Recent activity by shareholder governance advocates and the SEC has thrust proxy access back into the spotlight. Here we provide a brief refresher on proxy access and our thoughts on recent developments.
- Though SEC Rule 14a-11 mandatory proxy access was vacated a few years ago, shareholders are continuing to use the shareholder proposal vehicle in Rule 14a-8 to propose their own forms of proxy access
- The SEC recently announced that for this proxy season it will no longer provide “no action” concurrence for companies attempting to keep shareholder proxy access proposals out of proxy statements because of conflicts with more limited company proxy access proposals
- Proxy access proposals will likely pick up steam beyond this proxy season, and companies should prepare by considering a range of possible responses
- The primary users of proxy access are likely to be governance advocates rather than activist hedge funds and takeover proponents
- For governance advocates, the threat or reality of proxy access will create leverage potentially even more powerful than majority or plurality plus voting
A Brief History of Proxy Access
Proxy access refers to giving shareholders the right to nominate directors and list those nominees in the company’s own proxy statement and proxy card used to solicit support for director nominations. This ostensibly saves a shareholder proponent the cost of disseminating the alternative proxy statement and card, though not necessarily the campaign costs to persuade other shareholders to vote for the shareholder's nominees.
The true cost advantages of proxy access in the Internet age remain subject to discussion. However, the easier piggyback approach of proxy access will afford other advantages to proxy access advocates as well, such as making it more convenient for shareholders to propose dissident directors and to vote on such nominees under the aegis of a unitary company document which may lend more legitimacy and credence to these nominees.
The SEC has been contemplating proxy access for decades, and more recently began to focus on the issue in 2003 after the Enron and Worldcom scandals. In 2010, in the wake of the Dodd-Frank Act's authorization to implement proxy access, the SEC adopted Rule 14a-11, a mandatory proxy access rule allowing "eligible" shareholders owning at least 3% of the company’s shares for at least 3 consecutive years to nominate up to 25% of the company’s board through the company’s proxy statement.1 No nominations could be made by a shareholder seeking to change control of the company or nominate more than 25% of the board. In 2011, Rule 14a-11 was vacated on procedural grounds by the D.C. Circuit Court of Appeals.2
Although Rule 14a-11 is dead (at least for the foreseeable future), the SEC’s companion amendments to Rule 14a-8 live on. Those amendments permit shareholders to use the company’s proxy materials to propose precatory or binding amendments to the company’s bylaws that would establish a company-specific form of proxy access—referred to as “private ordering.”
Proxy Access Recently
Since the court ruling on Rule 14a-11, shareholder proposals under Rule 14a-8 have not enjoyed a particularly successful run. Of the 43 shareholder proxy access proposals that were voted on between 2012 and 2014, only 9 of the proposals received majority support, and the average shareholder vote in favor was only approximately 30%.3
However, the dialogue on proxy access among institutional shareholders, the governance community and companies has never abated. This proxy season, in a shot across the bow at Corporate America, the New York City Comptroller submitted proxy access shareholder proposals under Rule 14a-8 to 75 companies under the “Boardroom Accountability Project” banner.4 The Boardroom Accountability Project proposals are generally along the lines of the terms of the vacated Rule 14a-11. The companies were chosen based on three priority issues: climate change, board diversity and CEO pay.
Several companies have simply decided to put these and other shareholder proxy access proposals in the companies’ proxy statements but recommend their rejection. Others have attempted to work out a compromise with the proponents, principally to make the “eligible” shareholder requirements somewhat more difficult to meet. And still other companies have attempted to exclude from their proxy statements the proxy access shareholder proposals by countering with their own, stricter versions. They have cited Rule 14a-8(i)(9), which permits companies to exclude from their proxy statements shareholder proposals that “directly conflict” with management proposals. Some companies have sought “no action” relief from the SEC to bless the exclusion on these grounds.
For example, Whole Foods Market, Inc., faced with a Rule 14a-11 styled proxy access shareholder proposal, countered with its own proposal, which requires shareholders to hold at least 9% of the company’s shares for at least 5 years and limits the number of nominees to 10% of the board. The company obtained a “no action” letter from the SEC in December 2014 with respect to the company’s position to exclude the conflicting shareholder proposal. Other companies followed suit.5 In response to this development, many in the governance community complained that the SEC’s position was wrong and that it had inappropriately used Rule 14a-8(i)(9) to keep the shareholder proposal off the ballot.6 Caught in a whipsaw, the SEC announced in January 2015 that it would undertake a review of the Rule 14a-8(i)(9) exception and no longer express any views on the application of the exception during the current proxy season.7
Faced with the SEC’s new non-position, companies that had planned to rely on the Rule 14a-8(i)(9) exception during the 2015 proxy season are now scrambling to determine how they will handle shareholders’ proxy access proposals. The alternatives range from exclusion in continued reliance on the exception despite the lack of SEC support (with or without seeking court approval for this approach); including both the company and shareholder-proposed versions in the proxy statement; or including only the shareholder proposal in the proxy statement (with or without a company recommendation against the proposal). An informal survey by Broc Romanek of The Corporate Counsel indicated that there is a preference for continued exclusion of shareholder proposals,8 but given the likely blowback from many shareholders and proxy advisors, this tactic may turn out to be a pyrrhic victory. As a result, many companies are seeking a compromise with the proponents of proxy access.
