The Dodd-Frank Act: Corporate Governance

The Dodd-Frank Wall Street Reform and Consumer Protection Act addresses several high-profile areas of corporate governance, including proxy access, separation of Chairman and CEO, and brokers' discretionary voting. However, the Act does not include a provision mandating the election of directors by majority vote in uncontested elections, a provision that had been included in earlier drafts of the law.

Proxy Access

Proxy access makes it easier for shareholders to nominate director candidates by allowing shareholders to include their nominees on the company's proxy card. Historically, a shareholder seeking the election of a director candidate was generally required to fund an independent proxy solicitation.

Certain institutional investors have urged the SEC to adopt rules permitting proxy access for a number of years. These investors argued that proxy access would create more contested elections for directors, resulting in greater shareholder choice and increased accountability for incumbent directors. Business organizations and other groups, fearing the increased costs and disruption that could result from proxy access, took a contrary position, asking the SEC to leave the question of proxy access to be determined by each corporation and its shareholders. Some of these groups threatened possible legal action if the SEC were to adopt a proxy-access rule, arguing that such a rule would overstep the SEC's authority.

The Act ends the debate over whether the SEC has congressional authorization to regulate proxy access, expressly granting this authority to the Commission. During the conference committee negotiations, certain lawmakers proposed mandating minimum ownership thresholds or minimum holding periods as conditions for a shareholder to take advantage of proxy access, but these eligibility requirements were not included in the final law. The focus will now turn to the SEC rule-making process to see what eligibility thresholds will be imposed.

Congress did, however, permit the SEC to exempt a class of issuers from any proxy-access rules that are adopted. In determining whether to create such an exemption, Congress directed the SEC to consider, among other things, the burden of the new rules on small issuers.

We believe that the SEC will promptly adopt proxy-access rules and that these rules will dramatically increase the number of contested elections for corporate boards. While the exact scope of the rules is yet to be determined, companies should begin preparing now for the inevitable election contests. Working closely with a company's professional advisers to analyze the company's corporate governance profile and the strengths and weaknesses of individual board members (and of the board as a whole) will permit the company to be proactive rather than reactive when it gets drawn into the new world of corporate election campaigns.

Separation of Chairman and CEO

The Act requires the SEC, within 180 days of enactment, to issue rules that require an issuer to disclose in its annual proxy statement the reasons why the issuer has chosen either the same person to serve as Chairman and CEO or two different individuals to hold these offices.

Because the SEC adopted rules in late 2009 mandating very similar disclosure, it is unclear whether the Act requires the SEC to take any additional rule-making action in this area.

Brokers' Discretionary Voting

The vast majority of shareholders do not hold shares in their own names. Rather, their ownership interests are held in the names of banks, brokers, or other nominees. These intermediaries are required to forward proxy materials to the beneficial owners and, if the beneficial owners return voting instructions, to vote the shares accordingly. Even if a beneficial owner did not provide voting instructions, brokers historically were authorized to vote shares in their discretion upon "routine" matters, such as the uncontested election of directors.

The practice changed significantly in 2009 when the SEC approved a change to NYSE Rule 452, eliminating brokers' discretionary authority to vote in uncontested director elections. The Act expands on this change by mandating that all U.S. stock exchanges have rules prohibiting member brokers from voting on the election of directors, executive compensation, or any other "significant" matter (as the SEC may determine by rule), unless the beneficial owner has instructed the broker on how to vote.

Majority Voting

The laws of most states provide that corporate directors are elected by plurality vote, unless otherwise provided in a corporation's governing documents. In response to shareholder demands, many large public companies have altered this default rule to provide that director candidates must receive a majority of the votes cast in an uncontested election in order to be elected.

Although drafts of the Act contained provisions mandating majority voting for all public companies, those provisions were dropped from the final law, leaving the issue of majority voting to the states and to individual companies and their shareholders on a case-by-case basis.