On June 10, 2009, the SEC proposed a new Rule 14a-11, which would require public companies to include in their annual meeting proxy statements director nominees of shareholders (or groups of shareholders acting in concert) who meet specified ownership and other criteria, including the absence of intent to change control of the company. This new rule would also give shareholders the ability to include their nominees on the company’s proxy card and to solicit in favor of their nominees (and against the Board’s nominees) without having to incur the expense of preparing, filing and disseminating their own proxy materials. In addition, the SEC has proposed amendments to Rule 14a-8(i)(8) intended to eliminate a company’s ability to exclude from its proxy statement shareholder proposals to adopt or amend director nomination procedures and related disclosure requirements. The SEC release proposing these and related amendments is captioned “Facilitating Shareholder Director Nominations” and is available at http://sec.gov/rules/proposed/2009/33-9046.pdf. Comments on the proposed new rules must be submitted to the SEC on or before August 17, 2009. The proposed new rules would not apply to foreign private issuers, which are not subject to the US proxy rules.
The SEC released its proposals only a few months after the Delaware legislature enacted amendments (scheduled to become effective on August 1, 2009) to the Delaware General Corporation Law (DGCL) that will enable boards of directors, and shareholders acting without board approval, to adopt by-laws requiring the inclusion of shareholder nominees in the proxy materials of Delaware corporations and providing for expense reimbursement to shareholders who solicit proxies in election contests. In contrast to the mandatory provisions proposed by the SEC, new Sections 112 and 113 of the DGCL are flexible and leave to boards of directors and shareholders the power to decide whether shareholder nominees should be included in company proxy materials and, if so, the conditions for inclusion.
Proposed Rule 14a-11 would not provide an exclusive means for shareholders to have their nominees included in a company’s proxy statement. Boards of directors and shareholders would be free to adopt proxy access provisions in their governing documents, including by means of by-law amendments in accordance with new Section 112 of the DGCL. As a result, a company could in any year be required to include in its proxy materials shareholder nominees submitted under proposed Rule 14a-11 as well as shareholder nominees submitted under any proxy access provisions included in the company’s governing documents. In addition, shareholders would continue to have the ability to run separate proxy contests in which they do not seek to include their nominees in the company’s proxy materials. Accordingly, a company and its shareholders could be faced with the potential confusion of a multi-tiered election contest involving (1) Board nominees included in the company’s proxy materials, (2) shareholder nominees included in the company’s proxy materials pursuant to proposed Rule 14a-11, (3) shareholder nominees included in the company’s proxy materials pursuant to proxy access provisions of the company’s governing documents and (4) nominees proposed by shareholders running a proxy contest who do not seek (or were unable) to include their nominees in the company’s proxy materials.
There has been a significant amount of commentary regarding the potential costs and benefits of requiring companies to include shareholder nominees in their proxy materials but it now seems almost inevitable that the SEC will adopt a proxy access rule to take effect in time for the 2010 proxy season. It is not clear, however, whether activist investors will (or can) seek to utilize the proposed rule (which requires the absence of intent to change control of the company) rather than running traditional proxy contests or if the rule will generally be useful only to non-activist shareholders.
Proposed New Rule 14a-11
Eligibility. Proposed new Rule 14a-11 would require a public company to include in its proxy statement director nominees proposed by a shareholder (or group of shareholders acting in concert) if shareholders are not prohibited by state law or the company’s governing documents from nominating director candidates and the shareholder (or group) satisfies all of the following eligibility requirements:
- Ownership Requirements. The nominating shareholder (or group) must beneficially own a specified percentage of the company’s voting securities. The specified thresholds are 1% for large accelerated filers and registered investment companies with net assets of $700 million or more, 3% for accelerated filers and registered investment companies with net assets of $75 million or more but less than $700 million and -accelerated filers and registered investment companies with net assets of less than $75 million.
- Holding Period. The nominating shareholder (or each member of the group) must have held these securities continuously for at least one year and must intend to hold the securities through the date of the shareholders meeting.
- Absence of Change of Control Purpose. The nominating shareholder (or each member of the group) must certify that these securities are not held for the purpose of effecting a change in control or to gain more than a limited number of board seats. While the release indicates that a “change in control could include any number of extraordinary transactions,” it does not specifically define change in control for this purpose. In some cases, a greater than 5% shareholder may not be sufficiently passive to qualify to file a Schedule 13G instead of a Schedule 13D, but this would not, itself, prevent that shareholder from utilizing proposed rule 14a-11 unless the shareholder seeks to effect a change in control or gain more than a limited number of board seats.
