On June 10, the SEC issued controversial proposals that would provide public company shareholders with the ability to include in their company’s proxy materials their own nominees for election to the company’s board of directors. Shareholder nominees could not fill more than 25% of the company’s board seats, and the nomination process would have to be conducted in accordance with the revised proxy rules and applicable state law. To be eligible to submit nominations, shareholders would have to meet share ownership thresholds based on the company’s size, and would have to make representations, certifications, and disclosures intended to demonstrate that they have a significant, long-term equity interest in the company and no intention to seek a change of control of the company. The proposals would involve the adoption of a new Rule 14a-11 under the Exchange Act, amendments to the shareholder proposal provisions of Exchange Act Rule 14a-8, and other proxy rule changes. Comments on the proposals, which were published in Release No. 34-60089, are due by August 17, 2009.
Public companies generally have relied on the “election exclusion” under current Rule 14a-8 as the basis for excluding shareholder proposals relating to director nominations. As a result, shareholders wishing to add their own nominees to a company’s board are limited today under the proxy rules to:
- Recommending a director candidate to the company’s board or nominating committee;
- Proposing a board nominee at a shareholder meeting; or
- Launching a costly proxy contest designed to elect the shareholder nominees.
The SEC sought in 2003 to add a new option by issuing proposals that would have enabled long-term shareholders with significant shareholdings to have their own board nominees included in the company’s proxy statement and proxy card. The proposals generated significant public comment, much of which was negative, and the SEC did not pursue their adoption. The current proposals represent a renewed effort by the SEC to make a company’s proxy materials available for use by shareholders in electing their own board nominees. The SEC said it was moved to revisit shareholder access at this time because, in its view, the current economic crisis has sharpened concerns about whether public company boards are sufficiently accountable and responsive to shareholder interests. The SEC stated that it has significantly reformulated the agency’s 2003 proposals with the goal of “restoring investor confidence to the greatest number of shareholders as quickly as possible.”
Companies Subject to the Proposed Requirements
The proposed proxy access requirements would apply to all companies (including investment companies) subject to the SEC’s proxy rules, irrespective of their size and reporting history, other than companies that have only a class of debt securities registered under Section 12 of the Exchange Act. Foreign private issuers would not be subject to the new requirements, because Exchange Act Rule 3a12-3 exempts them from the SEC’s proxy rules.
The proposed requirements would apply unless shareholder nominations are prohibited either by (1) applicable state law or (2) the company’s governing documents. In the latter circumstance, a shareholder would be permitted under a proposed amendment to Rule 14a-8(i)(8) to submit a shareholder proposal to amend the company’s governing documents as they pertain to director nomination procedures or disclosures related to shareholder nominations, so long as the proposal would not conflict with the shareholder access requirements of proposed Rule 14a-11. The SEC observed that it is not aware of any law in any state or in the District of Columbia that currently prohibits shareholders from nominating directors. Delaware recently has enacted legislation expressly authorizing Delaware corporations to adopt proxy access bylaws containing reasonable criteria for nominating parties and director nominees.
Eligibility Requirements for Nominating Shareholders
The proposals seek to minimize disruption to companies by limiting proxy access under Rule 14a-11 to holders of a “significant, long-term interest” in the company. Shareholders would be eligible to submit director nominees for inclusion in their company’s proxy materials if the nominating parties:
- Meet specified beneficial ownership thresholds for the class of securities entitled to vote on the election of directors;
- Have beneficially owned the securities for at least one year as of the date they submit their nominees to the company; and
- Represent that they intend to continue to own the securities through the date of the meeting at which directors would be elected.
The number of securities of the relevant class required to be beneficially owned would be based on the size of the company, as follows:
- Nominating shareholders of “large accelerated filers” (generally companies with a public float of $700 million or more), and of registered investment companies with net assets of $700 million or more, would have to own beneficially at least 1% of the class;
- Nominating shareholders of “accelerated filers” (generally public companies with a public float of $75 million or more but less than $700 million), and of registered investment companies with net assets of $75 million or more but less than $700 million, would have to own beneficially at least 3% of the class; and
- Nominating shareholders of “non-accelerated filers” (generally companies with a public float of less than $75 million), and of registered investment companies with net assets of less than $75 million, would have to own beneficially at least 5% of the class.
