In a release dated August 25, 2010 (the “Release”),1 the Securities and Exchange Commission (the “SEC”) adopted final rules that will require public companies to include director nominees proposed by shareholders in the company’s proxy materials. The final rules, adopted under explicit authority granted to the SEC under the Dodd-Frank Wall Street Reform and Consumer Protection Act, are the culmination of a series of proposals on shareholder proxy access that the SEC has published for public comment since 2003.

This client briefing summarizes the key terms of the final proxy access rules, which will take effect on November 15, 2010 (60 days after publication in the Federal Register). As described further below, shareholders must submit nominees under the new proxy access rules no later than 120 days before the anniversary of the prior year’s proxy statement mailing date. On the effective date of the new rules, the nomination period will have expired for companies that had a 2010 proxy statement mailing date on or prior to March 12, 2010. As a result, the new proxy access rules will not apply to such companies for the 2011 proxy season.  

Executive Summary

New Rule 14a-11 under the Securities Exchange Act of 1934 (the “Exchange Act”) will allow shareholders who have exceeded an ownership threshold of 3% of a company’s voting power for at least three years to include their nominees for director in the company’s proxy materials, subject to compliance with state law requirements and the provisions of Rule 14a-11. Certain other key components of the new rules are as follows:

  • Shareholders may aggregate their holdings with those of other shareholders to meet the 3% ownership threshold.  
  • Companies are not required to include in their proxy materials shareholder nominees that represent more than 25% of the board of directors.  
  • To take advantage of Rule 14a-11, a nominating shareholder must send to the company and file with the SEC a Schedule 14N stating the shareholder’s intent to nominate a director through the company’s proxy materials and including other required information.  
  • Nominating shareholders are subject to liability for false and misleading statements and material omissions included in Schedule 14N.  
  • If a company has grounds to exclude a shareholder nominee from its proxy materials, it will need to follow a procedure similar to that currently used for shareholder proposals under Rule 14a-8.  

In connection with the adoption of Rule 14a-11, the SEC also amended Exchange Act Rule 14a-8 to narrow the “election exclusion” and allow shareholder proposals relating to the election of directors to be included in a company’s proxy statement.

Applicability

New Rule 14a-11 generally applies to all companies that are subject to the Exchange Act proxy rules, including investment companies registered under the Investment Company Act of 1940, as amended (the “Investment Company Act”), controlled companies and companies that have voluntarily registered a class of securities under Section 12(g) of the Exchange Act.2 The SEC delayed the implementation of the proxy access rules for three years for smaller reporting companies3 to allow such companies additional preparation time.  

Ownership Threshold

In order to take advantage of Rule 14a-11, a nominating shareholder or group of shareholders must have exceeded an ownership threshold of 3% of a company’s voting power for at least three years. For purposes of Rule 14a-11, “voting power” must include both the power to vote or direct the voting of the securities as well as investment power, which is the power to dispose or direct the disposition of securities. The ownership calculation for Rule 14a-11 purposes differs from that under certain other Exchange Act regulations, such as Rule 13d-3, which require either voting power or investment power over the subject securities.  

Aggregation of Ownership

Shareholders may aggregate their holdings with those of other shareholders to meet the 3% ownership threshold. In order to facilitate the creation of shareholder groups to nominate directors, the SEC has adopted new Rule 14a-2(b)(7), which provides an exemption from the proxy rules for solicitations by or on behalf of any shareholder in connection with the formation of a nominating shareholder group. The exemption is not available to any shareholder who holds 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 company could be required to include under Rule 14a-11.  

Written communications made pursuant to Rule 14a-2(b)(7) must generally be limited to a brief statement regarding the potential nominee or nominees, the percentage of voting power held by the nominating shareholder and the means by which shareholders may contact the soliciting party. In addition, any written soliciting material published, sent or given to shareholders in accordance with Rule 14a-2(b)(7) must be filed with the SEC no later than the date that such material is first published, sent or given to shareholders. Oral communications will not be as limited in content as written communications, but notification of any oral solicitation must also be filed with the SEC.  

Number of Shareholder Nominees

Companies are not required to include in their proxy materials shareholder nominees that represent over 25% of the board of directors.4 Where more than one nominating shareholder is eligible to have its nominees included in the company’s proxy materials, the company is required to include the nominees of the nominating shareholder with the highest qualifying voting power percentage. If the nominating shareholder with the highest qualifying voting power percentage does not nominate the maximum number of directors allowed under Rule 14a-11, the nominee or nominees of the nominating shareholder with the next highest qualifying voting power percentage will be included in the company’s proxy materials, up to and including the total number of shareholder nominees that may be included.  

