On July 27, 2007, the Securities and Exchange Commission posted two separate proposing releases that relate to shareholder access to a public company’s proxy ballot in connection with director elections. The unusual aspect of these releases is that they represent alternative and very different approaches to the same issue. By issuing two releases with alternative rules, the Commission apparently hopes to encourage broad-based public comment on ballot access issues. Each release had been approved earlier in the week by the Commission on a 3-2 vote. While other Commissioners voted in favor of only one proposal, Chairman Cox voted in favor of both, meaning both competing proposals were approved by the required majority.
As background, the SEC’s proxy rules require public companies to include in their own proxy materials certain proposals that qualifying shareholders could bring under state law before an annual or special meeting. This allows a proposing shareholder to avoid an expensive proxy solicitation. Certain types of shareholder proposals, however, may be excluded. Under Rule 14a-8(i)(8), for example, a proposal may be excluded if it “relates to an election for membership on the company’s board of directors or analogous governing body.” The rationale behind this exclusion is that there are other proxy rules, designed for the protection of shareholders, that govern proxies for a contested election of directors, and that require proponents of alternative slates to provide detailed information about themselves, their background and their interest in the solicitation.
The first of the proposals just released would codify a historical SEC Staff position that permits exclusion not only of matters that would directly or immediately result in a contested election, but also of procedural matters that could indirectly lead to a contested election at a future meeting, such as a by-law amendment that, if implemented, would permit a shareholder to include a nominee on the company’s own ballot. Addressing uncertainties that have resulted from a recent Second Circuit decision, the proposal would amend the rule to permit exclusion if a proposal relates to “a nomination or an election [of directors] or a procedure for such nomination or election.” This proposal would, in essence, confirm that the existing rules relating to solicitation of proxies in opposition to the company’s director nominees, and not the more general shareholder proposal rules, are the appropriate mechanism for contesting the election of directors or reforming the director election process.
The second proposal, in contrast, would permit certain qualifying shareholders to propose binding by-law amendments that would permit shareholders to include a director nominee on the company’s ballot at a later meeting. Any shareholders proposing such a by-law amendment would have to hold at least 5% of the company's stock collectively, to have held their shares for at least a year, and to have filed ownership reports on Schedule 13G (a form limited to use by passive investors not seeking to change or influence control of a company). Unlike a prior SEC proposal relating to shareholder access which were never adopted, these proposed rules would not outline the substantive content of any proposed by-law amendment, but rather leave it to the proposing shareholders so long as it was permissible under state law. Thus, the rules would not address shareholder qualification requirements for making nominations, the number of seats subject to the procedure, or allocation of costs, among other issues. The proposed rules would, however, require detailed disclosure by any shareholders proposing the by-law change, by way of amendment to its Schedule 13G and proxy disclosure, relating to their background, intentions and relationships with the company. For any shareholders actually using such a by-law provision to nominate director candidates, the existing disclosure requirements that apply to solicitations in opposition would apply.
The Commission has been struggling for years with the question of how to preserve the state law rights of shareholders to elect directors with the practical impact of the modern proxy system, which makes it virtually impossible for shareholders to do anything but affirm a company’s own slate of directors. The competing proposals released last Friday demonstrate that, internally, the Commission has still not reached resolution on an appropriate approach. Whichever way the Commission decides to go, it hopes to have a set of clear rules in place by the 2008 proxy season.