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State corporate laws generally provide that directors are elected by a "plurality" vote, in which a director nominee who receives the highest number of votes cast for an open director's seat is elected to that position.  Applicable Securities and Exchange Commission (SEC) voting requirements hold that shareholders in an election under a plurality standard have two voting choices for the election of directors:  "for" or "withhold."  Under the plurality standard, the only votes that count when director votes are being tabulated are "for" votes.  "Withhold" votes have no effect and are not counted.  Thus, a director could be elected by a single "for" vote.

Over the past few years, the plurality voting standard has been under attack by shareholder advocacy groups who are now actively promoting a "majority vote" standard for the election of directors.  Under a typical majority voting standard, a director would be elected only if he or she receives affirmative votes from a majority of either the votes cast at the meeting or the shares eligible to be voted at a meeting, depending on the standard chosen by an issuer. 

Since 2004, majority voting for directors has garnered significant and increasing support from shareholder organizations, including Institutional Shareholder Services (ISS) and the Council of Institutional Investors (CII), and numerous companies have implemented majority voting in various forms, generally as part of their corporate governance guidelines or other board policy.  Because majority voting will be an important topic for the 2006 proxy season and beyond, companies must understand both sides of the majority voting debate and the potential implications of changing from a plurality voting standard to some form of a majority voting standard.

Background

In October 2003, the SEC proposed new "shareholder access" rules that would have given shareholders, under limited circumstances, the ability to directly nominate directors for inclusion in a company's proxy statement.  These rules were supported by many institutional shareholders who believed the rules would provide shareholders a greater role in the director election process. 

The shareholder access proposal was controversial from the beginning, encountering substantial opposition in the issuer community.  It has not yet been (and may never be) adopted by the SEC.  As a result of the apparent demise of the proposed shareholder access rules, shareholder advocacy groups began to focus on alternative reforms to provide shareholders with what they argued would be a more meaningful role in the election of directors.  In particular, ISS, CII, and various other institutional investors and shareholder activists initiated campaigns to change the election of directors from a plurality voting standard to a majority voting standard.

Plurality vs. Majority Voting Standards

The plurality voting standard originated primarily due to concerns regarding contested elections, in which multiple candidates contend for a limited number of open board seats.  Experience has shown, however, that the vast majority of public company director elections are uncontested.  Under the plurality voting standard, director nominees in uncontested elections are virtually assured victory, even if holders of a majority of the voting shares choose to withhold support. 

A majority voting standard generally requires that director nominees receive at least a majority of the "for" votes either cast at a meeting or eligible to vote in such election.  In contrast to plurality voting, under this standard, a "withhold" vote essentially acts as an "against" vote.  As discussed below, some majority voting standards disregard the "withhold" vote altogether and permit shareholders to vote either "for" or "against" director nominees.   Proponents of majority voting argue that it is a simple, swift, and effective solution to make directors more accountable for their actions and to provide shareholders a meaningful role in the director election process.  However, despite its apparent simplicity, majority voting raises a number of substantive and technical issues:

The existence of "holdover" rules, in which (as under most state corporate laws) an incumbent director will continue to serve until his or her successor is elected.  Thus, if an incumbent director is not reelected, he or she will continue to be a director (a so-called "holdover" director) until the company holds another election or he or she resigns.  This fails to achieve the end sought by the shareholders seeking to reject a director's candidacy.

Despite the holdover rules, if one or more directors do not receive sufficient votes under the applicable majority vote standard (a "failed election"), the affected director(s) may resign.  This may result in vacancies on the board that could adversely affect the company's ability to maintain the requisite number of independent directors or directors with particular qualities that are required for various listing standards.  It may also result in a company having no directors, may trigger a change in control under a company's material agreements, or may result in a default of other material agreements, including debt instruments.

A failed election where a company's CEO/director does not receive the requisite director votes could, in some cases, constitute a breach of that officer's employment agreement (due to the failure to elect the CEO to the board), and this breach could trigger severance payments and other significant penalties for the company.