Special Scenarios

  • Where a company has a staggered board, the 25% threshold is calculated based on the total number of board seats, not the number of board members being elected in a given year.  
  • Where a nominating shareholder owns shares of a class that has the right to elect a subset of the full board, the maximum number of nominees that such shareholder may nominate may not exceed the number of directors that the class of securities is entitled to elect.  

Agreement to Include Shareholder Nominees in Company Proxy Materials

Where a company negotiates with a nominating shareholder that has filed the requisite notice of its intent to nominate a director nominee and the company ultimately determines to include such nominee as a company nominee in the proxy statement, such nominee will still count toward the 25% maximum number of board seats for which shareholders may nominate directors. This rule reflects the SEC’s intent to encourage constructive dialogue with shareholder nominees. Under the rule, the only time a negotiated agreement between a company and a nominating shareholder will create a position for another shareholder nominee would be if the company and the nominating shareholder began discussions prior to the filing by the nominating shareholder of the requisite notice of its intent to nominate a director.  

Nominating Shareholder Representations and Filing Requirements

To take advantage of Rule 14a-11, a nominating shareholder must send to the company and file with the SEC a Schedule 14N stating the shareholder’s intent to nominate a director to be included in the company’s proxy materials. The notice must be filed no earlier than 150 days prior and no later than 120 days prior to the anniversary of the mailing of the company’s proxy statement for the prior annual meeting. If the date of the annual meeting has changed by more than 30 calendar days from the prior year, a nominating shareholder must provide notice on Schedule 14N within a reasonable time before the company mails its proxy materials. In that case, the company will be required to disclose the date by which the nominating shareholder must submit the required notice in a Form 8-K filed pursuant to new Item 5.08 within four business days after the company determines the anticipated meeting date.  

The notice on Schedule 14N must include the following:  

  • biographical information regarding the nominating shareholder and the shareholder nominee, similar to the disclosure currently required in a contested election;  
  • information regarding the amount and percentage of voting power of the company’s securities entitled to be voted by the nominating shareholder and how long such securities have been held continuously;  
  • a statement as to whether or not the nominee satisfies the company’s director qualifications included in the company’s governing documents;  
  • a certification that the nominating shareholder’s securities are not held for the purpose, or with the effect, of changing control of the company or gaining more than a limited number of seats on the board of directors;  
  • representations that the nominating shareholder and the director nominee satisfy the requirements of Rule 14a-11;  
  • a written statement that the nominee’s candidacy or, if elected, board membership will not violate controlling state or federal law or rules of the applicable national securities exchange, other than rules relating to director independence;  
  • a written statement that the nominee meets the objective criteria for independence of the applicable national securities exchange or, in the case of an investment company, is not an “interested person” of the company;  
  • a written statement from the nominating shareholder verifying that such shareholder will continue to hold the qualifying amount of securities through the date of the meeting;  
  • a written statement with regard to the nominating shareholder’s intended ownership of the company’s securities following the election of directors;  
  • representations that neither the nominee nor the nominating shareholder has an agreement with the company regarding the nomination of the nominee;  
  • information regarding certain legal proceedings involving the nominee, as specified in Item 401(f) of Regulation S-K; and  
  • a written statement in support of the nominee not to exceed 500 words (at the option of the nominating shareholder).  

Nominating Shareholder Liability

Under new Rule 14a-9(c), nominees and nominating shareholders are prohibited from making any statement in Schedule 14N that, at the time and in the light of the circumstances under which it is made, is false or misleading with respect to any material fact, or that omits to state any material fact necessary in order to make the statements therein not false or misleading or is necessary to correct any statement in any earlier communication with respect to the solicitation of a proxy for the same meeting or subject matter that has become false or misleading. A nominating shareholder will be liable for any materially false or misleading statements in information provided to the company in its Schedule 14N, regardless of whether such statements ultimately appear in the company’s proxy statement.  

In addition, consistent with the current approach for shareholder proposals under Rule 14a-8, Rule 14a-11 provides that the company will not be responsible for information that is provided by the nominating shareholder and then repeated by the company in its proxy statement. Additionally, any information provided by a nominating shareholder and later included in the company’s proxy materials will not be incorporated by reference into any SEC filing unless the company chooses to incorporate it by reference in a specific filing. However, if a company does incorporate such information by reference, it will be considered the company’s own statement for purposes of the antifraud and civil liability provisions of the Securities Act of 1933 (the “Securities Act”), the Exchange Act or the Investment Company Act.

Nominee Independence Requirements

A company will not be required to include a shareholder nominee in its proxy materials if the nominee’s candidacy or, if elected, board membership would violate applicable state law, federal law or rules of the applicable national securities exchange and such violation could not be cured. As noted above, with respect to director independence, a nominating shareholder will be required to represent on Schedule 14N that a nominee satisfies the objective criteria for independence of the applicable national securities exchange. Where an applicable independence standard requires a subjective determination by the board or a group or committee of the board, the nominating shareholder will not have to represent that such element of the independence standard has been satisfied. In the case of an investment company, the nominating shareholder will have to represent that its nominee is not an “interested person” of the company as defined in the Investment Company Act.  

