The nature of contested director elections and the rules governing how shareholders vote in these proxy contests are on the cusp of fundamental change. New regulations issued by the SEC require U.S. companies to use a “universal proxy card” in contested director elections at shareholder meetings held after August 31, 2022.
Previous Proxy Card System
Investors likely understand the limitations of the existing two-card structure which forces shareholders voting by proxy to make an either-or decision: vote on the company’s card, without the ability to vote for any dissident nominees; or vote on the dissident’s card, for some or all the dissident nominees, without the ability to vote for any of the “targeted” incumbent directors who are left off the dissident card. This binary voting structure often gave rise to unintended consequences that shareholders (and proxy advisors) had to consider, thereby potentially altering voting behavior in these pivotal elections for ancillary, technical reasons, which sometimes led to sub-optimal outcomes for both shareholders and companies.
Universal Proxy Card System
Under the universal proxy card structure, the company and dissident parties will continue to produce their own voting card – but regardless of who produces them, each voting card must list all nominees who are up for election, whether they were nominated by the company or the dissident. This enables shareholders to pick and choose among all nominees from either side, using either card, allowing them to vote for the specific combination of directors and the amount of change (i.e. number of dissident nominees) that they prefer or believe is best, while also deciding which, if any, incumbents not to vote for.
Glass Lewis generally supports the use of a universal proxy card due to the enhanced flexibility it provides investors when deciding whether to support management and/or dissident nominees in a contested director election, and because it is expected to largely eliminate the “unintended consequences” problem.
Since the new rules were announced, there has been no shortage of predictions, and in some corners, warnings, of the potential implications of the use of universal proxy cards in practice. Some see more proxy contests ahead, given the perceived lower barriers and costs for activists to nominate alternative director candidates. There is also a belief that the new rules will make it easier for activists to succeed in contested director elections, possibly leading to more settlements before the shareholder vote. Others make a distinction, believing it will be easier for activists to win minority representation but more difficult to win control of a board. Here, we would remind clients that each proxy contest is a unique situation, with any particular campaign shaped and evaluated based on its specific fact pattern and individual set of circumstances.
That said, we would largely agree with the notion that the strategies and tactics employed in proxy contests are likely to alter in terms of how activists think about the “right” number of director candidates to nominate, who to nominate and, perhaps more consequentially, who to target among incumbent directors, now that universal proxy cards are the norm. We suspect it will take several campaigns and possibly a few years before companies, activists, shareholders and advisors fully understand the implications of the universal proxy card.
For our part, we do not expect our overall approach in evaluating proxy contests to change under the universal proxy card system. We would also note that these are not entirely uncharted waters – universal proxy cards are utilized in certain markets outside the United States, including limited use in North America in the past.
All that being said, in order to support any dissident nominee in a proxy contest, we still require the activist to make a compelling case for change and to nominate qualified, unconflicted director candidates who seem better suited to address deficiencies or to facilitate a superior outcome for shareholders. In short, the hurdles we believe an activist must clear in order to win board representation will not be lower under a universal proxy card system.
What Could Change from Universal Proxy Cards?
So what could change? The new rules will potentially make all incumbent directors on a board more vulnerable for replacement, whether they are specifically identified as a targeted director by the activist or not. In a non-classified board situation, this could mean more incumbent directors will need to be intimately involved in the situation, engaging with shareholders and other interested parties.
We also expect there to be a greater emphasis on evaluating the respective skills and qualifications of each individual company and dissident nominee, not only for those nominees who are pitted against each other, but also in terms of the board composition as a whole. Having all director nominees on the same ballot should facilitate less of a zero-sum proposition and a more holistic approach to assessing director candidates.
For the most part, companies will retain the responsibility of assembling and refreshing their boards of directors. When an activist nominates a larger or full slate of alternative directors using a universal proxy card, it will be incumbent upon shareholders and proxy advisors to continue to consider a range of important factors, such as board cohesion, the proper balance of new and existing directors and board diversity – not just in terms of gender, race and age, but also in terms of experience, ability, thought and perspective.
The positive and potentially negative implications of universal proxy cards notwithstanding, we look forward to the more democratic process their implementation will enable for shareholders, and the position we, as a proxy advisor, will be in to provide clients with more refined, nuanced voting recommendations in these important director elections.