 2010, amended NYSE Rule 452 will prohibit brokers from voting uninstructed shares in uncontested elections. As a result, the percentage of withhold votes will no longer be artificially depressed, and a just vote no campaign should have at least the same chance of success in the balloting as a proxy contest to replace the targeted directors. In fact, because many shareholders may be willing to send a "message" to the board through a just vote no campaign but may not be prepared to replace directors through a proxy contest, a just vote no campaign may have even greater chances of success than a proxy contest waged over the same issues. The key to running a low-cost, easily manageable campaign is qualifying for and complying with one or more exemptions from the SEC's proxy rules. If an exemption is available, a shareholder can solicit against management's nominees without having to produce a proxy statement, "clear" it through the SEC or mail it to shareholders. Another important development for the 2010 proxy season relates to the principal exemption from the proxy rules under which just vote no campaigns are conducted. A pending SEC proposal, likely to be adopted, would allow shareholders to distribute unmarked copies of management's proxy card and still be eligible for the exemption. Assuming this amendment is adopted, shareholders will be able to mail a proxy card together with a "fight letter" urging shareholders to "vote no." While this tactic may add somewhat to the relatively low cost of a just vote no campaign, it may also make such a campaign much more likely to succeed. Just vote no campaigns have the potential to be more potent than ever in 2010, creating low-cost opportunities for shareholders seeking corporate change and new concerns for boards and managements that are vulnerable to shareholder action. Leaving the ultimate decision up to the board is both their weakness and their strength: weakness because such campaigns cannot force a board to act and strength because the message is not muddied, as in an election contest, by concern on the part of shareholders that the cure of replacing directors might be worse than the disease. Just vote no campaigns can be a powerful tool for catalyzing corporate change, but they are not suitable for every situation and must be carefully planned and executed to stay within the proxy rule exemptions and to be effective. The strength of the message sent to a company's board depends both on the size of the withhold vote and the clarity of the issues driving the campaign. While boards of directors are not required to act on a clear message backed by a sizeable withhold vote, directors put their reputations on the line when such a call goes unheeded. From the shareholder perspective, just vote no campaigns are relatively easy to run and are substantially less costly in time and money than election contests. From the perspective of boards and managements, since a shareholder has chosen to pursue a just vote no campaign rather than an election contest may indicate some level of faith in the wisdom of the board to "do the right thing" as the shareholder sees it and may present an opportunity for dialog and a less contentious outcome. Michael A. Schwartz is a partner in Willkie Farr & Gallagher LLP's Corporate and Financial Services Department in New York. |
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