At an open hearing on August 25, 2010 the SEC, as expected, adopted amendments to its proxy rules providing for inclusion of shareholder nominees in company proxy statements. By contrast, current practice requires shareholders to pay for the preparation and mailing of proxy materials for their own nominees. The amendments were adopted by a vote of 3 to 2 along party lines, with Chairperson Schapiro and Commissioners Aguilar and Walter voting in favor, and Commissioners Casey and Paredes dissenting. They will become effective 60 days from publication in the Federal Register, which is expected shortly, thereby making proxy access available for most companies during the 2011 proxy season.

Rules

New Rule 14a-11, the centerpiece of proxy access, was first proposed in May 2009 after almost a decade of prior SEC attempts at proxy access rulemaking. This rule gives shareholders or shareholder groups that have collectively held both voting and investment power of at least 3% of a company's voting stock for three continuous years the right to use a company's proxy statement to include their nominees for up to 25% of the company's board of directors (but no less than one director). Borrowed shares and short positions are to be excluded in calculating the 3% threshold. Loaned shares can be included if recalled prior to the scheduled vote.

The proxy access regime spelled out in the rule is mandatory -- companies and shareholders are not permitted to "opt out" or to adopt a more restrictive process even if permissible under state corporate law.

The rule will apply to all Exchange Act companies, including registered investment companies. Proxy access for shareholders of smaller public companies, i.e., those with a public float of less than $75 million, will be deferred for three years. Foreign companies that are not subject to the SEC's proxy rules are exempt from the rule as are U.S. companies whose only publicly traded securities are non-convertible debt instruments.

As first proposed, Rule 14a-11 called for a one year holding period and share ownership thresholds, tiered by company size, ranging from 1% to 5%. The one year holding period was criticized by many public companies, business groups and others, which advanced counterproposals of five years and longer, citing their concern that a short holding period would facilitate the ability of agenda-driven short term investors to manipulate the make-up of a company's board of directors. The SEC appears to have sought middle ground by promulgating a "one size fits all" three year holding period and, somewhat unexpectedly, a 3% ownership threshold, thereby enhancing the appeal of proxy access to long term investors.

Shareholders seeking to place their nominees in a company's proxy statement will be required to inform the company and the SEC of their intent to do so on a new Schedule 14N no earlier than 150 days, and no later than 120 days prior to the anniversary of the mailing date of the company's proxy materials for the prior year. They will be required to make specific disclosures about themselves and their nominees that are similar to those currently required by the SEC for contested elections. Nominees will be required to meet the objective independent director standards of any stock exchange on which the company's shares are listed, but will not be required to meet director qualification standards contained in the company's governing instruments. Such shareholders also will be required to affirmatively state their lack of any intention to seek a change of control of the company or to pursue more board seats than permitted under the rules. A company will not be responsible for any information provided by shareholders for inclusion in its proxy materials.

If more than one shareholder or shareholder group proposes qualifying director nominees, the company will be required to include in its proxy materials the nominee or nominees of the shareholder or shareholder group with the greatest voting power percentage. This represents a change from the initial rule proposal which called for a "first in" standard.

The SEC also adopted amendments to Rule 14a-8 which will allow shareholders to make proposals to broaden (but not narrow) proxy access, such as a lower ownership threshold, a shorter holding period or to allow or a greater number of nominees.

Analysis

At the center of the debate that preceded the SEC's adoption of proxy access were the dual issues of the SEC's statutory authority to adopt such a regime and, if so adopted, how it would interface with state corporate law.

As to the first issue, the recently enacted Wall Street Reform Act of 2010 contained explicit authority for the SEC to adopt proxy access, but it left the details of the rulemaking up to the SEC by not mandating any specific holding periods or ownership criteria (as proposed by Senator Chuck Schumer of NY). As to the second issue, corporate governance law traditionally has been left to the states and state courts and the new rules represent a marked departure from that history in that they are not limited to facilitating the ability of shareholders to exercise their traditional state law rights to nominate and elect directors, but instead confer upon shareholders a new substantive federal right which in many instances runs contrary to what state corporate law otherwise provides. Most observers believe this will set up a lengthy series of lawsuits to prevent the rule from being enacted. The courts will likely look to Congress' intent when they hand down rulings. Since Congress did give the SEC the authority to propose such a rule, some observers believe it will withstand legal challenge while other believe that this is an unnecessary and unusual step into states' rights and will be struck down.

Assuming the proxy access rules survive a constitutional challenge, their immediate impact is unclear. There are only a limited number of companies that actually have 3% shareowners that would qualify for access. It is also unclear as to whether and under what circumstances qualified but perhaps disparate shareholders would band together in an effort to place their nominees on a company's board. Further, smaller companies are essentially exempt for a three year period during which the SEC will assess and possibly retool its rules based upon the experiences of larger companies.

The full text of the final proxy access rules is available at http://www.sec.gov/rules/final/2010/33-9136.pdf.