The move to majority voting election may make it more difficult to recruit suitable directors and a failed election could also result in long-term vacancies on a board until replacements are selected or could discourage a suitable candidate from agreeing to serve on the board.

Current Trends Indicate Shareholders Support Majority Voting

Current trends indicate, however, that shareholders generally support the adoption of some form of majority voting for directors.  According to ISS, in 2004, majority voting shareholder proposals appeared on 12 company ballots.  In 2005, at least 60 companies included such shareholder proposals on their annual meeting ballots (17 of which received a majority of votes cast).  This year, ISS estimates that there were over 140 such proposals on company ballots (many of which were withdrawn prior to the shareholder meeting, primarily because the company had agreed to institute some form of majority voting standard) and that over 180 companies had adopted some form of majority vote standard or director resignation policy either voluntarily or through shareholder proposals. 

In addition, according to ISS, through August 9, 2006 the 87 shareholder majority vote proposals that were being followed by ISS had garnered an average of 47.8 percent support, which represents an increase over the 43.7 percent support in 2005 for the 62 majority vote proposals filed by shareholders that year.

However, due in part to various perceived problems associated with adopting majority voting standards, including the fact that many state corporation laws specifically provide that the default option in director elections is that directors must be elected by a plurality vote (note that Delaware corporate law permits an issuer to "opt out" of the plurality requirement through a charter or bylaw provision), and that such directors "hold over" in the event a successor is not elected and qualified, many companies have resisted implementing majority voting policies and procedures. 

In order to address many of the concerns raised by a majority voting standard, proponents of majority voting as well as various companies have attempted to reach compromises between the plurality and majority voting standards.

"Modified" Plurality Standard

One of these compromises is the so-called "modified" plurality standard.  Under this standard, which was first adopted by Pfizer Inc., a board adopts a policy providing that a director who does not receive the affirmative vote from at least a majority of the votes cast (or a majority of the shares eligible to vote in such election, depending on the policy) must resign or agree to tender his or her resignation within a specified period of time, typically 90 days, following such election.  Such a policy may also be adopted through a bylaw amendment (see the Intel discussion and the ABA amendments to the MBCA, described below). 

Many companies that have adopted these board policies specifically provide that a director receiving less than a majority of the "for" votes does not automatically lose his or her seat.  In these situations, the director would submit his or her resignation to the board and the board would then review the perceived reasons for a nominee's failure to receive a majority vote, consider whether to accept the resignation, and make a recommendation as to whether the resignation will be accepted or rejected.  Public disclosure of the decision and the reason behind the decision typically follows. 

ISS estimates that, through August 18, 2006, at least 140 companies have adopted a form of director resignation policy.  The companies that have taken this approach, including Pfizer, ADP, Disney, Circuit City, General Electric, Hewlett-Packard, and Safeway, argue that this standard, which avoids the failed election problems discussed above, provides the board with flexibility to handle situations in which an immediate resignation would lead to the loss of a key board member (such as a CEO, the chairman of the audit committee, or an independent board member), and gives shareholders a role in setting board composition, subject to the oversight of the other directors. 

Proponents of a "true" majority voting standard argue that this approach is not sufficient, because it reinforces the status quo since the board retains final decision-making authority.  Moreover, those modified plurality standards adopted through the enactment of board policies (as opposed to bylaw amendments), as is the case with companies like Pfizer and Circuit City, are rejected by other proponents of majority voting because these policies can be easily modified or terminated by the board of directors without shareholder input.

Amendments to the Model Business Corporation Act

In June 2006, the Committee on Corporate Laws of the Business Law Section of the American Bar Association (the Committee), which had carefully studied the issue of majority voting since June 2005, adopted a series of amendments to the Model Business Corporation Act (the MBCA) (which is the basis for a substantial number of state corporate statutes, excluding Delaware and California, among others) that permit companies and their shareholders to adopt majority voting provisions that address the holdover director and the other failed election concerns described above.   Those states that have based their business corporation statutes on the MBCA must now decide whether to adopt these new amendments.

