On November 28, 2007, the Securities and Exchange Commission (SEC) adopted amendments to Rule 14a-8(i)(8) under the Securities Exchange Act of 1934, as amended, to codify its longstanding interpretation of that rule permitting companies to categorically exclude shareholder proposals on shareholder access to company proxy statements for director nominations. Additionally, the SEC adopted amendments to the proxy rules to facilitate the use of electronic shareholder forums.
Why is the SEC revisiting shareholder access rules at this time?
Shareholder proposals are governed by Rule 14a-8, which allows an eligible shareholder to request that the company include the shareholder’s proposal alongside management’s proposals in the company’s proxy materials. Companies may exclude a shareholder proposal by relying on one or more of 13 substantive bases for exclusion specified in Rule 14a-8. Rule 14a-8(i)(8), commonly known as the “election exclusion,” historically had provided that a company need not include a proposal that “relates to an election for membership on the company’s board of directors or analogous governing body.” However, in AFSCME1, the Second Circuit rejected the SEC’s long-held interpretation of 14a-8(i)(8) and held that a company could not rely on the election exclusion to exclude a shareholder proposal seeking to amend a company’s bylaws to establish procedures requiring the company, in particular circumstances, to include shareholder nominees for director in the company’s proxy materials for future shareholder meetings.2
The AFSCME decision created considerable uncertainty regarding the SEC’s interpretation as to when public companies may properly exclude shareholder proposals related to director nominations from their proxy materials. As a result of this decision, the SEC revisited the shareholder access rules to clarify and amend its interpretation.
What did the SEC originally propose?
In response to AFSCME, in August 2007 the SEC released for public comment two separate proposals relating to the proxy access rules.3 The first SEC proposal — the “status quo proposal” — sought to codify the SEC’s long-held position that would allow a company to rely on the election exclusion to exclude from its proxy statement all shareholder proposals under 14a-8 relating to director nominations or elections.
The SEC’s second proposal — the “shareholder access proposal” — contemplated amendments to Rule 14a-8 that would have allowed greater shareholder access, contingent upon specified ownership thresholds. This shareholder access proposal would have expressly enabled shareholders to include in the company’s proxy materials binding proposals regarding director nominations on the condition that the shareholder or shareholders making the proposal had continuously owned more than 5 percent of the company’s stock for at least one year and were eligible to file, and had filed, a Schedule 13G that incorporated specified public disclosures about the shareholder or shareholders and their relationships with the company.
What was the final rule adopted by the SEC and how does it affect shareholder access?
The SEC adopted the status quo proposal, as originally proposed, amending the text of Rule 14a-8 (i)(8) to codify the interpretation of the election exclusion held by the SEC since 1990. To implement this interpretation and further clarify the meaning of the election exclusion, the text of Rule 14a-8(i)(8) is amended to permit exclusion of a shareholder proposal “if [it] relates to a nomination or an election for membership on the company’s board of directors or analogous governing body or a procedure for such nomination or election.”4
The SEC takes the position that companies may exclude proposals that would result in an immediate election contest or would establish a process for shareholders to conduct an election contest in the future by requiring the company to include shareholders’ nominees in the company’s proxy materials for subsequent meetings. Thus, this amendment will permit the exclusion from the company’s proxy materials of all shareholder proposals concerning director nominations, including those postured as amendments to the company’s bylaws. The SEC noted that the changes to the rule will not affect any prior interpretations of the staff with regard to the election exclusion.
In support of the SEC’s decision to codify its existing interpretation, Chairman Cox pointed to the growing confusion in the investor community with regard to the status of the election exclusion in light of the Second Circuit’s AFSCME decision. He indicated it was necessary to act on this issue at this time, instead of postponing the decision until a future date, in order to prevent further litigation on the issue and potential circumvention by shareholders of the proxy rules governing election contests that ensure investors receive adequate disclosure. Not surprisingly, shareholder activist groups have already begun to criticize the SEC’s action and there will likely be further litigation on the matter.
What action did the SEC take with respect to electronic shareholder forums?
