On August 25, 2010, the Securities and Exchange Commission adopted new rules that require all U.S. public companies (and certain non-U.S. companies that comply with the U.S. proxy rules) to include in their proxy materials shareholder director nominees and shareholder proposals that seek to regulate the nomination and election of directors. With these new proxy access rules, the SEC hopes to facilitate the exercise by shareholders of their state law rights to nominate and elect directors to the boards of public companies, and to improve corporate suffrage, the disclosure provided in corporate proxy solicitations and communications among shareholders in the proxy process.
The new rules will become effective 60 days after publication in the Federal Register for all issuers, except “smaller reporting companies” which are exempt from proxy access for three years following effectiveness of the rules. A nominating shareholder or group must provide notice to a company of its intent to nominate directors under new Rule 14a-11 no earlier than 150 days and no later than 120 days prior to the anniversary of the mailing of the prior year’s proxy statement. Accordingly, if the rules were published in the Federal Register on September 2, 2010, the new nomination rule would effectively be applicable in the 2011 proxy cycle to companies (other than smaller reporting companies) that mailed their 2010 proxy statement on or after March 1, 2010.
Issuers which allow director nominations by shareholders are not permitted to “opt out” from the new proxy access rules, or alter them in a way that would restrict their availability to shareholders. Issuers can, however, impose more lenient conditions.
- All public companies listed or having equity securities registered in the United States (but not foreign private issuers) will be subject to these rules.
- The release sets forth a detailed process which companies and shareholders must follow to work through a nomination under the supervision of the SEC staff.
- Shareholder nominations must be permitted under state law (or applicable foreign law) and the company’s governing documents.
- Shareholder eligibility requirements ensure that the nominations are supported by large and long-term shareholders. The minimum ownership level required to make a nomination is 3% for all issuers regardless of size (shareholders are entitled to aggregate their holdings to meet this threshold) and the qualifying securities must have been held for at least three years prior to the director nomination.
- The proposing shareholder may not seek to change control of the issuer and shareholder nominees must meet all applicable objective independence standards of the relevant securities exchange.
- A new SEC filing is required when making a nomination (Schedule 14N).
- Where there are multiple nominating shareholders, the nominating group with the highest percentage of the company’s voting power will be entitled to nominate the greater of one nominee or 25% of the directors of the board.
- Nominating shareholders may solicit participation of other stockholders to form a “nominating group” without triggering the requirement to file a full proxy statement. Members of the nominating group will, under certain circumstances, remain “passive investors” eligible to file ownership reports on Schedule 13G.
Proxy Access Applies to Issuers Subject to the Proxy Rules
Rule 14a-11 applies to all companies subject to the Exchange Act proxy rules, provided the relevant state or foreign law and the company’s governing documents do not prohibit shareholder nominations. Rule 14a-11 does not apply to foreign private issuers, which are exempted from the proxy rules, and companies that are subject to the proxy rules solely because they have a class of debt registered under the Exchange Act. To address the situation of companies whose governing documents do not permit shareholder nominations, the SEC will allow shareholders to use the Rule 14a-8 shareholder proposal procedure to seek changes to the governing documents to allow shareholder nominations and proxy access.
Shareholder Eligibility Requirements
To qualify for shareholder nominations under Rule 14a-11, a nominating shareholder (or nominating group) is required to have a minimum stock ownership level of 3%, regardless of the size of the company. Each shareholder seeking to make a nomination under the rule (alone or as a member of a group) is required to have owned the required amount of securities for at least three years from the date of the notice of nomination and must continue to own them through the date of the meeting. A nominating shareholder or group is required to state its intent with respect to continued ownership of the shares after the election. The procedure is reserved for shareholders who did not acquire and do not hold their securities for the purpose or with the effect of changing control of the company.
Shareholder Nominee Requirements
A company may exclude from its proxy materials any nominee who, if elected, would cause the company to violate applicable laws or stock exchange requirements, and such violation could not be cured. A company may not impose additional requirements in its governing documents (such as compliance with enhanced director qualifications) as a condition to including in its proxy materials nominations made through Rule 14a-11. Nominees are required to meet the objective criteria of independence set forth in the relevant national securities exchange rules for directors (other than audit committee members). The subjective independence requirements in the applicable exchange rules and the company’s additional director independence qualification standards (if any) need not be satisfied. Employees or executives of shareholders are eligible to be nominated under Rule 14a-11.
