At an open meeting held yesterday, the Securities and Exchange Commission (SEC) proposed new rules that would give shareholders unprecedented access to a company’s proxy statement. The proposed rule, to be designated Rule 14a-11, would require, in certain circumstances, a company to include in its proxy materials nominees for election to the board of directors submitted by shareholders. The proposed rules also contain changes to Rule 14a-8(i)(8) that would require, in certain circumstances, that shareholder proposals relating to the election of directors be included in a company’s proxy materials. The proposals announced yesterday represent one of the SEC’s most significant rulemakings in years, and are anticipated to draw heavy comment.

The SEC has considered the concept of proxy access since the early 1940s and the SEC has, in recent years, released several proposals intended to facilitate shareholder access to a company’s proxy materials. In 2003, after receiving recommendations from the SEC’s Division of Corporation Finance, the SEC proposed rules that would have required the inclusion of shareholder nominees in company proxy materials after the occurrence of a triggering event, but the rules were never issued in final form. In 2007, in response to the uncertainty caused by the 2nd Circuit’s decision in AFSCME v. AIG, the SEC offered two shareholder access proposals, one of which would have granted a form of proxy access somewhat similar to the rules proposed yesterday. Rather than adopt the proxy access approach, the SEC adopted its other proposal, which codified its longheld position that allowed a company to exclude from its proxy statement all shareholder proposals under Rule 14a-8 relating to director nominations or elections.

Following the financial market turmoil this past fall, calls for regulatory efforts to increase corporate accountability to shareholders have increased. The new Chairman of the SEC, Mary Schapiro, has repeatedly indicated that proxy access is a priority for the SEC. Additionally, several bills have been introduced in Congress that would oblige companies to include shareholder proposals in proxy materials.

Structure of Proposed Rule 14a-11

Companies Subject to the Proposed Rules

The proposed rules would apply to public companies subject to the proxy rules (i.e., those with equity securities registered under Section 12 of the Securities Exchange Act and investment companies registered under Section 8 of the Investment Company Act). Whether or not a public company would be directly impacted by the proposed rules will depend on several factors, including:

  • Whether its shareholders otherwise have the right to nominate directors at a shareholder meeting, which is determined by state law and a company’s governing documents; and
  • Whether any of its shareholders are eligible and choose to utilize the nomination procedures under the proposed rules.

Shareholders Eligible to Nominate under the Proposed Rules

Under the proposed rules, the SEC would establish a tiered approach to determine a shareholder’s (or group of shareholders’) eligibility to require a company to include their nominees in the company’s proxy. The tiers would be based on company size as follows:

  • For large accelerated filers (those with a market cap greater than $700 million), shareholders who own greater than one percent of the issuer’s shares eligible to vote for directors would be eligible;  
  • For accelerated filers (those with a market cap between $75 million and $700 million), shareholders who own greater than three percent would be eligible; and  
  • For those companies with a market cap below $75 million, shareholders who own greater than five percent would be eligible.  

In all three cases, shareholders would be required to have held the shares for at least one year, and would have to declare their intent to hold the shares through the annual meeting. Additionally, nominations would be limited to 25 percent of the company’s board of directors or one nominee, whichever is greater. The SEC is proposing a “first-come, first served” system, where, in the event a company receives more shareholder nominees for directors than are required by the rule to be included, the company need only include those nominees put forward by the first nominating shareholder to notify the company. It is unclear at this point the procedures or timeline that would be utilized under the proposed rules for the “first-come, first-served” system, but the proposing release will presumably address this or request comments on it.

Additionally, the shareholder making the nomination must not be making the nomination with the intent of acquiring control of the company, or to gain more than minority representation on the board of directors.