The tiered beneficial ownership thresholds could be met individually or by aggregating the ownership of two or more persons. Aggregation could trigger filing requirements under the 5% ownership threshold of Exchange Act Section 13(d) or filing requirements and related short-swing trading restrictions under the 10% ownership threshold of Exchange Act Section 16 if the parties who aggregate their shareholdings are deemed to constitute a Section 13(d) group that collectively owns securities exceeding the ownership thresholds of the applicable provision. The proxy rules would be changed to permit a shareholder to solicit other shareholders to form a nominating group.
The SEC stated that it does not intend for proposed Rule 14a-11 to be available for any shareholder or group that is seeking to change the control of the company or to gain more than a limited number of seats on the company’s board under the new rule. Shareholders or groups with such a purpose would still be able to act under the SEC’s existing procedures governing contested elections of directors. Accordingly, a person or group would not be eligible to submit nominees under Rule 14a-11 if it has acquired or is holding securities for the purpose or effect of changing control of the company or gaining more than the maximum number of board seats permitted for shareholder nominees.
The proposed rules would disqualify shareholders who seek to act as surrogates of the company in submitting nominations to block other shareholders from submitting nominations. To prevent such an occurrence, the nominating shareholder or group would be required to represent that there exist no relationships or agreements among the company and its management, on the one hand, and the nominee or the nominating shareholder or group, on the other, regarding any nomination.
The maximum number of shareholder nominees a company would be required to include in its proxy materials would be the greater of one nominee or the number of nominees that would represent 25% of the authorized number of directors (or that would represent the closest whole number below 25%, if 25% of the board would not result in a whole number). If the company has a staggered board, any previously elected shareholder nominees continuing to serve on the board beyond the upcoming election would count against the 25% limit. If more than one shareholder or group is eligible to have its nominees included in the company’s proxy materials, a “first in” standard would apply under which the company would be required to include only the nominees of the first shareholders to deliver timely notice to the company of nominations up to the maximum number of shareholder nominees.
A company would not have to include in its proxy materials any shareholder nominee whose candidacy or board service would result in a non-curable violation of controlling state law, federal law, or rules of a national securities exchange or national securities association not involving director independence. Nominees for boards of listed companies would have to meet the applicable independence standards of the applicable stock exchange, other than any subjective independence determination required to be made by the company’s board. Nominees would not have to be independent of the nominating shareholders.
Notice Requirement and Other Obligations of Nominating Parties
When making a director nomination, the nominating shareholder or group would have to comply with various notice and disclosure requirements to be contained in SEC rules under the Exchange Act. Proposed Rule 14a-11 and proposed Regulation 14N, the chief component of which is a proposed new Schedule 14N, would set forth most of these requirements.
Timing of Notification
A shareholder or group relying on proposed Rule 14a-11 would have to provide a nomination notice to the company on Schedule 14N, and to file a copy of the notice electronically with the SEC. The deadline for furnishing the notice would be the date specified in the company’s advance notice provision for shareholder proposals. If the company’s governing documents do not contain an advance notice provision, the nominating shareholder or group would have to provide the notice at least 120 calendar days before the date corresponding to the date on which the company mailed its proxy materials for the prior year’s annual meeting.
Schedule 14N would require specified information and statements with respect to the nominees and the nominating shareholder or each member of the nominating shareholder group, all of which would be subject to the requirement of Exchange Act Rule 14a-9 that they not be materially false or misleading. The nomination notice would have to include the following information:
- Names and addresses of the nominating parties;
- Information regarding the amount and percentage of securities of the relevant class beneficially owned by the nominating parties and entitled to vote at the shareholder meeting;
- Verification by the record holder of the securities beneficially owned by the nominating parties that the securities have been continuously owned for the preceding year;
- Statement of intention of the nominating parties to continue owning the securities through the meeting date;
- Certification that the securities are not held for the purpose or effect of changing the control of the company or gaining more than the permissible number of board seats;
- Representations by the nominating parties regarding their eligibility to rely on Rule 14a-11;
- Disclosure about the nominating parties and their nominees of the type currently required in connection with a contested election of directors;
- Consent of the nominees to being named in the company’s proxy statement and, if elected, to serve on the board;
- Disclosure of relationships among the nominating parties, the nominee, and the company or any affiliate of the company; and
- Any statement in support of the nominee or nominees not exceeding 500 words that the nominating parties wish to have included in the company’s proxy statement.
