On June 10, 2009, the Securities and Exchange Commission (SEC) published for comment a new rule proposal that, if adopted, would provide shareholders with unprecedented access to companies’ proxy statements. This proposal represents the third time this decade that the SEC has considered the issue of proxy access, in the forms of both rule proposals and roundtable working groups.
The rule proposal, generally referred to as the “proxy access proposal,” provides that shareholders not seeking to change control of an issuer and owning a specified percentage of a company’s stock, ranging from 1% to 5% depending on the size of the company, for at least one year may nominate directors for inclusion in the company’s proxy statement. In addition, the rule proposes to amend the SEC’s current proxy rules to allow shareholders to propose amendments to a company’s bylaws to permit shareholder-nominated directors to be included in the company’s proxy statement.
To date, the proxy access proposal has received mixed reviews, both inside and outside the SEC. Supporters of the proposal generally believe that proxy access will be used sparingly as necessary to increase director accountability. Opponents, on the other hand, argue that the proposal preempts state law and may lead to greater board dysfunction and unnecessary election contests.
Overview of the Proposal
On May 20, 2009, the SEC announced its proxy access proposed rule, which includes both new Rule 14a-11 under the Securities Exchange Act of 1934 (Exchange Act) and an amendment to Exchange Act Rule 14a-8(i)(8). On June 10, 2009, the SEC published the rule for public comment. Comments on the proposal are due 60 days from its date of publication in the Federal Register, or August 17, 2009.
New Rule 14a-11 would enable shareholders that meet the requirements discussed below to include their nominees for director in the company’s proxy materials (unless otherwise prohibited by state law or a company’s bylaws from nominating candidates for election as a director). Currently, shareholders wishing to nominate opposition candidates must do so using their own proxy materials. If the proxy access proposal is adopted, shareholders could propose their own directors for election alongside the company’s board slate. To the extent multiple shareholders proposed director candidates, the SEC has proposed first in time policy, whereby the first eligible shareholder’s candidate(s) would be included. The proposed rule would apply to all Exchange Act reporting companies with registered equity securities, including investment companies and voluntary registrants.
Ownership Requirements. The proposed rule sets forth tiered minimum-ownership requirements for shareholders wishing to nominate directors for election. The tiered ownership threshold requirements vary depending upon the size of the company as follows.
The proposed rule allows shareholders to aggregate holdings to meet these thresholds and requires that shareholders have held their shares for at least one year and intend to continue to hold such shares through the company’s annual meeting.
The proposed rule applies equally to investment companies, except that it adopts a tiered approach based on a company’s net assets to determine shareholders’ eligibility to submit nominees. The tiers are based on the company values identified above and are calculated as of the end of an investment 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 or Form 8-K.
Disclosure Requirements. Under the proposed rule, nominating shareholders would be required to file with the SEC and submit to the company a new Schedule 14N that includes a certification that the shareholder is not seeking to change control of the company or gain more than minority representation on the board of directors. In addition, Schedule 14N requires disclosure regarding the shareholder’s securities owned, length of ownership, and intent to continue to hold the securities through the meeting date. The company would include this disclosure in its proxy relating to the shareholder-nominee.
Generally, companies will not be responsible for information provided by the nominating shareholder unless the company knows or has reason to know that the information is false. The proposed rule provides that information provided by the nominating shareholder would not be incorporated by reference into the companies filings under the Securities Act of 1933 (“Securities Act”), the Exchange Act, or the Investment Company Act of 1940 (1940 Act), unless the company determines to specifically incorporate such information in a particular filing. To the extent that a company did incorporate such information into a filing, the company would be subject to the antifraud and civil liability provisions of the Securities Act, Exchange Act, or 1940 Act with respect to such information.
The deadline for submitting nominees under the proposed rule would be tied to the company’s advance notice bylaw, or 120 calendar days before the first anniversary of the date the company’s proxy statement for the previous year’s meeting was released in the absence of an advance notice bylaw.
Nomination Limitations. The SEC does not intend for shareholders to use Rule 14a-11 to attempt to effect a change of control. In this regard, under the proposed rule shareholders may not propose more than one nominee or 25% of the company’s board of directors, whichever is greater, for election in the company’s board materials. For example, if a company’s board were composed of four directors, shareholders would be able to nominate one director, whereas if a board were composed of ten directors, shareholders would have the ability to nominate two directors.
The proposed rule also includes certain independence standards that a shareholder’s nominee would be required to meet. As currently proposed, the rule requires that nominees meet the independence standards of the national exchange listing standards applicable to a company, or in the case of a business development company or investment company, the nominee must not be an “interested person” of the company, as defined by § 2(a)(19) of the 1940 Act; it does not propose adoption of a standard that would require boards to make a subjective determination regarding a nominee’s independence.
Timeframe for Nominations. Under the proposed rule, a nominating shareholder must notify the company of its intent to include a nominee in the company’s proxy materials by furnishing a Schedule 14N to the company by the date specified in the company’s advance notice bylaw provision. In the absence of such a provision, the Schedule 14N must be provided to the company no later than 120 calendar days prior to the one year anniversary of the date the company mailed its proxy materials for the previous year’s annual meeting.
