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What you need to know

New proxy access rules effective in the 2011 proxy season will make it easier for long-term shareholders to utilize a company’s proxy statement to propose nominees for election to the board.

What you need to do

Public companies need to engage with shareholders now to anticipate potential director nominees and possible proposals regarding procedures for including shareholder nominees in company proxy materials.

The SEC has adopted proxy access rules that will enable qualifying public company shareholders to nominate directors for election at shareholder meetings directly utilizing the company’s proxy statement. These new rules, which will be effective for most companies in the 2011 proxy season, are a dramatic change from the status quo. Prior to the adoption of these rules, shareholder nominees were not required to be included in the company’s proxy statement, and a proposing shareholder had to separately, and at the shareholder’s cost, solicit votes in favor of the nominee.

Highlights of the new proxy access rules

Who may use the new rules:

  • Holders of at least 3% of a company’s voting securities during the last continuous three years may nominate candidates for inclusion in the company’s proxy statement. This 3%, three-year rule is a change from the SEC’s original proxy access proposals that had a tiered ownership requirement based on the size of the company and required only a one-year holding period.
  • The 3% ownership level may be satisfied by an individual shareholder or a group of shareholders and may include shares that have been lent to third parties (provided the shares may be called back); in addition, the calculation may not include borrowed shares and is determined net of short positions.
  • Nominating shareholders must give the company notice of nominations by publicly filing a newly-created Schedule 14N no earlier than 150 days and no later than 120 days before the anniversary of the date of mailing of the company’s proxy statement in the prior year. Nominating shareholders must make specified disclosures, including their intent to hold the securities through the date of the meeting, the absence of intent to change control of the company or to elect a number of directors beyond what is permitted under the new rules, and whether the nominee satisfies the director qualifications in the company’s governing documents.  

Which public companies are covered:

  • The new rules apply to all companies with equity securities registered under the Securities Exchange Act of 1934. Companies may not opt out of the new rules.
  • The new rules will not apply to “smaller reporting companies” (those with a public float of $75 million or less) until three years after the effective date of the rules.

Nominee criteria:

  • Shareholders may nominate up to 25% of the entire board (or one director, if greater) under the new rules. In the case of companies with a staggered or classified board, previously-elected shareholder nominees count towards the 25% maximum in future years to the extent the term of office of a previously elected nominee extends past the date of the pending shareholder meeting.
  • In the event that there are a greater number of shareholder nominees proposed for election under the new rules than are required to be included under the new rules, preference is given to the nominees of the largest shareholders. This is a change from the SEC’s proposed rules that provided for a “first to file” concept.
  • Nominees must meet the objective independence standards of the applicable stock exchange, but need not satisfy the corporate governance standards that a company may have adopted.

Impact on prior rules:

  • The new proxy access rules do not limit or replace the existing proxy contest rules. The new rules are in addition to these prior rules. As a result, a company could face in any year both a shareholder nominee under the new proxy access rules and a separate, traditional shareholder-funded proxy fight.
  • In passing the new rules, the SEC also amended the existing shareholder proposal rule, Rule 14a-8, such that companies will no longer be able to exclude a shareholder proposal seeking to establish a procedure in a company’s governing documents for the inclusion of shareholder nominees for director in the company’s proxy materials.

Practical implications of the new proxy access rules

The new proxy access rules will enable an easier means for long-term shareholders in a company to have board nominees elected. Small and mid-cap companies will be particularly vulnerable to the risk of shareholder-nominated director candidates because their market capitalization makes it more likely that they will have one or more qualifying 3% shareholders. Regardless of size, all companies will need to be engaged with their shareholders in advance of proxy season regarding possible director nominees or shareholder proposals relating to the procedure for the inclusion of shareholder nominees in the company’s proxy materials.