Determining Eligibility  

Upon receipt of a nominating shareholder’s Schedule 14N providing notice of its director nominee, the company may evaluate whether any of the events permitting exclusion of the nominee have occurred. Such events of exclusion include a finding that:  

  • proposed Rule 14a-11 does not apply to the company;  
  • the nominating shareholder or nominee failed to satisfy the eligibility requirements in Rule 14a-11; or  
  • the company has received more shareholder nominees than it is required to include in its proxy statement.  

If no events of exclusion exist, the company must provide the nominating shareholder with written notification, postmarked or transmitted electronically at least 30 days before the filing of its definitive proxy statement, that it will include the nominee in its definitive proxy statement and form of proxy filed with the SEC.  

If, after receiving notice of a shareholder’s intent to have a nominee included in the proxy statement, the company determines that it is permitted to, and wishes to, exclude a shareholder nominee, the company must follow the procedure for exclusion described in the Release. Click here to see the procedure, which is similar to the procedure used to determine whether other shareholder proposals must be included.

Proxy Statement

If a company includes a shareholder nominee or nominees in its proxy statement, the company must identify any shareholder nominees as such on the form of proxy and may recommend that shareholders vote for or against, or withhold votes from, the shareholder nominees. The company also will be required to include in the proxy statement information from the nominating shareholder’s Schedule 14N, including a statement by the nominating shareholder in support of the nominee that does not exceed 500 words. In addition, both the company and the nominating shareholder would be able to solicit proxies in favor of their nominees outside of the proxy statement, provided that such solicitations were made in accordance with applicable proxy rules.  

Interaction with State Laws

While state laws cannot impose more restrictive requirements on proxy access than those provided in Rule 14a-11, states can permit parallel procedures for proxy access that may differ in some respects from the procedures set forth in Rule 14a- 11.5 Where a state has adopted a proxy access framework, a nominating shareholder may elect to use the state law provisions rather than Rule 14a-11. A nominating shareholder must indicate on Schedule 14N whether it is using Rule 14a-11 or an alternate means of nominating directors. The only way for state laws to prohibit the use of Rule 14a-11 is to prohibit shareholder nominations altogether.  

Additional Considerations for Nominating Shareholders

Affiliate Status

The final rule does not include a previously proposed safe harbor that would have provided that a nominating shareholder would not become an “affiliate” of the company for purposes of the Securities Act solely as a result of acting as a nominating shareholder. Instead, the Release provides that a nominating shareholder must analyze affiliate status on a case-by-case basis, taking into consideration all relevant facts and circumstances, including the circumstances surrounding the nomination and election of a shareholder nominee.  

Beneficial Ownership

A nominating shareholder or group of shareholders must also consider whether they have formed a group that is required to file beneficial ownership reports under Exchange Act Section 13(d) (3) and Rule 13d-5(b)(1). Any group of persons that is directly or indirectly the beneficial owner of more than 5% of a class of equity securities of a reporting company generally must file a Schedule 13D with the SEC. However, a passive investor that owns between 5% and 20% of a class of equity securities and did not acquire the securities with the purpose or effect of changing or influencing control of the company may file its beneficial ownership report on a Schedule 13G. The SEC clarified in the Release that a nominating shareholder or group of shareholders would not lose its eligibility to file as a passive investor on Schedule 13G solely as a result of the nomination and/or election of a director under Rule 14a-11.  

Election-Related Shareholder Proposals

In connection with the adoption of Rule 14a-11, the SEC also amended the shareholder proposal regulations under Exchange Act Rule 14a-8. Previously, Rule 14a-8 allowed a company to exclude from its proxy statement shareholder proposals that related to the election of directors. Under revised Rule 14a-8(i) (8), a company may exclude a shareholder proposal relating to the election of directors only if such proposal:  

  • would disqualify a nominee who is standing for election;  
  • would remove a director from office before his or her term expires;  
  • questions the competence, business judgment or character of one or more nominees or directors;  
  • seeks to include a specific individual in the company’s proxy materials for election to the board of directors; or  
  • otherwise could affect the outcome of the upcoming election of directors.

Companies may still exclude election-related proposals that do not meet the procedural requirements of Rule 14a-8 or are subject to one of the other substantive exclusion provisions in Rule 14a- 8. The practical effect of the revisions to Rule 14a-8 is to permit shareholders to propose amendments to a company’s governing documents that would expand proxy access rights or modify the procedures with respect to the exercise of those rights.