As public companies prepare for the upcoming proxy season and conduct annual reviews of corporate governance documents, this Public Company Alert highlights timely issues that public companies should keep in mind as they plan for 2009.

E-Proxy Rules  

Rules Now Mandatory for All Public Companies. For proxy solicitations commencing on or after January 1, 2009, all public companies must comply with the SEC’s rules requiring issuers to post their proxy materials and annual reports on a specified, publicly accessible website (other than the SEC’s EDGAR website) (the “E-Proxy Rules”). During 2008, the E-Proxy Rules were voluntary for all issuers except large accelerated filers. Compliance with the E-Proxy Rules could require public companies to begin planning their annual meetings and proxy materials earlier than in previous years.  

Two Options for Making Proxy Materials Available to Shareholders. The E-Proxy Rules permit issuers to choose between two options for making proxy materials available to shareholders: (1) the “notice only” option and (2) the “full set delivery” option. Regardless of the delivery option selected, every public company must send shareholders a Notice of Internet Availability of Proxy Materials in the form required by Rule 14a-16 (the “Notice”) and must post a complete set of all proxy materials to be furnished to shareholders to a website no later than the date the Notice is first sent to shareholders, and any additional soliciting materials must be posted to the website no later than the date on which those materials are provided to shareholders. The information required in the Notice may be incorporated into the proxy statement if the full set delivery option is chosen. The proxy materials must remain accessible on the website through the conclusion of the related shareholder meeting, at no charge to the shareholder. Any additional soliciting materials sent to shareholders prior to the meeting date must be posted to the website no later than the day on which those materials are first sent or given to shareholders.  

Under the notice only option, a public company must post its proxy materials on a website and send the Notice to shareholders at least 40 calendar days before the shareholder meeting date. As of the time the Notice is sent to shareholders, public companies must have in place a method to execute proxies. This requirement can be satisfied by providing a toll-free telephone number for voting or a printable or downloadable proxy card on the website. A proxy card cannot be sent along with the first Notice mailing. However, 10 calendar days or more after sending the Notice to shareholders, a public company may send a paper or electronic proxy card to shareholders, so long as the proxy card is accompanied by another copy of the Notice.  

Under the full set delivery option, a public company must deliver a full set of proxy materials in paper or electronic form to shareholders (including the information required in the Notice). If the full set delivery option is chosen, the proxy materials need not be delivered to shareholders 40 calendar days before the meeting date.  

Public companies are not required to select an exclusive delivery option for all shareholders and may use the notice only option for some shareholders and the full set delivery option for other shareholders. Public companies should analyze their shareholder bases and determine the appropriate strategy for delivery of their proxy materials.  

Mandatory Website Posting Requirements. Whether a public company selects the notice only option or the full set delivery option, it must post all proxy materials on a website no later than the date the Notice or proxy materials are first sent to shareholders. The Notice or proxy materials must identify clearly the website address at which the proxy materials are available. The website address must be specific enough to lead shareholders directly to the proxy materials so that shareholders do not have to browse the website to find the proxy materials. The proxy materials must be posted in a manner that is convenient for both printing and viewing online. This requirement may necessitate posting the proxy materials in two different formats: a format that provides a version that is substantially identical to the format of the paper version of the materials (such as a PDF format) and a format that is readily searchable (such as HTML).  

The website must be operated in a manner that does not infringe on the anonymity of a person accessing the website. For example, the website may not track the identity of persons accessing it or install cookies or other tracking features, and the company may not use an e-mail address obtained from a shareholder for any purpose other than to send a paper copy of the proxy materials to such person.  

Update D&O Questionnaires for Modified Director Independence Tests  

Recently, NASDAQ and NYSE published changes to their definitions of “independent director.” In light of these changes, public companies should carefully review their director and officer questionnaires in order to comply with the applicable stock exchange’s amended rules. Prior to the rule amendments, both NASDAQ and NYSE rules provided that a director of a listed company cannot be deemed independent if the director has received, or an immediate family has received, any compensation from the listed company in excess of $100,000 during any period of 12 months within the last three years. The rule change increases the threshold amount from $100,000 to $120,000. The increase in the monetary threshold conforms the NASDAQ and NYSE rules with the SEC’s August 2006 amendment of Item 404 of Regulation S-K increasing the dollar-amount threshold applicable to related-party transactions to $120,000.  

In addition, NYSE listed companies should note that NYSE has amended its auditor affiliation test for director independence. Under the amended rule, a director may still be considered independent if a director’s immediate family member is employed by the listed company’s internal or external auditor, as long as the immediate family member (i) is not a current partner of the company’s auditor; (ii) is not a current employee of the company’s auditor who personally worked on the company’s audit; or (iii) was not, within the last three years, a partner or employee of the company’s auditor who personally worked on the company’s audit during that time period.  

