With proxy season now upon us, we at Westlaw Business see it as our job to inform you of the top issues raised in recent proxies, SEC correspondence and other related documents.  With difficult economic conditions and increasing shareholder activism, this year’s proxy statements require a degree of re-thinking not seen for some time.  To help you with that, we’ve begun this series, covering must-haves in this season's proxies.

Are boardrooms suddenly thrown open to new board slates, removing current boards? With declassification on the tip of so many tongues, you might think so.  Motivated by under-performing businesses, under-water stock prices and over-protected boards, demand for board declassification has grown.  Surprisingly, the boards themselves seem quite willing to go along with the move, claiming to be singing from the good governance songsheet.  In truth, these moves may be intended to ease the way for premium-paying acquirors or operations-improving activist shareholders. Regardless, companies entering this year’s proxy season should consider this dynamic and their role in it.

As background, a declassified board structure allows an annual voting nomination process for the entire directorship.  The ability to simultaneously re-elect (or replace) the entire board can serve to do two things:  aid in hostile proxy battles leading to director musical chairs; or allow shareholders to annually approve (or disapprove) certain directors that may have performed worse (or better) than expected.  Stated otherwise, annual board re-elections allow greater shareholder control over a company’s operation.  However, they also offer the “tomato-tomAHto” events termed contested slates, proxy contests, or “unlocking shareholder value” (when voiced by shareholder activists).

Recently, shareholders frustrated by companies’ underperformance have been asking companies to remove their classified structures and put in place a declassified, annually elected board.  While in years past this approach drew jeers from entrenched board members, management has recently become much more flexible in their willingness to listen.  Some companies are including shareholder proposals (or proposals directly from boards) in their proxies asking for boards to be declassified – along with a thumbs-up from the board.  Other companies’ boards are more resistant, adding shareholder’s proposals to the proxies, but with board’s asking for a no vote.  The SEC has joined the fray as well, making clear its supportive position on this (so long as it’s done in the right ways).

The SEC’s stance comes through loud and clear from recent comment letters advocating declassification where it’s sought.  Consider two examples:  Fisher Communications sought to exclude a declassification proposal based on the grounds that the proposal would disqualify board members to complete their terms.  The SEC agreed with Fisher, but should the proposal be revised to have the directors serve out their terms, the company would have to include the proposal in its proxy.  Further, through staff comment letters, the SEC has asked companies to clarify just what board declassification would entail.  Grubb & Ellis Co. responded to the SEC’s requests for more detail by claiming its declassification would “champion a platform of corporate governance best practices” and increase responsiveness (from the  directors) to the wishes of shareholders.

In light of the SEC’s receptiveness, it’s perhaps no surprise that certain, change-hungry boards have moved in the same direction. Several have recently included, or formally adopted, proposals asking for their boards to be declassified. Heavy equipment manufacturer Deere & Co. claims the elimination of its classified board will allow an increase in accountability to shareholders.  Medical equipment maker Becton Dickinson’s board restated the company’s articles of incorporation to allow for declassification.   3Com recently implemented the declassification proposal that its shareholders had approved.  In all cases, shareholders must still approve the declassification move, which the company claims is to the shareholder’s best interest.  While all are cast in the terms of willingness, it’s difficult to ascertain how willing these moves actually are – protestations of willingness notwithstanding, they sometimes smack of senior executives leaving beloved jobs to “spend more time with their family.”

Some boards object to declassification but opt for shareholder democracy.  When dealing with declassification proposals, they let the votes at the annual meeting decide.   Homebuilder Toll Brothers’ recent proxy includes a proposal from Amalgamated Bank’s LongView MidCap 400 Index Fund asking to declassify the company’s board.  Toll Brother’s board recommends that shareholders vote against the proposal, citing its classified board structure as able to “engage in long-term strategic planning.”  Another such company, who has seen its share price halved in the past 52 weeks, is Analog Devices.  The chip maker received an individual shareholder proposal asking for board declassification against the board’s ideals.  The company solely focuses on its board’s classified structure as a way to avoid unwanted takeovers.  

Declassification opens up a company’s management to replacement.  This can serve to shake up boards or facilitate premium-paying hostile acquirors.  It may also allow companies to more easily replace ineffective directors, along the way earning higher grades from those measuring corporate governance (including all-important proxy firms).  Notwithstanding the implicit calls of  “…and don’t let the door hit you on your way out,” boards are surprisingly amenable.  With this sort of move afoot, both the corporate action and its disclosure should be under consideration today as a part of governance reviews.

Published:  February 26, 2009