On August 25, 2010, in a 3-2 vote along party lines, the Securities and Exchange Commission (the “Commission”) adopted amendments to its proxy rules to facilitate the nomination of directors by shareholders. The “proxy access” rules come just 34 days after the passage of the Dodd-Frank bill, which explicitly authorized the Commission to issue regulations governing proxy access. Previously, some questioned the Commission’s authority to regulate an area historically reserved to state corporate law.
The final rules follow the structure of the Commission’s June 2009 proposals in that they are mandatory, with no ability to opt out or private order -- unless state law or the company’s governance documents prohibit shareholders from nominating directors. In addition, the rules continue to be unavailable to any shareholder who holds any of the company’s securities with the purpose or with the effect of changing control of the company. However, the final rules vary from those proposed in June 2009 in some important respects, including a tightening of the thresholds for shareholder eligibility to nominate directors, a three-year deferral of the rules’ applicability to smaller reporting companies, and a rejection of the first-to-file standard when there are too many nominees under the new rules.
In summary, new Rule 14a-11 will permit a shareholder or a group of shareholders to include its nominees for director in a company’s proxy materials if it has continuously held a number of shares equal to at least 3% of the shares entitled to vote in the director election for at least three years. This is in contrast to the June 2009 proposals that included a holding period of just one year and ownership thresholds ranging from 1% to 5%, depending on the size of the company. Rule 14a-11 will permit shareholders to nominate at least one director and up to a number of directors that represents not more than 25% of the total number of the company’s directors. Unlike the earlier proposals, if there are competing nominees under Rule 14a-11 that exceed the allowable number of directors, the nominating shareholders holding the highest percentage of voting power will be permitted to include their nominees, instead of the first-to-file standard.
The new rules will be effective 60 days after their publication in the federal register, and will therefore apply to the 2011 proxy season for calendar year companies.
Eligible shareholders will be able to include their nominees for director in a company’s proxy materials.
Under Rule 14a-11, eligible shareholders or groups of shareholders will have access to a company’s proxy materials in order to facilitate the election of directors nominated by those shareholders. Rule 14a-11 will apply only when applicable state law or a company’s governing documents do not prohibit shareholders from nominating a candidate for election as a director. The 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. However, Rule 14a-11 will not be available to shareholders of “smaller reporting companies” (generally companies with under $75 million in public float) until the third anniversary of the effective date of the new rule. Consistent with the rules proposed last year, Rule 14a-11 would not be available for shareholders seeking to change the control of the company or to gain more than the limited number of board seats contemplated by the rule.
Eligibility to Nominate Directors
Shareholders will be able to include their nominees for director in a company’s proxy materials by notice to the Company filed with the Commission on Schedule 14N if they have continuously owned, for at least three years, individually or together with other members of a shareholder group, at least 3% of the company’s securities entitled to vote at the meeting at which directors are to be elected. The shareholders must to continue to hold those shares through the date of the applicable shareholder meeting and will be required to disclose their intention with respect to the holding of securities after the meeting, assuming their nominees are elected. In determining a shareholder’s or group’s holdings, only shares over which the nominating shareholder or group member has voting and investment power are included. However, shares loaned by the shareholder or group member to another person may be included if the shareholder or group member has the right to recall the loaned shares and will do so if the shareholder’s or group’s nominees will be included in the company’s proxy materials. Shares that are borrowed or have been sold short may not be included in a shareholder’s or group’s holdings.
Number of Nominees Permitted
Under Rule 14a-11, a nominating shareholder or group of shareholders will be able to nominate a number of directors (not less than one) that represents 25% of the total number of a company’s directors, even in the case of a staggered board. If 25% of the total number of directors is not a whole number, the maximum number of nominees that the company will be required to include in its proxy materials will be the closest whole number below 25%. The adopting release emphasizes that 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, including the current director, exceeding the 25% limit. If a company negotiates with a shareholder or shareholder group to include the shareholder or group’s nominee in the company slate of directors, that nominee will still be counted toward the 25% maximum but only if those negotiations began after the filing of a Schedule 14N. If a company receives more than the maximum number of nominations from shareholders under Rule 14a-11, nominees will be included in a company’s proxy materials based on the highest qualifying voting power percentage, instead of the “first-to-file” standard included in the June 2009 proposals.