The SEC also adopted at the open meeting on November 28, 2007, amendments to the proxy rules that will promote the use of electronic shareholder forums to facilitate more effective and more efficient communication among shareholders and between shareholders and management. Instead of prescribing any specific approach to creating an online forum, the amendments will allow for continued private sector experimentation. As such, companies are free to create, operate and develop forums suitable for their needs, and will be permitted to establish their own rules for their forums, including whether participants in the forum are required to provide personally identifiable information. The amendments do not, however, require companies to establish electronic forums.
The amendments exempt any solicitation in an electronic shareholder forum made by or on behalf of any person who does not seek directly or indirectly, either on its own or another’s behalf, the power to act as proxy for a shareholder and does not furnish or otherwise request a form of revocation, abstention, consent or authorization. This exemption applies so long as the solicitation occurs more than 60 days prior to the date announced by the company for its annual meeting of shareholders. If a company announces the date of its annual meeting less than 60 days before the meeting date, then the solicitation may not occur more than two days following the company’s announcement. Under the amended rules, any person who participates in an electronic shareholder forum and makes solicitations in reliance on this exemption will continue to be eligible to solicit proxies, provided that any such solicitation complies with Regulation 14A.
The amendments further clarify that companies, shareholders or third parties acting on behalf of a company or shareholder will not be liable under the federal securities laws for any statement or other information provided by another person on an electronic forum. Members of the SEC staff also stated that the amendments do not impose any new obligations on a company to monitor and correct any incorrect information posted in its electronic forum. Shareholders who have filed a Schedule 13D with the SEC are not eligible to use the electronic forum.
While it remains unclear whether companies will embrace the potential for electronic shareholder forums, one can expect multiple market participants, perhaps at the insistence of one or more significant activist institutional investors, to establish electronic forums for many of the nation’s largest companies, which historically have received the lion’s share of the shareholder proposals under Rule 14a-8. It will be interesting to see what effect electronic forums have on the number and success of precatory shareholder proposals under Rule 14a-8 in the 2009 proxy season, as they are likely to have little effect in the upcoming proxy season. Additionally, it remains to be seen whether these forums will result in any meaningful increase in the level of shareholder activism at smaller companies, which have historically enjoyed criticism mainly through electronic investor chat rooms, rather than the Rule 14a-8 proposal process.
Did the SEC address NYSE Rule 452, related to broker-voting?
Although the SEC had previously indicated that it would address proposed amendments to NYSE Rule 452 — to eliminate broker discretionary voting for director elections — it did not do so at the SEC’s open meeting on November 28, 2007. Further updates on this issue will be provided when available.
What should companies expect in the future?
Chairman Cox indicated that, in his opinion, the adopted amendment to Rule 14a-8 will preserve the status quo and will bring certainty to the 2008 proxy season, by confirming the SEC’s longstanding interpretation of the election exclusion in light of the confusion surrounding the Second Circuit’s decision in AFSCME.
Chairman Cox also stated, however, that he believed the rule only temporarily addresses the issues surrounding shareholder access, and that this amendment will not lessen the swell of support for increased shareholder access in the future. He noted that the SEC received over 34,000 comments on the proposed amendments, including letters from members of Congress. Chairman Cox stated his intention to revisit the issue in the near future.
In adopting the status quo proposal, the SEC did not address the shareholder access proposal in depth, however, Chairman Cox noted the lack of consensus among the commissioners for the greater access proposal at that time. He also noted that adopting a greater access proposal would require significant revisions of the proxy rules. Commissioner Nazareth, who dissented on the action, noted that the comment process revealed serious concerns among investors about the greater access approach as proposed. If the SEC reconsiders shareholder access again in 2008, it is possible that any shareholder access proposal could be substantially different than what was originally proposed.
The text of the amendments is not yet available, and the descriptions provided in this special alert are based on statements made by the commissioners and staff at the open meeting. The text of the amendments is expected to be publicly available shortly. The amendments will go into effect 30 days after their publication in the Federal Register.