On June 10, 2009, the Securities and Exchange Commission (the "Commission") published proposed amendments to the Commission's proxy rules intended to facilitate the nomination of directors by shareholders. The proposed amendments represent the third time in the last six years that the Commission has considered amendments to its rules regarding "proxy access," reflecting the controversial nature of shareholder proxy access, which pits shareholder and corporate governance activists (e.g., labor unions and government pension funds) against the business community and those who favor states' rights in corporate law matters. In the proposing release, the Commission cited the current economic downturn and concerns about the accountability of boards of directors to shareholders and about whether boards are exercising appropriate oversight of management. The Commission said it is focused on allowing shareholders to hold boards accountable by "removing burdens that the federal proxy process currently places on the ability of shareholders to exercise their basic rights to nominate and elect directors." Although past amendments supporting proxy access were not adopted, we believe it is likely that some form of proxy access will be adopted as a result of this latest proposal.  

The Commission has stated a desire to adopt final rules in time for the 2010 proxy season. However, the 250-page release contains more than 170 requests for comment that raise numerous significant issues. As a result, we expect comments to be substantial, and it is possible that the debate triggered by the comments will affect timing of the adoption of final rules. Comments are due by August 17, 2009. The proposing release is available at http://www.sec.gov/rules/proposed/2009/33-9046.pdf.

Eligible shareholders will be able to include their nominees for director in a company's proxy materials.

Under the new proposed Rule 14a-11, eligible shareholders will have access to a company's proxy materials in order to facilitate the election of directors nominated by those shareholders. The proposed rule would apply to all companies registered under the Securities Exchange Act of 1934 (the "Exchange Act") (other than those companies with only publicly-held debt securities) and certain investment companies registered under the Investment Company Act of 1940. The proposed rule would not be available for shareholders seeking to change the control of the company or to gain more than a limited number of board seats.

Eligibility to Nominate Directors

Shareholders will be able to include their nominees for director in a company's proxy materials if they have owned the requisite amount of shares for at least one year and intend to continue to hold those shares through the date of the applicable shareholder meeting, unless shareholders are otherwise prohibited by applicable law or the company's governing documents from nominating a director.

A nominating shareholder must own, individually or in the aggregate with other shareholders of the company, the following percentage of a company's voting stock in order to include nominees in the company's proxy materials:

  • at least 1% of the voting stock of a large accelerated filer (companies with a public float of $700 million or more) or of a registered investment company with net assets of $700 million or more.
  • at least 3% of the voting stock of an accelerated filer (public float of $75 million or more but less than $700 million), or of a registered investment company with net assets of $75 million or more but less than $700 million.
  • at least 5% of the voting stock of a non-accelerated filer (public float of less than $75 million) or of a registered investment company with net assets of less than $75 million.

Number of Nominees Permitted

Under proposed Rule 14a-11, a nominating shareholder or group of shareholders will be able to nominate the greater of one director and a number of directors that represents not more than 25% of the company's board of directors. If the company has a director currently serving on its board who was elected as a shareholder nominee pursuant to Rule 14a-11 and the term of that director extends past the date of the shareholders meeting, the company would not be required to include nominees that could result in the total number of directors who were elected as shareholder nominees exceeding this limit. If more than the maximum number of nominations is received, nominees from shareholders will be included in a company's proxy materials based on a "first-to-file" standard.

Required Filing by Nominating Shareholder

A nominating shareholder or group would be required to file a notice on new Schedule 14N with the Commission and to provide a copy of the notice to the company. Schedule 14N would include disclosure concerning the nominating shareholder or group and the nominees similar to the disclosure currently required in a contested election. The nominating shareholder or group can include in Schedule 14N a statement in support of the nominees, which may not exceed 500 words, if it wishes to have the statement included in the company's proxy statement. The nominating shareholder or group also must certify that to the best of the nominating shareholder's or group's knowledge and belief, its stock is not held for the purpose of changing the control of the company or gaining more than a limited number of seats on the board of directors.

Schedule 14N also would include: (i) the nominating shareholder's or group's stock ownership and period of ownership; (ii) a statement that the nominating shareholder or group intends to continue to own the requisite number of shares through the date of the shareholder meeting; (iii) a statement concerning the nominating shareholder's or group's intent with respect to continued ownership of the stock after the shareholder meeting; (iv) each nominee's consent to be named in the proxy materials and to serve on the board, if elected; (v) disclosure concerning any relationships between (a) the nominating shareholder or group and the nominees and (b) the company or any affiliate of the company; and (vi) certain other disclosures and representations concerning legal proceedings and the eligibility of the nominating shareholder or group to make the nominations and qualifications of the nominees to serve as a director.

Schedule 14N would need to be filed with the Commission and sent to the company by the date specified in the company's advance notice bylaw provision or, if no such provision is in place, generally no later than 120 calendar days before the first anniversary of the date on which the company mailed its proxy materials for the prior year's annual meeting.

The nominating shareholder or group would be required to file a final amendment to Schedule 14N within 10 days after announcement of the final results of the election disclosing the nominating shareholder's or group's intention with regard to continued ownership of its stock.

Qualifications of Nominees

The nominees would not be required to meet a nominating committee's or board of director's qualifications criteria. The only qualifications to be a nominee are: (i) the nominee's candidacy and board membership cannot violate controlling state law, federal law or rules of a national securities exchange applicable to the company; and (ii) unless the company is an investment company, the nominee must meet the objective criteria for "independence" of the national securities exchange rules applicable to the company. The nominee does not have to be independent of the nominating shareholder. In addition, the nominating shareholder or group may have no direct or indirect agreement with the company regarding the nomination of the nominee.