Update Risk Factor and MD&A Disclosure If Necessary to Reflect Impact of Market Uncertainties  

In the past few months, the market has seen a range of significant developments, including the unavailability of capital markets and sources of liquidity, an economic slowdown affecting the strength of customers and suppliers, and government intervention in support of capital markets, most notably in the form of the Troubled Asset Relief Program. In light of these significant developments, public companies should review risk factor and MD&A disclosure and revise if necessary, to the extent such uncertainties could have a material effect on the company. Possible disclosure that might be affected by market uncertainties includes:  

  • Risk factor disclosure in Form 10-K and Form 10-Qs to the extent previously disclosed risk factors have changed or new risk factors have developed due to, for example, lack of access to capital markets, and the impact of recent financial results and stock price declines on current lending arrangements, covenant compliance, liquidity concerns, asset impairment, and stock exchange listing requirements.  
  • MD&A disclosure concerning the impact of recent developments on liquidity and capital resources as well as known trends and uncertainties that are reasonably likely to have a material impact on the company.  

Executive Compensation Disclosure

Based on recent comments by SEC Director John White, it is clear that the SEC will continue to focus heavily on CD&A and executive compensation disclosure in its systematic review program of all public companies as mandated by SOX. Based on SEC review during the 2008 proxy season, the primary areas of concern for 2009 executive compensation disclosure are (i) the need for more analysis in the CD&A, (ii) disclosure of performance targets, and (iii) disclosure relating to benchmarking. In addition, the SEC expects that CD&A disclosure will take into consideration the effect of market uncertainties on executive compensation. Additional guidance on these issues can be found on the SEC website under the text of John White’s recent comments at and under the updated Regulation S-K Compliance & Disclosure Interpretations at  

Analysis. The SEC continues to comment heavily on the need for the CD&A to provide informative analytical discussion of the material elements of compensation, how companies arrived at the varying levels of compensation, and why they believe their compensation practices and decisions fit within their overall objectives and philosophy. In other words, the SEC wants more meaningful discussion of the “how and why” of a company’s executive compensation policies.  

Performance Targets. S-K Item 402 requires disclosure of all material elements of a registrant’s executive compensation policies and decisions. If performance targets are a material element of executive compensation, disclosure must be provided. Instruction 4 of Item 402(b) provides that disclosure of actual performance target levels is not required if they involve “confidential trade secrets or confidential commercial or financial information, the disclosure of which would result in competitive harm to the registrant.” Where this instruction has been relied upon by a registrant, the SEC has been consistently requesting issuers to provide legal analysis, similar to that provided in a confidential treatment request, setting forth the reasons why a registrant believes that competitive harm would result from disclosure. The SEC recommends that such legal analysis be prepared contemporaneous with the preparation of the CD&A rather than after receiving SEC comments concerning disclosure of performance targets. Where a registrant concludes that it has sufficient basis to omit performance target disclosure on the basis of competitive harm, detailed disclosure is then required regarding the degree of difficulty associated with achievement of the omitted performance targets and the connection between the achievement of the performance objective and the characteristics of the incentive payments to which the goal applies.  

Benchmarking. When a company benchmarks a material component of compensation against other companies, the SEC expects the company to identify the companies that constitute the peer group being used. Disclosure is required that describes the basis for selecting the peer group and the relationship between actual compensation and the data utilized in the benchmarking or peer group studies.  

Effect of Stock Price Drop on Continued Listing Requirements  

While all public companies should be aware of the continued stock market listing standards applicable to them, those that have experienced a significant stock price drop should monitor compliance more closely. Both the NYSE and the NASDAQ Stock Market have financial criteria that companies must meet in order to continue being listed. The most well-known requirement is that a company’s stock price must remain above $1 per share. For this requirement, the NYSE compliance test is based on the average closing price over 30 consecutive trading days, while the NASDAQ test involves whether the closing price remains below $1 for 30 consecutive trading days. Both exchanges have other financial criteria, including those based on market capitalization (which is also affected by stock price), stockholders equity and income. The dollar amounts of these standards and how they are calculated vary between the markets and even within each market depending on certain factors.  

In mid-October, NASDAQ implemented a moratorium on the delisting process for companies whose stock was in danger of being delisted because it did not meet the NASDAQ continued listing requirements for $1 bid price or public market capitalization. This moratorium is scheduled to end on January 16, 2009. NYSE has not issued any similar moratorium.  

If a company is out of compliance, or almost so, with the $1 per share requirement, one technique a company may consider to increase its stock price is a reverse stock split. Remember that a reverse stock split typically requires an amendment to the company’s articles of incorporation, and if so, shareholder approval of the amendment would also be required. If a company intends to bring a reverse stock split proposal before its shareholders at its next annual meeting or otherwise, management should plan for the additional time periods that would be needed for preliminary submission of such proposals to the SEC.  

