On August 25, 2010, the Securities and Exchange Commission (“SEC”), by a 3-2 vote, adopted new Exchange Act Rule 14a-11 and related rule amendments, which are commonly referred to as the “proxy access” rules. As a result, for the first time, eligible shareholders can nominate directors for election using the company’s proxy materials (i.e., the company’s proxy statement and proxy card) instead of being required to prepare their own separate proxy materials. The SEC believes the new proxy access rules will improve shareholders’ ability to exercise their traditional state law right to nominate directors and allow for increased communication among shareholders with respect to the director nomination process.
To be eligible, a shareholder or group of shareholders must have continuously owned, for at least three years, shares representing at least 3% of the voting power of a company’s securities and must hold the shares passively without a “control intent.” Under Rule 14a-11, shareholders that meet these eligibility requirements can nominate directors comprising up to 25% of the board of directors (or a minimum of one director).
In addition, the SEC amended the shareholder proposal rule (Exchange Act Rule 14a-8) to allow proxy access shareholder proposals in a company’s proxy materials. As a result, a shareholder could propose a “parallel” proxy access scheme by adopting a bylaw provision requiring the company to include shareholder nominations in its proxy materials subject to less restrictive eligibility requirements. If such a proposal was approved (and if it was binding), shareholders could gain proxy access through either Rule 14a-11 or the less restrictive bylaw provision.
The SEC also adopted certain related rule amendments, which, among other things, exempt from the proxy solicitation rules shareholder communication for the purpose of forming a nominating group and amend the Schedule 13D/13G rules so that shareholders availing themselves of new Rule 14a-11 can continue to file the shorter Schedule 13G.
By adopting the proxy access rules, the SEC is seeking to facilitate the ability of shareholders to nominate and elect directors. Because of the share ownership and passive intent requirements adopted in the rule, however, we believe that the mandatory proxy access rules will have limited impact on most public companies, at least in the near term. The proxy access rules will primarily benefit long-term, passive, institutional shareholders, such as pension funds, that wish to nominate a limited number of candidates to oppose the board’s nominees. The new rules, however, are not likely to be as useful to hedge funds or activist shareholders because, among other things, activist shareholders are less likely to be able to satisfy the stock ownership requirements and may not have a “passive” investment intent. The change to Rule 14a-8 could potentially have far-reaching effects, as it may be used by shareholders to require or pressure companies to establish a parallel proxy access process that is less restrictive than Rule 14a-11. Ultimately, it remains to be seen how frequently the proxy access rules are actually utilized and to what extent shareholders seek to establish parallel proxy access processes.
When the Rules Go Into Effect
The new rules become effective 60 days after publication in the Public Register and will be effective for companies if the first anniversary of mailing its proxy statement for its 2010 shareholders meeting is more than 120 days following effectiveness. Companies should expect that the rules will be in place for the 2011 proxy season. The new rules do not become effective for “small reporting companies” (i.e., generally those with a public float below $75 million) until three years following effectiveness for larger companies.
The text of the SEC release adopting the proxy access rules is available on the SEC’s website.
Immediate Implications for Public Companies
Every public company should consider taking the following steps prior to effectiveness of the new proxy access rules:
- Determine whether any existing shareholders are eligible to submit nominations under the new rules. For example, does the company have a passive 3% shareholder that has held the shares for three years?
- Review corporate governance guidelines and director nomination policies and processes to determine how the existing policies and processes will interact with the new rules and determine if any changes are necessary. For example, will the company have a different procedure for considering nominations made under the proxy access rules from those made under its bylaws?
- Review the company’s bylaws and consider amending them to better align the timetable for shareholder nominations under the proxy access rules and shareholder nominations outside of the proxy access rules. Many companies have advance notice bylaw provisions that require the submission of director nominations between 90 and 120 days prior to the anniversary of last year’s annual meeting while nominations under Rule 14a-11 must be delivered between 120 and 150 days prior to the anniversary of the distribution of last year’s proxy materials. For example, if the 2009 proxy materials were mailed on April 1 and the 2009 annual meeting was held on May 15, then
- Shareholder nominations under Rule 14a-11 must be submitted between November 2 and December 2; and
- Shareholder nominations outside of Rule 14a-11 (i.e., that do not seek to use the company’s proxy materials) must be submitted between January 15 and February 14.
