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January 10, 2006

Majority-Vote Director Election Shareowner Resolutions To Top 100, Dominate Proxy Season
    by William Baue

A memo from corporate law firm Wachtell, Lipton, Rosen & Katz opines that majority-vote elections will become universal, but shareowners still seek proxy access to nominate directors.

SocialFunds.com -- As the 2006 proxy season is taking shape, majority-vote director elections (in contrast to the current standard practice whereby directors need secure only one vote to be elected) is emerging as one of the biggest issues on corporate ballots. The issue came to the fore last proxy season as investors grew restless with the US Securities and Exchange Commission (SEC) postponing (seemingly ad infinitum) implementation of its October 2003 rule proposal to allow shareowners access to the proxy to nominate board candidates. Of the 79 majority vote shareowner resolutions filed for the 2005 proxy season, 55 went to vote with average support of 43 percent, according to Georgeson Shareholder, which tracks shareholder activity for companies.

This year, the number of shareowner resolutions seeking majority vote director elections is set to exceed 100, according to Institutional Shareholder Services (ISS). Driving this increase are unions such as the United Brotherhood of Carpenters and Joiners (which has filed 66 such resolutions), the American Federation of State, County, and Municipal Employees (AFSCME), and the Sheet Metal Workers International Association (SMWIA).

"The landscape of director elections is shifting in important ways," state David Katz and Laura McIntosh, attorneys at Wachtell, Lipton, Rosen & Katz, a law firm that specializing in representing corporations on governance issues, in a December 29, 2005 memo. "For the second year in a row, it appears that the issue of majority voting in the election of directors will dominate the proxy season."

"In light of the hardening of the position of shareholder activists and the now-unstoppable momentum toward majority voting for directors, it is advisable for companies to consider carefully whether their individual circumstances indicate a persuasive reason to resist the trend," continue Mr. Katz and Ms. McIntosh in the memo. "It appears clear that, given the high level of shareholder support, the strong commitment of influential institutional shareholders and institutional shareholder advisory services, and the lack of powerful opposition, majority voting will become universal."

The memo notes three responses taken by companies to majority voting shareowner resolutions: rejecting majority voting, implementing majority voting, or the compromise solution of asking directors who do not receive a majority of "for" votes to resign from the board. Pfizer (ticker: PFE) engineered this tactic in June 2005, and nearly 30 companies have since followed suit.

"This approach has many advantages, the most important of which is that the board retains flexibility in handling situations in which an immediate resignation would lead to the loss of a key board member, such as the CEO, the chairman of the audit committee or another independent director," state Mr. Katz and Ms. McIntosh in the memo.

The complexity of the majority voting landscape is matched by the complexity of voting strategies and recommendations on the issue. ISS issued a 2006 policy update noting that it will recommend voting against majority vote resolutions if the company has implemented a "meaningful alternative," outlining what elements this alternative must entail. These elements include annual proxy statement disclosure of guidelines for nominees who receive less than a majority of votes; a clear decision-making timetable regarding a nominee's status; management of the process by independent directors, excluding the nominee in question.

ISS subsequently clarified this position. A Question and Answer document on its website, notes that these elements represent "'bare minimum requirements' that directors must meet in order for ISS to even consider whether their proposed 'alternative' is equal to or better than a majority voting proposal."

"To the question of what would constitute a meaningful alternative or effective equivalent to majority voting, ISS suggested that it is 'too early to tell,'" states Mr. Katz and Ms. McIntosh in the memo. "As a practical matter, therefore, it is not clear that ISS's carefully crafted policy in fact differs from the approach of activist institutional shareholders."

The Council of Institutional Investors (CII), an organization of over 140 public, corporate, and union pension funds with more than $3 trillion in investments, supports majority-vote elections, as CII Executive Director Ann Yerger explained in a May 2005 letter to 1,500 companies. So does the California Public Employees Retirement System (CalPERS), which announced in a March 2005 press release its multi-pronged approach, including advocating for company bylaw and charter amendments, state law changes, and SEC support for the concept.

AFSCME has taken this a step further. In addition to filing binding majority vote resolutions at several companies (most shareowner resolutions are "precatory," or non-binding), AFSCME filed a lawsuitlawsuit against American International Group (AIG) in the Second Circuit of the US Court of Appeals. AFSCME is seeking a judgment requiring AIG to place a binding resolution on its proxy ballot seeking access to the proxy to nominate directors (SEC staff had allowed AIG to exclude the resolution from its ballot.)

The suit is winning friends in high places. A group of five Harvard Law professors has filed an Amicus Curiae (or "friend of the court") brief supporting AFSCME's position.

"AIG argued, and the District Court erroneously accepted, that the AIG may exclude the Proposal as one that 'relates to an election for membership on the company's board of directors,'" state the Harvard professors in the brief. "This exclusion provision should be understood as permitting the exclusion of proposals that relate to the election of a particular individual to membership on the board of directors."

"This exclusion should not be understood as permitting the exclusion of 'rules-of-the-game' provisions that do not relate to the election of a particular individual but rather to the procedural and substantive rules that govern the election process," they continue.

This suit reveals the high stakes of the director election process. Ironically, the imminent universality of majority vote director elections represents only a partial victory for shareholder activists, as it falls short of gaining access to the proxy to nominate director candidates. In this sense, companies may prefer to grudgingly accept majority vote elections as a partial defeat to avoid a more complete "defeat" of losing domination over the board member nomination process.

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