The Securities and Exchange Commission (SEC) released for public comment new rules that would give shareholders unprecedented access to a company’s proxy statement. The SEC has considered the concept of proxy access since the early 1940s, and this proposal marks the third time in this decade that the SEC has attempted to address this complex issue. This time around, all indicators point to the SEC adopting some form of the proposed proxy access rules in time for next year’s proxy season. The proposed rules are subject to a 60-day comment period, ending August 17, 2009.  

Outline of Proposed Proxy Access Rules

The proposed rule, to be designated Rule 14a-11, would require a company, in certain circumstances, to include in its proxy materials nominees for election to the board of directors, submitted by a shareholder or a group of shareholders a (“nominating shareholder”). The proposed rules also contain changes to Rule 14a-8(i)(8) that would require, in certain circumstances, shareholder proposals relating to the election of directors to be included in a company’s proxy materials. The proposals represent one of the SEC’s most significant rulemakings in years and are anticipated to draw heavy comment.  

Which Companies Would Be Subject to the Proposed Rules?

Proposed Rule 14a-11 would generally apply to all companies with equity securities registered under Section 12 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), except for foreign private issuers who are exempted from the proxy rules, and investment companies registered under Section 8 of the Investment Company Act of 1940. Additionally, if applicable state law permits companies incorporated in a state to prohibit shareholder nominations through provisions in a company’s charter or bylaws, then the proposed nomination procedure would not be available to shareholders of a company that had validly included such a provision in its governing documents.

Which Shareholders Would Be Eligible to Submit a Nominee for Inclusion in the Company’s Proxy Materials?

The proposed rule includes shareholder eligibility requirements based on duration and level of ownership. Each nominating shareholder would be required to have held the company’s securities for at least one year prior to submitting a nomination. A tiered approach would be used to determine whether a nominating shareholder is eligible. The tiers, based on company size, are as follows:

  • for large accelerated filers (those with a non-affiliate market cap of at least $700 million or more), shareholders who own at least one percent of the issuer’s shares eligible to vote for directors would be eligible;
  • for accelerated filers (those with a non-affiliate market cap of $75 million or more but less than $700 million), shareholders who own at least three percent would be eligible; and  
  • for non-accelerated filers (those with a non-affiliate market cap below $75 million), shareholders who own at least five percent would be eligible.1  

For eligibility purposes, in addition to satisfying these bright-line requirements, a nominating shareholder must:  

  • not acquire or hold the company’s securities for the purpose or with the effect of changing control of the company, or to gain more than a limited number of seats on the board;  
  • provide and file with the SEC by the appropriate deadline a notice to the company on proposed new Schedule 14N of the nominating shareholder’s intent to require the company to include its nominee; and  
  • include disclosure and representations about various items regarding the nominating shareholder and its nominee in the Schedule 14N.  

Are There Restrictions on Whom a Nominating Shareholder May Nominate?

A shareholder nominee would not be required to be included in a company’s proxy materials if the nominee’s candidacy or, if elected, board membership would violate controlling state law, federal law or rules of a national securities exchange or association (other than rules regarding independence of directors), and such violation could not be cured. With respect to director independence standards, if a company is subject to the requirements of a national securities exchange, the shareholder nominee must be independent within the meaning of generally applicable objective independence requirements of the applicable national securities exchange. The SEC has clarified that a rule imposing an independence standard requiring a subjective determination by board members would not have to be satisfied under the proposed rules.

Because Rule 14a-11 would require a company to include only a limited number of shareholder nominees, absent an explicit prohibition, the rule as proposed could have offered an opportunity for the company to use a nominating shareholder as a surrogate to block the inclusion of a bona fide shareholder nominee. Thus, to be eligible under the proposed rule, neither the nominee nor the nominating shareholder may have an agreement with the company regarding nominations. The SEC has stated that, where negotiations with a company’s nominating committee to have the nominee included as a management nominee are unsuccessful, or where negotiations are limited to whether the company is required to include the shareholder nominee in accordance with Rule 14a-11, these would not be considered a direct or indirect agreement with the company for purposes of this rule.

Finally, the SEC has clarified that the use of Rule 14a-11 would not, by itself, establish a relationship between the nominating shareholder and the company that would result in that holder being deemed an “affiliate” of the company for purposes of federal securities laws.

How Many Shareholder Nominees Would a Company Be Required to Include in Its Proxy Materials?

The company must include in its proxy statement no more than one shareholder nominee or the number of nominees that represents 25 percent of the company’s board of directors, whichever is greater.2 The SEC has also proposed a “first-come, first served” system, where, in the event that a company receives more shareholder nominees for directors than are required by the rule to be included, the company need only include those nominees put forward by the first nominating shareholder to notify the company.

