The Advisors' Blog

– Sean Quinn, Head of ISS’ Governance Institute

The 2014 proxy season opened amid substantial investor criticism of one flavor of bylaw amendment that caught both investors and companies, as well as their advisers, flat-footed and led many boards to repeal the amendment prior to their annual meetings. Most states, including Delaware, allow boards to amend company bylaws without obtaining shareholder approval. Boards often exercise this prerogative to approve minor or administrative changes to the bylaws. However, others have used it to approve amendments that diminish shareholder rights, including, for example, those creating staggered boards or weakening of (or altogether eliminating) shareholders’ right to call special meetings.

Beginning in May 2013, a number of companies amended their bylaws to adopt a new director qualification provision. Although several variations were observed, all excluded from board service individuals who agreed to receive compensation from third parties in connection with board service or candidacy. The amendments appeared to be in response to post-candidacy compensation arrangements offered to unaffiliated nominees in the 2013 proxy contests at Hess Corp. and Agrium Inc. Market reaction to the agreements was mixed. Ultimately, dissident nominees at Hess declined to receive such payments and dissident nominees at Agrium were not elected by shareholders, which suggested investors are capable of factoring such arrangements into their consideration of board candidates. The new bylaw provisions, however, would have precluded investors from doing so.

In addition to the substance of the amendments, the ubiquitously unilateral nature of adoption concerned investors. Filed disclosures lacked company-specific rationales and did not indicate whether investor input was sought or obtained prior to the board’s approval of the amendments. Additionally, there was no indication that companies would seek shareholder ratification of the bylaws. Further, a substantial number of the companies in question had supermajority vote thresholds for shareholder initiatives to amend or rescind the bylaws, or precluded shareholders from amending the bylaws altogether.

By the end of 2013, 35 companies had adopted such bylaws. The first to hold an annual meeting following adoption was Provident Financial Holdings, which held its annual meeting on Nov. 26, 2013. Each nominee received “withhold” votes from approximately one-third of votes cast, a stinging rebuke given that the company’s insiders and its ESOP collectively controlled nearly 25 percent of shares outstanding.

Issuers took notice of the vote results. By the end of January 2014, two companies had repealed the bylaw. After board nominees of Rockwell Automation received substantial opposition at the company’s Feb. 4, annual meeting, the floodgates opened, as companies rushed to repeal the bylaw prior to their annual meetings. The number of repeals reached 16 by the end of February and 23 by the end of March. Some companies did not repeal the bylaw in its entirety but made substantial changes. CST Brands and WPX Energy amended the bylaw to require only that such compensatory agreements be disclosed, a far less onerous provision for a potential dissident nominee. Wynn Resorts, Ltd. sponsored an advisory vote on its bylaw provision at its May 16 meeting. After shareholders failed to approve the proposal, the board repealed the bylaw. Another company that chose to hold an advisory proposal on its new bylaw was First Reliance Bancshares, where the proposal was approved.

Just a handful of companies kept the bylaw in place through their annual meetings. At Entropic Communications, the two nominees on the ballot received support of 69.4 percent and 70.4 percent, while the three nominees at Chatham Lodging Trust received support of 49.8 percent, 55.2 percent, and 55.2 percent of votes cast. Directors fared better at companies with high levels of officer and director ownership. At Penn National Gaming, where insiders hold approximately 12 percent of shares outstanding, the two nominees received 74.5 percent support and 78.4 percent. The two nominees of Gaming & Leisure Properties, whose officers and directors hold approximately 24 percent of shares outstanding, received support of 81.4 percent and 84.6 percent.,/

By the end of the 2014 proxy season, 28 companies had repealed or amended the controversial bylaws. This does not include National Fuel Gas Co., which repealed the ban on candidate payments and will hold an advisory vote on director payments in 2015. The number of new adoptions of the exclusionary bylaw has slowed, but has not stopped: a handful of companies adopted such provisions following their respective annual meetings. Additionally, the provision is found in the governing documents of companies that have yet to conduct their initial public offering or have recently gone public but have not yet held an annual meeting.