As proxy access bylaws have continued to proliferate—with 60% of the S&P 500 now having adopted some form of proxy access provisions—the Council of Institutional Investors has decided that the time is right to update its 2015 best practices guide. In particular, the 2017 update addresses practices that, while viewed by companies as designed to ensure the legitimate and appropriate use of proxy access, are viewed by CII as impairing the ability of shareholders to use proxy access. But will companies be guided by CII’s advice?
First, CII’s basic policy on proxy access advocates a 3% ownership threshold and minimum two-year holding period for eligibility and the right to elect up to but less than a majority of the board. In the 2017 update, the policy has been expanded to mandate equal space and treatment in proxy materials for proxy access nominees, as well as adherence by nominating shareholders “to the same SEC rules governing disclosure requirements and prohibitions on false and misleading statements that currently apply to proxy contests for board seats.”
The following CII positions have not materially changed in the update:
- Opposition to post-annual meeting holding requirements for nominating shareholders although a requirement to hold the shares at least until the date of the meeting is acceptable.
- Ability of shareholders to nominate at least two candidates, which helps to ensure that an independent representation is meaningful and that elected nominees can serve on multiple committees.
- Opposition to restrictions on re-nominations when a nominee fails to receive a specific percentage of votes.
- Opposition to provisions that make candidates ineligible if they have a compensation arrangement with a party other than the company, although CII supports disclosure prior to the election about any compensation arrangements with parties other than the company.
You may recall that, under Nasdaq Rule 5250(b)(3), adopted in 2016, listed companies are required to disclose the material terms of “golden leash” arrangements—arrangements between any director or nominee and any person or entity, other than the company, relating to compensation or other payment in connection with that person’s candidacy or service as a director. Although the rule is intended to be construed broadly, there are a number of exceptions, such as arrangements that relate only to reimbursement of expenses in connection with director candidacy or certain otherwise disclosed preexisting arrangements. While there is no set format for these arrangements, they may include compensation conditioned on achievement of specified benchmarks, such as an increase in share price over a fixed term. Nasdaq feared that these arrangements “may lead to conflicts of interest among directors[,] call into question the directors’ ability to satisfy their fiduciary duties [and] tend to promote a focus on short-term results at the expense of long-term value creation. Nasdaq believes that enhancing transparency around third-party board compensation would help address these concerns and would benefit investors by making available information potentially relevant to investment and voting decisions.” (See this PubCo post.)
Interestingly, in a footnote to a resubmitted version of the proposal, Nasdaq indicated that it was considering whether to separately propose additional requirements regarding third-party payments to directors and candidates, including whether these directors should be prohibited from being considered independent under Nasdaq rules or prohibited from serving on the board altogether. The implication was that transparency alone may not suffice to resolve the potential problems created by golden leash arrangements, which, under some circumstances, could include director conflicts of interest, compromises of director independence, motivation of directors to focus on their own short-term interests to the detriment of the company and its shareholders as a whole and development of fragmented and dysfunctional boards. The resubmission of the proposal also noted that, under the subjective prong of the definition of independent director, any “individual having a relationship which, in the opinion of the Company’s board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director” is not considered to be independent. Implicit in this statement is the view that, even if Nasdaq elected not to seek to enhance the definition of independence in this regard, directors may already be obligated to consider this type of third-party payment when assessing director independence. (See this PubCo post.)
There are a number of changes or additions in the 2017 update:
- The requirement that nominating shareholders demonstrate requisite share ownership with evidence from a broker or bank should entail only a number of shares, not a percentage. The percentage should be determined “only on a date at least one week prior to the notice date that is also a date on which the company makes public its outstanding shares” and should be required only once, so long as the holding period has been met.
- Although CII policy supports a two-year holding period, CII acknowledges that three years is now the market standard.
- CII has consistently taken the position that loaned shares should count toward the ownership threshold, provided certain conditions are satisfied: in 2015, CII’s position was that the shareholder represent “that it has the legal right to recall those securities for voting purposes and will vote the securities at the shareowner meeting, accompanied by a representation that the participant will hold those securities through the date of the annual meeting.” The update omits the voting requirement and adds that any requirement to recall loaned shares should allow shareholders at least a five-day window to collect.
- Although CII has not supported caps on aggregation to meet the ownership threshold, CII now recognizes that a 20-shareholder cap is the market standard and that many investors are willing to accept the cap so long as families of funds are counted appropriately: two or more funds should be treated as one shareholder for purposes of aggregation if they are “under common management and investment control, under common management and funded primarily by the same employer, or are considered a group of investment companies as defined by the Investment Company Act of 1940.”
- Directors who were previously elected through proxy access should not count against the limitation on proxy access nominees even if they are still on the board “unless proxy access nominees from the current and previous two annual meetings would constitute a majority of the board.” The look-back should not exceed two years.
- CII opposes the imposition on nominating shareholders and their nominees of disclosure requirements that exceed those imposed by the SEC in proxy contests or that the company imposes on its own candidates. This prohibition would include requirements on oral communications and communications unrelated to proxy access that exceed SEC requirements. In CII’s view, qualification and independence standards should apply universally to both shareholder and management nominees. CII believes that imposing “onerous reporting requirements not applicable to the board’s nominees is unfair and could potentially make proxy access unworkable.”
- CII opposes automatic suspension of proxy access in the event of a proxy contest, except that a shareholder group may be barred from waging a proxy contest and, at the same time, using proxy access. CII believes that proxy access nominees “would be nominated by long-term shareholders who may differ from activist shareholders running a proxy fight based on short-term financial engineering or other goals in tension with long-term holders.”
- Companies should provide equal space and treatment in the proxy statement for shareholder and management nominees.
- The board should not have sole discretion to interpret the proxy access bylaws; rather, interpretive questions should be subject to the same judicial review as other bylaw provisions.
- CII opposes unlimited indemnification requirements on nominating shareholders; indemnification that is too broad “could be used to inhibit the proxy access process.”