What Notices and Filings Would Be Required of Nominating Shareholders?

As noted above, a nominating shareholder would be required to provide notice to the company by the date specified by the company’s advance notice provision in its bylaws or, where no such provision is in place, no later than 120 calendar days before the date that the company mailed its proxy materials for the prior year’s annual meeting.3

On the date the notice is sent to the company, the proponent would also file such notice with the SEC on a new Schedule 14N.4 The Schedule 14N would be required to contain information, representations and supporting documentation regarding:

  • the eligibility of the nominating shareholder to submit a nominee;  
  • the nominating shareholder (including information relating to its relationship with the company and any interests they may have with competitors—as they are currently required to do in contested elections);  
  • the nominee’s eligibility (including independence);  
  • the nominee (similar to that required to be disclosed for director nominees in proxy statements);  
  • the relationship between the nominee and the company, including the existence of any agreements;  
  • the amount and ownership percentage of the company’s securities and certain representations with regard to their ownership of such securities, including a statement regarding the proponent’s intent to continue to own the requisite shares through the meeting;5 and  
  • the methods by which the nominating shareholder may solicit shareholders, including any web site address on which the nominating shareholder may publish soliciting materials.

Additionally, if desired to be included in the company’s proxy statement, the Schedule 14N must include any statement in support of the shareholder nominee, which may not exceed 500 words.

The Schedule 14N would be required to be amended promptly for any material change, such as the eligibility of the nominating shareholder. The nominating shareholder also would be required to file a final amendment to the Schedule 14N disclosing, within 10 days of the final results of the election being announced by the company, the nominating shareholder’s intention with regard to continued ownership of its shares.

What Would Be the Obligations of the Company After It Receives a Nomination Notice?

Determination Regarding Inclusion

Companies would be able to reject shareholder nominations if:

  • the proposed rules are not applicable to the company because of state law or provisions in the company’s governing documents;  
  • the nominating shareholder has not complied with the proposed rules;  
  • the nominee does not meet the requirements of the proposed rules;  
  • any representation required to be included in the notice to the company is false in any material respect; or  
  • the company has received more nominees than it is required to include, and the nominating shareholder is not entitled to have its nominee included in that situation.  

In any such case, the company would be required to notify the nominating shareholder of its determination to exclude the nominee in sufficient time to consider the validity of such a determination. To resolve these issues, the SEC is proposing a procedure similar to that used in connection with Rule 14a-8 shareholder proposals, whereby if a company intends to exclude a shareholder nominee, it can seek staff advice through a no-action request, with respect to that determination.  

While the process is modeled after Rule 14a-8, the SEC has built additional time into the process. The process would be as follows:  

  • The company must notify the nominating shareholder of its decision to exclude the nominee or nominees within 14 calendar days after the nominating shareholder’s Schedule 14N is filed and provide an explanation for the exclusion.  
  • The nominating shareholder must respond within 14 calendar days after the company’s deficiency notice and correct any eligibility or procedural deficiencies identified in that notice.6  
  • If the company still determines to exclude the nominee, as in Rule 14a-8, the company must provide notice of its intent to exclude the nominating shareholder nominee and the basis for its determination to the SEC no later than 80 calendar days before the company files its definitive proxy statement. A nominating shareholder has 14 calendar days to respond to the company’s notice to the SEC. The SEC staff may then provide an informal statement of its views to the company and the nominating shareholder via a no-action letter.  

In any such case, the company would be required to notify the nominating shareholder of its determination to exclude the nominee promptly after that determination and in no event later than 30 calendar days before the company files its definitive proxy statement. As with Rule 14a-8, the documents filed with the SEC would be made available to the public.

Procedures Regarding Inclusion

If the company does not determine to exclude a nominee, the company would be required to inform the nominating shareholder that the nominee will be included in the company’s proxy materials no later than 30 calendar days before the company files its definitive proxy statement. The company would then include disclosure regarding the nominee in the company’s proxy statement, although the company could identify any shareholder nominees as such and recommend how shareholders should vote on such nominees.7 The company must also provide the opportunity to the nominating shareholder to include in the company’s proxy materials a statement of support for the candidate not exceeding 500 words, which will have been required to be included in the Schedule 14N filed by the nominating shareholder. A preliminary proxy statement would not need to be filed with the SEC.

Additionally, like the company, a nominating shareholder can solicit support for its nominee outside of the proxy statement, provided that such solicitations are within the applicable proxy rules and are filed with the SEC on the date of first use.

How Would Nominating Shareholders’ Solicitations Be Treated Under the Proxy Rules?