- Ensure sufficient time is built into the company’s proxy preparation schedule in the event that the company needs to go through the SEC’s new exclusion process for any shareholder nominations received.
- Review majority voting policies for the election of directors (if applicable) and ensure that, if the election of directors includes a candidate nominated pursuant to Rule 14a-11, plurality voting will be utilized for such an election insofar as the election should be treated as a contested election.
- Know the company’s large shareholders and meet with them regularly to understand the issues that are important to them. Shareholder activism is here to stay. Shareholders are pursuing proxy fights more frequently and with more success. The number of proxy fights increased to 133 in 2009 (as opposed to 56 in 2008 and 46 in 2007). In contested situations, dissident shareholders were successful in obtaining at least one board seat in over a majority of contested situations. The proxy access rules are just one additional tool that can be used by shareholders to get a company’s attention. The best defense against a proxy contest is an active shareholder relations program. Public companies should meet with their large shareholders on a regular basis and be aware of the operational and corporate governance issues that shareholders believe are important.
Highlights of New Rule 14a-11
Mandatory Inclusion of Shareholder Nominee. Companies subject to Rule 14a-11 must include in their proxy materials, at the company’s expense, any director candidate nominated in compliance with Rule 14a-11 unless the shareholders are prohibited by the company’s governing documents or applicable state law from nominating candidates for director. No states currently prohibit a shareholder from nominating candidates for director, and it is unlikely that any will do so in the foreseeable future. The new rules also allow shareholders to submit shareholder proposals to eliminate any restrictions contained in the governing documents. Companies have no ability to “opt out” of the new rules so long as shareholders have a right to nominate directors.
Companies Subject to 14a-11. Rule 14a-11 applies to all companies, including investment companies, that are subject to the SEC proxy rules other than “debt only” public companies (i.e., companies with public reporting obligations solely because they have a class of debt securities registered under Section 12 of the Exchange Act). Rule 14a-11 does not apply to foreign private issuers and other non-U.S.-domiciled companies not subject to the U.S. proxy rules.
Eligibility to Submit Nominations. To be eligible to submit nominations, shareholders must have continuously held, in the aggregate, shares representing at least 3% of the voting power of the company’s securities for three years and must hold the shares passively without a “control intent.”
Shareholders are permitted to aggregate their holdings to meet the minimum share ownership threshold and the SEC has adopted an exemption to the proxy solicitation rules allowing shareholders to freely communicate with each other for the purpose of forming a nominating group. In addition, the shareholder or group must hold the shares through the date of the annual meeting and must disclose their intentions with respect to continued ownership of the shares after the annual meeting.
Calculating the 3% Ownership Threshold. New Rule 14a-11 requires that a nominating shareholder or group have both investment and voting power over its shares. A shareholder may treat as beneficially owned any shares that it has lent to third parties if it has the right to recall such shares and certifies that it will do so if its nomination is accepted. In addition, shareholders must deduct from their holdings any borrowed shares or shares that have been sold short. Also, for the purposes of Rule 14a-11, shares that a shareholder has the right to acquire (e.g., shares underlying unexercised options) are not counted as being owned.
No Control Intent. The nominating shareholder or group must certify that it is not holding the shares for the purpose or with the effect of changing control of the company or to gain more seats on the board of directors than may be nominated pursuant to Rule 14a-11 (i.e., a “control intent”).
What acts evidence a “control intent” will likely be the subject of much scrutiny, as the SEC has historically viewed “control intent” broadly based on a fact-specific “totality of the circumstances” analysis. In view of these considerations, we expect that public companies may 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.
Maximum Number of Shareholder Nominees. A company is required to include in its proxy materials each year shareholder nominees comprising 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. If the number of shareholder nominations exceeds the nominee limit, then the company must include the nomination(s) received from the nominating shareholder or group representing the highest percentage ownership. If a company agrees not to nominate a director candidate in opposition to a shareholder nominee (i.e., effectively conceding the election), the shareholder nominee will nevertheless count against the nominee limit.
Shareholder Nominee Requirements. A company is not 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. For example, in certain circumstances, U.S. antitrust law prohibits an individual from serving as the director of two direct competitors. Shareholder nominees have to satisfy the objective independence standards of the stock exchange rules applicable to the company (i.e., stock exchange rules that impose specific quantitative, objective criteria that at a minimum must be satisfied in order for a director to be considered independent) but not the subjective independence standards (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). The nominating shareholder or group may not have any agreement with the company regarding the nomination; however, the rules do not prohibit shareholders from nominating themselves or their affiliates for candidacy.