If the company determines to include the nominee in its proxy materials, it must notify the nominating shareholder that it is doing so at least 30 calendar days prior to filing its definitive proxy statement with the SEC. If the company determines it is not required to include the shareholder’s nominee in its proxy materials, it must inform the nominating shareholder within 14 calendar days of receipt of the shareholder’s Schedule 14N. Upon receipt of the company’s notice, the nominating shareholder then has 14 calendar days to respond to the company’s notice and correct any deficiencies identified by the company in its notice.
If, after receiving the proposing shareholder’s response, the company determines it may still exclude the nominee, the company must provide notice of its determination, including the basis therefor, to both the SEC and the nominating shareholder no later than 80 calendar days before the company files its definitive proxy materials. The nominating shareholder may submit to the SEC a response to the company’s notice within 14 calendar days of receipt of the company’s notice. The SEC may provide a informal no-action letter regarding its view of the company’s determination. The company’s final determination of its treatment of a shareholder nominee must be provided to the nominating shareholder no later than 30 calendar days prior to filing its definitive proxy materials. The SEC has provided the following timeline setting forth the relevant deadlines.
In addition to new Rule 14a-11, the SEC has also proposed an amendment to Exchange Act Rule 14a-8(i)(8). Amended Rule 14a-8(i)(8), as proposed, would allow shareholders to require companies to include proposals in their proxy materials to amend the company’s governing documents to revise the company’s procedures and/or disclosure provisions relating to director nomination, so long as the proposals are not more restrictive than the provisions of Rule 14a-11.
This represents a significant change from Rule 14a-8(i)(8) as currently in effect, which permits companies to exclude shareholder proposals relating to an election of directors. However, as proposed, amended Rule 14a-8(i)(8) does continue to permit certain proposals to be excluded from a company’s proxy, including proposals that would:
- Seek to disqualify a nominee standing for election;
- Remove a director from office before the expiration of his or her term;
- 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 through the Rule 14a-11 process, applicable state law or a company’s governing documents; or
- Otherwise affect the outcome of the upcoming election of directors.
The current eligibility provisions of Rule 14a-8 would continue to apply to the amended rule, thus “qualifying shareholders” would include shareholders that have continuously held for at least one year prior to submission of the proposal the lesser of $2,000 or more in market value or 1% of the company’s voting securities.
Response to the Proxy Access Proposal
The SEC has asked for and expects to receive voluminous comments on the proxy access rule proposal. To date it has already received more than 40 comment letters in response to its more than 150 specific requests for comment, many of which include multiple questions. In addition to the SEC Commissioners, the main commentators to the proxy access proposal to date can be divided into two general groups: (1) corporate governance activists, including institutional investors such as labor unions and pension funds and the Council of Institutional Investors, and (2) the business community, as represented by the U.S. Chamber of Commerce and the Business Roundtable.
The SEC Commissioners voted 3-2 to propose the proxy access rules. SEC Chairman Mary Schapiro along with Commissioners Elisse Walter and Luis Aguilar supported the proposal, and Commissioners Kathleen Casey and Troy Paredes dissented. Chairman Schapiro has been vocal in her opinion that proxy access rulemaking is one of her key priorities, stating that she believes “that the most effective means of providing accountability…is to ensure that shareholders have a meaningful opportunity to effectuate the rights that they already have under state law to nominate directors.”4 Echoing her sentiments, both Commissioner Walter and Commissioner Aguilar issued statements at the SEC’s May 20 meeting emphasizing the importance of achieving proxy access for shareholders.
In their dissenting statements, both Commissioner Casey and Commissioner Paredes questioned the SEC’s authority to adopt the proposed rule and expressed concern that the proxy access proposal encroached on corporate matters that should be left to the purview of the states. By mandating proxy access, Commissioner Casey argued, “[the SEC] will substitute its judgment for the judgment of those parties and bodies having the greatest knowledge of, and responsibility for, public companies—including state legislatures, the duly-elected directors of public companies, and even the shareholders themselves.” Commissioner Casey also argued that the proposal increases the risk of conducting a U.S. Initial Public Offering, thereby leading to the “potential suffocation of innovation and growth in our economy.”