To limit the risk that companies could encourage shareholders to nominate supportive nominees to block future unwelcome nominations, new Rule 14a-11 requires that no relationships or agreements exist between the nominee, or the nominating group, and the company and its management. Negotiations to determine whether the shareholder nominee could receive the support of management (if they are unsuccessful) or whether the company is required to include the nominee in its proxy materials do not disqualify a nominating shareholder or group. To avoid discouraging dialogue between company management and nominating shareholders, shareholder nominees that a company agrees to include as “company nominees” after the filing of Schedule 14N would count towards the 25% limit on Rule 14a-11 shareholder nominees.
The SEC did not include in the final rules a safe harbor providing that a nominating shareholder would not be deemed an “affiliate” of the company under the Securities Act or the Exchange Act solely as a result of using Rule 14a-11, as originally proposed. Instead, nominating shareholders who use Rule 14a-11 must analyze affiliate status on a case-by-case basis as they would in other contexts, taking into consideration all relevant facts and circumstances, including the circumstances surrounding a nomination and election of a shareholder nominee.
The maximum number of nominees that shareholders may nominate through the Rule 14a-11 procedure is capped at one director for boards with seven or less members and at 25% of the full board for larger boards, regardless of whether the company has a classified (staggered) board. This limitation is applicable on an ongoing basis (any existing shareholder nominee counts against the limitation) to prevent shareholders from using this procedure for control purposes.
If competing nominations are made by more than one shareholder or group, proxy access will be allocated first to the nominating shareholder or group with the highest qualifying voting power percentage in the company’s securities as of the date of filing the Schedule 14N. If such nominating shareholder or group does not nominate the maximum number of directors allowed under the rule, the nominee(s) of the nominating shareholder or group with the next highest qualifying voting power percentage will be included in the company’s proxy materials, up to and including the total number permitted by the rule.
New Schedule 14N
In order to make a nomination under Rule 14a-11, a shareholder or group is required to send the company and file with the SEC a shareholder notice on Schedule 14N by the advance notice deadline for shareholder proposals set forth in the company’s governing documents or, where no such provision is in place, no earlier than 150 days and no later than 120 days prior to the date the company mailed the proxy materials for the prior year’s annual meeting.
The Schedule 14N notice generally requires disclosure of the type that nominating shareholders are required to provide in a proxy contest. The disclosure is intended to enable the company and the SEC to assess whether the proponents meet the shareholder eligibility and other requirements of Rule 14a-11. In particular, the notice must contain the following disclosure:
- the name and address of the nominating shareholder or, if a nominating shareholder group is filing the Schedule 14N, of each member of the group
- information regarding the amount and percentage of securities beneficially owned and entitled to vote at the meeting and the voting power that derive from shares that have been loaned or sold in short sale transactions that remain open
- a statement from the record holder of the shares beneficially owned by the nominating shareholder confirming that the shareholder continuously held the securities for at least three years
- a statement of the intent of the nominating shareholder(s) to continue holding the requisite number of shares through the shareholder meeting at which directors are elected and regarding the intent of the nominating shareholder(s) with respect to continued ownership after the election
- a certification that the shares are not held for the purpose of, or with the effect of, changing the control of the issuer or gaining more than the maximum number of board seats that the issuer is required to make available for proxy access, and that each nominating shareholder and shareholder nominee meets the applicable eligibility requirements under Rule 14a-11
In addition, the nominating shareholder or group is required to make certain representations and disclosure regarding compliance with the shareholder eligibility requirements of Rule 14a-11, as follows:
- a representation that the nominating shareholder or group is eligible to submit a nominee under Rule 14a-11
- a statement that, to the best of the nominating shareholder’s or group’s knowledge, each shareholder nominee satisfies the company’s director qualifications provided in the company’s governing documents, if any
- a representation that the nominee meets the objective criteria for independence under the applicable rules of a national securities exchange or national securities association
- a statement that the nominee consents to be named in the company’s proxy statement and to serve on the board if elected
- disclosure concerning the nominee that would be required to be included in a Schedule 14A (biographical information, legal proceedings, transactions and relationships with the company)
- disclosure concerning the nominating shareholder or group of shareholders that would be required to be included in a Schedule 14A in a contested election
- disclosure concerning the nature and extent of the relationships between the nominating shareholder or group of shareholders and nominee and the company and any affiliate of the company
- a supporting statement (which may not exceed 500 words)
The Schedule 14N must be amended promptly if there is any material change in the information previously submitted. The nominating shareholder or group is also required to file a final amendment to its Schedule 14N within 10 days of the final results of the election to disclose its intent with regard to continued ownership of their shares.
