Pick Your Own Apples: Universal Proxy Means More Choice. But Will It Deliver Better Outcomes?

Written By Elizabeth Saunders, Partner & Delphine Robert, Senior Consultant

October 5, 2022

Ever buy a bushel of apples only to find one or two not quite to your liking? Whether one bad apple can really spoil the bunch is debatable. But it’s clear that selecting each piece based on its individual merits will increase your satisfaction with the lot.

That’s the general idea behind the new universal proxy rule, which went into effect on September 1, 2022. Under the new rule, shareholders who vote by proxy can now pick and choose individual candidates rather than being beholden to either the full corporate or activist proxy card.

And that changes (almost) everything.

How does universal proxy work?

You have no doubt heard of the ExxonMobil proxy contest that occurred in 2020.  Engine No. 1, an activist investor presented its own board slate because it believed ExxonMobil wasn’t properly managing the climate transition, among other grievances. Shareholders voting by proxy had to choose between the company’s board slate or the dissident board slate and vote on the white or the blue proxy card accordingly. If a shareholder wanted to pick some candidates from each panel, he or she had to attend the company’s shareholder meeting in person to cast a vote on both the white and blue cards up to the available number of board seats.

For example, this year, the activist investment firm Macellum Capital Management proposed its own 10 nominees for Kohl’s board on the white card but attended the retailer’s shareholder meeting to vote in favor of two company directors on the blue card. In this case, Kohl’s had 13 seats on the board.

Up until the end of August 2022, that is how proxy contests went.

Now, there is just one universal slate for proxy voting that will list all nominees on one card for all voters, in person or otherwise. The universal proxy allows the virtual voting experience to mimic in-person options. Shareholders can mix and match as much as they like, as long as they vote for no more than the total number of seats.

Universal proxy will impact all future proxy seasons. And the new rules have significant implications for virtually every party that plays a role in the process. We’ve highlighted the most significant changes for each group below.

Activists: Many believe universal proxy will give ESG activism a boost.

First, universal proxy makes it easier and cheaper for more activist shareholders to launch a proxy contest. Activist investors can now nominate individual directors to the board of a company instead of coming up with an entire coherent board slate. It evens the playing field and opens the door for smaller activist investors to try their hand. Since candidates will be listed on one proxy card, the activists will not have to incur the expense of printing and mailing proxy cards to shareholders or spend valuable time and resources forming a board slate.

Second, issue-oriented investors who have generally submitted shareholder proposals and have encountered uncompromising or unresponsive companies now have another avenue for furthering their agendas. They may opt to put a director with the requisite expertise up for election to the board rather than submitting a new proposal.

While ESG activists are expected to take full advantage of the new rule, they will have to proceed with some degree of caution, so as not to dilute each other’s efforts. They may need to coordinate their efforts to avoid having too many proposed directors and not enough votes for any of them to win a seat.

Furthermore, anti-ESG shareholders will equally seize their opportunity. Indeed, they already have. ExxonMobil is in the headlines once again with the first observed use of the universal proxy rule as National Legal and Policy Center has proposed a pro-fossil fuel extraction member to the energy giant’s board.

Shareholders: More shareholders will have more influence.

Shareholders can vote in favor of the directors they see best fit to be on the board rather than being constrained by a set of directors on one of two slates. This lifts a major barrier for shareholders and allows them to be more selective in the voting process.

But it comes with greater responsibility. Shareholders must be mindful of the potential for picking individual directors versus a slate to deteriorate into a personality contest. If it does, incumbent directors who won’t stand to have their egos bruised may rescind their board seat rather than run the risk of humiliation. This could adversely affect the size of the qualified director pool and undermine the objective of the rule.

Proxy advisors: Proxy firms say their approach will remain largely unchanged.

Proxy advisors may be the sole party in the mix to contend that not much will change under the universal proxy rule, although they do acknowledge that the new process is better for shareholders. 

