In recent years, some activist shareholders and institutional investors have been pushing companies to allow long-term shareholders to propose candidates for election to a company’s board of directors. "Proxy access" proposals seek to provide shareholders with a mechanism for placing their nominees for election to the board of directors in a company's proxy statement and on its proxy card, thereby avoiding the cost to a shareholder of sending out its own proxy materials. Approval of a shareholder’s proxy access proposal by shareholders is merely advisory in nature and requires implementation by the company’s board of directors. However, such approval often results in pressure from institutional investors and proxy advisory firms to implement the proposal in response to the shareholders’ expressed will.
In 2010, the SEC approved an amendment to its proxy rules automatically giving shareholders the right to nominate directors to a company’s board of directors if they held a 3 percent stake in the company for three years. The new SEC rule (Rule 14a-11), was later stayed and ultimately vacated by DC Court of Appeals in 2011, when the court concluded that the SEC had acted “arbitrarily and capriciously” in issuing the rule. The SEC subsequently withdrew the rule without issuing any revised rules. Instead, the SEC implemented changes to Rule 14a-8 to allow shareholder proposals for proxy access to be made, in effect permitting each company to make its own decision on whether to allow proxy access, and, if allowed, the specific criteria a shareholder must satisfy (so-called “private ordering”). The number of proxy access shareholder proposals is on the rise as evidenced by the 75 proposals put forth so far this season by the New York City pension funds as discussed below.
Proxy Access Proposals Today
The most successful form of proxy access proposal in the past is one that follows the ownership requirement of the SEC’s vacated Rule 14a-11. These proposals would create a proxy access right for 3 percent shareholders (or groups) who have held their stake for at least three years, (“3 plus 3”) and would cap the number of shareholder-nominated candidates in the proxy materials at 20 percent of the number of directors then serving.
Although the once anticipated flood of proxy access proposals has never materialized, the New York City Pension Funds recently announced a broad initiative to advance the cause of proxy access, by filing “3 plus 3” shareholder proposals with 75 public companies seeking the right to include director nominees in each company’s proxy statement. The proposals are phrased as non-binding recommendations to the board that it adopt a proxy access bylaw. Some companies have agreed to let 3 percent holders nominate up to one-quarter of their directors, including CenturyLink, Chesapeake Energy, Hewlett-Packard, McKesson, Verizon and Western Union.
Many companies resist potentially opening the boardroom to investors in this manner by asking the SEC for permission to exclude the proposals from their proxy materials under the SEC staff no-action letter process and Rule 14a-8 of the proxy rules. Companies that receive a proxy access proposal should first assess whether the basic procedural requirements of Rule 14a-8 are satisfied. These gating items are read literally by the SEC staff and missing one or more of them by the proponent will usually result in the exclusion of the proposal from the company’s proxy solicitation materials.
If exclusion is not available, however, a company has three choices for responding to a proxy access proposal: (1) submit the proposal to a shareholder vote and make a board recommendation as to how shareholders should vote on it, (2) preemptively adopt a proxy access bylaw or submit a competing proxy access proposal (providing potential grounds for exclusion), or (3) attempt to negotiate a compromise or alternative outcome with the shareholder proponent. A recent SEC no-action letter pertaining to preemptively adopting a proxy access proposal may significantly impact the future of these proposals.
Whole Foods Market
In December 2014, the SEC staff granted Whole Foods Market, Inc. a no-action letter request allowing the company to omit from its proxy statement a non-binding shareholder proposal to permit “3 plus 3” proxy access for up to 25 percent of the board seats up for election. Seeking to exclude the proposal, Whole Foods indicated in its no-action letter request that it had determined to submit for a vote of its shareholders at the same meeting, a proxy access proposal that would allow any single shareholder owning at least 9 percent of the company’s common stock for five years to submit nominations to be included in the company’s proxy statement.
On the basis of Rule 14a-8(i)(9), the SEC staff agreed with Whole Foods that its proposal directly conflicted with the shareholder proposal and that submission of both proposals would have the potential for inconsistent and ambiguous results. Rule 14a-8(i)(9) allows a company to exclude from its proxy statement and annual meeting materials a shareholder proposal that “directly conflicts with one of the company's own proposals to be submitted to shareholders at the same meeting.” As such, Whole Foods could exclude the shareholder’s proxy access proposal from its proxy solicitation materials. The Whole Foods request was the first time that the SEC staff considered an argument to exclude a proxy access proposal because it was “in direct conflict” with a management proposal.
If a company either preemptively adopts a proxy access bylaw or submits a competing proposal to shareholder vote with higher eligibility thresholds, however, the shareholder proponent may come back with another shareholder proposal next year, seeking to reduce the thresholds. In that event, the company will likely not have a basis for excluding a “3 plus 3” proposal in the following year because the “substantially implemented” grounds for exclusion under Rule 14a-8(i)(10) will not be available. In prior SEC staff no-action letters, the staff has declined to permit the exclusion of a proxy access shareholder proposal on the basis that the company had “substantially implemented” the proposal by adopting its own form of proxy access that required a higher shareholding threshold or a longer shareholding period as compared with the shareholder proposal.
