Financial Regulatory Forum

Corporate Governance: Staggered U.S. boards are endangered species

By Guest Contributor
March 23, 2011

By Erik Krusch

NEW YORK, March 23 (Westlaw Business) – Classified boards may be moving towards the endangered species list, as investors and even management are hunting them down.

Valero and Biogen Idec’s management teams, for example, are recommending that shareholders approve amendments declassifying their respective boards. Other corporations, such as Alcoa and McDonald’s Corp, however, are fighting their shareholders’ attempts to level their staggered boards. It remains to be seen how many staggered boards emerge from this proxy season unscathed.

Despite the success of classified boards in fending off many hostile acquirers, they can sometimes entrench management and disenfranchise shareholders. Given these possibilities, it should come as no surprise that staggered boards are on many shareholders’ hit list.

The overwhelming trend in corporate governance is towards the declassification of boards and this year is no exception, with several shareholder proposals calling for declassification making their way onto 2011 proxies. Other companies are seeing the proverbial writing on the wall and declassifying their boards. Despite these clear trends, some companies are attempting to quash shareholder declassification proposals and at least one company is asking its shareholders to sign off on a staggered board.

Shareholders often agitate for corporate governance reforms and the ongoing makeover of staggered boards is no exception. Alcoa, Ames National Corporation, and Reynolds American’s proxy materials all include shareholder proposals calling for declassified boards. This year, energy exploration and production company Helmerich & Payne, Inc’s shareholders have already approved a shareholder declassification proposal.

NONBINDING, WITH IMPACT

Of course, these proposals – like all shareholder proposals – are nonbinding. Losing one of these declassification resolutions, however, usually has an impact on the company’s future corporate governance practices.

While shareholder proposals are non-binding, the prospect of a poor governance reputation or a “withhold” campaign against a companies’ directors is often enough to spur action. Companies on the losing end of shareholder declassification proposals often make their own declassification proposal at the next annual meeting. The management of DTE Energy and Baxter International have both floated and supported declassification proposals in their 2011 proxy materials. Both companies’ shareholders approved non-binding declassification proposals during the 2010 proxy season.

Nonetheless, sometimes shareholders do not even need to win a vote. Activist investor Carl Icahn has three representatives on Biogen Idec’s board and he has been peppering the company with director nominations and shareholder proposals annually for years. Last proxy season Icahn withdrew a declassification proposal after he reached a settlement with Biogen. Then, in a rather stunning turn of events, Biogen made its own declassification proposal in its recently released 2011 proxy materials.

NO ACTION

Other companies are trying to avoid a shareholder vote on the issue, often via the Securities and Exchange Commission’s no action process. McDonald’s and Western Union have both attempted to get out of the declassification hot seat by arguing that the proposals should be excluded under Rule 14a-8(i)(8), which provides that a proposal may be omitted if it “relates to a nomination or an election for membership on the company’s board of directors or analogous governing body or a procedure for such nomination or election.” One type of proposal the SEC has ruled is excludable under this rule are those that would have the effect of removing a director from the board prior to the time his or her term expires. Western Union and McDonald’s both argued that the declassification proposals would have just this effect.

The SEC broadly agreed with the argument, stating in letters to McDonald’s and Western Union that: “There appears to be some basis for your view that [Western Union or McDonald’s] may exclude the first proposal under rule 14a-8(i)(8) to the extent it could, if implemented, disqualify directors previously elected from completing their terms on the board.”

The SEC, however, quickly switched tracks in both letters. In the Western Union letter, the SEC stated:

…this defect could be cured if the proposal were revised to provide that it will not affect the unexpired terms of directors elected to the board at or prior to the upcoming annual meeting. Accordingly, unless the proponent provides Western Union with a proposal revised in this manner, within seven calendar days after receiving this letter, we will not recommend enforcement action to the Commission if Western Union omits the proposal from its proxy materials in reliance on rule 14a-8(i)(8).

The SEC’s response to McDonald’s no action request was very similar and the declassification proposal has been included on McDonald’s preliminary proxy statement. It remains to be seen if either McDonald’s or Western Union’s definitive proxies will include a declassification proposal.

On the opposite end of the staggered board spectrum, Isle of Capri Casinos’ management recently proposed at its annual meeting on March 18, 2011, that shareholders vote to classify the board. Classifying the board, like declassifying, requires an amendment and restatement to the corporation’s certificate of incorporation, which requires a majority vote of outstanding shares. Shareholders would normally not support such a measure; however, directors and executive officers as a group own 47.4 percent of the company’s outstanding shares. Most directors and officers do not hold anywhere near this percentage of voting power in their companies and classification or reclassification of a public company is seen as a non-starter.

Declassification is clearly the trend in corporate America. Shareholder pressure and proposals are wearing down companies’ defenses, such as the staggered board. It is notable just how effective shareholders are at leveling staggered boards. It may take more than one annual meeting, years of pressure or revised shareholder proposals, but shareholders are toppling many of the remaining staggered boards. Even with this clear trend, however, there are many legal intricacies that shareholders, executives, and corporate counsel should review.

(This article was first published by ThomsonReuters’ Westlaw Business Currents, a leading provider of legal analysis and news on governance, transactions and legal risk. Visit Westlaw Business Currents online at http://currents.westlawbusiness.com.)

(This article was first published by ThomsonReuters’ Westlaw Business Currents, a leading provider of legal analysis and news on governance, transactions and legal risk. Visit Westlaw Business Currents online at http://currents.westlawbusiness.com.)

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