The SEC is proposing an exemption from the proxy rules8 for communications related to Rule 14a-119 that are limited in content and filed with the SEC. Shareholders could also continue to structure their solicitations to comply with an existing exemption from the proxy rules, including the exemptions for solicitations of no more than 10 shareholders and certain communications in electronic shareholder forums.

Additionally, the SEC is proposing a similar exemption from the proxy rules for solicitations by or on behalf of a nominating shareholder in support of a nominee included in the company’s proxy statement, provided that the soliciting party does not seek the power to act as proxy for a shareholder and each written communication includes:

  • the identity of the nominating shareholder and a description of indirect interests (including securities holdings);
  • a prominent legend advising shareholders that a shareholder nominee will be included in the company’s proxy statement and to read the company’s proxy statement when it becomes available because it includes important information; the legend must also direct shareholders to where they can find the proxy statement and other relevant documents on the SEC’s web site; and
  • any soliciting material must be filed with the SEC no later than the date of first use.  

What Changes Would Be Made to Existing Shareholder Proposal Rules Due to the Proxy Access Rules?

Changes to the Election Exclusion

The proposed rules also revisit shareholder proposals relating to the election of directors. Currently, Rule 14a-8(i)(8) allows a company to exclude from its proxy statement shareholder proposals relating to the election of directors. Under the proposed rules, the SEC would amend Rule 14a-8(i)(8) to narrow this “election exclusion.”

In 2007, the SEC responded to the AFCSME10 decision by formally adopting the position that Rule 14a-8(i)(8) expressly permits the exclusion of a proposal that would result in an immediate election contest or would set up a process for shareholders to conduct an election contest in the future. In adopting this approach, the SEC reasoned that Rule 14a-8 proposals were not the proper means for conducting campaigns or effecting reforms with respect to corporate elections as other proxy rules, including heightened disclosure requirements, applied directly to such contests.

In the proposed rules, however, the SEC is proposing to revisit the Rule 14a-8(i)(8) election exclusion. Citing the creation of the new disclosure requirements under the proposed Schedule 14N, the SEC has proposed to no longer permit the exclusion of shareholder proposals relating to shareholder nomination bylaw amendments under the election exclusion, as long as such proposals are not more restrictive than the provisions of the new Rule 14a-11.

Under the proposed rules, a shareholder bylaw amendment proposal under 14a-8(i)(8) would not require any additional disclosure requirements.

The SEC is proposing to codify certain prior interpretations of Rule 14a-8(i)(8), that will permit certain types of proposals to continue to be excluded from a company’s proxy material. Under the proposed amendment to the election exclusion, companies would be able to continue to exclude proposals that would:  

  • seek to disqualify a nominee standing for election;  
  • remove a director from office before the expiration of his/her term;  
  • question the competence, business judgment or character of a nominee or director; and  
  • nominate a specific individual for election to the board of directors, other than through the Rule 14a-11 process, applicable state law provision or a company’s governing documents; or  
  • otherwise affect the outcome of the upcoming election of directors.

Additional Disclosures for Shareholder Nominations Outside of 14a-11

For shareholder nominations pursuant to a provision of state law or a company’s governing documents, but outside of the proposed Rule 14a-11, the SEC is proposing to create Rule 14a-19. The SEC acknowledges that bylaw amendments or changes in state corporate law may result in shareholder nominations required to be included under state law in a company’s proxy by a shareholder ineligible for inclusion under the proposed Rule 14a-11. To address this issue, the SEC has proposed that, pursuant to new Rule 14a-19, any such nomination would require a shareholder to file a Schedule 14N with the information outlined above.

What Changes Would Be Made to Existing Beneficial Ownership Reporting Rules?

Schedule 13G

The SEC has also proposed changes to the beneficial ownership reporting rules. Specifically, the SEC would allow individuals currently permitted to report their beneficial ownership on Schedule 13G to continue to do so throughout the shareholder nomination process under proposed Rule 14a-11. Absent the proposed amendments to Schedule 13G, a nominating shareholder would find difficulty in certifying passive intent with regard to the company, and therefore would likely be ineligible to report their beneficial ownership on the short-form Schedule 13G.

In order to address this concern, the SEC has proposed an amendment to the beneficial ownership reporting rules regarding Schedule 13G, to provide an exception for activities solely in connection with a nomination under Rule 14a-11. However, any actions beyond a Rule 14a-11 shareholder nomination would result in a shareholder being ineligible for this exclusion and Schedule 13G would not be available. A nominating shareholder with holdings greater than five percent would need to closely evaluate its Schedule 13G eligibility following the successful election of a director nominee.

Section 16

In its shareholder access proposal in 2003, the SEC proposed an exemption from Section 16 for groups formed solely for the purpose of nominating a director pursuant to the proxy access rules. The SEC declined to include such an exemption in this proposal. Instead, the SEC would continue to apply the current analysis for the determination of whether a 10 percent owner group has been formed for the purposes of Section 16.