These amendments, which followed the Committee's January 2006 preliminary report addressing the majority voting situation and a request for comment issued in March 2006, provide that shareholders or directors, subject to certain limitations, are permitted to adopt a modified plurality standard through a company's bylaws.  Under the modified plurality standard adopted by the Committee, unless a company's articles of incorporation (i) specifically prohibit a bylaw amendment that adopts these majority voting procedures, (ii) alter the plurality vote for the election of directors required by the MBCA, or (iii) provide for cumulative voting in the election of directors:

Directors of public companies will continue to be elected under a plurality standard.

• Any director who receives more "against" votes than "for" votes in any director election ("withhold" votes and abstentions have no effect in such a standard) must resign no later than the earlier to occur of (a) 90 days following the election or (b) the date on which such director's position on the board is filled by the other directors.  
• Any vacancies created by the resignation of such directors may be filled by the other directors during the 90-day period following the election, which could include the director who received more "against" votes that "for" votes.
• If the vacancy is not filled by the board during this 90-day period, the vacancy may be filled by either the board or the shareholder, unless the articles of incorporation vest this power exclusively in either group.
• Any repeal of such bylaw amendment can be made only by (a) the shareholders, if originally adopted by the shareholders, or (b) the directors, if originally adopted by the directors.  

In addition, the Committee adopted other MBCA amendments that expressly permit companies to adopt resignation policies, including those policies that provide that a director resignation would be effective upon the happening of certain events (e.g., the failure to receive a certain percentage of "for" votes in a director election), that are binding and enforceable.  It should be noted that, based on comments received by the Committee prior to the adoption of these amendments, the majority voting standard set forth in the MBCA amendments does not apply in any contested director election.

By agreeing that these voting standards may be implemented through a company's bylaws and requiring the director to resign without a director review of such resignation, the Committee addressed a significant concern of shareholder advocacy groups.  However, many shareholder activists, including the ISS, believe that the Committee's actions are ineffective to provide a sufficient shareholder voice in corporate governance because, among other things, such provisions permit the board to fill any resulting vacancy with the resigned director and the amendments retain a plurality voting default rule. 

Shareholder Proposals

In 2005, CII sent letters to 1,500 of the largest U.S. companies requesting that they voluntarily adopt policies providing that, if permissible under state law, such companies would adopt charter and bylaws amendments requiring the election of directors by majority vote (CII is continuing this letter campaign in 2006).  Additionally, the letter provided that, if a company's state law requires the election of directors to be made pursuant to plurality voting, each such company's board of directors "should" adopt a modified plurality system in which directors would tender resignations if the number of "withhold" votes exceeds the number of "for" votes as a compromise position. 

As was the case with many majority vote proposals introduced by shareholder groups in 2005, the CII request was "precatory," in that it encouraged boards to take action instead of forcing the companies to make a change.  The threat in these precatory actions is that if a company does not effect the requested change, the shareholder groups may try to force such changes on the company through a formal shareholder proposal.

In November 2005, ISS announced its intention to support shareholder proposals in 2006 that force companies to cause directors to be elected with an affirmative majority of votes cast and/or the elimination of the plurality standard for the election of directors.  However, ISS stated that it would consider not supporting such binding majority voting proposals if the company has a formal corporate governance policy that presents a "meaningful alternative" to majority voting. 

