The Securities and Exchange Commission (SEC) stayed implementation of its recently adopted proxy access rules on October 4, 2010, in response to a motion filed with it by the Business Roundtable and the U.S. Chamber of Commerce, which also filed a petition for judicial review of the rules with the U.S. Court of Appeals for the District of Columbia Circuit. As a result of the stay, the rules likely will not be in effect for the 2011 proxy season. Absent the stay, the rules would have become effective on November 15, 2010.

New Rule 14a-11 under the Securities Exchange Act of 1934 (Exchange Act) gives certain shareholders the ability to include a nominee or nominees for director in company proxy materials. Investment companies cannot “opt out” of Rule 14a-11. The proxy access right would apply regardless of whether the company has a provision in its governing documents providing for, or prohibiting, the inclusion of shareholder nominees in its proxy materials. The only exception to the applicability of Rule 14a-11 would be if the investment company’s governing documents or relevant state law prohibit such action.

To be eligible to have their nominee(s) included in the company’s proxy materials under Rule 14a-11, the shareholder or shareholder group must have held at least 3 percent of the securities eligible to vote for directors continuously for at least three years and must continue to hold that amount of securities through the date of the election. Shareholder director nominees would be limited to the greater of one director or 25 percent of the board at any time. Where there are multiple eligible nominating shareholders, the nominating shareholder or shareholder group with the highest percentage of the company’s voting power would have its nominees included in the company’s proxy materials. If a shareholder or shareholder group nominates less than the number of individuals it is entitled to nominate, the company would be required to include the nominees of the shareholder or shareholder group with the next highest qualifying ownership percentage, and so on, up to the 25 percent cap. A company would not be required to include shareholder nominees in its proxy materials if their candidacy or board membership would violate controlling state or federal law, or the rules of a national securities exchange or national securities association.

Shareholders who submit nominees to be included in company proxy materials are required to notify the company of their intent and to file notice (Schedule 14N) with the SEC on the date it is provided to the company. The notice must be provided and filed no earlier than 150 calendar days before the anniversary of the mailing date of the prior year’s proxy statement and no later than 120 calendar days before that anniversary date. If the company did not hold an annual meeting during the prior year, which is often the case for open-end investment companies, or the date of the meeting has changed by more than 30 calendar days from the prior year, the nominating shareholder or shareholder group must provide notice a “reasonable” amount of time before the company mails its proxy materials. In those circumstances, the company would be required to disclose the date by which the shareholder would have to submit the notice in a Form 8-K filed within four business days after the company determines the anticipated meeting date. Most mutual funds presumably would have to do this for every shareholder meeting.

The SEC also amended Rule 14a-9 so that a nominating shareholder or shareholder group relying on Rule 14a-11, an applicable state law provision, or a company’s governing documents to include a nominee in company proxy materials would be liable for any materially false or misleading statements in information provided by the nominating shareholder or shareholder group to the company.

The final rules also include an amendment to Rule 14a-8(i)(8) that would narrow the election exclusion so that companies would not be able to rely on Rule 14a-8(i)(8) to exclude shareholder proposals seeking to establish procedures for shareholders to nominate directors in a company’s governing documents. The SEC also amended Rule 14a-8(i)(8) to codify prior staff interpretations regarding the types of proposals that companies could continue to exclude.

Importance of Getting to Know Your 3 Percent Shareholders

For purposes of the 3 percent ownership threshold, only those shares over which the nominating shareholder or shareholder group has current voting and investment power may be counted. A nominating shareholder or shareholder group may count securities that have been loaned by it or on its behalf, but only if the nominating shareholder or shareholder group has the right to recall the loaned securities and will recall those securities upon being notified by the company that the shareholder or group’s nominee(s) will be included in the company’s proxy materials. Shareholders may not count any securities sold short or any securities that could be, but have not yet been, acquired, such as securities underlying options or warrants that are exercisable but have not yet been exercised.

The ownership threshold would be calculated as of the date a Schedule 14N is first filed. In order to determine calculation of the 3 percent threshold, nominating shareholders or shareholder groups would rely on the most recent annual, quarterly or current report filed by the company, unless the shareholder or shareholder group knows or has reason to know that the information contained in the report is inaccurate.

Number of Directors

Shareholder director nominees would be limited to the greater of one director or 25 percent of the board at any time. Where the term of a director that was nominated pursuant to Rule 14a-11 continues past the meeting date, the director would continue to count for the purposes of the cap. Where a company has a staggered board, the 25 percent cap would be calculated on the total number of board seats, not the number up for election at a specific meeting.

Shareholder Nominee Requirements

The nominating shareholder or shareholder group would have to represent that their nominee is not an “interested person” as defined in Section 2(a)(19) of the Investment Company Act of 1940 (1940 Act). The nominating shareholder or shareholder group would be required not to have any agreements with the company with respect to the nomination prior to the submission of the Schedule 14N. If the company decides to include a shareholder nominee on the company proxy card as a company nominee, however, the company can count the nominee toward the 25 percent cap so long as the company did not have an agreement or enter into negotiations with the shareholder(s) before the shareholder filed its notice on Schedule 14N.