What Would Be the Potential Liability for Statements Made by the Company and by the Nominating Shareholders under the Federal Securities Laws?

Exchange Act Liability for False or Misleading Statements

The proposed rules provide that the nominating shareholder, and not the company, would be responsible for any false or misleading statements included in the notice provided by the nominating shareholder to the company that is then included in the company’s proxy statement, unless the company knew or had reason to know that the statements were false or misleading.11

Securities Act and Exchange Act Liability Resulting from Incorporation by Reference

Under the proposed rules, any information that is provided to the company by the nominating shareholder, and then included in the company’s proxy materials, would not be incorporated by reference into any filing under the Securities Act, the Exchange Act or the Investment Company Act, unless the company determines to incorporate that information by reference specifically into that filing. To the extent that the company does incorporate that information by reference in any future filing, the information would be treated as being the company’s own disclosure for purposes of the antifraud and civil liability provisions of the Securities Act, the Exchange Act or the Investment Company Act.

How Would the Proposed Rules Apply to Investment Companies?

A tiered approach, based on the net assets of the companies, is used with respect to registered investment companies to determine whether a nominating shareholder is eligible to require a registered investment company to include its nominees in the company’s proxy. Specifically, the tiers are based on the worldwide market value levels used by reporting companies (other than registered investment companies) to determine filing status, as set forth above.

The amount of net assets of a non-series investment company is calculated as of the end of the company’s second fiscal quarter in the fiscal year immediately preceding the fiscal year in which the shareholder meeting occurs, as disclosed in the company’s Form N-CSR. For a series company, the amount of net assets is calculated as of June 30 of the calendar year immediately preceding the calendar year in which the shareholder meeting occurs, as disclosed in a Form 8-K filed within four business days after the company determines the anticipated meeting date.12 Additionally, if an investment company did not hold an annual meeting during the prior year or the date of the meeting has changed by more than 30 days, it will be required to file a Form 8-K disclosing the date by which the shareholder notice must be provided to the company.

With respect to registered investment companies or business development companies, any nominating shareholder or group of shareholders must not be an “interested person” of the company, as defined in Section 2(a)(19) of the Investment Company Act.

What Has Precipitated the SEC’s Movement in This Area?

Following the financial market turmoil this past fall, calls for regulatory efforts to increase corporate accountability to shareholders have increased. The new Chairman of the SEC, Mary Schapiro, has repeatedly indicated that proxy access is a priority for the SEC, and members of Congress and the Obama administration have announced similar sentiments. Additionally, several bills have been introduced in Congress that would, among other corporate governance initiatives, direct the SEC to establish proxy access rules.

Most notably, Senator Charles Schumer (D-NY) introduced legislation designed to reform several aspects of corporate governance, including proxy access. The “Shareholder Bill of Rights Act of 2009” would, among other things, amend the Exchange Act to require shareholder advisory votes on compensation, require the SEC to facilitate shareholder nominations, eliminate staggered boards and require independent chairmen. In addition, legislation introduced in the House of Representatives would go beyond the Senate legislation. The “Shareholder Empowerment Act of 2009,” introduced by Congressman Gary Peters (D-MI), would also amend the Exchange Act, and in addition to the requirements in the Senate legislation, require the clawback of certain bonuses, eliminate severance payments for separation due to poor performance and require the disclosure of specific performance targets related to compensation for executives of public companies absent the grant of a formal confidential treatment request.

Although these bills address multiple facets of corporate governance, for proxy access purposes, this legislation would, in part, help address concerns regarding the SEC’s authority to propose proxy access rules. While it is unclear what form any final corporate accountability legislation may take, these proposals demonstrate Congress’ desire for federally mandated proxy access.

As a result of increased pressure from Congress and the administration, it appears that, after attempts to address proxy access by every SEC chairman since the 1940s, the current momentum may make this proxy access proposal— the third this decade—a reality for companies and shareholders in time for the next proxy season.

If Adopted, When Would Companies have to Comply with Proxy Access?

Indications are that the SEC intends to put in place some form of the proposed rules in time for next year’s proxy season and a majority of the SEC’s Commissioners have stated that proxy access is a priority for the SEC. The proposed rules have been the subject of much attention and controversy, as Congress, shareholder activist groups and public companies alike have waded into the public debate surrounding their much-anticipated release. Several commentators have suggested that the SEC may receive over 1,000 comment letters regarding the proposed rules. In an effort to address this issue head on, while remaining sensitive to the interests of affected parties, the SEC exercised great care in drafting the proposal, which spans 249 pages, contains 384 footnotes and poses well over 150 separate questions, many with subparts, for commentators to consider.