- No Violations of Law or Stock Exchange Rules. The nominee’s candidacy or board membership must not violate state or federal law or applicable stock exchange rules (other than independence requirements, which are dealt with separately by proposed Rule 14a-11).
- Independence Requirements. The nominee must satisfy the “objective” director independence standards of the applicable stock exchange. The nominee would not have to comply with subjective or company specific independence criteria. Moreover, there are no proposed restrictions on the relationships between a nominating shareholder (or group) and its nominees.
Number and Priority of Nominees. Under proposed Rule 14a-11, a company would be required to include in its proxy materials a number of nominees that represents the greater of 25% of the company’s board of directors (rounded down) or one shareholder nominee. If a company has a staggered board, shareholder nominated directors who were elected pursuant to Rule 14a-11 but whose term extends past the current election would count against the 25% maximum but the number of shareholder nominees could constitute more than 25% of the number of directors up for election at a particular meeting. Moreover, the 25% maximum number of shareholder nominees is measured based on the size of the entire board of directors, even in a context in which the proposing shareholder or shareholders hold a class of stock that elects only a limited number of directors. As a result, shareholders of a class may be allowed to include in the company’s proxy statement more than 25% of the nominees entitled to be elected by that class. Also, if a shareholder (or group) has an agreement with a company to nominate a director then such nominee does not reduce the number of shareholder nominees that can be submitted under proposed Rule 14a-11.
Under the proposal, the first shareholder or group to make a qualifying nomination will be given priority over all other shareholders, without regard to relative share ownership, and each of the next nominating shareholders (or groups) will have priority in the order of their nomination until the 25% maximum is exhausted. We anticipate that the SEC will receive numerous comments regarding the first-to-file rule. These commentators are likely to argue in favor of giving priority to the shareholder (or group) holding the greatest number of shares who satisfies the established criteria and submits a notice by the required deadline on the grounds that (1) giving priority to the largest shareholders is more consistent with principles of shareholder democracy than a first-to-file system, (2) it is more appropriate that the shareholder (or group) with the greatest interest in the company (and who therefore absorbs the greatest portion of the cost) have priority under the rule and (3) a first-to-file-rule may encourage “premature” filings by shareholders (or groups) who may very well not have incurred the effort and expense of making a nomination if they knew other shareholders were making director nominations.
The text of the proposed rules does not provide a specific mechanism for a shareholder to withdraw a proposed nomination, although the SEC’s release indicates that withdrawal of a nomination would be the subject of an amendment to Schedule 14N (discussed below). Further, while not specifically addressed in the proposed rules, it would seem that if a particular shareholder nominee who would have been given priority for inclusion in a company’s proxy statement based on the first-to-file rule is either disqualified or withdrawn, the next eligible nominee would move up in order of priority. In that case, a company that receives Schedules 14N nominating a number of individuals for election in excess of the 25% maximum may need to address both potential procedural (e.g., order of priority) and substantive (e.g., independence and disclosure) justifications for excluding each nominee named in a Schedule 14N in the event of disqualification or withdrawal of any particular nominee with greater priority.
Schedule 14N. In order to utilize Rule 14a-11, a shareholder (or group) would be required to file a Schedule 14N no later than the date specified by the company’s “advance notice provision.” If a company has not adopted an advance notice provision, the deadline for filing would be 120 days before the anniversary of the date that the company mailed its proxy materials for its prior year’s annual meeting. In order to comply with state law, advance notice provisions for the nominations of directors typically include a deadline of 90 days before the annual meeting date or the anniversary of the prior year’s annual meeting, a date that is generally 60-70 days after the 120th day before the anniversary of the date that the company mailed its proxy materials for its prior year’s annual meeting. It is unclear whether the “advance notice provision” referred to in proposed Rule 14a-11 must be the same advance notice provision for nominations of directors generally or could be a separate advance notice provision that sets a different (perhaps, earlier) deadline for including nominees in the company’s proxy statement.
Under proposed Rule 14a-11, if a company did not hold an annual meeting during the prior year, or the date of the meeting has changed by more than 30 days from the prior year, it would be required to file a Form 8–K disclosing the deadline for making shareholder nominations pursuant to Rule 14a-11 within four business days after it determines the anticipated meeting date.
The Schedule 14N would include specified disclosures, representations and certifications regarding the shareholder (or group) and nominee(s) that are similar to the information that would need to be included in the shareholder’s proxy statement if it were soliciting outside of the context of Rule 14a-11.
