July 22, 2015 Changing Voting Behavior and Proxy Contests

By Bruce H. Goldfarb and Patrick J. McHugh

This article originally appeared in the July edition of Activism Monthly Magazine

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As shareholder activism in the US reaches record levels, both investors and companies should pay close attention to shifts in voting behavior by institutional investors. Alongside new regulatory guidance, these shifts are starting to impact the outcome of corporate elections, making what used to be considered “certain” votes yet more difficult to come by. As a result, both companies and activists will need to be more engaged with major shareholders on a one-to-one basis, and present credible analyses demonstrating long-term strategy in order to prevail in contested elections in situations ranging from mergers and spin-offs to proxy fights.

One significant change came last year when the Securities and Exchange Commission issued new guidance on shareholders’ use of proxy advisory firms, such as ISS and Glass Lewis. Part of that guidance made clear that investment advisors like mutual funds and ETFs are required to vote in their clients’ best interests. But the SEC clarified that voting in their clients’ best interests can also mean not voting at all, leaving smaller institutional holders who don’t have the resources to analyze every voting decision free to not vote in as many elections.

Less voting overall could have a profound impact on the outcome of campaigns, making shareholder engagement even more crucial ahead of important meetings.

Proxy advisory firms are an important part of the voting landscape, but many shareholders are employing a more independent tack and activist campaigns are sure to be affected. While we continue to see a heavy reliance on proxy advisory firms, there has been outside pressure for investors to shy away from unflinching use of outside recommendations. Jamie Dimon, CEO of JPMorgan Chase, and outgoing SEC Commissioner Daniel Gallagher, have recently spoken out against dependence on these, while Commissioner Gallagher said he was encouraged by the recent proxy fight at DuPont, where the company’s top three institutional shareholders decided to vote against the adviser recommendations, instead supporting management.

Large shareholders themselves are also weighing in on voting behavior. BlackRock CEO Larry Fink recently wrote a letter to the CEOs of the S&P 500 and other large companies around the world warning that support will not come easy unless management demonstrates appropriate action and commitment. In other words, activists need to have a clear vision for bringing long-term value to the company, but companies can’t rest on value they’ve created in the past; they have to communicate a clear vision for the future.

Other investors have made similar calls. We saw this new reality play out in several recent proxy fights, but none more starkly than the one at Darden Restaurants. In that campaign, as proxy solicitor for Starboard Value, we heard from shareholders who were frustrated at the company’s lack of long-term strategy and inspired by Starboard’s plan to create value by rejuvenating the company’s brands, among other measures. In the end, Starboard successfully replaced the entire board of Darden. Since the campaign, performance has improved and, the company recently announced plans to spin-off its real estate holdings into a REIT as another way to further unlock shareholder value.

Importantly, both activists and companies need to have a vision for the future that investors can understand and buy into. Spin-offs, buybacks and dividends will garner some votes, but they may not convince big investors like BlackRock or Vanguard unless there’s a strategy behind it.

Understanding which shareholders are likely to vote and the issues about which they care is now vitally important to winning a proxy campaign. Some activists may now have to evaluate more closely whether they go after a certain target based on the makeup of the shareholder base and how those shareholders are likely to respond.

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