Companies lukewarm to e-proxy option.

The looming question about the U.S. Securities and Exchange Commission (SEC)'s new electronic proxy rule is not "deal or no deal," but is it a big deal?

It may be, in time, but plainly isn't yet. The rule, which went into effect January 1 for large accelerated filers (companies with more than $700 million in public float), is still too new to truly evaluate, and even this coming proxy season may not provide an answer. Some observers think it could be a year or two before companies decide just how they want to approach the rule: send a stand-alone notice of the availability to provide proxy materials online, or incorporate that notice into traditional proxy materials (for an explanation of the rule, see box, "What the SEC Rule Says").

The impetus for the new rule seems to have come from the SEC's belief that widespread Internet availability has made online delivery of proxy materials a viable option, and that shareholders who elect online delivery wouldn't need printed materials. That, of course, could save considerable printing costs and help the environment by reducing the tonnage of proxy-related paper currently wending its way into landfills.

In its printed rule, the SEC says, "We expect that the reductions in printing and mailing costs and the potential decrease in the costs of proxy contests to be the most significant sources of economic benefit to investors of the amendments."

Just what those savings are, of course, will vary by company. Thomson Financial, in its survey of investor relations officers (IROs) last year, found that for an "average" company with 35,000 shareholders, adopting the electronic proxy option could shave proxy costs by $160,000 a year. That's close to the total saved by Applied Micro Circuits Corp. (see sidebar, "How the New Rule Helped One Company Save," on page 24), which chose the "notice-only" option last year for smaller shareholders.

SEC Runs the Numbers

In a lengthy analysis of its own, the SEC looked at the number of proxy pieces mailed by Automated Data Processing (ADP) in 2005 and estimated that issuers and other persons soliciting proxies from beneficial owners (in effect, shareholders) spent approximately $481.2 million in total postage and printing fees to distribute paper proxy materials to them.

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Based on the assumption that 19 percent of shareholders will choose to have paper copies sent to them when an issuer relies on the notice-only model, the SEC estimated related yearly savings ranging from $48.3 million to $241.4 million, depending on what percentage of companies choose that model.

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Projections about companies' adoption of the rule are only informed speculation at this point. "Unfortunately, there's not a lot [of research] out there," says Barry H. Genkin, a partner with law firm Blank Rome LLP in Philadelphia.

Company reaction to date is largely based on data from only a dozen early adopters, whose cumulative savings amounted to just over $500,000, according to research from Broadridge Investor Communications Solutions Inc. (Broadridge was formed from the Brokerage Services Business of ADP, which has been responsible for virtually all shareholder mailings in recent years.)

Genkin thinks that for a year or two, most companies will take both tacks--printing the usual "full set" proxy materials and also offering the notice-only option. This online option will be particularly meaningful for larger, institutional shareholders, he adds, and less so for smaller holders accustomed to paper proxies.

Down the road, the online option "will save money, and it will be better for the environment," Genkin says. But he thinks it may be three years before companies really benefit from the rule, getting the mechanics of the process down and benefiting from the necessary economies of scale.

Another attorney, Chris Hewitt of Jones Day in Cleveland, doesn't expect a significant dropoff in paper proxies for perhaps five years. Printing the proxies, he argues, represents a relatively minimal cost; the real expense is in fulfillment, mailing, legal fees and fees to PR firms.

The rule's requirement that companies provide materials for the website 40 days before the annual meeting--as opposed to 30 days now--will create a real strain, Genkin believes. "Getting things ready to go 30 days before an annual meeting is hard enough," he says, especially if the company is printing a glossy annual report and is having to make lots of incidental changes, as well as obtaining the signatures required for Sarbanes-Oxley Section 302 compliance.

Putting proxy materials on the Web will itself cost money, of course, though proxy service companies like Broadridge are rolling those costs into traditional proxy offerings. The National Investor Relations Institute (NIRI) says a proxy website should be tested at least 46 days prior to the annual meeting to make sure it is up and running, and that materials are readable and can be printed--and that the site has the capacity to handle a possible spike in traffic at any one time.

"Part of the challenge is that until [companies] go through it, they may not know how much [investors] will take to it," said Jeffrey Morgan, NIRI's new president and CEO, in an interview. "You don't want to do overprints [of your printed materials]" if you select the notice-only option. NIRI has 4,400 members, 3,100 of them in corporate positions; most of those are investor relations officers.

Company Reaction

Based on early polling, most companies are still sitting firmly on the fence. NIRI's research found that 46 percent were undecided about what do this season, with 22 percent electing the notice-only model and 29 percent expecting to use a combination of notice and full-set delivery (see adjacent chart).

Thomson's survey found that 54 percent of IROs it polled were unsure about the notice-only model. Of those, 58 percent were taking a "wait and see" reaction to the notice-only model; 26 percent cited a high number of older shareholders (ostensibly less keen on Internet-based voting); 13 percent cited cost concerns and 5 percent feared a negative reaction from shareholders accustomed to printed proxies.

Several large public companies, among them Merck & Co. and The Walt Disney Co., have publicly expressed concerns about the notice-only option's overall costs, continuing demand for hard copies, the potential for increased corporate activism and confusion about how the new program would function.

Companies do seem comfortable, however, with offering their proxies online. Thomson found that 94 percent of the IROs it surveyed said their companies post their annual reports online, and 84 percent said their firms were either already compliant with the e-proxy rule or would be ready this year; just 3 percent said the deadline would present a problem.