The new proxy access rules set forth a detailed process which companies and shareholders are required to follow to work through a nomination under the supervision of the staff. The process is modeled after the existing procedures for excluding shareholder proposals under Rule 14a-8. The principal steps are as follows:
- A company must inform a nominating shareholder or group within 14 days of the close of the period during which nominations can be made whether it has reasons to believe that it may disregard the nominations.
- The nominating shareholder or group must respond within 14 days of receipt of the company’s notice of deficiency and is given an opportunity to cure certain eligibility or procedural deficiencies affecting the nominations.
- If the company wishes to exclude the nomination, it must request a determination of no-action from the SEC no later than 80 days prior to filing its definitive proxy statement (and include an opinion of counsel stating the basis for such exclusion).
- The nominating shareholder or group may submit a response to the company’s notice to the SEC within 14 days of receipt of a copy of the company’s request to the SEC.
- If the company so requests, the staff may provide its views to the company and the nominating shareholder or group informally before issuing a formal response to the no-action request.
- The company must inform the nominating shareholder or group no later than 30 days before filing its definitive proxy statement whether it intends to include the nominations.
The release sets forth the SEC’s timeline for this process.
Under certain circumstances, if a shareholder nominee withdraws or is disqualified before the company commences printing the proxy materials, the company may be required to include a substitute nominee, if there are additional eligible nominees. Accordingly, the adopting release instructs companies to seek a no-action letter from the staff with respect to all nominees that the company believes should be excluded at the outset of this process.
Preliminary Communications Among Shareholders
The SEC has also adopted a limited exemption from the prohibition against solicitations made prior to filing a proxy statement to facilitate preliminary communications among shareholders in connection with Rule 14a-11 nominations. The exemption, contained in Rule 14a-2(b)(7), allows shareholders who are seeking to make a nomination, but do not own the required percentage or wish to build support in advance of their nominations, to solicit other shareholders to form a nominating group. The exemption is available for written and oral communications by shareholders who do not hold the company’s securities with the purpose, or with the effect, of changing control of the company or to gain a number of seats on the board of directors that exceeds the maximum number of nominees that the registrant could be required to include under Rule 14a-11. Communications made in connection with nominations outside Rule 14a-11, such as nominations pursuant to state law and the company’s governing documents which are not to be included in the company’s proxy, are not exempt. The staff states that a shareholder may lose the exemption if such shareholder later takes steps to make nominations outside of Rule 14a-11 or becomes member of a group. The Rule also requires that a Notice of Commencement of Oral Solicitation and all written materials provided to shareholders be filed with the SEC on Schedule 14N no later than the date of first communication or use. In addition, the content of written materials is restricted to the following:
- a statement of the shareholder’s intent to form a nominating shareholder group in order to make a nomination under the rule
- a statement describing the proposed nominee or, if no nominee has been identified, the proposed characteristics of the nominee whom the shareholder intends to nominate
- the percentage of shares that the shareholder or group beneficially owns
- the means by which shareholders may contact the soliciting party
Schedule 13G/D and Section 16 Issues
The staff advises shareholders seeking to make a Rule 14a-11 nomination to consider their obligations under Regulation 13D and Section 16. Regulation 13D requires any shareholder (or group) who is the beneficial owner of more than 5% of the shares of a public company to file a beneficial ownership report on Schedule 13D with the SEC, unless the shareholder is permitted to file on Schedule 13G because it is a qualified institutional investor or it owns less than 20% of such shares and does not hold any shares for control purposes. The staff believes that the formation of a group solely for the purpose of making a nomination under Rule 14a-11 would not make a 5% nominating shareholder or group lose its eligibility to file on Schedule 13G. However, to clarify this point, the SEC has adopted a carve-out covering Rule 14a-11 activities in the instructions regarding Schedule 13D. This carve-out does not extend to communications or other actions by shareholders in connection with nominations made pursuant to state law or a company’s governing documents. Concerning Section 16, the staff states that, because the ownership thresholds for Rule 14a-11 nominations are well below 10%, a carve-out for groups established for purpose of making a Rule 14a-11 is not needed.
