April 4, 2011

Proxy Season Preview: Takeover Defenses

Here is analysis from ISS’s Ted Allen:

During the 2011 U.S. proxy season, investors again will see a significant number of shareholder proposals that address corporate takeover defenses, such as supermajority voting requirements, classified boards, and limits on shareholder-called special meetings.

Once again, most of these resolutions have been submitted by California shareholder activist John Chevedden and other affiliated investors. So far, shareholders have filed 166 proposals that target takeover defenses, which account for 43 percent of the 386 governance proposals tracked by ISS this year. By contrast, investors have submitted 120 proposals on board issues (such as majority voting and independent chairs), and just 55 resolutions on compensation topics.

So far, investors have filed 48 proposals that urge companies to allow investors holding a certain minimum stake (such as 10 percent) to call a special meeting. However, 12 companies have obtained permission from the Securities and Exchange Commission under Rule 14a-8(i)(9) to omit these proposals by offering their own management proposals with higher ownership thresholds (such as 25 or 40 percent) and other limits on special meetings. Allstate, FirstEnergy, and YUM! Brands are among the issuers that have successfully argued that shareholder proposals would conflict with their management resolutions. In addition, Mattel and Waste Management have told the SEC that they plan to add one-year net-long position requirements to their management proposals.

These companies assert that a higher ownership hurdle is necessary given the expense and distraction of holding a special meeting. While activists would prefer lower thresholds, 53.8 percent of S&P 500 firms do not provide the right to call special meetings, according to ISS GRId data. Another 14.4 percent have ownership thresholds under 25 percent, 14.8 percent require between a 25 and 49 percent stake, and 17 percent have a 50 percent or greater standard.

So far, special meeting proposals have survived no-action challenges on eligibility or other grounds at Honeywell, General Dynamics, AT&T, American Express, and Verizon Communications. As of March 9, 31 proposals on this topic were still pending. It remains to be seen whether these proposals will fare better than last year, when the average support fell to 43 percent, down from 50.1 percent in 2009.

Meanwhile, Chevedden and other retail investors again are filing a greater number of resolutions that urge companies to allow a majority of investors to act by written consent. ISS is tracking 40 proposals this year, up from 29 in 2010. So far this season, 16 companies have asked the SEC for permission to exclude these proposals, but just one request (from Bank of America) has been granted.

Last year, written consent proposals, which appeared on 2010 proxy statements after more than a decade absence, averaged a surprising 54 percent support, but these resolutions may not fare as well this season as some institutional investors have revised their voting guidelines to consider other governance factors, such as a company’s threshold for calling special meetings. About 30 percent of S&P 500 firms now allow investors to act by written consent, ISS data shows.

Supermajority Voting Rules

Investors also will see a significant number of proposals from retail activists that seek to repeal the supermajority (such as 80 or 66 percent) voting rules that some companies have for bylaws or other agenda items. ISS is tracking 35 of these proposals this year; but 20 face no-action challenges. This topic averaged more than 73 percent support, the highest support level for a shareholder measure in 2010, and had 70.5 percent approval in 2009. Notwithstanding these votes, supermajority rules remain common; 55 percent of S&P 500 companies have such rules, according to ISS GRId data.

In a new development since last spring, companies are successfully using Rule 14a-8(i)(9) to exclude these proposals. In most cases, management seeks to propose a majority-of shares-outstanding threshold, while the activists are asking the companies to adopt a majority-of-votes-cast standard. Del Monte Foods successfully used this argument to omit a supermajority proposal filed for its September 2010 meeting. Since then, Alcoa, Medco Health Solutions, Fluor, and three other issuers have used this approach to exclude 2011 proposals on this topic. Four other proposals have been omitted on other grounds. Prudential Financial sought to exclude this resolution based on insufficient proof of ownership, but was turned down. Twenty-two proposals remain pending.

Board Declassification

Another widely supported reform is board declassification, which averaged 58 percent support in 2010. So far, ISS is tracking 34 proposals for 2011. The Nathan Cummings Foundation has filed at least 11 of these resolutions that seek annual elections for all directors. Other proponents include the American Federation of State, County, and Municipal Employees (AFSCME); the Florida State Board of Administration; New York City’s pension funds; and retail investors affiliated with Chevedden.

So far, Allergan, Dun & Bradstreet, DirecTV, and three other issuers have obtained permission to exclude these resolutions by arguing that they had substantially implemented them. The Nathan Cummings Foundation has withdrawn five proposals, typically after the companies agreed to declassify. Meanwhile, KBR has sued Chevedden in federal court over a declassification proposal and contends that he failed to provide sufficient proof of ownership.

In addition, AFSCME has asked Ball Corp. and Wellpoint to reincorporate to Delaware from Indiana, where a 2009 state law requires staggered board terms unless a company’s board votes to opt out.

Oklahoma-incoporated firms may be a target of similar proposals in the future. In September, a new Oklahoma corporate law took effect that mandates classified boards; to opt out, a company would have to wait until 2015 and then obtain support from a majority of shares outstanding. John Keenan, a strategic analyst with AFSCME, said the union pension fund has no immediate plans to file reincorporation proposals at Oklahoma firms, but noted: “we’ll continue to evaluate the changes and overall corporate governance regime of Oklahoma law.”

Classified boards have received more attention in recent months after a trio of Delaware court decisions upheld poison pills at Airgas, Selectica, and Borders Group, which all had staggered board terms. In a recent Wall Street Journal commentary on the Airgas decision, Harvard Law Professor Lucian Bebchuk observed that a declassified board can be an “antidote” to a poison pill. “Despite the Delaware court’s decision, investors still have recourse–because a poison pill is powerful only as long as the directors supporting it remain in place,” Bebchuk wrote. “If, by contrast, a company’s shareholders could replace a majority of its board more quickly, the board’s power to block a takeover bid would be correspondingly weakened.”

Overall, U.S. companies have responded to shareholder demands for this reform in recent years. Within the S&P 500 index, 61.6 percent of companies now have declassified boards, and another 6.2 percent are in the process of eliminating their staggered board terms, according to ISS GRId data.

Investors also have filed a handful of proposals that address other takeover defenses. Retail investors have asked Ford Motor, Martha Stewart Living Omnimedia, Telephone & Data Systems, Constellation Brands, and Ingles Market to drop their dual-class equity structures, while Comcast was allowed to omit a recapitalization proposal on ownership grounds.

The Amalgamated Bank’s LongView Fund filled a proposal at J.C. Penney that asked for a shareholder vote on its poison pill, but that resolution was withdrawn after the retailer announced new board appointees. While activists no longer submit dozens of pill proposals each season, investors still care about this issue. In 2010, the failure to seek shareholder approval for a poison pill contributed to majority withhold votes against directors at least seven Russell 3000 companies.