Required Filing by Nominating Shareholder
A nominating shareholder or group seeking to take advantage of Rule 14a-11 will be required to file a notice on new Schedule 14N with the Commission and to provide a copy of the notice to the company. The nominating shareholder or group can include in the 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 the number of seats on the board of directors permitted by Rule 14a-11.
Schedule 14N also would include: (i) the nominating shareholder’s or group’s stock ownership percentage and period of ownership, (ii) a statement that the nominating shareholder or group intends to continue to hold 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 shares 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 the nominating shareholder or group, the nominee and 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.
The Schedule 14N will need to be filed with the Commission and sent to the company no earlier than 150 days and no later than 120 calendar days before the anniversary of the date on which the company mailed its proxy materials for the prior year’s annual meeting. If the company did not hold an annual meeting the prior year, such as in the case of a newly public company, or if the date of the meeting has been changed by more than 30 days from the date of the annual meeting in the prior year, then the nominating shareholder or group must file and transmit the Schedule 14N a “reasonable period of time before the company mails its proxy materials”. The date representing this “reasonable period of time before the company mails its proxy materials” is required to be established by the company and disclosed in a new Item 5.08 of Form 8-K filed within four days after the company establishes the meeting date.
Qualifications of Nominees
Rule 14a-11 does not require that a nominee meet a nominating committee’s or board of director’s qualifications criteria, but the Schedule 14N must disclose whether the nominee meets those criteria. However, the nominating shareholder or group must certify in the Schedule 14N that, to the best of its knowledge, the nominee meets the objective criteria for “independence” of the national securities exchange rules applicable to the company (or, in the case of an investment company, that the nominee is not an “interested person,” as defined in Section 2(a)(19) of the Investment Company Act of 1940). 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. This provision is designed to avoid situations in which a shareholder agrees with the company to file a Schedule 14N in order to take up one or more of the board seats that can be nominated by shareholders under Rule 14a-11.
Excluding a Shareholder Nomination
If the company receives a nominating shareholder’s or group’s notice on Schedule 14N and determines that there is no basis for excluding the nominations, the company must notify the nominating shareholder or group in writing not 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 applicable deadline for shareholders to transmit a Schedule 14N to the company with respect to the shareholder meeting at which directors are being elected. This is a change from the June 2009 proposals, which would have required companies to notify the shareholder or shareholder group within 14 days after receipt of the nominating shareholder’s or group’s notice. The nominating shareholder or group would have 14 days after receipt of the company’s notice to cure any deficiencies, but could not substitute a new nominating shareholder or nominee. A company intending to exclude a shareholder nominee after providing the requisite notice and opportunity to cure must provide notice of the basis for the exclusion to the Commission no later than 80 calendar days before the filing of its definitive proxy statement. The Commission staff may permit a later notice upon demonstration of good cause for missing the deadline. At the time of the company files its notice, the company may, but is not required to, seek the informal views of the staff in a procedure that would resemble the no-action letter procedure used for shareholder proposals under Rule 14a-8.
Material to be Included in Proxy Materials
If there is no basis for excluding 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 identify each nominee as a shareholder nominee and recommend how shareholders should vote with respect to that nominee. However, when a shareholder nominee is included in the company’s proxy card, the company will not be permitted to provide the option of voting for or withholding authority to vote for nominees as a group.
Solicitation by the Nominating Shareholder
The 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 such 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.
The Commission is of the view that use of 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.
Nominating shareholders will need to consider whether they have formed a group that is required to file beneficial ownership reports under Section 13 of the Exchange Act. However, if a group’s activities are solely in connection with a nomination under Rule 14a-11, the Commission has confirmed that Schedule 13G filers would continue to be eligible to report on Schedule 13G, rather than Schedule 13D.
A group also would need to consider issues under Section 16 of the Exchange Act. The adopting release states that a nominating 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.
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 were excludable from a company’s proxy materials. On August 25, 2010, the Commission explicitly reversed this position and amended Rule 14a-8(i)(8) to 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 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 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) seeks to include a specific individual in the company’s proxy materials for election to the board of directors, or (v) otherwise could affect the outcome of the upcoming election of directors.
These new rules have the potential to alter fundamentally the composition and functioning of boards and the relationship between management, the board and shareholders. Companies will need to consider the rules in the context of their unique circumstances, including state law, board composition, management structure and shareholder base.