Both ISS and Glass Lewis have welcomed the rule and put out guidance on the subject. They state that their main approach in evaluating proxy contests will remain the same: They will continue to evaluate if change is warranted. If so, they will evaluate if the proposed alternative candidate will lead to stronger governance and oversight of management.

However, both major proxy advisors have emphasized that when evaluating the dissident nominee, individual qualifications will be scrutinized more closely.

Issuers: Companies will need to act now to strengthen board composition.

Universal proxy effectively increases the number of directors up for election for a select amount of board seats, making it more challenging for any candidate to obtain a majority of votes. Even companies with poor governance structures—such as ownership structure that favors management, uneven voting power, differing vote classes, or entrenched boards— will not be as shielded in the event of contested situations. They could still lose a board seat due to the dilution of voting power that occurs when there are more candidates than seats available.

Ultimately, this rule may push companies to get ahead of potential threats and strengthen their board composition with best-in-class directors. But it could also make them more willing to settle with activist and shareholder requests.

The best bet for issuers is to proactively promote the directors they believe are best suited for the job and to demonstrate their candidates’ expertise in ways that satisfy shareholders’ concerns. Here are a few strategies that can help:

  1. Engage, engage, engage. Fall engagements are now more important than ever. Be ready to discuss board composition, demonstrate shareholder best interest, and discuss board oversight of ESG processes. Use your engagements to discuss your environmental and social initiatives and explain how board members are directly involved and making a difference in material areas.
  2. Start disclosing along an ESG framework. ESG laggards in each industry will likely be targeted by activists wishing to promote candidates more willing to advance ESG policies. Assess where you stand. If you are behind, start improving your ESG track record through better disclosures.
  3. Address low support levels or say on pay vote losses. If you have been unresponsive to shareholder proposals that received significant support in the past, now is the time to return to the drawing board. Evaluate what you can do in short order to demonstrate to shareholders that you are listening to and addressing their concerns, especially those related to executive compensation.
  4. Ensure board charters specifically include oversight of key E&S topics. Board oversight of ESG promotes strategic alignment and ownership of environmental, social, and governance matters across the enterprise and is one of the most effective ways to move the needle in these areas. Rating agencies, proxy advisors, and investors alike are asking for oversight to be formalized and clearly demonstrated. Issuers can comply by updating charters and governance documents to assign oversight and management of ESG risks to specific board committees with the right qualifications to manage the individual pillars of ESG. For more insight, see this post on Which board committee is right for ESG ownership at your firm.
  5. Review your board composition. Proxy advisors have significant influence, so it is wise to review your board composition in accordance with their best governance practices guidelines. Specifically look at the demographic make-up of the board, the average tenure of members, average director age, and independence level to determine if you have any weak spots. Then, make a plan for addressing them before activists do.
  6. Create a board skills matrix. One of the most effective ways to demonstrate the qualifications and expertise of your board members is to create a matrix that visually depicts the strengths and capabilities of each board member including their ESG experience. Including a matrix in the proxy along with detailed biographical descriptions that elaborate on each board member’s ability to oversee and manage ESG risks, priorities, and opportunities can increase shareholders’ confidence in your company’s preferred directors.

More choice requires more diligence.

Universal proxy will lead to more candidates for all available board seats as well as a greater likelihood of a shareholder or activist’s nominee winning an election. While it is now much easier to have candidates considered by a broader range of shareholders, that doesn’t necessarily mean it should be. Any candidate recommended by any party must first and foremost be qualified to deliver on shareholders’ best interests. To ensure this is the case, all parties—whether nominating or voting—have a greater responsibility to vet their candidates, make sound choices, and do their part to ensure the best men and women win in the end.

If you need counsel around showcasing your boards’ oversight of ESG, contact us. Our team of governance experts can help you identify potential weak points that make you vulnerable to ESG activism and develop materials to effectively communicate board experience and oversight to your shareholders.

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