Another concern has been voiced about getting the required number of proxy votes, and based on the Broadridge survey, there may be cause for alarm. While the data came from only a dozen firms who had completed annual meetings prior to early September 2007, Broadridge found that the percentage of shares voted with the notice-only process averaged about 5-6 percent (highest at the largest companies), compared to up to 25 percent at the largest companies using the full-service option.

A Boost for Challengers

The new rule has elevated the potential for activist shareholders to launch proxy campaigns to unseat directors, push for a sale of the company or other management challenges. (The notice-only model may not be used in conjunction with a proxy solicitation related to a business combination transaction.) As noted, the SEC believes this model would cut the cost of proxy contests.

Yet, the rule "poses a real opportunity for a significant mismatch," attorney Genkin argues. Insurgents who target smaller public companies, in particular, may be able to gain an upper hand in a proxy battle. Where the company would be required to deliver a full set of printed proxy materials, the challengers need only present their materials online, and target big institutional holders where they could quickly amass a major voting bloc. "It could give a well-organized insurgent a real competitive advantage," he adds.

Genkin thinks the SEC may not have anticipated the current rise in shareholder activism, and if competitive mismatches do occur, that could trigger additional rule-making to make the playing field more even. Yet, the Thomson Financial survey of investor relations officers found that only 12 percent expressed concern that the rule would make it easier for activists to initiate proxy battles.

Will the large financial printers, like Bowne & Co., take a financial hit from the rule? That depends on the rate of adoption for the notice-only option; some expect that it may take a few years for that to become meaningful. And most observers say there will always be a substantial minority who would demand paper materials.

Jones Day's Hewitt says the notice-only option "makes the most sense for the large issuers with vanilla proxy statements. Outside of that, and particularly when you have a proxy contest, you'll want to do a paper mailing. For small issuers, the problem [with going to an online vote] is you may not get a quorum." He expects adoption rates "in the low teens" this year, and says that the potential savings from the online option will be more important to smaller issues with fewer revenues than for large corporations.

"The big deal is cost savings. [IROs and their companies] have limited budgets," says NIRI's Morgan. "Also, there is the issue of training the investment community." For retail investors, he says, the question may be: how quickly can they adapt? "You don't want to see companies get into quorum issues" if online voting proves to be disappointing.

RELATED ARTICLE: What the SEC Rule Says

Beginning Jan. 1, 2008 for large accelerated filers, and Jan. 1, 2009 for all others, the new ruling will require issuers to post their proxy materials (annual report, proxy card, and proxy statement) on an Internet website and send shareholders a notice of the availability of these materials. This notice can either be a stand-alone mailing (commonly referred to as the "notice only" model) or else it can accompany and be incorporated into the full proxy materials package (the "full delivery" model).

In both cases, the notice must inform shareholders that the proxy materials are available on the site and must provide instructions for how to access those materials. Any intermediaries and solicitors must also follow these guidelines. Though all issuers are required to post their annual report online, each issuer may chose either of the two delivery methods.

Additionally, issuers can contact some shareholders using the notice-only model and contact other holders using the full delivery model. However, issuers may not send a portion of the proxy materials with the notice card; the full delivery model requires that all materials be sent.

Along with the notice, the issuer must provide shareholders with an electronic voting platform, a toll-free number for voting or a printable or downloadable proxy voting card on the website.--Thomson Financial

RELATED ARTICLE: How the New Rule Helped One Company Save

Just how effective the election of a "notice only" campaign to encourage online access to proxy materials can be was detailed in the December 2007 issue of Investor Relations Update from the National Investor Relations Institute (NIRI).

NIRI spoke to executives at Applied Micro Circuits Corp. (AMCC), a small-cap semiconductor company in Sunnyvale, Calif., about the campaign it launched last summer. The company decided to mail standard proxy materials to those holding 10,000 or more shares, and "notice only" cards to those holding fewer shares to promote voting online. The overwhelming majority of AMCC's 70,000 shareholders held less than 10,000 shares, the company noted.

The decision to undertake the program came after 20 hours of research by Scott Dawson, vice president of treasury and investor relations. He concluded it was worth it and recommended it to CFO Robert Gargus.

AMCC engaged Broadridge Financial Solutions, which does investor communication and proxy processing, to build and host an SEC-compliant Web page where shareholders could access the proxy materials. A transfer agent was authorized to provide shareholder data to Broadridge. The company then ordered 8,000 printed copies of traditional proxy materials and annual reports, assuming more than 3,000 would be "excess" that could be issued on request to smaller shareholders.

According to AMCC executives, the notice-only option and the decision to print fewer full proxies generated savings of $140,000. Ninety percent of shareholders voted, similar to the previous year. Interestingly, only 187 requested printed annual reports, and the company plans to print fewer this year.

RELATED ARTICLE: TAKE AWAYS

* The SEC's new e-proxy rule requires companies to create Web-based proxy materials and to notify shareholders that they can vote online.

* Traditional proxy processes remain a viable option, and early research suggests many larger issuers--the first to be subject to the rule--are reluctant to jump into e-proxies and may elect to offer both online and printed materials.

* Among the reasons for the hesitation: uncertainty about the process, fear that shareholders wouldn't like voting online or not receiving materials, as well as concerns that electronic voting might not be robust enough to ensure a quorum of shareholders.

* Observers think the rule will make shareholder challenges to management easier and more effective, but an early sampling found few investor relations officers concerned about that issue.

Expected Model to be Used in 2008

Notice only Model                            22%
Full set delivery model                       3%
Combination of notice and full set delivery  29%
Undecided                                    46%

Source: NIRI

Note: Table made from pie chart.

Will New Rule Spur Proxy Fights?

I do not know  28%
Yes            12%
No             60%

Source: Thomson Financial

Note: Table made from pie chart.