Recently, the SEC proposed a new rule and amendment that would give certain shareholders the right to nominate directors on corporate boards—including registered investment companies—as well as to modify nomination procedures. According to SEC Chair Schapiro, the proxy access initiative is intended to empower shareholders by giving them a meaningful opportunity to nominate directors to boards. Proxy access to shareholders is highly controversial, however, and if the rule and amendment are adopted, it is likely that the SEC will see opposition and, potentially, even legal action.

The SEC also recently proposed rule amendments to enhance governance disclosure for proxy and registration statements. Importantly, the SEC is also proposing mandated disclosure with respect to a board’s role in oversight of risk management.

Shareholder Nominees in Proxy Materials

Proposed new Rule 14a-11 to the Securities Exchange Act of 1934 (the Exchange Act) would give certain shareholders the ability to include a nominee, or nominees, for director in company proxy materials, as long as the investment company’s governing documents (such as the charter and bylaws) or the relevant state law do not otherwise prohibit it. Under the proposal, shareholders would be able to use shareholder proposals to modify the company’s nomination procedures or disclosure about elections, as long as those proposals do not conflict with fund governing documents, state law or SEC rules.

To be eligible to have their nominee(s) in the proxy materials, the shareholder or shareholders must meet certain proposed threshold stock ownership and other requirements. The percentages required range from 1 percent to 5 percent, depending on the size of the company, as follows.

In order to meet the above thresholds, shareholders would be permitted to aggregate their holdings. The shareholders must own that percentage of the fund’s securities for at least one year, and in the case of a shareholder group, each member of the group would have to meet the requirement.

Shareholders who submit nominees would be required to notify the fund of their intent in order for the shareholders’ nominees to be included in the proxy materials, and the shareholders must also file the notice (called Schedule 14N) with the SEC on the date it is provided to the fund. The notice would need to be provided by the date set by a fund’s advance notice provisions, or in the absence of a provision, no later than 120 calendar days before the date the fund mailed its proxy materials the prior year. Schedule 14N would require the following:

  • Name and address of the nominating shareholder or each member of the nominating shareholder group;
  • Disclosure of the amount and percentage of securities owned and entitled to vote at the meeting;
  • A written statement from the record holder verifying that the shareholders had held the securities for at least one year as of the date of the notice on Schedule 14N;
  • A written statement regarding the nominating shareholder’s or group’s intent to continue to own the requisite shares through the shareholder meeting at which directors are elected, as well as the shareholder’s intent regarding continued ownership after the election; and
  • A certification that to the best of the nominating shareholder’s or group’s knowledge and belief, the securities are not held for the purpose or effect of changing the control of the issuer or gaining more than a limited number of seats on the board of directors.

Qualifying shareholders would be able to include at least one shareholder nominee in the proxy materials, but not more than 25 percent of the board of directors, whichever is greater. That is, if a board has 12 directors, a qualified shareholder could include up to 3 qualified nominees in the proxy materials.

Requirements for Funds that Receive Notice from a Nominating Shareholder or Group

Within 14 days of receiving notice, the fund would be required to notify the shareholder or group if it determines that it may exclude the nominee. A fund may determine that it is not required under proposed Rule 14a-11 to include a nominee in its proxy materials if it determines any of the following:

  • Proposed Rule 14a-11 is not applicable to the fund (i.e., applicable state law or a company’s governing documents prohibit shareholders from nominating candidates for the board of directors; however, if a company’s governing documents do prohibit nomination rights, shareholders who want to amend the provision may seek to do so by submitting a shareholder proposal.);
  • The nominating shareholder or group has not complied with the requirements of the Rule;
  • The nominee does not meet the requirements of the Rule;
  • Any representation required to be included in the notice to the fund is false or misleading in any material respect; or
  • The fund has received more nominees than it is required to include by proposed Rule 14a-11 and the nominating group is not entitled to have its nominee included under the criteria proposed in Rule 14a-11(d)(3).

The shareholder or group then has 14 days to respond. If the fund determines that it may still exclude the nominee, the fund must provide notice to the SEC and the nominating shareholder or group of its intent to exclude, and the notice must be provided at least 80 days before it files the fund definitive proxy materials with the SEC. At its discretion, as soon as practicable, the SEC staff may provide an informal statement of its views on the matter to the fund and nominating shareholder. At least 30 days prior to filing its definitive proxy statement, the fund must then provide the nominating shareholder or group with notice of whether it will include or exclude the nominee(s).

