Keith Paul Bishop
May 2006

Los Angeles Daily Journal

American entertainer W.C. Fields once quipped, "I never vote for anybody, I always vote against." Fields, of course, was hoping for a laugh. Voters in political elections, of course, are not normally given the option of voting against a candidate. They can either cast a vote for a candidate or cast no vote at all. Until recently, the same principle prevailed in most corporate elections. Shareholders could cast their votes for a candidate but not against. Now some selfstyled reformers have been pushing for a new way of voting that in theory counts votes against and in some cases even abstentions.

This new voting system is being dishonestly promoted under the banner of "majority voting." Shareholders, however, should be wary of this latest corporate governance fad. Majority voting has many serious drawbacks that jeopardize shareholder interests.

Historically, shareholders of American corporations have elected directors under a voting rule known as the "plurality vote" rule. Plurality voting is relatively straightforward. The candidates who receive the highest number of affirmative votes up to the number of directors to be elected are elected as directors.

For example, if there are three candidates, Smith, Jones and Brown, vying for two board seats and they receive 5, 4 and 3 votes, respectively, Smith and Jones will be elected as directors. In California, plurality voting is mandated for all California corporations by virtue of Section 708 of the California Corporations Code.

In the case of publicly traded corporations, elections are rarely contested. This means that the number of candidates does not typically exceed the number of board seats to be filled. Few elections are contested in large publicly traded companies because the Securities and Exchange Commission's proxy rules impose considerable costs and burdens on shareholders who want to solicit votes for a competing candidate.

Without the support of a broad proxy solicitation effort, a candidate has little chance of election. Critics of the plurality-vote rule point out that when an election is uncontested, a candidate who receives just one vote will be elected because he or she necessarily will have received the largest number of votes.

A majority-vote rule addresses this perceived problem by requiring that a candidate receive at least a majority of the votes cast in order to be elected. Suppose, for example, Smith has been nominated at a meeting in which a single director is to be elected. If 100 shares (each representing one vote) are present at the meeting and 49 votes are cast for Smith and 51 votes are cast against her, she would not be elected under a majority vote scheme. If a plurality voting rule applies instead, Smith would be elected as a director because she received the highest number of affirmative votes.

While it may seem reasonable to deny election to someone who can't achieve a majority of affirmative votes, majority voting can create huge problems for shareholders and the corporations that they own. If an election is uncontested and one or more nominees is not elected, what happens?

Many states, including California, have a holdover rule. Section 301(b) of the Corporations Code provides that a director continues to hold office until a successor is elected and qualified. This means that if a nominee is a sitting director, he or she will continue as a director notwithstanding the fact that she was not elected.

Some corporations have tried to address this problem by adopting a majority-vote policy that requires a sitting director to tender her resignation if she fails to be elected. This is far from a satisfactory result. In most instances, the corporation will want to avoid the considerable expense in holding another shareholder election. Thus, the board is likely to appoint someone to fill the vacancy. The majority voting will in many instances actually vitiate shareholder democracy by replacing elected directors with appointed directors.

Majority voting also endangers shareholder interests by leading to the possible removal of hard to replace directors. In the last few years, the stock exchanges and the Nasdaq stock market have imposed stringent requirements on board composition. These tougher criteria, enhanced director responsibilities and heightened concerns about liability have combined to make it more difficult for corporations to find suitable candidates for board seats. When a key director is lost through her non-election, the company's continued listing can be threatened.

If the entire board is to be elected at a meeting, it is possible under a majority voting scheme that no directors will be elected. As a result, the corporation will be left without any directors and the shareholders will be forced to incur the expense of another meeting and the possibility of yet another failed election. It is difficult to imagine anything more disruptive to a corporation than the decapitation of its entire board.

California has had a long tradition of protecting minority shareholder interests. One way that it does so is by granting shareholders the right to cumulate their votes when voting for directors.

Under cumulative voting principles, a shareholder has a number of votes equal to the number of shares multiplied by the number of directors to be elected. For example, if a shareholder has 100 shares and five directors are to be elected, she would have a total of 500 votes. She could distribute these votes amongst the candidates in any manner that she sees fit. When cumulative voting is in effect, a shareholder or shareholders with a sufficient number of shares can elect one or more directors even though these shareholders do not have a majority of the votes.

Without the right to cumulate votes, the shareholder or shareholders with a majority of shares will have the power to elect the entire board and the minority shareholders will have no means to elect any directors. To protect the shareholder franchise generally and cumulative voting in particular, California has adopted special rules governing the removal of directors.

Section 303 of the Corporations Code requires the affirmative vote of the outstanding shares to remove any or all of the directors. Thus, if a corporation has 100 shares issued and outstanding and 51 shares are present at a meeting, removal of a director would require the affirmative vote of all 51 shares (not 26 shares).

Majority voting would effectively gut this standard by allowing the non-election of a director by far fewer votes than it would take to remove the director. In the foregoing example, non election could be effected by as few as 26 votes. Rather than vote affirmatively for removal, a shareholder could simply vote against.

Section 303 also protects cumulative voting by imposing a special rule when less than the entire board is to be removed. In those cases, no director may be removed when the votes cast against removal, or not consenting in writing to the removal, would be sufficient to elect the director if voted cumulatively at an election at which the same total number of votes were cast (or, if the action is taken by written consent, all shares entitled to vote were voted) and the entire number of directors authorized at the time of the director's most recent election were then being elected.

Without this rule, the majority shareholders could immediately remove a director after that director's election by a minority shareholder under cumulative voting rules. If a majority vote standard is adopted, this protection of cumulative voting will be lost.

In the recent meetings, shareholders have rejected proposals to require majority voting. Apparently stymied at the ballot box, the California Public Employees Retirement System, or CalPERS, is sponsoring a bill in the California Legislature, SB 1207, that would mandate majority voting for California corporations with shares listed on the New York or American Stock exchanges or the Nasdaq National Market. Apparently, CalPERS fails to recognize or is simply ignoring the irony in this hamfisted attempt to overrule legislatively shareholder votes.

Shareholders should be wary of majority vote proposals. These proposals offer the promise of greater shareholder power. In practice, however, they can jeopardize shareholder protections and interests. Perhaps W.C. Fields had it right, voting against should not be taken seriously.

Keith Paul Bishop is a partner in the Irvine office of Buchalter Nemer. He formerly served as California's commissioner of corporations.