Whole Foods must have sensed the issue because it recently filed preliminary proxy solicitation materials with reduced proxy access eligibility thresholds. Under the revised management proposal, any single shareholder or group of funds under common management (but not a group of shareholders) owning at least 5 percent of the company’s common stock continuously for five years would be eligible to nominate board candidates for inclusion in the company’s proxy statement. The approach used by Whole Foods may simply postpone for one year the shareholder activists’ “3 plus 3” shareholder proxy access proposal.
Subsequent SEC Pronouncement
Due to questions about the scope and application of Rule 14a-8(i)(9), on January 16, 2015, SEC Chair Mary Jo White directed the staff of the Division of Corporation Finance (“Division”) to review its interpretation of Rule 14a-8(i)(9) with respect to excluding shareholder proposals that directly conflict with a company proposal to be submitted at the same shareholder meeting. Concurrent with the Chair's statement, the Division staff withdrew the Whole Foods letter and indicated that it will not be providing no-action relief for pending or subsequent no-action requests relating to proxy access proposals or any other pending no-action requests relying on Rule 14a-8(i)(9) during the 2015 proxy season.
While companies are not required to obtain no-action relief from the staff to exclude a shareholder proposal under Rule 14a-8, the consequence of the Division’s announcement is that companies that determine to exclude a shareholder proposal on the basis that it directly conflicts with management’s proposal will run the additional risk of enforcement action by the SEC. While companies may be able to conclude that, consistent with the Division’s precedents, they are justified in excluding a shareholder proposal that directly conflicts with management’s proposal, there would seem to be greater risk of doing so during the current proxy season until the SEC completes the reassessment of its position on the Rule 14a-8(i)(9) exception. Any company that determines to exclude a proposal without seeking a no-action letter from the Division must, under Rule 14a-8(j), inform the Division that it intends to exclude the proposal and "file its reasons" for excluding the proposal with the Division.
Where a proposal has been received and the company intended to exclude it under Rule 14a-8(i)(9), the company is now in a difficult position, as the usual Division guidance and no-action process will be unavailable. Interestingly, the procedural materials from the Division that accompany its no-action letters include language that says:
It is important to note that the staff's and Commission's no-action responses to Rule 14a-8(j) submissions reflect only informal views. The determinations reached in these no-action letters do not and cannot adjudicate the merits of a company's position with respect to the proposal. Only a court such as a U.S. District Court can decide whether a company is obligated to include shareholders proposals in proxy materials. Accordingly a discretionary determination not to recommend or take Commission enforcement action, does not preclude a proponent, or any shareholder of a company, from pursuing any rights he or she may have against the company in court, should the management omit the proposal from the company’s proxy material.
Companies should consider simply implementing their competing proposal, if implementation may occur without shareholder approval, and including the shareholder’s proposal in the proxy statement. In addition to eliminating any litigation risk for failing to comply with Rule 14a-8, this option effectively turns the shareholder proposal into a referendum on management’s alternative and changes management’s statement in opposition into a discussion of the merits of management’s alternative and why it is a better alternative than the shareholder proposal without the confusion that would result from presenting competing proposals in the proxy statement.As a result, any company receiving a shareholder proposal, and particularly companies that intended to exclude a shareholder proposal on the grounds provided by Rule 14a-8(i)(9), should consider seeking a declaratory judgment from a U.S. District Court well in advance of finalizing and filing their proxy materials for their 2015 annual meeting. Unfortunately, with the Division’s position on Rule 14a-8(i)(9) in limbo, it seems less likely that a court would follow the Division’s no-action letter precedents, introducing an additional element of uncertainty into the process where Rule 14a-8(i)(9) serves as the grounds for exclusion.
For future years, companies should consider steps to better prepare for, respond to and potentially avoid proxy access proposals, including maintaining a dialogue with key shareholders and monitoring market trends in this area. For example, companies may wish to consider the terms of a proxy access provision that might be generally acceptable to the company’s shareholder base, or other governance enhancements that may prevent the company from becoming a proxy access target and having it ready to propose to shareholders in the event the company receives a proxy access proposal. A company with some form of proxy access implemented may be in a stronger position to defeat a subsequent shareholder’s proposal if put to a vote, as it could be used by the company to argue that the board of directors already made a determination as to what is best for the company in light of its circumstances. Having a proxy access provision in place may also encourage activist shareholders to move on to companies with no provision in place.
A key consideration in deciding how to respond to a proxy access proposal is to assess whether the proposal is likely to receive majority shareholder support. If it does, proxy advisory firms such as ISS and Glass, Lewis & Co. (“Glass Lewis”), will expect the board to be appropriately responsive to the proposal, such as by adopting a compliant form of proxy access or explaining in its public filings why it did not, taking into account the factors ISS and Glass Lewis think are important.
Public companies should also review their advance notice bylaws to be sure they appropriately address nominations for director, particularly since there is no reason to think that traditional proxy contests will become less frequent.