A fund would not be required to include a shareholder nominee in its proxy materials if his or her candidacy or board membership would violate controlling state or federal law, or the rules of a national securities exchange or national securities association. In addition, the nominating shareholders would have to represent that their nominee is not an “interested person” as defined in Section 2(a)(19) of the Investment Company Act of 1940 (1940 Act).

The fund would include in its proxy materials disclosure regarding the nominating shareholder, as well as the nominees themselves. The SEC is proposing amending Rule 14a-9 so that a nominating shareholder or group relying on Rule 14a-11, an applicable state law provision, or a company’s governing documents to include a nominee in company proxy materials would be liable for any materially false or misleading statements in information provided by the nominating shareholder or group to the company (in its shareholder notice on Schedule 14N). Likewise, the proposed rule also contains express language that the fund company would not be responsible for information that is provided by the nominating shareholder or group under Rule 14a-11 and then repeated by the company in its proxy statement, except where the company knows or has reason to know that the information is false or misleading. In addition, any information that is provided to the fund company in the notice from the nominating shareholder or group under Rule 14a-11 and then included in the company’s proxy materials would not be incorporated by reference into any filing under the Securities Act of 1933, the Exchange Act or the 1940 Act unless the company specifically incorporates it.

The SEC is also proposing an amendment to codify prior staff interpretations regarding the types of proposals that fund companies could continue to exclude. Specifically, a fund company could exclude a shareholder proposal under amended Rule 14a-8(i)(8) if it ould:

  • Disqualify a nominee who is standing for election;
  • Remove a director from office before his/her term expired;
  • Question the competence, business judgment or character of a nominee or director;
  • Nominate a specific individual for election to the board of directors, other than pursuant to Rule 14a-11, an applicable state law provision or a company’s governing documents; or
  • Otherwise affect the outcome of the upcoming election of directors.

Enhanced Disclosure for Proxy and Registration Statements

In early July, the SEC also proposed amendments to enhance corporate governance disclosures that registrants are required to make in their proxy and information statements, annual reports and registration statements under the securities laws. The proposed amendments have two major elements that expressly relate to registered investment companies: enhanced director and nominee disclosure, and new disclosure about the structure of fund boards and the board’s role in the risk management process.

Specifically, the SEC is proposing to amend Item 401 of Regulation S-K to enhance disclosure for each director and director nominee so that it details the particular experience, qualifications, attributes or skills that qualify that person to serve as a director of the company and as a member of any committee that the person serves on or is chosen to serve on, in light of the company’s business and structure. The expanded disclosure would apply to incumbent directors as well as nominees.

In addition, the SEC has proposed required disclosure of any directorships of public companies held by each director and nominee at any time during the past five years. It also proposed to increase the reporting period for specified legal proceedings involving directors, executive officers and persons nominated to become directors that are material to an evaluation of the ability or integrity of any director, director nominee or executive officer from five years to 10 years.

The SEC also proposed a new disclosure requirement to Item 407 of Regulation S-K and a corresponding amendment to Item 7 of Schedule 14A that would require disclosure of a company’s leadership structure (e.g., whether and why a lead independent director is designated, and the role the lead independent director plays in the leadership of the company) and why the company believes it is the best structure for it at the time of filing. The fund would also be required to disclose whether the board chair is an “interested person” of the fund, as defined in Section 2(a)(19) of the 1940 Act. If the chair is an interested person, a fund would be required to disclose whether it has a lead independent director and what specific role the lead independent director plays in the leadership of the fund.

Risk Management Disclosure

The SEC proposed to require disclosure in proxy and information statements about the board’s role in the fund’s risk management process and the effect that this has on the fund’s leadership structure. According to the Release, the SEC believes it is important for investors to understand a board’s, or board committee’s role in this area, given the role that risk and adequacy of risk oversight have played in the recent market crisis. According to the Release, such disclosure might include:

  • How the board implements and manages its risk management function;
  • Whether the persons who oversee risk management report directly to the board as a whole, or to one of the board’s standing committees; and
  • Whether and how the board or board committee monitors risk.

The proposals would amend the disclosures in proxy statements (in Schedules 14A and 14C), as well as Forms N-1A and N-2. Comments on the proposed amendments regarding this enhanced disclosure were due by September 15, 2009.