Proposing Nominees – Notice and Disclosure Requirements. Nominating shareholders or groups are required to submit nominations to the company by filing a Schedule 14N with the SEC and delivering a copy to the company. The shareholder must submit a Schedule 14N no earlier than 150 calendar days, and no later than 120 calendar days, prior to the one-year anniversary of distribution of the prior year’s proxy materials. If the date of the shareholder meeting is changed by more than 30 days from the prior year’s meeting, then the company must file a Form 8‑K setting forth a new deadline that is a reasonable time prior to distribution of the proxy materials.
Schedule 14N requires information regarding the nominating shareholder or group as well as information on the nominees. In addition, the shareholder or group must certify that the shareholder or group meets the share ownership requirements described 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 seats on the board of directors than is permitted under Rule 14a‑11. The Schedule 14N can also include a statement of support (not to exceed 500 words) from the nominating shareholder or group, which the company must include in its proxy materials. The nominating shareholder or group may 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.
Exclusion of Shareholder Nominees. Rule 14a-11 establishes procedures and deadlines for a company to follow if it determines that a shareholder nomination should be excluded because it did not satisfy the requirements of the rule. Generally, the burden will be on the company to show that a shareholder nomination should be excluded, and the process is similar to the SEC’s process for obtaining a “no action” letter to exclude a shareholder proposal. Companies are required to notify nominating shareholders or groups of a challenge within 14 calendar days following the expiration of the deadline for shareholders to submit nominations, and shareholders must respond within 14 calendar days of receiving such notice.
Exemption from the Proxy Solicitations Rules. To facilitate the operation of Rule 14a-11, the SEC has also adopted amendments to the proxy rules that provide a limited exemption from the proxy rules for solicitations in support of a shareholder nominee and solicitations by a shareholder in connection with the formation of a nominating group. Solicitations in support of a shareholder nominee are exempt if they do not, among other things, seek proxy authority or furnish a proxy and any written communications includes the identity of the nominating shareholder or group and a description of its direct or indirect interests, and are filed with the SEC on the date of first use. Written solicitations by a shareholder seeking to form a nominating group are exempt if the solicitations are limited to, among other things, a statement of the shareholder’s intent to form a nominating group, certain limited information on nominees or potential nominees and the soliciting shareholder’s voting power, and are filed with the SEC on the date of first use. Oral solicitations by a shareholder seeking to form a nominating group may only be made following the filing of a Schedule 14N cover page with the SEC.
Shareholder Groups and Beneficial Ownership Reporting Requirements. The new rules make clear that a shareholder or group of shareholders does 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 such a nominee to the company’s board. These changes apply only to shareholder nominations under Rule 14a-11.
The new rules do 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.
Amendments to Rule 14a-8(i)(8) to Require Companies to Include Proxy Access Shareholder Proposals in Company Proxy Materials
The SEC also adopted amendments to Exchange Act Rule 14a-8(i)(8), the so-called “election exclusion” provision of the shareholder proposal rule. Previously, Rule 14a-8(i)(8) allowed a company to exclude a shareholder proposal if it related to a nomination or election to the company’s board or the related procedures for such nomination or election. After the amendment, companies may not exclude from its proxy materials a shareholder proposal that would amend or request an amendment to a company’s governing documents regarding shareholder proxy access as long as the proposal does not conflict with applicable law, including Rule 14a-11. The proxy access shareholder proposals would be subject to the same eligibility and procedural requirements as other shareholder proposals under Rule 14a-8 (i.e., to be eligible to submit a proposal, a shareholder must have continuously held at least $2,000 in market value, or 1% of the company’s securities entitled to vote, for at least one year).
While companies may exclude a shareholder proposal from their proxy materials if the proposal limits Rule 14a-11, it is important to understand that nothing prohibits shareholders from proposing the adoption of an alternative proxy access mechanism in the company’s governing documents that is less restrictive than Rule 14a-11, for example, by having lower eligibility thresholds. So long as the proposed alternative mechanisms do not restrict the operation of Rule 14a-11, the proposal cannot be excluded from the proxy materials.