Restoring American Financial Stability Act of 2009: Majority Vote Provisions and Preemption of State Law

Buried within the bill are a host of corporate governance provisions.  Once again, the principal method of imposing the requirements is through the use of listing standards.  We have already discussed the problems associated with this form of regulation.  Moreover, there is a mandatory right to cure which means companies can violate the requirements with the only consequence that they must cure when caught.  Having said that, the listing standards approach applies to all companies traded on the exchanges, not just those in the financial industries.

Section 971 of the Act would add a new Section 14A of the Exchange Act that would effectively impose a majority vote requirement on all exchange traded companies.  Specifically, companies must require majority voting in uncontested elections.  The requirement is, in some ways, consistent with state law.  The provision preserves the plurality system employed under state law by requiring directors who do not receive a majority to resign and allowing the board to determine whether or not to accept the resignation.

The provision, however, overturns state law in several subtle but unmistakable ways.  First, under state law, companies have the choice whether to require a resignation letter upon a failure to receive a majority of the votes cast.  This requirement eliminates that discretion.  Second, in some states (but not Delaware), it is unclear whether directors who receive a plurality and are, therefore, elected, can be forced to resign if they do receive a majority.  This provision clarifies that directors not receiving a majority can be forced to resign.  Third, in a change that will probably not have significant impact, the decision to decline approval of the resignation letter must be unanimous.  A single director, therefore, can block the return of the directors who did not receive a majority.  Finally, the Commission has the authority to require companies to disclose the reasons for refusing to accept the letter.  The company must, however, “make public the reasons” why refusal was “in the best interests of the issuer and shareholders.”  The provision does not exactly overturn as much as sidestep contrary state (read Delaware) law.

The approach in the Act is premised around the idea that majority vote provisions are useful and benefit shareholders.  There is substantial reason to believe that this is not the case.  By merely requiring letters of resignation, but leaving the board with the authority to accept or reject the letter, they mostly enhance the authority of the board.  Nonetheless, the mandatory resignation requirement when coupled with rigorous disclosure obligations of the reasons and process used by the board in declining to accept the letters may have a salutatory impact.  Rather than have to dance around disclosure obligations, more boards may simply accept the resignation letters. 

The provisions also places the Commission more squarely in the middle of the corporate governance process.   Not only must the Commission adopt the requisite rule requiring the exchanges to impose the majority vote requirement, the Agency was also given specific authority to exempt companies from the requirements.  In other words, it will be the Commission, not the exchanges and, more critically, not state law, that dictates the governance rights for the different categories of public companies.

In the meantime, the bill and a summary are posted at the DU Corporate Governance web site.

SEC. 971. ELECTION OF DIRECTORS BY MAJORITY VOTE IN UNCONTESTED ELECTIONS.

The Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.) is amended by inserting after section 14 (15 U.S.C. 78n) the following:

SEC. 14A. CORPORATE GOVERNANCE.

(a) CORPORATE GOVERNANCE STANDARDS.—

(1) LISTING STANDARDS.—

(A) IN GENERAL.—Not later than 1 year after the date of enactment of this subsection, the Commission shall, by rule, direct the national securities exchanges and national securities associations to prohibit the listing of any security of an issuer that is not in compliance with any of the requirements of this subsection.

(B) OPPORTUNITY TO COMPLY AND CURE.—The rules established under this paragraph shall allow an issuer to have an opportunity to come into compliance with the requirements of this subsection, and to cure any defect that would be the basis for a prohibition under subparagraph (A), before the imposition of such prohibition.

(C) AUTHORITY TO EXEMPT.—The Commission may, by rule or order, exempt an issuer from any or all of the requirements of this subsection and the rules issued under this subsection, based on the size of the issuer, the market capitalization of the issuer, the number of shareholders of record of the issuer, or any other criteria, as the Commission deems necessary and appropriate in the public interest or for the protection of investors.

(2) COMMISSION RULES ON ELECTIONS.—In an election for membership on the board of directors of an issuer—

(A) that is uncontested, each director who receives a majority of the votes cast shall be deemed to be elected;

(B) that is contested, if the number of nominees exceeds the number of directors to be elected, each director shall be elected by the vote of a plurality of the shares represented at a meeting and entitled to vote; and (C) if a director of an issuer receives less than a majority of the votes cast in an uncontested election— (i) the director shall tender the resignation of the director to the board of directors; and(ii) the board of directors—

(I) shall— (aa) accept the resignation of the director; (bb) determine a date on which the resignation will take effect, within a reasonable period of time, as established by the Commission; and (cc) make the date under item (bb) public within a reason able period of time, as established by the Commission; or

(II) shall, upon a unanimous vote of the board, decline to accept the resignation and, not later than 30 days after the date of the vote (or within such shorter period as the Commission may establish), make public the reasons that— (aa) the board chose not to accept the resignation; and (bb) the decision was in the best interests of the issuer and the shareholders of the issuer.