On October 18, 2011, the Staff of the Securities and Exchange Commission’s (SEC) Division of Corporation Finance issued Staff Legal Bulletin No. 14F1 (the “Bulletin”), giving its views on a number of topics pertaining to shareholder proposals under Rule 14a-8 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). As the proxy season gets underway, the SEC is again interested in ensuring a clear understanding of the requirements for submitting shareholder proposals. In this vein, the Bulletin contains a shift in the Staff’s view on introducing brokers and who will constitute a “record” holder under Rule 14a-8(b)(2)(i) and a review of common errors shareholders can avoid when submitting proof of ownership to companies along with their shareholder proposals, as well as views on the submission of revised proposals, procedures for withdrawing no-action letters and the expanded role of email in corresponding with the Staff.

Although this Bulletin is mostly directed to shareholders submitting proposals under Rule 14a-8, companies should be aware of the Bulletin, as it may impact their responses to shareholder proposals.

What is the Staff’s new view on “record” holders under Rule 14a-8(b)(2)(i)?

The Shareholder Requirement

Under Rule 14a-8(b)(1), a shareholder submitting a shareholder proposal for consideration at the next general meeting must have been a “record” holder of at least $2,000, or one percent, of the company’s shares for a continuous year up to the date such proposal is submitted. For shareholders who hold shares directly, this is a straightforward matter of the company verifying the shareholder’s ownership itself by looking at its shareholder register.

How Do Beneficial Holders Give Proof of Ownership?

The vast majority of shareholders, however, are beneficial owners, holding through a securities intermediary such as a clearing broker or bank. These shareholders must submit written statements from the clearing broker or bank showing that they are the beneficial holder of the company’s shares. In many cases, though, clearing brokers and banks deposit their customers’ securities with the Depository Trust Company (DTC). Clearing brokers and banks that deposit securities with DTC are called “participants” in DTC. DTC maintains a “securities position listing” for each company that lists all of the participants that hold the company’s shares. As such, to show proof of share ownership for the purpose of Rule 14a-8(b)(1), a shareholder whose shares are held via a clearing broker and DTC would submit evidence from the clearing broker as a “record” holder that the shareholder is the beneficial owner of the shares, and the company could then check the securities position listing of DTC to verify that the broker or bank was a company shareholder. This would provide a continuous chain of proof of ownership.

The Problem with Introducing Brokers

An introducing broker is a broker that engages in sales and other activities involving customer contact, such as opening customer accounts and accepting customer orders, but is not permitted to maintain custody of customer funds and securities. Introducing brokers are usually not participants in DTC, and therefore do not appear on the securities position listing for a company. On October 1, 2008, the Staff took the position in a no-action letter, The Hain Celestial Group, Inc. (Oct. 1, 2008), that introducing brokers could be considered “record” holders for the purpose of Rule 14a-8(b)(1), with the result that companies would have to accept proof of ownership letters from introducing brokers on behalf of shareholders evidencing shareholdings in DTC, even though the company would not be able to verify these against its own transfer agent records or the DTC securities position listing. In taking this position, the Staff reasoned that because of the introducing broker’s relationship with the clearing brokers, it was in a position to know and verify the beneficial ownership of its shareholder customers.2

The New View – Hain Reversed

As a result of numerous questions regarding this position following the outcome of two recent court cases,3 the SEC has reversed the position concerning introducing brokers set forth in Hain. Going forward, only participants in DTC will be considered “record” holders for the purposes of Rule 14a-8(b)(2)(i), providing greater clarity to both beneficial holders and companies.

The Bulletin makes it clear that a company seeking no-action relief from the inclusion of a shareholder proposal on the basis that the shareholder has submitted proof of ownership from a non-DTC participant, in its notice of defect to the shareholder, must have described the proof of ownership requirement in a way consistent with the guidance contained in the Bulletin. In essence, the Bulletin explains why an introducing broker cannot be a “record” holder, and how the shareholder can obtain proper proof of ownership from a DTC participant.

Proxy season tips and guidance

The Bulletin also includes some tips and guidance for shareholders and companies on certain aspects of shareholder proposals. Companies should be aware and follow this guidance when crafting their responses to a shareholder proposal or when submitting a no-action letter to the SEC on a shareholder proposal:

  • Common Errors Regarding Proof of Ownership – Proof of share ownership under Rule 14a-8(b)(1) must be shown to cover a continuous year ending on the day the proposal is submitted. A common error made by shareholders is to request a letter from their broker or bank dated before the proposal is submitted, leaving a gap of a few days that are not covered by the proof of ownership letter, or a letter that is dated after the submission but only covers a year from the date of the letter, not from the date of the submission, thus falling short of evidencing a full year of ownership. The Bulletin provides sample language that a shareholder can request that its broker or bank include in a proof of ownership letter to help avoid the above errors.
  • Submission of Revised Proposals
    • Revisions submitted prior to the deadline - When a shareholder submits a revised proposal before a company’s deadline for receiving proposals has expired, the company must accept the revision. The revised proposal effectively replaces the initial proposal, so the shareholder has not violated the one-proposal limitation in Rule 14a-8(c). In addition, if the company files a no-action letter, it must be in regards to the revised proposal.
    • Revisions submitted after the deadline - If a shareholder submits a revised proposal after the company’s deadline for receiving proposals has expired, the company need not accept the revised proposal. However, if the company does not accept the revised proposal, it must treat the revised proposal as a second proposal, and must submit a notice stating its intention to exclude the revised proposal as required by Rule 14a-8(j). The notice must cite Rule 14a-8(e) as the reason for excluding the revised proposal.
    • Proof of ownership requirements - A shareholder must provide evidence of share ownership at the time it submits its original shareholder proposal, and does not have to resubmit such proof when filing a revised proposal.
  • Withdrawal of No-Action Letters – In many cases, multiple shareholders submitting a proposal will nominate a lead shareholder who can act on their behalf. A company, in seeking to withdraw a no-action letter pertaining to a proposal that has been withdrawn by the lead shareholder, should submit a letter from the lead shareholder that includes a representation that the lead shareholder is authorized to withdraw the proposal on behalf of each of the shareholders that submitted the proposal.
  • Use of Email to Transmit 14a-8 No-Action Responses – The SEC will now be using email to transmit its no-action letter responses to companies. As a result, companies should include their email address in all no-action correspondence. If an email address is not provided, the SEC will mail the response via regular post.