Requirements for Companies that Receive Notice from a Nominating Shareholder or Group

Within 14 calendar days of receiving notice, a company is required to notify the shareholder or shareholder group if it determines that it may exclude the nominee. A company may determine that it is not required under Rule 14a-11 to include a nominee in its proxy materials if it determines any of the following:

  • Rule 14a-11 is not applicable to the company (i.e., applicable state law or a company’s governing documents prohibit shareholders from nominating candidates for the board of directors; however, if a company’s governing documents do prohibit nomination rights, shareholders who want to amend the provision may seek to do so by submitting a shareholder proposal);
  • The nominating shareholder or shareholder group has not complied with the requirements of the Rule;
  • The nominee does not meet the requirements of the Rule; or
  • Including the nominee(s) would require the company to include more than the maximum number of shareholder nominees.

The shareholder or shareholder group then has 14 calendar days to respond. If the company determines that it may still exclude the nominee, the company must provide notice to the SEC and the nominating shareholder or shareholder group of its intent to exclude, and the notice must be provided at least 80 calendar days before it files the company’s definitive proxy materials with the SEC. The nominating shareholder or shareholder group would then have 14 calendar days to submit a response to the SEC. At its discretion, as soon as practicable, the SEC staff may provide an informal statement of its views on the matter to the company and nominating shareholder or shareholder group. At least 30 calendar days prior to filing its definitive proxy statement, the company must then provide the nominating shareholder or shareholder group with notice of whether it will include or exclude the nominee(s).

Liability for Nominating Shareholder Statements

The company would include in its proxy materials disclosure regarding the nominating shareholder, as well as the nominees themselves. The SEC amended Rule 14a-9 so that a nominating shareholder or shareholder group would be liable for any materially false or misleading statements in information provided by them to the company. The final rules modified the standard for company liability for shareholder-provided statements regarding shareholder nominees. As proposed, companies would not have been responsible for information that was provided by the nominating shareholder or shareholder group under Rule 14a-11 and then repeated by the company in its proxy statement, provided that the company did not know or have reason to know that the information was false or misleading. The final rule removed the knowledge condition, thereby eliminating companies’ responsibility for information provided by nominating shareholders or shareholder groups. In addition, a company would not be required to recirculate or correct proxy materials if it learns that the materials provided to shareholders included false or misleading information from the nominating shareholder or shareholder group.

Application of the Other Proxy Rules to Nominating Shareholder Solicitations

Written and oral communications made pursuant to Rule 14a-11, which would be considered to be solicitations under the SEC proxy rules, will be exempt from certain disclosure, filing and other requirements of those rules so long as the shareholder is not holding the company’s shares with the purpose or effect of changing control of the company.

Amendments to the Election Exclusion in Rule 14a-8

Rule 14a-8, the shareholder proposal rule, currently allows a company to exclude from its proxy statement a shareholder proposal that relates to a nomination or an election for membership on the company’s board of directors or a procedure for such nomination or election. The final rules include an amendment to Rule 14a-8(i)(8) that would narrow the election exclusion such that companies would not be able to rely on Rule 14a-8(i)(8) to exclude from the proxy materials a shareholder proposal seeking to establish in a company’s governing documents procedures for shareholders to nominate directors. For example, a shareholder may propose to amend a company’s governing documents to adopt a lower ownership threshold for shareholder nominations if the shareholder deems that the 3 percent ownership threshold under Rule 14a-11 is too high.

The SEC also amended Rule 14a-8(i)(8) to codify prior staff interpretations regarding the types of proposals that companies could continue to exclude. Specifically, a company could exclude a shareholder proposal under amended Rule 14a-8(i)(8) if it would:

  • Disqualify a nominee who is standing for election;
  • Remove a director from office before his/her term expired;
  • Question the competence, business judgment or character of a nominee or director;
  • Nominate a specific individual for election to the board of directors, other than pursuant to Rule 14a-11, an applicable state law provision or a company’s governing documents; or
  • Otherwise affect the outcome of the upcoming election of directors.

SEC Issues Order Granting Stay of New Rule 14a-11 and Amended Rule 14a-8

The Business Roundtable and the U.S. Chamber of Commerce filed a petition with the U.S. Court of Appeals for the District of Columbia Circuit September 29, 2010, seeking review of newly adopted Rule 14a-11 and amended Rule 14a-8. The same day, the petitioners also filed with the SEC a motion to stay Rule 14a-11, including the November 15, 2010, effective date of the rules, pending judicial review. On October 4, 2010, the SEC, without addressing the merits of petitioners’ challenge to the rules, granted a stay of Rule 14a-11 and Rule 14a-8 and the related rule changes, pending resolution by the Court of Appeals. The SEC did not address in its order granting the stay the merits of the petitioners’ challenge to the rules. While petitioners did not seek a stay of amended Rule 14a-8, the SEC said the amendment was adopted contemporaneously with Rule 14a-11 and was designed to complement Rule 14a-11. Since the rules are intertwined, the SEC was concerned about the potential for confusion if amended Rule 14a-8 became effective while Rule 14a-11 is stayed. The SEC noted in its order that “a stay avoids potentially unnecessary costs, regulatory uncertainty, and disruption that could occur if the rules were to become effective during the pendency of a challenge to their validity.” The order also noted that “questions about the rules’ validity will be resolved as quickly as possible” because the SEC and petitioners are seeking expedited judicial review. Nevertheless, the rules likely will not be in effect for the 2011 proxy season.

A copy of the final rule is available at http://www.sec.gov/rules/final/2010/33-9136fr. pdf. A copy of the SEC’s order granting a stay is available at http://www.sec.gov/rules/ other/2010/33-9149.pdf.