Shareholder Solicitations in Support of Nominations
The SEC has adopted a new exemption from the proxy rules to facilitate written and oral solicitations by shareholders in connection with Rule 14a-11 nominations. Pursuant to Rule 14a-2(b)(8), after receiving notice that its nominations will be included in the company proxy, a nominating shareholder or group may solicit shareholders in favor of, or in opposition to, director candidates included in a company proxy without having to file a proxy statement, so long as such shareholder or group is not soliciting authority to act as proxy for other shareholders and do not furnish or request a proxy card. Any written communication made for that purpose must be filed with the SEC on Schedule 14N on the date of first use and include the following:
- the identity of the nominating shareholder or group and a description of their interests in the company by security holdings or otherwise
- a prominent legend advising shareholders that a shareholder nominee will be included in the company’s proxy statement and to read the proxy statement when it becomes available
The parties are also free to solicit outside of the proxy statement subject to any filing requirement under the proxy rules.
The adopting release clarifies that solicitations in support of Rule 14a-11 nominations are not “solicitations in opposition” for purposes of Rule 14a-6, and therefore do not trigger the filing and disclosure requirements applicable to shareholders’ proxy contests. Upon receipt of a valid nomination, a company is required to include the names of the nominees and supporting statement in its proxy statement, and to present the nominees in an impartial manner on its proxy card. Issuers must provide shareholders with the ability to vote on each company and shareholder nominee individually, and not on the company nominees as a separate group.
The SEC has modified Rule 14a-9 to provide that companies will not be liable for any information furnished by the nominating shareholder or group and included in the company’s proxy statement. Nominating shareholders or groups are liable for statements made in their Schedule 14N or other communications, and for any information provided for inclusion in the company’s proxy materials (regardless of whether such information is actually included in the materials).
Shareholder Election Proposal Rule
In connection with the new proxy access rules, the SEC has amended Rule 14a-8, the rule that requires companies to include a qualifying shareholder proposal in their proxy statement, to facilitate its use by shareholders in connection with the director election process. Until now, companies could exclude proposals that relate to a director nomination or election, or a procedure for nomination or election. The new amendments to Rule 14a-8 narrow this exclusion to a few limited situations.
Rule 14a-8 now requires companies to include in their proxy materials shareholder proposals that would amend a company’s governing documents regarding director nomination procedures or disclosures related to such nominations (so long as the proposal complies with the other requirements of Rule 14a-8 and does not conflict with Rule 14a-11). As amended, Rule 14a-8 also permits shareholders to make binding proposals providing other means for director nominations than the nomination process contemplated by Rule 14a-11, but such proposals may not impose more onerous requirements for shareholders nominations made in reliance on Rule 14a-11.
No new disclosure requirements are triggered by the use of Rule 14a-8 for such proposals so long as the proponent does not make any director nomination. However, if the proponent makes a nomination after the proposal has been adopted, or pursuant to a separate right under state law or the company’s governing documents to have shareholder nominees included in the company’s proxy statement, new Rule 14a-19 requires that the proponent file a shareholder notice on Schedule 14N including disclosure similar to that required in an election contest. The company is required to include this disclosure in its proxy statement.
The SEC has also codified certain existing interpretations under Rule 14a-8, which will continue to allow companies to exclude proposals on certain limited grounds. A 14a-8 proposal may still be excludable if it would disqualify a nominee, remove a director from office before the end of such director’s term, questions the competence of a director, nominates a specific individual for election or would affect the outcome of the upcoming election.
Because issuers may not opt out or impose more restrictive conditions on proxy access, the new rules effectively reduce their ability to restrict shareholder nominations, short of prohibiting them entirely – a poor solution for those concerned with good corporate governance. For this reason, and despite the limitations introduced by the SEC on its use for control purposes, proxy access may over time provide shareholders, and in particular patient proactive investors, with a powerful new tool to monitor – and progressively influence – the management of the companies in which they are invested. There remains skepticism concerning its immediate effect, however, because the three-year holding requirement may deter a large universe of potential users.
The authors gratefully acknowledge the assistance of Holland & Knight Associate Aaron Goldberg in the preparation of this alert.