Dispute Procedures and SEC No-Action Process. Following receipt of a Schedule 14N, a company would need to determine if a proposed nominee can be excluded from its proxy materials. A company would be able to exclude a proposed nominee if the shareholder (or group) fails to comply with Rule 14a-11 in a timely manner, if a nominee fails to meet the requirements of Rule 14a-11 or a representation in the Schedule 14N is false or misleading in any material respect. Nominees may also be excluded once the company has received nominations for the maximum number of directors required to be included under the rule. If a company determines to exclude a proposed nominee, it must notify the nominating shareholder (or group) within 14 calendar days after receipt of the Schedule 14N. The shareholder will then have 14 calendar days to cure certain deficiencies, but neither the identity of the nominees or composition of the nominating shareholder (or group) may be revised. If a deficiency is not cured within this time period and the company determines that it may exclude a shareholder nominee, then the company must provide notice of the basis for its determination to the SEC no later than 80 days prior to the filing of its definitive proxy materials. A nominating shareholder (or group) may submit a response to the company’s submission to the SEC. The staff of the SEC may provide the company and the nominating shareholder with an informal statement of its views similar to a no-action letter. The company must provide the nominating shareholder or group with notice of whether it will include or exclude the shareholder’s nominee no later than 30 calendar days before filing its definitive proxy materials with the SEC.
Universal Proxy Card. The proposed rules provide that if shareholder nominees are included in a company’s proxy statement pursuant to Rule 14a-11 or as a result of an alternative provision of state law or a company’s governing documents, then the company must use a “universal proxy” in which each nominee for director included in the company’s proxy statement is listed on the proxy card. Under the proposed rule, the company may indicate for each nominee whether the board recommends a vote “for” such nominee. However, the company would not otherwise be allowed to discriminate among the nominees. If shareholder nominees are included on the company’s proxy card, the proxy card could not include a place where a shareholder can check a box to vote for the entire slate of company nominees. The proposed rules would require only that nominees proposed for election who are included in the company’s proxy materials be included on the “universal” proxy card.
The proposed rules do not provide a shareholder who is running a proxy contest with the ability to include all of the company nominees and other shareholder nominees on its proxy card. Because of these disparities, the implementation of Rule 14a-11, as proposed, does not solve the current issue faced by shareholders who want to pick and choose among various nominees included in the company’s proxy materials and nominees named in separate shareholder proxy materials since a shareholder can only use one proxy card to vote its shares. As a result, shareholders who seek to elect individuals whose names are not included in the company’s proxy statement could be significantly disadvantaged in a complex election contest.
Liability for False or Misleading Statements. The SEC has proposed an amendment to Rule 14a-9 to specifically allocate to a nominating shareholder (or group) liability for false and misleading statements in information provided by it that is included in a company’s proxy statement. Further, proposed Rule 14a-11(e) specifies that a company would not be responsible for any information included in a nominating shareholder’s Schedule 14N unless it knew or had reason to know the information was false or misleading, in which case the company could also be liable for a shareholder’s false or misleading information. As a result, a company could face a choice between excluding shareholder-provided information it believes to be false or misleading in violation of new Rule 14a-11 and including the false and misleading information in its proxy statement and potentially facing liability. The ability to obtain relief from the SEC staff permitting exclusion of this information may not allow a company to avoid this dilemma. For example, the company may discover that the information is false or misleading only after the deadline for requesting relief.
“Affiliate” and Section 16 Status. Proposed Rule 14a-11 includes an instruction making clear that a shareholder will not be deemed an “affiliate” of the company under the federal securities laws (e.g. relating to the application of Rule 144 for resales of shares) solely as a result of nominating a candidate for election as a director or soliciting for the election of such candidate or against a registrant’s nominee. The instruction also provides that, where a shareholder nominee is elected and the nominating shareholder or group does not have an agreement or relationship with that director (other than relating to the director’s nomination, solicitation for the election of the nominee or against a registrant’s nominee, or the election of the shareholder director nominee), the nominating shareholder will not be deemed an affiliate of the company solely by virtue of having nominated that director.
The proposed rules do not provide any relief from Section 16 of the Exchange Act in connection with the formation of nominating groups, in part because the nomination ownership thresholds are below the 10% ownership threshold that triggers Section 16 obligations. If the proposed rule were to be amended to provide nomination priority to shareholders based on aggregate ownership, the SEC may need to reconsider this issue. Further, the proposed rules do not address under what circumstances a shareholder nominee who is elected pursuant to Rule 14a-11 would be deemed a “deputized” director for Section 16 purposes, although the analysis should be the same as under current practice.