Proxy Access is Here to Stay
Whatever the outcome this proxy season, most observers believe it is likely that proxy access bylaws or policies will proliferate and become a more ordinary part of the corporate landscape. It remains to be seen whether proxy access will become as widespread as, say, majority voting and anti-poison pill bylaws or policies have become in recent years. Like the arc of those other proposals, proxy access may gain a foothold at the largest market cap companies and then move its way down the corporate food chain to the mid-caps.
This is not to say that proxy access bylaws, even if widely adopted, will approach uniformity in material terms. The proxy advisors and many institutions themselves have indicated that companies must be viewed on a case by case basis.9 The “conventional” 3%/3 year/25% of the board paradigm may in fact be inappropriate given a particular company’s shareholder demographics, size, board profile or recent history. Nevertheless, companies should be forewarned that many shareholders and their proxy advisors will view the Rule 14a-11 terms as appropriate. Companies may bear a heavy burden to justify any material deviation from these terms or else continue to face shareholder proposals calling for terms the governance advocates consider more regularized. Accordingly, whether or not companies are facing a proxy access proposal this spring, boards need to be educated about the topic and discuss likely positions as part of their shareholder engagement efforts. Companies that wish to defer taking a position on the issue, at least in the near term, would do well to maintain good governance policies and avoid the types of controversies that make companies targets for governance advocates or activists.
The Real Bite of Proxy Access; the Cat’s Paw of the Proxy Advisors?
Where proxy access has been available to date, we know of no instance where it was actually used by shareholders at larger companies to put up director nominees.10 Given its novelty and controversial nature, observers have widely divergent opinions as to who will actually use proxy access if it becomes more widespread. Not surprisingly, many of these predictions are influenced by whether or not the observer thinks proxy access is a necessary governance tool.
Many observers believe that proxy access will not be put to frequent use by activists and other takeover participants. The typical shareholding time requirements will make ineligible many short term activists such as hedge funds. Other typical restrictions limiting use in change of control contexts will also have bite. Finally, such activists and other takeover participants, because of their platforms, usually invest in active and more resource-intensive proxy solicitations to better assure that their proposals are well articulated and ultimately persuasive.11
It is more likely that, at least in the near term, proxy access will strengthen the positions of shareholder constituencies advocating governance, pay practice and other social, political or environmental issues, particularly if the areas are a focus for the key proxy advisors. ISS and Glass Lewis influence and sometimes even determine the outcome of shareholder voting decisions at typical mid- or large-cap companies.12
The proxy advisors’ policies with respect to chastening recalcitrant boards will also bolster the impact of proxy access. Currently, ISS will recommend a negative vote against directors if the board “failed to act” on a shareholder proposal supported by a majority of the votes cast in the previous year.13 Glass Lewis will scrutinize the board’s responsiveness where 25% or more of the shareholders vote against the recommendation of management on any proposal.14 Under a proxy access regime, proxy advisors would be able to recommend dissident directors who support the shareholder and proxy advisors’ positions.
This symbiotic interrelationship of proxy access, the governance community and the whip hand of the key proxy advisors may have even more bite than majority or “plurality plus” voting policies, now predominant at S&P 500 companies.15 Some governance advocates have complained these voting policies do not have enough teeth to provide meaningful influence for shareholders, citing the number of “zombie” directors who did not receive the requisite vote but remain on boards.16 Armed with the increased leverage of proxy access, these advocates can now pressure boards to better accommodate their policies or not ignore previous shareholder voting decisions. If they don’t comply, such companies will now face the prospect of welcoming new, unwanted colleagues into their board rooms. And even if the actual number of proxy access-elected directors remains small, that may not necessarily mean that the implementation of proxy access at companies was a non-event. Rather, it may simply mean that the threat of proxy access has worked to better implement shareholder-driven policy initiatives.
Although the proxy access movement has been around for a while, recent developments suggest this proxy season may be an inflection point in its evolution. The outcomes this season could determine both the future direction of proxy access and its contours for years to come.