Excluding a Shareholder Nomination

If the company receives a nominating shareholder's or group's notice and determines that there is no basis for exclusion of the nominations, the company would notify the nominating shareholder or group in writing no later than 30 calendar days before the company files its proxy materials with the Commission that it will include the nominations.

If the company determines that there is a basis for exclusion, it must notify the nominating shareholder or group in writing of the determination within 14 days after the company's receipt of the nominating shareholder's or group's notice. The nominating shareholder or group would have 14 days to cure any deficiencies, but could not substitute a new nominating shareholder or nominee. If a dispute exists, the contemplated resolution procedure would resemble the no-action letter procedure used for shareholder proposals.

Material to Be Included in Proxy Materials

If there is no basis for exclusion of the nominations, the company would be required to include in its proxy statement certain information from the nominating shareholder's or group's Schedule 14N similar to the disclosure currently required in a contested election, including: (i) the statement concerning the nominating shareholder's intent to continue to own the shares through the date of the shareholder meeting and intent with respect to continued ownership after the shareholder meeting; (ii) each nominee's biographical information; (iii) disclosure concerning any relationships between (a) the nominating shareholder or group and the nominee and (b) the company or any affiliate of the company; (iv) the website on which the nominating shareholder may publish soliciting materials; and (v) any statement in support of the nominee. The nominating shareholder or group will be liable for any false or misleading information provided to the company that is included in the proxy materials, and the company will be liable for that information only if it knows or has reason to know that it is false or misleading.

The company also would be required to include the nominees on its proxy card. The company would be permitted to indentify each nominee as a shareholder nominee and recommend how shareholders should vote with respect to that nominee. When a shareholder nominee is included in the proxy card, the proposed amendments would not permit a company to provide the option of voting for or withholding authority to vote for nominees as a group.

Solicitation by the Nominating Shareholder

The proposed amendments would provide an exemption from the proxy rules for limited written communications by the nominating shareholder or group made in connection with formation of a nominating group pursuant to Rule 14a-11 and in support of a nominee placed on a company's proxy card in accordance with Rule 14a-11. The nominating shareholder or group would be required to file any materials with the Commission on their date of first use and would not be permitted to seek the power to act as a proxy for a shareholder. Nominating shareholders or groups also would be able to continue to rely on existing exemptions from the proxy rules.

Other Issues

The Commission is of the view that use of proposed Rule 14a-11, by itself, should not be deemed to establish a relationship between the nominating shareholder or group and the company that would result in the holder or group being deemed an "affiliate" of the company under federal securities law. In addition, if the nominee is elected, and the nominating shareholder or group does not have an agreement or relationship with that director, other than relating to the nomination, the nominating shareholder or group would not be deemed an affiliate of the director solely by virtue of having nominated that director under the proposed rule.

Nominating shareholders will need to consider whether they have formed a group under the Exchange Act that is required to file beneficial ownership reports. If a group's activities are solely in connection with a nomination under Rule 14a-11, the Commission proposes to allow the group to report on Schedule 13G, rather than Schedule 13D.

A group also would need to consider issues under Section 16 of the Exchange Act, and the Commission states that the group would be analyzed the same way as any other group for purposes of determining whether group members are 10% beneficial owners subject to Section 16. The Commission does not propose standards for establishing the independence of the nominee from the nominating shareholder or group for purposes of Section 16, including the potential for the nominating shareholder or group being deemed a director under the "deputization" theory developed by courts in Section 16 short-swing recovery cases.

Impact on State Proxy Access Laws

Recently adopted Section 112 of the Delaware General Corporation Law permits companies to include proxy access provisions in their corporate bylaws. The proposed amendments appear to prevent companies from adopting proposed standards in their corporate bylaws that are more strict than those included in the proposed amendments. We expect that debate will continue over whether the approach taken by Delaware is preferable to the one-size-fits-all approach in the proposing release, and that the Commission's initiative will be challenged as a usurpation of states' rights to govern the internal substantive affairs of corporations that are creatures of state law.

Shareholders will be able to make shareholder proposals concerning proxy access in a company's proxy materials.

In 2007, the Commission amended Rule 14a-8(i)(8) to state that proxy access shareholder proposals are excludable from a company's proxy materials. The Commission has proposed an amendment to Rule 14a-8(i)(8) that would allow a shareholder to require a company to include in its proxy materials a shareholder proposal that amends, or requests an amendment to, the company's governing documents to address the company's nomination procedures or other director nomination disclosure provisions. Any such shareholder proposal must not conflict with state law or proposed Rule 14a-11.

The Commission acknowledges that the amendment could result in shareholders proposing amendments that would establish procedures for nominating directors and disclosures related to such nominations that require a less restrictive ownership threshold, holding period or other qualifications than those proposed in Rule 14a-11.

In addition to the current procedural and substantive means for excluding a shareholder proposal from a company's proxy statement, a company would be able to exclude a proposal under amended Rule 14a-8(i)(8) if it: (i) would disqualify a nominee who is standing for election; (ii) would remove a director from office before his term has expired; (iii) questions the competence, business judgment or character of one or more nominees for director; (iv) nominates a specific individual for election to the board, other than pursuant to proposed Rule 14a-11, an applicable state law provision or the company's governing documents; or (v) otherwise could affect the outcome of the upcoming election of directors.

Conclusion

In anticipation of the adoption of proxy access rules, companies should review their advance notice bylaw provisions, including by confirming that the nomination deadline is at least as favorable as that contemplated by the proposing release in order to permit the company sufficient time to avail itself of the no-action letter process if a shareholder nomination is received. Adoption of proxy access rules also will increase the importance of companies communicating and improving relationships with significant shareholders.