Required Disclosure/Procedures/Liability

The proposed rules would require shareholders making nominations to provide certain disclosures relating to their relationship with the company in their preliminary notice of shareholder nomination to the company on a new Form 14N. Proponents would be required to disclose the amount and ownership percentage of the company’s securities and make certain representations with regard to their ownership of those securities. Also, the new Form 14N would require that proponents provide information relating to their relationship with the company and any interests they may have with competitors – as they are currently required to do in the context of a proxy fight. Material misstatements in this disclosure would constitute grounds for exclusion by the company of the proponent’s director nominees. Additionally, liability for material misstatements in connection with a shareholder’s nominees would be placed with the proponent shareholder, rather than the company unless the company knew or had reason to know that the statement was materially misleading or false.

Eligible Nominees

The proposed rules would also require that certain criteria be met before a nominee would be eligible to be included in a company’s proxy materials:

  • Neither the election of the nominee, nor board membership, may violate applicable laws and regulations;  
  • A shareholder nominee must qualify as an independent director under the applicable SRO’s rules; and  
  • Neither the nominee, nor any of the nominating shareholders, may have any direct or indirect agreement with the company concerning their nomination to the board of directors of the company.  

Changes in Rule 14a-8(i)(8)

Under the proposed rules, the SEC would amend Rule 14a-8(i)(8) to narrow the “election exclusion” under that rule. Although it is currently unclear how this amendment will be structured, the revised rule would no longer permit the exclusion by a company of shareholder proposals seeking to amend a company’s organizing documents to address nomination rights, disclosures or procedures related to shareholder nominations, provided that the proposals are not otherwise excludable under Rule 14a-8, or conflict with the disclosure provisions of the proposed Rule 14a-11.

Effect on Other Rules

The proposed rules would not alter existing rules relating to the conduct of proxy contests, which would continue to apply to shareholders seeking to exercise control over a company. Additionally, the proposed rules would make clear that an eligible shareholder would not lose Schedule 13G eligibility solely as a result of making a nomination or a shareholder proposal relating to the election of directors under the new rules. The proposed rules would also add additional exemptions regarding the solicitation of proxies for efforts to form a nominating shareholder group, as well as solicitations by nominees or a nominating shareholder intended to gather support for the shareholder nominee.

The proposed rules would apply only in situations where state law and a company’s governing documents permit the nomination of directors by shareholders. Although most states (including Delaware) permit shareholders to make nominations, many of those states also allow companies, through their charters and/or bylaws, to restrict the right of shareholders to nominate persons to the board of directors. The SEC indicated that the proposed rules are not intended to alter state law in that regard.

State law has actually become more permissive in this regard. For example, recent amendments to the Delaware General Corporation Law regarding shareholder access to a company’s proxy statement will be effective August 1. These amendments allow, but do not require, companies or their shareholders to adopt bylaws that would give shareholders access to a company’s proxy statement for the purpose of nominating directors, subject to certain conditions. In addition, the amendments authorize, but again do not require, a company’s bylaws to provide for the reimbursement to shareholders of expenses incurred when soliciting proxies to elect directors.

Next Steps

At yesterday’s open meeting, the comments of the SEC’s Commissioners indicated a sharp divide between its members. Commissioners Aguilar and Walter joined Chairman Schapiro in expressing support for the proposal, all three agreeing that shareholder proxy access will provide greater accountability for corporate boards of directors. Commissioners Paredes and Casey, however, were vocal in their opposition to the measure, specifically citing their concerns with regard to federalism and the constitutionality of the federalization of corporate law via SEC rulemaking. As in previous years, this topic has been subject to a great deal of informal commentary by both the shareholder and business communities, and we expect this commentary to increase with the release of the proposed rules for formal comment.

The full text of the proposals is not yet available, so the description provided in this Special Alert is based on the SEC’s press release and statements made by the Commissioners and the staff at the open meeting. The proposed rules will be subject to a 60-day comment period, beginning with their publication in the Federal Register, which should occur in the next several weeks.

SEC Press Release:

Remarks by Chairman Schapiro:

Remarks by Commissioner Aguilar:

Remarks by Commissioner Paredes: 

Remarks by Commissioner Walter:

Remarks by SEC Staff: