In an effort both to address litigation surrounding shareholder director nominations on public company proxy cards and to promote communication among shareholders and public companies, the Securities and Exchange Commission has adopted rules to codify its interpretation of Rule 14a-8(i)(8) and facilitate the use of shareholder electronic forums.
The new rule amendments will be effective by the end of January 2008 in advance of the 2008 proxy season for calendar-year-end public companies.
While shareholders typically can submit recommendations to a nominating company for seats on a board of directors, federal law does not permit a shareholder to directly place nominees on the company proxy card. Rule 14a-8 under the federal proxy rules provides a means for public companies to exclude certain shareholder proposals from the company proxy materials. One of the grounds for exclusion is where the shareholder proposal relates to the election of directors.
Historically, the SEC interpreted paragraph (i)(8) of Rule 14a-8 to broadly extend to proposals covering specific nominees, as well as to mechanisms to elect nominees. In recent years, however, many shareholder activists have sought access and influence in the selection of directors, including through litigation. Most notably, in June 2006, the U.S. Court of Appeals for the Second Circuit’s AFSCME v. AIG decision invalidated the SEC interpretation of Rule 14a-8(i)(8) questioning the agency’s procedure in adopting the interpretive position. As a result, the SEC staff took a “no view” position on direct election shareholder proposals in the 2007 proxy season, and the SEC in June 2007 submitted two alternative proposals for public comment. One proposal reaffirmed the SEC’s historic position while the other proposal contained a limited but significant expansion of shareholder ability to access the company proxy card.
On November 28, 2007, the SEC voted to reaffirm its historic position that companies may exclude from proxy materials any shareholder proposals bearing upon the election process. As amended, the Rule 14a-8(i)(8) election exclusion will apply where “the proposal relates to a nomination or an election for membership on the company’s board of directors or analogous governing body or a procedure for such nomination or election.”
As to the application of Rule 14a-8(i)(8), the proposing release provided specific examples of excludable proposals, including those that have the effect of: (1) disqualifying board nominees who are standing for election; (2) removing a director from office before his or her term expired; (3) questioning the competence or business judgment of one or more directors; or (4) requiring companies to include shareholder nominees for director in the company proxy materials, or otherwise resulting in a solicitation on behalf of shareholder nominees in opposition to management-chosen nominees. In addition, the proposing release provided specific examples of non-excludable proposals, including those that relate to: (1) the qualifications of directors or board structure (as long as the proposal will not remove current directors or disqualify current nominees); and (2) voting and nominating procedures.
Despite the SEC’s action, beyond 2008, any certainty the affirmation of Rule 14a-8(i)(8) establishes for companies may be short-lived. Three developments in 2008 will impact this issue in the future:
- Judicial: Immediately following the November 28, 2007 rule adoption, AFSCME announced it will challenge the SEC’s position in the Second Circuit once again. Another rebuke of the SEC by the Second Circuit—although directly affecting only companies within New York, Vermont, and Connecticut— would likely again reverberate throughout the public company community. The SEC, however, is expected to vigorously defend its rule by citing a subsequent United States Supreme Court decision this past summer that overturned another Second Circuit decision relating to the Department of Labor’s interpretation of its own rules.
- Administrative: Chairman Cox has pledged to continue exploring this issue of shareholder access in 2008. With his support, coupled with two new Democratic appointees expected in 2008, the SEC can be expected to propose some expanded manner of shareholder access on proxy materials governing director nominations as soon as 2009.
- Political: Democratic leaders in Congress have openly opposed the SEC’s position. Action from Congress, whether in the form of pressure upon the SEC or outright legislation, may be forthcoming in 2008. Additionally, the results of the presidential election in 2008 further will influence the composition and priorities of the SEC in 2009 and beyond.
Because the SEC’s Rule 14a-8(i)(8) election exclusion position will come under increased pressure in 2008 and possible change by 2009, public companies over the next year should consider reassessing their corporate governance strategy, including review of policies governing shareholder nominations, and should continue to monitor this important and evolving issue of shareholder proxy access.
Concurrent with its reaffirmation of its Rule 14a-8(i)(8) position, the SEC also voted to adopt rules designed to permit and protect the ability of companies and shareholders to engage in communication through electronic forums. Traditionally, the proxy rules have served to limit communications because the tem solicitation includes “[a]ny request for a proxy whether or not accompanied by or included in a form of proxy[.]” Other rules under the Securities Exchange Act of 1934 governing beneficial ownership reporting and liability for materially false and misleading statements also serve to inhibit company and shareholder actions facilitating public communications.
Under the new SEC rules, participation in an electronic forum now will be exempt from most proxy rules so long as: (i) the shareholder’s communications occur more than 60 days prior to the date announced by the company for its annual (or special) meeting of shareholders, and (ii) the party communicating in the forum does not solicit proxy authority while relying upon the exemption. A participant in a forum will be eligible to solicit proxy authority—provided such solicitation is in accordance with Regulation 14A of the federal proxy rules— after the date that the exemption is no longer available. If the company announces a shareholder meeting less than 60 days before the meeting date, the solicitation could not occur more than two days following the company’s announcement. The new SEC rules also will provide that shareholders, companies, or parties acting on behalf of shareholders or companies will not be liable under the federal securities laws for establishing, operating, or maintaining electronic shareholder forums.
Although the SEC is encouraging the utilization of shareholder electronic forums, it is unlikely that public companies will embrace the concept. The SEC position is intended as an experiment. Indeed, the SEC staff has indicated it anticipates unforeseen issues and that questions will arise for which legal guidance is necessary and will be provided. Many third-party sites, such as Yahoo and RagingBull, already provide a system—albeit unfiltered and unreliable—for investor dialogue. In turn, a handful of public companies now directly sponsor some degree of shareholder forum.
Public companies that choose to explore the concept should act conservatively in initially setting standards for a shareholder electronic forum. For instance, companies may wish to eliminate anonymous commenting; supplement their disclosure policies by extending such policies to the shareholder electronic forum; and strictly monitor content in the forums, particularly when such content originates from the company or its affiliates. Similar and more strategic questions may arise for public companies that learn of a shareholder-established electronic forum. While best practices and better standards may evolve over the long run, establishing a shareholder forum in the near future will require careful planning involving management, investment relations personnel, legal counsel, and perhaps even shareholder representatives.