According to ISS, the minimum elements of any majority voting standard that could satisfy these requirements are:

• Established and disclosed guidelines concerning the process to follow for nominees who receive majority withhold votes;
• Clear and reasonable timetables for deciding such nominee's status following such vote;
• Procedures that require the determination as to a nominee's status will be made by independent board members, excluding the nominee;
• A clearly articulated range of remedies that can be considered concerning the nominee (for example, acceptance of the resignation or rejecting the resignation but curing deficiencies); and
• A prompt disclosure of the final decision concerning the nominee via an SEC filing, including an explanation of the decision.  In addition, any company implementing such a policy must articulate to shareholders why this alternative is the "best structure at this time for demonstrating accountability to shareholders."  However, even a company with a policy that incorporates these criteria is not guaranteed that ISS will recommend voting against a majority vote shareholder proposal.

The only majority voting shareholder proposal that has not been supported by ISS in 2006 was General Electric's majority vote shareholder proposal, which received the support of only 19 percent of the voting shareholders.  In making the decision not to support the shareholder proposal, ISS found that General Electric's voluntary adoption of a director resignation policy pursuant to a bylaw amendment was an "acceptable alternative" to the shareholder proposal on the company's ballot.  However, there is no assurance that ISS will make the same decision in the future for other companies.  General Electric is a New York corporation and, as such, is required to include in its certificate of incorporation any change in the voting standards for directors.  Thus, a binding "true" majority voting standard would have been difficult, if not impossible, to implement by General Electric and its shareholders.

According to ISS, as of May 10, 2006 shareholder proposals for majority voting alternatives had been approved at 11 of the 13 companies followed by ISS that had not adopted a director resignation policy or other majority voting alternatives before issuing their proxy statements.  Companies in which these proposals were approved include Union Pacific (with 53 percent support), Verizon (61 percent support), and Sprint Nextel (67 percent support).  In addition, as of the end of July 2006, according to ISS, majority vote proposals filed by shareholders had received over 50 percent support at approximately 38 percent of the 84 companies where the majority voting proposal had appeared on the company ballots, including over 95 percent support at Marriot International and Host Hotels.

Majority Voting Pursuant to Bylaw Amendments

In an effort to preempt a binding shareholder majority vote proposal, many companies have implemented majority voting to varying degrees.  For example, in January 2006 Intel amended its bylaws to remove its plurality voting standard and allow for majority voting for uncontested director elections.  Under Intel's new bylaws, shareholders will vote either "for" or "against" a director (which is different from the "for" or "withhold" vote required by other companies with a plurality voting standard, such as Pfizer).  Any incumbent nominee in an uncontested election who receives more "against" than "for" votes would be required to tender his or her resignation.  The company's corporate governance and nominating committee would review the resignation and make a recommendation to the board.  

Intel's bylaw amendment approach has been favorably received because it gave shareholders an effective means to communicate their dissatisfaction with existing directors by providing the option of casting a meaningful vote against a nominee.  However, the fact that the Intel board could rescind such a bylaw amendment at any time without shareholder approval has caused some concerns about this approach. 

According to ISS, between January 1, 2006 and August 18, 2006 at least 40 companies adopted the Intel majority voting model, including Dell, Clear Channel, Office Depot, and NorthWestern Energy.  Other companies, including Advanced Micro Devices, Anadarko, and Hartford Financial, have agreed to do so on or before their 2007 annual shareholder meetings.

Hewlett-Packard and Gannett's Challenges to Shareholder Proposals

Even if a company implements a form of majority voting standard, there is no certainty that such preemptive actions will be successful and head off a binding shareholder proposal.  For example, on January 5, 2006, the SEC denied Hewlett-Packard's no-action request to exclude from its 2006 proxy materials, on the basis of the "substantial implementation" exception included in Rule 14a-8(i) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act), a shareholder proposal to include a majority vote standard in its corporate governance documents.  On January 10, 2006, the SEC denied a similar request by the Gannett Company. 

