The Securities and Exchange Commission recently published its proposed proxy access rules, which would allow shareholders to nominate directors for election using the company’s proxy materials (i.e., the company’s proxy statement and proxy card). In addition, the proposal includes an amendment to the shareholder proposal rule (Exchange Act Rule 14a-8) to allow proxy access shareholder proposals in a company’s proxy materials, to the extent permissible under state law. These proposed amendments would apply to all companies, including investment companies, with a class of equity securities subject to the proxy rules, regardless of their size. The SEC is proposing these changes to “remove impediments” to shareholders’ rights to nominate directors.
If adopted, the proxy access rules will significantly benefit passive, institutional shareholders that wish to nominate a limited number of candidates to oppose the board’s nominees. The proposed rules, however, are not likely to be useful to activist shareholders because, among other things, the shareholder cannot hold the stock or make a nomination if the purpose or effect of the nomination is to influence control of the company, which the SEC has historically interpreted very broadly.
The text of the SEC release proposing the proxy access rules is available on the SEC’s website. Public comments on the proposed rules are due by August 17, 2009.
Immediate Implications for Public Companies
Based on SEC statements related to the proxy access proposal, the final rules may be applicable for the 2010 proxy season. As a result, there are a number of steps that every public company should consider in anticipation of the approval of proxy access rules, including:
- Reviewing its advance notice bylaw provisions to determine whether:
- If applicable, reviewing its majority voting policies for the election of directors and ensuring that, if the election of directors includes a candidate nominated through the Rule 14a-11 process, plurality voting will be utilized for such an election insofar as the election should be treated as a contested election.
- Reviewing its investor relations programs and considering ways to strengthen its relationship with key institutional investors so that such investors do not feel that resorting to the proxy access rules is necessary to get the company’s attention.
Proposed Rule 14a-11 to Require Companies to Include Shareholder Nominees for Director in Company Proxy Materials
Application of Rule 14a-11. As proposed, Exchange Act Rule 14a-11 would allow a shareholder or group of shareholders, which meet the proposed eligibility standards and other conditions discussed below, to nominate a limited number of director candidates using the company’s proxy materials. A company would be required to nominate the shareholder candidate for election and include him or her in its proxy materials unless the company’s shareholders are prohibited by the company’s governing documents or applicable state law from nominating candidates for director. There are currently no states that prohibit a shareholder from nominating candidates for director. If a company’s governing documents do prohibit shareholder nomination rights, then shareholders may seek to amend such documents by submitting a so-called “proxy access shareholder proposal,” which is discussed below.
Shareholders Nominating Directors – Eligibility and Obligations. To be eligible to nominate a director candidate under the proposed rule, a shareholder or group of shareholders must beneficially own, individually or in the aggregate, a minimum percentage of the company’s voting securities continuously for at least one year as of the time of the nomination. The share ownership requirements would be tiered according to company size as follows:
- 1% of the voting securities of a “large accelerated filer” or of a registered investment company with net assets of $700 million or more;
- 3% of the voting securities of an “accelerated filer” or of a registered investment company with net assets of $75 million or more but less than $700 million; and
- 5% of the voting securities of a “non-accelerated filer” or of a registered investment company with net assets of less than $75 million.
Shareholders would be permitted to aggregate their holdings to meet the minimum share ownership threshold. In addition, the shareholder or group would be required to certify that they intend to hold the shares through the date of the annual meeting and state their intentions with respect to continued ownership of the shares after the annual meeting.
The shareholder or group would also be required to certify that they are not holding the shares for the purpose or with the effect of changing control of the company or to gain more than a limited number of seats on the board of directors. This is likely to be a difficult requirement to administer and will have the effect of precluding many shareholders from utilizing the proxy access rules, particularly those with a history of activism. As proposed, the requirement raises a number of challenging questions as to the scope of its reach, as the SEC views so-called “control intent” broadly. These questions, to name a few, include whether the proxy access rules will be unavailable to a shareholder whose intent changes subsequent to making the foregoing certification, whether the shareholder whose nominee is successfully elected will be precluded from changing its passive intent (including by engaging in a proxy contest) for so long as its nominee is serving as a director, and whether and to what extent a shareholder will be able to voice concerns to the company’s management or board without fear of jeopardizing its passive intent status. In view of these considerations, we expect that public companies will seek to exclude shareholder nominees on the basis that the shareholder seeking to make the nomination does not have the requisite lack of control intent, making proxy access an available tool only for traditionally passive, institutional investors.