More recently, at a conference on shareholder rights, Commissioner Paredes expressed his concern regarding the proposal, explaining,
[t]he proposal reaches too far past the point of being about disclosure or even about the voting process. Rather, the essence of the proposal is to realign corporate control at the federal level, upsetting the longstanding federalism balance in the area of corporate governance. The mandatory quality of Rule 14a-11—particularly when one recognizes that the proposal allows a firm to adopt a more generous access regime but not one with more restrictions—belies that the rule is about disclosure or process as compared to achieving a particular substantive outcome.5
Commissioner Paredes believes that amending Rule 14a-8(i)(8), rather than adopting a new Rule 14a-11, will implement proxy access while still preserving state law. His proposed amendment to Rule 14a-8(i)(8) would permit shareholders to include in a company’s proxy materials a bylaw proposal that would allow shareholders proxy access for nominating directors so long as the company’s jurisdiction of incorporation has adopted a provision explicitly authorizing a proxy access bylaw. Currently both Delaware’s and North Dakota’s corporate codes have such a provision, and according to Commissioner Paredes, “active consideration” is being given to amending the Model Business Corporation Act.6
The Business Community
Both the Business Roundtable and the U.S. Chamber of Commerce issued statements voicing strong opposition to the proxy access proposal. The Chamber of Commerce focused largely on the fact that it believes the SEC does not have the authority to regulate shareholder rights relating to director elections. Specifically, the Chamber of Commerce argued that regulation of corporate governance is in the states’ purview, and therefore the proxy access proposal preempts state law. In making these arguments, the Chamber of Commerce highlighted Delaware’s April 2009 amendment to the Delaware General Corporation Law to permit (but not require) Delaware corporations to adopt proxy access bylaws that give shareholders the right to include their nominees in a company’s proxy materials. It also emphasized the need for flexibility in design and implementation of any proxy access right, and expressed concern that that a one-size-fits-all federal access right would overburden small and mid-sized public companies.
Like the Chamber of Commerce, the Business Roundtable stated that the proxy access proposal represents “an unprecedented preemption of state corporate law.” In addition, the Business Roundtable expressed concern that proxy access would result in special interest groups gaining representation on and sidetracking corporate boards. Adding new representation to the corporate boards, in the opinion of the Business Roundtable, creates the “potential to derail the ability of U.S. businesses to innovate, create jobs, and build shareholder value.”
Corporate Governance Activists
The Council of Institutional Investors (“Council”) issued a statement shortly after the announcement of the proxy access proposal applauding the SEC’s efforts to allow shareholders access to corporations’ proxy materials for director nominations. In its statement, the Council noted that allowing investors to include their nominees on the company’s proxy card is standard in most of Europe and that the United States is in need of corporate governance reform in this area. Contrary to the Business Roundtable’s position, the Council does not believe that proxy access will stymie public companies’ ability to create long-term shareholder value. To the contrary, it believes that proxy access would “invigorate board elections and make boards more responsive to shareowners, more thoughtful about whom they nominate to serve as directors and more vigilant in their oversight of companies.”
Generally speaking, corporate governance commentators have rejected the business community’s complaints that the proposal creates an unworkable one-size-fits-all approach that encroaches on matters traditionally governed by state law. Many believe that, although the proposal establishes some mandatory requirements regarding shareholder nominations, it allows companies flexibility in crafting arrangements that provide shareholders with more expansive proxy access. As for concerns regarding state law preemption, proxy access proponents have been arguing that the SEC’s proxy rules already mandate the inclusion of certain information in companies’ proxy materials, including certain shareholder proposals. Therefore, they believe that, although the new proposal expands current mandatory requirements, it is not addressing any new subject previously untouched by federal law.
One significant side effect of proxy access that some corporate governance commentators have identified is its potential impact on majority voting. As the SEC noted in its proposal, since the issue of proxy access was first raised in 2003, there has been a movement away from plurality voting in favor of majority voting standards for director elections. If Rule 14a-11 is implemented as proposed and a shareholder of a company with a majority voting standard nominated a director for election, then majority voting provisions may default back to a plurality standard. This is because majority voting may apply only in the absence of a “contested election,” and contest is usually defined to include a situation where there are more candidates than board seats. The concern expressed regarding this default plurality standard is that it may limit the power of “vote no” campaigns and of Institutional Shareholder Services’ “vote no” recommendations. The SEC has identified this issue and is specifically seeking comment regarding the interplay between proxy access and majority voting.
In addition to the groups discussed above, the proposal of several bills addressing shareholder access to companies’ proxy materials, the most prominent of which is Senator Charles Schumer’s recent announcement of his Shareholder Bill of Rights Act of 2009, suggest that at least some members of Congress support the creation of a federal shareholder access regime. And although proxy advisory firms, namely RiskMetrics, have been silent to date regarding the proxy access proposal, most observers expect such advisory firms to come out in favor of proxy access.
Most observers believe that the shareholder proxy question is no longer a question of if, but rather what the final rule will look like. As a result of Delaware’s recent amendments and Senator Schumer’s proposed legislation, the final shape of the SEC’s rule regarding proxy access remains uncertain. Although the proposed rule was published for comment substantially in the form expected, it includes 150 specific comments, many of which involve multiple questions. Issues ripe for comment include the board’s role, the balance of state and federal law, and general election mechanics and reform.
Companies and constituencies wishing to comment will need to act swiftly to meet the 60-day deadline for comments, as Chairman Schapiro has indicated, and many commentators expect, that a final proxy access rule will be in place in late October or early November, in time for the 2010 proxy season. To be prepared to respond, companies will want to monitor the development of the proxy access debate.
Companies may want to begin reviewing their bylaws and their annual meeting timelines with counsel to identify any issues and potential inconsistencies with the proposed rules. Furthermore, because the Schedule 14N deadline is tied to companies’ advance notice bylaws, companies should begin reviewing these provisions with counsel to determine if any amendments will be needed.