In the Hewlett-Packard letter, the company argued that it had "substantially implemented" a majority voting shareholder proposal by adopting a modified plurality standard by adopting a director resignation policy.  In the Gannett letter, the company made the same argument that its recently adopted corporate policy requiring the resignation from any director who receives more "withheld" votes than "for" votes in an uncontested election "substantially implemented" the shareholder proposal.  The SEC rejected both of these arguments and required Hewlett-Packard and Gannett to include the shareholder majority vote proposals in their respective proxy materials.  The Hewlett-Packard shareholder proposal was ultimately defeated earlier this year by garnering 45 percent support. 

According to ISS, other similar proposals have been defeated so far this year, including Analog Devices (with 35 percent support), Wal-Mart (22.3 percent support), Ciena (31 percent support), PepsiAmericas (27 percent support), Wells Fargo (39 percent support), and Paccar (32 percent support).  

States Join the Majority Voting Fray

In January 2006, the California Public Employees' Retirement System shifted this battle out of the federal arena and into the states through its participation in the drafting of a California bill sponsored by state Senator Richard Alarcon.  Under Alarcon's bill, as amended through August 14, 2006, every listed corporation incorporated in California (other than those that have cumulative voting for directors) may amend its articles or bylaws to provide that, in an uncontested election, directors must be elected by a majority vote of the shareholders, and the term of any incumbent director not re-elected by a majority of all votes cast would expire 90 days after such vote, or, if the director had earlier resigned, the date on which the board fills the vacancy resulting from such resignation. 

In contrast to the standards proposed or adopted by the Committee, ISS, and Intel, this bill does not provide for the board of directors to reject or delay any resignation of a director who receives less than a majority of the affirmative votes, which could result in the holdover and failed election issues described above.  Moreover, it should be noted that, under prior versions of this bill, essentially all California corporations would have been required to elect directors by a majority vote in all uncontested elections; any director who failed to be elected by a majority of the votes cast would have been prohibited from being appointed to fill the vacancy created by his or her resignation.  As of August 23, 2006, each of these provisions had been removed by the California lawmakers.  Even though this bill only applies to California corporations, it could set a substantial precedent for future bills in other states.  The bill, as amended, is currently being discussed in the California Senate.  If passed, the bill would most likely affect the 2007 proxy season for California public companies.

In June 2006, Delaware enacted a bill that amends the Delaware General Corporation Law to, among other things, address the majority voting debate.  Under the terms of the amendments, a director's resignation could be declared effective upon the occurrence of certain events, including a failure to receive a specified vote for reelection.  Moreover, such "springing" resignation in connection with a failure to receive a specified vote for reelection could be made irrevocable.  In addition, the amendments prohibit any stockholder-approved bylaw amendment that specifies the vote necessary for the election of directors (e.g., a majority of the outstanding or a majority of the quorum) being amended or repealed by the board. 

The net effect of these provisions is that companies can continue to adopt director resignation policies regarding majority voting and be able to confirm to ISS and other activist shareholders that any such resignation is meaningful because it cannot be revoked by the director.  Moreover, shareholders can now introduce proposals for binding bylaw amendments promulgating a majority voting regime, knowing that, if such an amendment were adopted by the required vote, the board could not overturn it. 

NYSE Proposed Amendment on Broker Voting Rules

On June 5, 2006, the Proxy Working Group of the New York Stock Exchange (NYSE) recommended the adoption of an amendment to the NYSE's Rule 452 (the so-called "10-day broker vote rule"), which would, among other things, eliminate discretionary voting by brokers on all director elections.  Currently, Rule 452 permits brokers to vote the shares held by them on behalf of the "street" holders of such shares on "routine" matters (which currently includes uncontested director elections) if the broker does not receive voting instructions from the beneficial owner of the stock within a certain period of time prior to a shareholder vote.  If this amendment is approved by the NYSE board and the SEC (which must approve all NYSE rule amendments), such rule may have a substantial effect on board elections for companies that have implemented majority voting, since the large block of "for" votes that directors usually receive in uncontested elections (traditionally, brokers have voted these shares in favor of management and the board's director nominees) would be significantly reduced.  This could lead to many directors not receiving the requisite shareholder approval in director elections, which could ultimately give activist shareholders, who may hold a majority of the votes cast, control over board composition.

