Director elections no longer are “routine” in any sense of the word. Activist and other investors, who in years past often focused on peripheral issues such as confidential voting and  achievement of a range of societal objectives (perhaps worthy, but frequently lacking sufficient  tie-in with shareholder value creation), have  finally discovered the ultimate corporate pressure point – the board.

THE PROBLEM – MOST INVESTORS DO NOT UNDERSTAND OR APPRECIATE THE BOARD’S ROLE AND CONTRIBUTIONS

Instead of trying to directly  micro-manage corporate behavior, investors are  now focused on the oversight of these behaviors.  This focus  includes who serves on the board, the process by which they are  nominated and  elected, their perceived independence,  and their accessibility  and accountability to investors. This scrutiny typically  is limited  to  review  and  comment on  the  observable – such as board structure (annually-elected or classified, separate  or  combined CEO/Board Chair);  number of board and  committee meetings; and  the election mechanisms (plurality or majority election standard, whether shareholders have  the right to call special meetings or to act  by consent). This focus on the observable, in turn, too often leads to “one-size-fits-all”  box checking when it comes to “grading governance”, proxy voting and  activism.

Unfortunately, the greatest value provided by boards typically is unobservable to the majority of shareholders and  other commentators. And this is for good reason. To be effective,  directors must operate and  interact with each other  in an  atmosphere of confidentiality, trust  and  mutual  respect (i.e. collegiality).  Shareholders and  others outside the boardroom have  little means to measure and  appreciate the true independence and  unique contribution of each  individual director or of the  board collectively.  Clearly,  these contributions cannot be measured or appreciated through obsessive focus  on the above observable metrics and  criteria.

This yields a situation  in which truly valuable directors may be judged, or misjudged, by the wrong criteria.  This can  both affect  their election and  thus  their ability to serve, or even  discourage some from offering to serve in the first place.

To mitigate this situation, companies and their boards are challenged to find the right balance between increasing the level and quality  of director disclosure, transparency and accessibility to investors, while maintaining the necessary degree of collegiality.

While it is true  that  the  SEC,  earlier  in 2010,  expanded the  proxy  disclosure requirements about directors, this  simply  raised the  floor for these disclosures, so companies meeting these new  requirements will not automatically gain  credit for exceeding the required level of disclosure.

WHY DIRECTOR ELECTIONS NO LONGER ARE “ROUTINE”

• As you know, the NYSE eliminated broker discretionary voting in uncontested director elections, beginning in 2010.

• Increasingly, companies are transitioning to “majority” election standards, from the traditional US “plurality” standard. These first two items give real teeth  to “withhold” (or “against”) votes  on directors.                   1

•  Concerns and  publicity  about perceived excessive CEO  pay  are  causing many  investors to consider board  oversight of compensation as the  litmus  test  of their  effective  independence. This,  in turn,  has  contributed to more frequent votes  withheld from compensation committee members at companies where  investors or their proxy advisors have  compensation-related concerns.

• While Say  on Pay  (and  Say  When  on Pay)  votes  may siphon some discontent away  from withholding  on compensation committee members (at least  for the initial Say on Pay votes  most  companies will conduct in 2011), companies selecting biennial  or triennial frequency may in the future find themselves in receipt of higher  levels of director withholds  in the years between Say on Pay votes.

• Although  “Proxy Access” is temporarily on hold  due  to a court  challenge, we must  all be  prepared for the  likelihood  that  it will survive  in some form and  be  in place for 2012.  More cost-effective means for shareholders to nominate alternative candidates  will inevitably  lead  to an  increase in this type  of activity which,  in turn,  will  compel targeted companies to wage “true campaigns” in support of their preferred nominees.

• With Proxy Access on hold, the United Brotherhood of Carpenters and Joiners of America (the “Carpenters’ Union”)  has  started a  letter-writing  campaign to  encourage large   issuers to  adopt “Board  Access” guidelines, which would allow one-percent investors or groups the opportunity to meet  directly with board committees, in particular with all members of the nominating committee. While such meetings and  related dialogue might  initially be  less  confrontational than  submitting alternative Proxy Access nominees, the proposed 1% Board Access ownership requirement is a significantly lower hurdle  than the 3% requirement contemplated under Proxy Access.

• Each   year,   the  proxy  advisory services  expand  the  list  of  reasons they  will issue “withhold”  vote recommendations, and  this year  is no exception. For 2011,  ISS indicated that the presence of any one  of the following may by itself trigger  withhold votes  from compensation committee members:

1. Excessive perquisites or tax gross-ups

2. Change in Control agreements exceeding 3 times base salary and  average bonus or without involuntary job loss (i.e. single-triggers)

3. Repricing or replacing underwater options without prior shareholder approval

DIRECTOR WITHHOLD VOTES – TALE OF THE TAPE

During 2010,  ISS recommended votes  against 17% of all U.S. company directors up for election. Put another way, this translates to over 2,000 director nominees receiving negative voting recommendations. Of this group, almost  one half received 20% or higher  votes  withheld.

Percentage of Nominees Exceeding Various Thresholds of Opposition*

Much  has  been made of the  fact  that  “only” 95  director nominees at  54  Russell  3000 companies failed  to receive majority support in 2010 — almost  all of these at smaller, plurality voting companies — and  that to date, directors have stepped down  from the board at only four of these 54 companies.**

That analysis fails to account for the downstream consequences. Even though the plurality companies are under no obligation to take  action,  the Council  of Institutional  Investors (CII) already has  written to these apparently unresponsive companies, urging  their boards to remove the  directors who did  not receive majority support. Other  activists may  opportunistically target these  companies,  claiming  “where  there  is  smoke (of investor  discontent), there  must be fire”, in support of their own short-term agenda.

The key takeaway is that, while majority opposition makes headlines, directors with 20% or greater withholds can expect increased scrutiny in future elections, hence the need to identify and address the underlying causes before they escalate.

*Russell 3000 meetings through August 31, Source:  Proxy Governance

**Sources: ISS; Council of Institutional Investors

THE ACTIVIST 2011 GAME PLAN

In response to this tepid  action from plurality companies, activist investors — who were bitterly disappointed that

Dodd-Frank did not mandate majority elections — are continuing to push this in 2011:

• This summer the  Florida  State  Board  of Administration wrote  to all Russell  3000  companies that  do  not have majority elections, urging  them to make  this change.

• The  Carpenters’ Union  is filing 75  to 85  majority  vote  proposals at  S&P 500  companies (i.e.  the  vast majority of S&P 500 companies that have  not yet adopted majority voting).

• CalPERS  has  asked the  58  largest companies in its portfolio  to embrace majority  voting,  and  is filing

proposals at four of these.

• CalSTRS is filing 25 such proposals at smaller  companies.

As we  indicated earlier,  adoption of the  majority  election standard gives  director withhold  votes  real  teeth. This means that companies need to manage the director election process – and  take  all reasonable steps to anticipate and  minimize  director withholds  – before they  find themselves exposed to negative publicity  and  future “piling-on” activism campaigns.

PHOENIX ADVISORY PARTNERS CAN HELP YOU IN THE FOLLOWING WAYS:

• Provide   a  road-map for and   support you  in effective   engagement with the  proxy  voters   at  your  top institutional investors;

• Quantify the likely impact and  influence of proxy advisors such as ISS and  Glass-Lewis over your unique ownership base;

• Identify vulnerabilities in your governance profile and  board composition;

• Project  the vote on a range of potential management and  shareholder-sponsored proposals;

• Develop and  implement strategies to improve  retail voting participation.