The nominating parties would have to file promptly with the SEC an amendment to the notice describing any material changes in the information set forth in the original submission.
A company receiving a Rule 14a-11 notice from a shareholder or group of shareholders would first have to determine whether it may exclude a shareholder director nomination because:
- Rule 14a-11 is not applicable to the company;
- The nominating shareholder or group does not satisfy the security ownership requirements or otherwise has not complied with the requirements of Rule 14a-11;
- The nominee does not meet the independence requirements of the applicable stock exchange as required by Rule 14a-11;
- The notice to the company on Schedule 14N includes materially false or misleading statements; or
- The company has received more nominees than it is required to include under Rule 14a-11.
If the company determines that none of the exclusions applies, it would be required to notify the nominating parties in writing of its determination at least 30 calendar days before the company files its definitive proxy statement and form of proxy with the SEC.
The proxy rules would not permit the company to provide shareholders with the option of voting for or withholding authority to vote for the company nominees as a group, which the SEC believes would confer an advantage on the company’s slate vis-à-vis the shareholder-nominated candidates. Instead, the company would be required to permit its shareholders to vote separately on each company nominee and each shareholder nominee.
The company and the nominating parties would be free to solicit proxies in favor of their nominees outside the proxy statement, such as on a designated web site, so long as they conduct the solicitations in accordance with the applicable proxy rules.
Procedures for Excluding Non-Compliant Shareholder Nominations
If a company believes that a shareholder nomination may be excluded from its proxy materials, the company and the nominating parties would have to follow the procedures described below, which are modeled after the exclusion procedures applicable to shareholder proposals submitted under Rule 14a-8.
- The company would notify the nominating parties in writing within 14 calendar days after receipt of their nomination notice of (1) the company’s belief that the nominating parties have not satisfied the eligibility requirements of Rule 14a-11 and (2) the basis for the company’s belief;
- The nominating parties would have 14 days to respond to the company’s notice regarding eligibility after their receipt of the notice;
- If the company determines that it still may exclude the nominees after reviewing any response by the nominating parties, it would have to notify the SEC and the nominating parties of the basis for its determination at least 80 calendar days before filing its definitive proxy statement and form of proxy (although the SEC may waive the deadline if it believes good cause exists for doing so);
- The nominating parties could submit to the SEC (with a copy to the company) a response to the company’s notice to the SEC no later than 14 calendar days after receipt of the notice; and
- The SEC staff typically would issue a letter expressing its informal views on the controversy, which either party could contest by requesting that the SEC Commissioners review the staff’s position.
Once a company has notified a shareholder or shareholder group of a deficiency in a shareholder nomination, the nominating parties could not change either the composition of the shareholder group or the shareholder nominees to correct the identified deficiency. If, however, a shareholder or shareholder group were inadvertently to submit a number of nominees that exceeds the maximum number required to be included by the company, the shareholder or group could specify which nominee or nominees are not to be included in the company’s proxy materials.
Companies wishing to take advantage of the proposed exclusion process would have to amend their advance notice bylaws for director nominations if the current nominations deadline is too close to the date of the shareholder meeting to permit compliance with the SEC’s timetable.
The proxy access proposals represent one of the most controversial rulemaking efforts by the SEC in years. The appropriateness of shareholder access has been vigorously debated within the SEC, and issuance of the proposals was opposed by two of the five SEC Commissioners.
The SEC has made a considerable effort to address in the new proposals the adverse comments directed at the proposals it issued in 2003. Shareholder proxy access for board nominations, however, would represent such a fundamental departure from the current regulatory regime and corporate practice relating to director elections that the new proposals are likely to attract significant objections from many companies and their advisers. The proposals raise a host of policy, legal and practical issues, many of which the SEC recognized in its release by requesting comment on over 150 questions. The SEC identified many of the concerns held by opponents of shareholder access regarding the potential impact shareholder-nominated directors might have on the functioning of a public company and its board. If, as expected, these and other concerns generate a new round of voluminous comments during the comment period ending on August 17, 2009, the SEC may not be able to take final action on the proposals in time to achieve its goal of having the new rules in place for the 2010 proxy season. Implementation of any new rules also may face delay as a result of possible challenges in federal court to the SEC’s rulemaking authority in this area.