One of the regulatory functions of the NYSE is to govern the relationship between member firm broker-dealers and their customers. Such customers may hold shares in "street name" that have been issued by NYSE-listed companies, Nasdaq-listed companies, and other companies listed or traded on other U.S. markets and exchanges. Thus, this proposed amendment would affect not only the director election process of NYSE-listed companies, but also that of other publicly traded companies.

The NYSE opened a comment period for listed companies that expired on June 30, 2006.   After reviewing and considering the comments, NYSE's board will file any proposed changes to Rule 452 with the SEC so that the SEC can solicit additional public comment before any such changes are implemented.
 
What Should a Company Do?

It appears that, given the significant shareholder support, the commitment of large institutional investors and advisory services, and the lack of persuasive opposition, majority voting, in some form, is poised to become a corporate governance standard.  In light of this situation, it is prudent for companies to consider whether they have a persuasive reason to resist the trend.

Companies that are not currently subject to a shareholder majority vote proposal may wish to seize the initiative and adopt a board policy that implements a modified plurality system similar to Pfizer or a bylaw amendment that implements a majority voting standard similar to Intel.  By doing so, the company may position itself as a leader in corporate governance best practices, avert a possible shareholder proposal, and maintain important flexibility for the board in dealing with director resignations.  However, activist shareholders may still attempt to force a more restrictive majority voting standard on the company through a shareholder proposal even if a company has adopted such a modified plurality or other majority voting approach - and the company will likely be unable to reject such a proposal on a "substantial implementation" claim under Rule 14a-8(i) of the Exchange Act.

Companies that are currently faced with a shareholder majority vote proposal may either support or oppose the proposal.  Because such a decision involves a facts-and-circumstances analysis, before deciding,  it would be prudent for the company to examine a variety of factors to determine if the shareholder proposal would be problematic.  For example, according to ISS, in 2005 only 14 of the 35,000 director nominees at U.S. companies received at least a majority of the "withhold" votes in director elections, which shows that such results are not typical.  Moreover, if the company's shareholder base is diverse and held by non-institutional investors, obtaining a majority "withhold" vote in any director election may be difficult (it should be noted, however, that if the NYSE amendments to Rule 452 are implemented, a large block of "for" votes that directors usually receive in uncontested elections may be significantly reduced, which could materially affect director elections).  Last, there is no indication that ISS and other shareholder activist groups will stop introducing such proposals each year until a form of majority voting is passed.  Thus, a company should review these factors and determine if such a shareholder proposal would actually have any impact on the composition or operation of its board.  

Companies that determine that it would be in their best interests to oppose any such shareholder proposal have a few options.  First, if the proposal is a non-binding precatory proposal, the company may wait until the annual meeting occurs and, if the proposal receives the requisite support, the board can then determine the best means to implement majority voting, if at all.  Alternatively, in the very unlikely event of a binding proposal that contemplates a bylaw amendment, a company can either (a) try to convince the SEC that the proposal can be excluded under the SEC rules for "substantial implementation" or (b) initiate a proxy campaign to formally oppose the proposal.  Either way, the likelihood of successfully defeating the proposal may be low. 

New trends and approaches to majority voting are continuously developing.  As a result, companies should seek the advice of their investor relations advisors, proxy solicitors, and legal counsel in reviewing all the factors that may affect a company's response to the majority voting trend.  Some companies may feel that a voluntary approach, like those taken by Pfizer or Intel, is appropriate, while others may choose to wait.  A company that waits to see the results of all the shareholder proposals on majority voting for the 2006 proxy season should be in a position to gauge shareholder support for such proposals and determine whether the adoption of a majority voting policy or bylaw amendment is the best course of action for the company and its shareholders.

*Through August 24, 2006.  This article will be periodically updated as we continue to monitor the developments in this rapidly changing area.