Nominating Groups and Compliance with Proxy Rules. The proposed rules exempt a shareholder from complying with most of the proxy rules under Regulation 14A in connection with the organization of a nominating group so long as the shareholder limits the information contained in its written communications and files any such written communications with the SEC. In addition, nominating shareholders would be free to engage in written solicitations for their nominees included in the company’s proxy statement pursuant to Rule 14a-11 and against the company’s nominees provided that they do not seek power to act as proxy or furnish a form of proxy, include specified legends on such communications and file them with the SEC.1
The proposed rules do not include an analogous exemption for solicitations by shareholders whose nominees are included in a company’s proxy statement in accordance with state law or the company’s governing documents, but not 14a-11. Such shareholders, particularly those who have filed on Schedule 13D and reserved the right to engage in a control transaction may not have the benefit of an exemption from the proxy rules that would allow them to solicit other shareholders in favor of their nominees included in the company’s proxy statement unless they file and disseminate a separate proxy statement in compliance with Regulation 14A.
Section 13(d) Compliance. Notwithstanding the exemptions from the proxy rules described above, shareholders who form a nominating group will still need to consider whether they have formed a group under Section 13(d)(3) of the Exchange Act and Rule 13d–5(b)(1) such that they would be required to file beneficial ownership reports on Schedule 13D or Schedule 13G. However, the SEC has proposed amending Rule 13d-1(b)(1)(i) to clarify that a shareholder (or member of a shareholder group) would not lose its ability to use Schedule 13G (instead of the more onerous Schedule 13D) solely as a result of its utilization, or participation in a group that has utilized, Rule 14a-11 to nominate directors and solicit votes for its nominees. Under the rule as proposed, this exception would not be available to shareholders whose nominations are included in a company’s proxy statement under other provisions of state law or a company’s governing documents and would not be available following the election of a nominee to the board, in which event the shareholder would need to consider whether it continues to be eligible to file on Schedule 13G.
Proposed Changes to Rule 14a-8
Rule 14a-8, which governs when a company must include a shareholder proposal in its proxy statement and the procedures shareholders must follow in order to have their proposals included in a company’s proxy statement, currently provides that a company may exclude a shareholder proposal if it relates to a nomination or an election for membership on the company’s board of directors or a procedure for such nomination or election. This so-called “election exclusion” is contained in Rule 14a-8(i)(8). The SEC has proposed amending Rule 14a-8(i)(8) so that a company would be required to include in its proxy statement proposals relating to proposed amendments to the company’s governing documents relating to nomination procedures and related disclosures. A company would still be able to exclude a shareholder proposal if it:
- would disqualify a nominee who is standing for election;
- would remove a director from office before his or her term expired;
- questions the competence, business judgment, or character of one or more nominees or directors;
- nominates a specific individual for election to the board of directors, other than pursuant to Rule 14a–11, an applicable state law provision, or the company’s governing documents; or
- otherwise could affect the outcome of the upcoming election of directors.
In light of the changes to Delaware law described above, these revisions to Rule 14a-8 could result in a significant number of shareholder proposals to adopt proxy access by-laws. Since proxy access by-laws adopted by means of a proposal submitted under proposed, amended Rule 14a-8 need not include any limitations on the shareholders that could utilize its proxy access provisions or the number of nominees that may be included by shareholders, this proposed change to Rule 14a-8 could have implications for shareholders and companies that far exceed Rule 14a-11.
While there have been numerous criticisms of the proposed new rules, including suggestions that the SEC should not adopt a stand-alone proxy access rule (but instead allow companies and their shareholders to determine whether, and on what terms, shareholders should have the ability to include nominees in the company’s proxy statement), it is likely that an SEC shareholder access rule (likely similar to proposed Rule 14a-11) will be adopted in time to have a significant impact on the 2010 proxy season.
While many companies and nominating committees currently engage with their significant shareholders on a regular basis, the adoption of proposed Rule 14a-11 and recent amendments to the Delaware General Corporation Law will result in a greater need to meaningfully engage with a broader group of shareholders regarding the board nomination process. In addition, if the SEC adopts a proxy access rule generally consistent with proposed Rule 14a-11, companies should review their existing policies and procedures, as well as the advance notice provisions in their by-laws, to determine whether they allow sufficient time to address potential shareholder nominations or proposals for by-law amendments relating to the director nomination process. In some cases, companies may want to extend their advance notice deadlines in order to provide additional time to negotiate with shareholders who have made nominations. Companies may also want to accelerate their internal timetables regarding the preparation of proxy materials to allow for earlier mailing of proxy materials in the event of a contested election as well as a result of the recent amendment to NYSE Rule 452 that eliminates broker discretionary voting of uninstructed client shares in uncontested director elections.2