May/June 2006 • Volume 14, Number 3 MAJORITY VOTE MOVEMENT Implementation of Majority Voting: The Devil in the Details By Charles Nathan Majority voting for directors, the latest and one can be elected with only one “for” vote even though of the most successful activist investor initiatives, all other votes are “withheld” against the candi- is rapidly gathering traction throughout Corporate date. With the exception of relatively few states America. Company announcements of adoption that mandate either cumulative voting or majority of some type of a majority vote structure are now voting for directors, state corporation laws provide an almost daily occurrence. Recently, companies that plurality voting is the default rule, meaning such as Intel, Motorola, and Dell have announced that directors are elected by a plurality vote unless they have foregone their plurality standard and the charter or by-laws otherwise specify. adopted a majority vote standard. And many more companies have maintained their plurality When deciding whether to change from a plu- standard, but adopted policies that mimic certain rality voting standard, the initial consideration is aspects of a majority vote standard. whether to implement a modified plurality struc- ture or full-fledged majority voting. A modified Notwithstanding the growing acceptance of the plurality system continues to use plurality voting, majority voting concept, there is a large degree so that the candidates receiving the highest num- of variability in the types and formulations of ber of votes are elected. However, the modified majority vote structures. Many companies have plurality system appends to the standard plurality not acted as they weigh the alternatives available voting a “director resignation policy,” specify- to them. This article examines some of these dif- ing that if an elected candidate does not receive ferences, as well as a number of potentially critical a majority vote he or she is obligated to submit implementation issues. a resignation, which the board can or must act on within a specified period of time. Under this scheme, the candidate, whether an incumbent or Modified Plurality Voting or a new nominee, is legally elected as a director and Full-Fledged Majority Voting the holdover rule of state corporate law (i.e., that a director serves until a successor is duly elected) Today, most companies elect their directors is not implicated. Rather, the teeth of the scheme under a plurality standard. A plurality standard is in its director resignation policy. means that the directors with the most “for” votes wins, notwithstanding the number of “abstain” or A full-fledged majority voting structure pro- “withhold” votes. Under this standard, a director vides that directors are elected by majority vote. As a consequence, if an incumbent does not Charles Nathan is a Partner of Latham & Watkins LLP. receive a majority vote, he or she is not elected to another term but continues to serve solely by matter of corporate governance, and modified plu- reason of the holdover rule. A new nominee who rality voting is not an acceptable substitute. This fails to receive a majority likewise is not elected conclusion is typically premised on the belief that but obviously does not serve under the holdover full-fledged majority voting, because of its stron- rule. Rather the predecessor director continues to ger “legal” effect (failure to achieve a majority serve and if there is no predecessor (or the prede- means the director has not been elected) and con- cessor resigns), there is simply a vacancy on the sequently its stronger moral effect, will result in board. Because of the holdover rule, companies greater accountability of directors and the board implementing a full-fledged majority vote system as a whole to shareholders. typically add a director resignation policy, like those used to implement modified plurality vot- Through its proxy voting guidelines, ISS has ing, to cope with the inappropriate effect of the reached the same conclusion regarding the supe- holdover rule. riority of full-fledged majority voting, with the consequence that it ordinarily will recommend the As a practical matter, the director resignation support a full-fledged majority voting proposal, policy operates to minimize differences between even if the company has previously adopted a the two systems. In the case of incumbent direc- modified plurality standard. In addition, the SEC tor nominees, both systems rely on a director Staff, through its no-action letter process, has resignation policy to deal with a so-called “failed accepted the proposition that the two systems are election,” where the incumbent nominee fails to not functional equivalents and will not allow a receive a majority vote but is elected either by vir- company to exclude a majority voting proposal on tue of plurality voting or holds over as a director the grounds that its adoption of a modified plural- until his successor is duly elected. Likewise, in the ity system is substantially the same under Rule case of a new (rather than incumbent) nominee, 14a-8, the shareholder proposal rule. This means the director resignation policy would be applicable that a company cannot foreclose shareholder pro- to the new nominee who is elected by a plurality posals—and a public debate through the annual vote under a modified plurality system, and is fre- meeting proxy process—merely by adopting a quently made applicable to the holdover incum- modified plurality policy. bent under a full-fledged majority system. On the other hand, it is not clear yet that there In other words, in all cases under a modified is a broader consensus among investors in favor of plurality system and most, if not all, cases under full-fledged majority voting. Several high profile full-fledged majority voting, the consequence of a shareholder proposals to install full-fledged major- failed election (that is, an election in which a can- ity voting in lieu of company adopted modified didate did not receive a majority of votes cast) is plurality systems have failed to achieve a majority that the board is faced with the decision whether vote. Because at this early stage in the 2006 proxy to replace the nominee by accepting her resigna- season the die is not yet cast, and proponents of tion or for her to continue in office notwithstand- modified plurality voting can hold out hope that ing the lack of a majority vote. it may prove to be an acceptable majority voting standard among the wider investor community. Current State of Play Assuming investor sentiment continues to be Because the issue of majority voting has been mixed for the balance of the 2006 proxy season, it driven by activist institutional investors, a decision will leave boards which prefer a modified plurality between the two prevailing systems presumably system in something of a quandary. On the one should take into account prevailing investor views hand, they can follow their convictions and imple- as to which system is preferable. Unfortunately ment modified plurality voting with the knowledge for a board seeking answers, the institutional that the investor community is currently divided investor community has not clearly settled on a on the issue and their company may well prevail single paradigm. if activist shareholders choose to challenge their modified plurality policy in forthcoming proxy Most activist institutional investors feel strongly seasons. On the other hand, they need to recog- that full-fledged majority voting is superior as a nize the probability that this policy dispute is not The Corporate Governance Advisor May/June 006 likely to go away, and they may face continuing better for companies and their shareholders than challenges to their modified plurality choice for either majority vote systems and may conclude years to come. that, unless forced by circumstances beyond their control, inaction is preferable to unwanted and Timing for Implementation perhaps premature action. of Majority Voting These considerations lead to the conclusion The issues surrounding whether—and when—a that boards that have not yet acted should wait at board should implement majority voting are no least until the Fall of 2006 to consider whether to simpler than, and in many ways linked to, the act. While all of the issues undoubtedly will not issues the board faces in terms of choosing a be resolved by then, hopefully there will be some majority vote system. additional clarity concerning investor sentiment and the overarching policy debate. First, of course, why do anything? Decision making for the 2006 proxy season is over for com- Defining a “Majority” panies with calendar fiscal years and fiscal years ending in the first quarter; only those companies Although seeming self evident, there are sev- with fiscal year-ends later in the year are facing eral important issues subsumed in the concept of decisions for this proxy season. There is much to a “majority.” First, a majority of what—all out- be said for a “wait and see” approach. The out- standing shares, all shares present at the meeting come of the 2006 proxy season should shed light or all shares voting in the election? on a number of issues, including: While a number of companies have used all • Whether proponents of majority vote proposals outstanding shares as the denominator, they are in can muster consistent majority support at com- a distinct minority. This is, of course, the hardest panies that have not voluntarily acted. majority to obtain and the standard most likely to lead to a failed election. Nor does it have any obvi- • Whether proponents of full-fledged majority ous connection to ordinary concepts of democratic vote proposals can muster consistent majority voting, which in most, if not all, manifestations support at companies that have adopted modi- is measured against the actual, not theoretical, fied plurality systems.