Consider Whether Recent Case Law Affects Your Bylaws  

Advance Notice Bylaws. Many public companies have provisions in their bylaws that require shareholders to provide the company with advance notice of shareholder meeting business and director nominations. These provisions are intended to eliminate the potential disruption that surprise business or nominations at the annual meeting would cause and to provide the board of directors with sufficient time and information to consider these matters in a deliberate and informed manner in advance of the shareholders meeting.  

Two recent Delaware court decisions involving advance notice bylaw provisions at CNET and Office Depot construed these provisions very narrowly, with the result that shareholders were permitted to bring business or nominees before the meeting even though they did not comply with the relevant bylaw provisions.  

In the first case, involving CNET, the advance notice bylaw required a shareholder to own at least $1,000 worth of stock for a year as of the meeting date as a condition to making a nomination. The defendant shareholder was attempting to replace a majority of the board with its own nominees. CNET challenged the shareholder’s nominations because the shareholder did not satisfy the ownership requirement in the bylaw. The court, however, construed the advance notice bylaw to apply only to proposals governed by SEC Rule 14a-8, which permits shareholders to include their proposals in the company’s proxy statement if certain form and notice requirements are met. Because director nominations and elections are not covered by Rule 14a-8, the bylaw’s requirements were held not to apply.  

The second recent case involved a proxy contest relating to Office Depot’s board. The shareholder failed to give the company the advance notice required by the bylaw and instead filed its proxy statement soliciting proxies for its nominees a few days after Office Depot filed its proxy statement. The court held that the election of directors had been brought before the meeting by means of the company’s notice of its annual meeting and, therefore, according to the bylaw’s terms, the advance notice requirements did not apply.  

Although these cases are not binding precedent for corporations organized outside the state of Delaware, other state courts, including those in Michigan, are likely look to these cases for guidance when considering the application of advance notice bylaw provisions. Public companies should consider reexamining their advance notice bylaw provisions in light of the lessons learned from these cases, to ensure they will be applied as intended.  

Advancement of Expenses to Former Directors and Officers. The recent decision in Schoon v. Troy Corp. by the Delaware Chancery Court may have important ramifications for the indemnification and feeadvancement rights of Delaware corporation directors. Prior to the Schoon decision, the prevailing view of most Delaware directors was that the right to advancement of expenses under a company’s indemnification policy vested either at the time the director took office (assuming that advancement was provided for in the company’s bylaws at such time) or at the time of the underlying events that gave rise to the action triggering advancement and indemnification.  

The Schoon court enforced a bylaw amendment that eliminated a company’s advancement obligations to former directors, even though the director seeking advancement had served under the company’s prior bylaws and had left the board before the amendment. In rendering its decision, the Court found that the right to advancement is vested not by the director’s joining the board or the occurrence of the alleged wrongdoing, but rather by the filing of the subsequent lawsuit against the director relating to the alleged wrongdoing. The Court also found that the bylaws unambiguously provided for unequal treatment of current and former directors in receiving advancement, despite the fact that former directors were still entitled to indemnification under the bylaws, due to a clear separation of the advancement and indemnification sections and a lack of extensive cross-references between them.  

The director in Schoon did not appeal the decision and the time to do so has expired. Thus, unless and until the Delaware Supreme Court decides otherwise, the Schoon decision stands as important precedent in determining the circumstances under which advancement rights are triggered and may be limited. In particular, Schoon has called into question the reliability of advancement and indemnification rights for directors of Delaware corporations, who may no longer be able to assume that corporations will make advance payment of, or indemnify them for, legal fees incurred in the defense of lawsuits brought against them.  

Typically, companies draft their bylaws so as to provide their directors with the fullest protection available under the law. However, Schoon provides Delaware companies with a flexibility that most boards probably do not realize that they had. For instance, companies may choose to amend their bylaws to limit advancement and indemnification for already-occurred wrongdoing, or at least retain the ability to do so in the future. Alternatively, companies and directors may seek to cement their indemnification and advancement obligations through a number of options. In either case, we recommend that companies review their bylaws at least annually to confirm that they provide the desired degree of protection for directors and officers.  

If a company or director wishes to ensure that former directors are entitled to advancement and indemnification for acts or omissions that occurred at the time of their service on the board, the bylaws should clearly state that the rights to advancement and indemnification vest at the time a person becomes a director and that subsequent amendments may not adversely affect the rights of directors with respect to acts or omissions occurring prior to the amendment. To the extent a company wishes to treat indemnification and advancement differently, the bylaws should clearly separate those rights both verbally, through clear language, and structurally, through clear organization. Another option is for directors to sign individual advancement and indemnification agreements with the company that cannot be amended or terminated without the director’s consent, thus converting the indemnification and advancement rights into contractual obligations.