March 8, 2010

Proxy Season Preview: Takeover Defenses

Here is something from RiskMetrics’ Ted Allen:

While board declassification and other proposals on takeover defenses typically get less media and investor attention than compensation-related resolutions, these resolutions appear likely to again receive the broadest level of investor support this season.

Last year, the two shareholder proposal topics with the greatest level of average support were those seeking to rescind or reduce supermajority requirements (69.7 percent support at 17 companies) and to declassify the board and require annual elections for all directors (65.6 percent at 63 issuers), according to RiskMetrics Group data. Another takeover defense topic–the right of shareholders to call special meetings–averaged 50.8 percent approval at 61 meetings, and had the fourth-highest average support among U.S. shareholder proposals.

So far this year, investors have filed just 15 declassification proposals, down from 30 at this time last year. One reason for the fewer proposals is that many companies already have adopted this reform. Among S&P 1500 firms, 52 percent now have declassified boards, up from 50 percent in 2008, according to RiskMetrics Group’s forthcoming Board Practices study.

This season’s proponents include state pension funds from California, New York, and Connecticut; the AFL-CIO and the Amalgamated Bank’s LongView funds; and several individual activists. The Connecticut Retirement Plans and Trust Funds filed declassification resolutions at Nabors and Abercrombie & Fitch in an effort to draw more attention to the firms’ pay practices. The companies’ classified board structure makes it more difficult for investors to protest pay decisions by withholding support from compensation committee members, who aren’t up for election every year.

So far, declassification resolutions have been withdrawn at Toll Brothers and Brocade Communications. Brocade plans to put a management proposal on its 2010 ballot to fully declassify the board over three years, while Toll has pledged to offer a management proposal in 2011. Textron also plans to sponsor a 2010 proposal to declassify over a three-year period.

Ball Corp., which is headquartered in Colorado but incorporated in Indiana, won permission to exclude a declassification proposal filed by the California Public Employees’ Retirement System by pointing to a new Indiana law that mandates classified boards unless a company opted out by July 31, 2009. Some activist investors were outraged by the company’s decision not to opt out and then push for exclusion, noting that declassification resolutions have earned majority support at Ball four times in the last five years.

Supermajority Provisions
As of Feb. 15, investors had filed 26 proposals that seek to repeal supermajority requirements to approve bylaws, corporate transactions, and other matters. The primary filers are retail investors affiliated with California-based activist John Chevedden, while the Florida State Board of Administration has filed at Hospitality Properties Trust.

At some firms, supermajority thresholds are as high as 80 percent of outstanding shares. So far, 19 proposals are still pending, while four have been withdrawn. CalPERS withdrew at Brocade after the board pledged to seek shareholder approval this year to rescind its supermajority requirements. Three proposals have been omitted on various grounds, and four other resolutions face no-action challenges.

Instead of submitting a no-action petition to the SEC, Apache sued Chevedden in federal court in an effort to exclude his supermajority proposal. The Houston-based energy company contends that he failed to provide sufficient proof of ownership, while Chevedden points to the agency staff’s rejection of a similar no-action challenge by Hain Celestial in 2008. A federal judge held a Feb. 11 hearing in the case and has directed the parties to file briefs by March 5. Shareholder activists have expressed concern that other companies may take investors to court if Apache is successful.

Special Meetings
So far this season, companies have been able to exclude 14 of the 57 special meeting proposals filed by Chevedden’s network of retail investors by moving to offer their own management resolutions this year with higher ownership thresholds.

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). In virtually all of these cases, the companies are acting in response to a 2010 shareholder proposal that requests a 10 percent (of outstanding shares) threshold, and/or a similar investor resolution that received majority support in 2009.

Companies have offered various arguments in support of higher thresholds. 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. The issuers 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 SEC staff to omit the investor resolutions. In their no-action requests, the companies are successfully citing 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.

Among the companies that have successfully used the (i)(9) argument to exclude special meeting proposals are: CVS Caremark, Medco, Goldman Sachs, Honeywell, NiSource, Baker Hughes, Becton Dickinson & Co., Eastman Chemical, Safeway, Dow Chemical, Pfizer, Chevron, Bristol-Myers Squibb, and Time Warner. However, the SEC staff rejected Boeing’s challenge to a special meeting resolution despite the aerospace company’s argument that it violated state law, was vague and misleading, and was beyond the authority of the board to implement.

Solicitation Reimbursement
The American Federation of State, County, and Municipal Employees has expanded its campaign to urge companies to establish policies to reimburse the solicitation expenses incurred by dissidents who run successful short-slate proxy contests. The labor fund has filed that proposal at six issuers this year. Similar proposals received 39.1 percent support at Office Depot and a 35.2 percent vote at Dell in 2009.

AFSCME sees reimbursement as a complement to proxy access, which remains the subject of an ongoing SEC rulemaking process. HealthSouth adopted a reimbursement bylaw in October; one of the company’s directors is Professor Charles Elson of the University of Delaware, who has argued that proxy access would be “an empty right without a corresponding right to shareholder expense reimbursement.”

Other Issues

Chevedden’s network also has filed 15 proposals to permit investors to act by written consent. Within the S&P 500, about 350 companies allow shareholder action by written consent, while the remaining issuers either do not allow such action or impose some restrictions on that right, according to RiskMetrics data.

Virtually all of these resolutions face no-action challenges. The SEC staff has allowed Bank of America, AT&T, Merck, Fortune Brands, Kimberly-Clark, and Pfizer to omit these proposals on the grounds that they would violate state law. However, the investors have revised their written consent proposals to include the qualifying language, “to the fullest extent permitted by law,” and none of those resolutions have been omitted so far, Chevedden said.

Investors continue to file fewer resolutions that ask companies to redeem their poison pills or put those defenses to a shareholder vote. So far, RiskMetrics is tracking just one 2010 proposal, down from eight in 2009, 14 in 2008, and 25 in 2007.

However, labor investors say they plan to oppose Pulte Homes’ bid for shareholder approval for its poison pill. Pulte adopted a pill in March 2009 as a means to protect the future tax treatment of net operating loss (NOL) carry-forwards, but labor investors warn that the company may use such a pill as an entrenchment device. In November, President Obama signed legislation to extend the NOL carry-back period from two to five years so that companies may sell real estate for a loss and recoup the taxes they paid on past profits. Most homebuilders made profits before the subprime mortgage crisis of 2008, and thus are more likely to use their recent losses to recover past taxes.