On 24 August the SEC adopted rule changes that will provide public company shareholders with the ability to include in their company's proxy materials their own nominees for election to the company's board of directors. In a 3-2 vote reflecting the controversial nature of the changes, the SEC Commissioners took action that will allow shareholders owning at least 3% of their company's shares continuously for at least the prior three years to submit nominees to fill up to 25% of the company's board seats.
New Rule 14a-11 under the Exchange Act will govern the shareholder nomination process. It will require nominating shareholders to meet the eligibility requirements for submitting nominees and to make representations, certifications, and disclosures intended to demonstrate that the shareholders have a significant, long-term equity interest in the company and no intention to seek a change of control of the company. The rule changes also involve other revisions to the SEC's rules, including amendments to Rule 14a-8 that will enable shareholders to submit proposals that their company establish a procedure in its governing documents for the inclusion of shareholder director nominees in the company's proxy materials. The rule changes are described in Release No. 34-62764, and generally will apply to all Exchange Act reporting companies other than foreign private issuers and companies whose only publicly-owned securities are debt securities.
The changes will become effective 60 days after publication in the Federal Register, subject to several variables that will defer the effectiveness of some provisions in specified circumstances. Under Rule 14a-11, shareholders will have to submit nominees no later than 120 days before the anniversary date of the mailing of the company's proxy statement in the previous year. As a result, shareholders will only be able to submit nominees for inclusion in the company's 2011 annual meeting proxy materials if the 120-day deadline falls on or after the effective date of the new rules.
Shareholders wishing to add their own nominees to a company's board historically have been limited to the following methods for doing so:
- Recommending a director candidate to the company's board or nominating committee;
- Proposing a board nominee at a shareholder meeting; or
- Launching a costly proxy contest designed to elect the shareholder nominees.
The first two methods rarely have been successful, while the third generally has achieved some success, but only at considerable expense.
Recognizing that shareholder participation in the nomination and election of directors has been hindered by restrictions imposed by the proxy rules, the SEC issued proposals in 2003 to provide a fourth option — allowing long-term shareholders with significant shareholdings to have their own board nominees included in their company's proxy statement and proxy card. Seven years and one additional round of proposals later, the SEC has achieved its objective of making the fourth option available to shareholders. The major features of the proxy access option are summarized below. It seems likely that the option is here to stay in view of the express authorization of its adoption in the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act.
Companies subject to the requirements
The proxy access requirements of Rule 14a-11 will apply to all domestic Exchange Act reporting companies (including investment companies), with the exception of companies that have only debt securities registered under Section 12 of the Exchange Act. Foreign private issuers will not be subject to the new requirements, because Exchange Act Rule 3a12-3 exempts them from the SEC's proxy rules. Companies that qualify as "smaller reporting companies" under Exchange Act Rule 12b-2, which are companies with a public float of less than $75 million, will receive temporary relief from the new requirements as a result of the SEC's decision not to apply the changes to these companies until three years after their effective date.
Eligibility to make a nomination
Proxy access under Rule 14a-11 will be limited to holders of what the SEC characterizes as a significant, long-term interest in the company. Shareholders will be eligible to submit director nominees if they:
- Hold (either individually or in the aggregate with other shareholders) at least 3% of the total voting power of the company's securities eligible to be voted on the election of directors at the meeting at which directors will be elected;
- Have held the securities continuously for at least three years on the date they provide notice to the company of their nominations; and
- Represent that they will continue to hold the minimum required amount of securities through the date of the meeting, and actually do so.
In determining compliance with the ownership requirement, borrowed shares and shares sold short will not be counted. Shares loaned to third parties will be counted where the nominating shareholder can and will recall the shares if its nominee is to be included in the company's proxy materials.
The 3% standard is a "one size fits all" approach that responds to the considerable criticism directed at the tiered ownership standards proposed by the SEC in 2009 under which the ownership requirements would have been set at 1% for "large accelerated filers," 3% for "accelerated filers," and 5% for "non-accelerated filers." A shareholder will be permitted to solicit other shareholders to form an ownership group that meets the 3% standard, if the shareholder (1) complies with the general requirement for proxy access that the shareholder not have an intent to control the company or seek more board seats than permitted, and (2) makes the disclosures specified in new Rule 14a-2(b)(7).