Shareholder Nominee Requirements. A company would not be required to include a shareholder nominee in its proxy materials if the nominee’s candidacy would violate controlling state law, federal law or stock exchange rules, other than stock exchange rules regarding subjective independence of directors (e.g., the NYSE’s requirement that the board make an affirmative determination that a director is independent because he or she has no material relationship with the company). Shareholder nominees would have to satisfy the objective independence standards of the stock exchange rules applicable to the company (e.g., the rules of the applicable stock exchange that impose specific quantitative, objective criteria that at a minimum must be satisfied in order for a director to be considered independent). While the SEC stated in the proposing release that it did not believe it was appropriate for shareholder nominees to be required to meet the nominating committee’s or board’s director qualification criteria, it remains unclear to what extent, if any, a shareholder nominee must comply with other company-imposed qualification criteria that are permissible as a matter of state law, such as those often found in code of ethics, corporate governance, conflict of interest, director and management succession or other similar policies, or the company’s charter or bylaws (e.g., objective criteria such as age limitations, subjective criteria such as diversity and industry experience requirements, and other criteria such as no affiliation with a competitor). Although the nominating shareholder or group could not have any agreement with the company regarding the nomination, the rules would not prohibit shareholders from nominating themselves or affiliates for candidacy. Furthermore, a nominating shareholder would not be deemed an “affiliate” of the company under securities law solely as result of nominating a director.
Maximum Number of Shareholder Nominees. A company would be required to include in its proxy materials each year shareholder nominees for up to 25% of the size of the company’s board (rounded down) or one nominee, whichever is greater (the “nominee limit”). An incumbent director previously elected as a shareholder nominee under the proxy access rules whose term extends beyond the upcoming annual meeting would count towards the nominee limit. In addition, if more shareholder nominations are submitted than could be included because of the nominee limit, then the earliest nomination received by the company would govern. As proposed, the rule does not provide for the earliest date on which shareholders may submit nominations, but most companies’ bylaws contain advance notice provisions that provide a window during which shareholders may submit director nominations and proposals to be considered at the next annual meeting of shareholders (as discussed below). Whether or not the company has advance notice procedures, the proposed rules are likely to result in a “rush to the gate” mentality among shareholders seeking to avail themselves of the proxy access rules, presenting challenging timing interpretations for companies that receive multiple nominations on the same day.
Proposing Nominees – Notice and Disclosure Requirements. Nominating shareholders or groups would be required to submit nominations to the company on, and contemporaneously file with the SEC, a new Schedule 14N. The deadline for a shareholder to submit a Schedule 14N would be the deadline provided in the company’s advance notice bylaw provisions (or if the company does not have such a provision, 120 days prior to the one-year anniversary of distribution of the prior year’s proxy materials).
The new Schedule 14N would require information regarding the nominating shareholder or group as well as information on the nominees. In addition, the shareholder or group would have to certify that the shareholder or group meets the share ownership requirements set forth above and intends to continue to own the shares through the annual meeting and that the shares are not being held for the purpose or with the effect of changing control of the company or to gain more than a limited number of seats on the board of directors. The Schedule 14N can also include a statement of support (not to exceed 500 words) from the nominating shareholder or group, which the company would be required to include in its proxy materials. The nominating shareholder or group would be liable for false or misleading statements in information provided to the company for inclusion in the proxy statement, and the company would not be responsible for such information unless the company knew or had reason to know the information was false.
Exclusion of Shareholder Nominees. Rule 14a-11 would establish procedures and deadlines for a company to follow if it determined that a shareholder nomination should be excluded because it did not satisfy the requirements of the rule. The process provides for deadlines and SEC staff involvement similar to the no-action letter process of Exchange Act Rule 14a-8. Generally, the burden would be on the company to show that a shareholder nomination should be excluded and the timing requirements of many advance notice bylaw provisions (which timing requirements would be used under Rule 14a-11) are not likely to provide many companies with the time required to seek exclusion of shareholder nominations under the rule as proposed.
Exemption from the Proxy Solicitations Rules. To facilitate the operation of Rule 14a-11, the SEC has also proposed amendments to the proxy rules that would provide a limited exemption from the proxy rules for written solicitations in support of a shareholder nominee and written solicitations by a shareholder that is seeking to form a nominating group. Solicitations in support of a shareholder nominee would be exempt if they do not, among other things, seek proxy authority or furnish a proxy and contain the identity of the nominating shareholder or group and a description of their direct or indirect interests, and are filed with the SEC on the date of first use. Solicitations by a shareholder who is seeking to form a nominating group would be exempt if the solicitations are limited to, among other things, a statement of the shareholder’s intent to form a nominating group and the proposed nominees or sought after qualifications for a nominee, and are filed with the SEC on the date of first use.
Shareholder Groups and Beneficial Ownership Reporting Requirements. The proposed rules would make it clear that a shareholder or group of shareholders would not lose eligibility to file beneficial ownership reports on Schedule 13G as a result of such shareholder’s or group’s nomination of director nominees, such shareholder’s or group’s solicitation in favor of such a nominee or the election of a nominee to the company’s board. These changes would only apply to shareholder nominations under Rule 14a-11.
As part of the proposed rules, the SEC did not include an exclusion from Section 16 for shareholders forming a group to nominate a director. Thus, shareholders must apply existing SEC rules and interpretations to determine whether a group has been formed such that Section 16 would require the group members to file Forms 3 and 4 and be subject to potential short swing trading liability.