Number of nominees
The maximum number of shareholder nominees will be the greater of one nominee or the number of nominees that would represent 25% of the total number of board seats. Companies having a staggered board with carryover directors who are not being voted on at the meeting would include those directors in the count of total board seats. Previously-elected shareholder nominees whose terms will extend beyond the meeting date would be counted against the number of seats available for such nominees. If more than one shareholder or group is eligible to have its nominees included in the company's proxy materials, the shareholders with the largest ownership interests will be given priority to include their nominees. This is a departure from the proposals, which would have accorded priority to those shareholders who submitted their nominees first.
Both a nominee's eligibility for election to the board and service on the board must be consistent with applicable law. Shareholder nominees also must satisfy the independence standards of the applicable national securities exchange. There can be no agreement by the nominating shareholder or the nominee with the company regarding the shareholder's nomination. It will not be necessary, however, for nominees to be independent of the shareholders who nominate them.
Nominations under Rule 14a-11 must be submitted no later than 120 days before the anniversary date of the mailing of the company's proxy statement in the previous year. If the 120-day deadline falls on or after the effective date of Rule 14a-11, nominations may be submitted for inclusion in the company's 2011 annual meeting proxy materials. If the deadline falls on a date that precedes the effective date, Rule 14a-11 will not be available for the next year. For example, if the new rules become effective on November 1, 2010, proxy access would generally be available at companies that mailed their last annual meeting proxy statement no earlier than March 1, 2010.
The nomination process under Rule 14a-11 requires the submission of a new Schedule 14N containing information about (1) the ownership interest of the nominating shareholder, (2) the nominating shareholder and the nominee, (3) any involvement in legal proceedings, and
(4) other matters. Certifications relating to the nominating shareholder's eligibility and the accuracy of the information in the Schedule also must be included, along with a consent of the nominee. An optional statement in support of the nominee also may be included. All Schedule 14N filings will be publicly available on the SEC's EDGAR filing system.
Disclosures regarding the nominating shareholder and the shareholder nominee must be included in the company's proxy materials. The disclosures will be similar to those currently required in a contested election of directors. A supporting statement submitted by the nominee of 500 words or less also may be included.
Nominating shareholders will be subject to potential liability for any false or misleading statements provided to their company in connection with their nominations. Accordingly, companies will not be responsible for information provided by nominating shareholders that is included in the company's proxy materials.
Solicitations by shareholders
In addition to the previously mentioned exemption allowing shareholders under certain conditions to engage in a solicitation to form a shareholder nomination group, shareholders will be permitted to solicit support for their nominees if they do not seek a proxy and meet other specified conditions. If, however, a proxy contest is being conducted at the time a shareholder wishes to solicit support for a shareholder nominee, the shareholder will not be able to be participate in the proxy contest or solicit in support of any nominees advanced by another shareholder or group. Any soliciting materials relating to activities subject to Rule 14a-11 will have to be filed on Schedule 14N.
The proxy access changes include a complete revision of Exchange Act Rule 14a-8(i)(8) that will allow shareholders to submit proposals to alter their company's procedures for nominating directors if the procedures do not permit shareholders to make such nominations. The rule previously had allowed companies to exclude from their proxy materials any proposals relating to the nomination or election of directors. In recognition of the inconsistency of this exclusion with its proxy access initiative, the SEC narrowed the exclusion to apply only to matters relating to the election of individuals to the board of directors or to the outcome of an upcoming election of directors.
Beneficial ownership reporting
The SEC provided comfort that shareholder activities under Rule 14a-11 will not cause a person filing ownership reports on short-form Schedule 13G under the Exchange Act to have to switch to the more burdensome Schedule 13D. It did not, however, provide any relief from the application of Section 16 under the Exchange Act to groups formed solely to nominate a shareholder to be a director. The determination not to provide such relief may inhibit persons close to Section 16's 10% ownership threshold from joining a soliciting group.