On June 10, 2009, the Securities and Exchange Commission (the “SEC”) proposed a series of amendments to the proxy rules that would, among other things, afford certain shareholders the right to include their director nominees in an issuer’s proxy materials. The amendments are intended, in part, to increase the accountability of directors to company owners and to restore what SEC Chairman Mary Schapiro called the “fundamental right” of shareholders under state law to nominate and elect members to company boards of directors.
Among other things, the amendments would create new Rule 14a-11 to give shareholders who own a prescribed amount of stock the right to include a certain number of qualifying nominees in an issuer’s proxy materials (i.e., the proxy statement and proxy card). The amendments would also revise Rule 14a-8(i)(8) to require an issuer, under certain circumstances, to include proposals in its proxy materials that seek to amend provisions of the issuer’s governing documents regarding director nomination procedures or disclosure relating to sharholder nominees.
Under the current system, an issuer’s board or board committee selects the slate of director nominees who are included in the issuer’s proxy materials. A shareholder wishing to nominate one or more different candidates must either appear in person at the meeting to nominate those candidates or prepare and distribute its own proxy materials to the issuer’s shareholders.
The SEC examined this system against the backdrop of the current global economic crisis, the ongoing debate over board oversight, accountability and focus on shareholder interests, and the SEC's prior rulemaking efforts in this area. It recognized the difficulties faced by shareholders wishing to present their own slate of director nominees, including the impracticality of introducing the slate of directors for the first time at the meeting of shareholders, and the cost associated with the preparation and distribution of a competing set of proxy materials. The SEC concluded that these amendments were necessary for shareholders to meaningfully exercise their rights to nominate the directors of the companies that they own.
New Exchange Act Rule 14a-11
If adopted, new Rule 14a-11 will allow eligible shareholders to include their director nominees, up to a prescribed limit, in an issuer’s proxy materials, unless such shareholders are otherwise prohibited — either by applicable state law or the issuer’s charter or bylaws — from nominating a candidate for election as a director. The proposed rule would apply to all Exchange Act reporting companies, including investment companies, with a registered class of voting equity securities.
Which Shareholders Are Eligible?
To rely on Rule 14a-11 to have its nominee(s) included in an issuer’s proxy materials, a shareholder must have a significant, long-term interest in the issuer, which is measured by the following levels of stock ownership (other than for investment companies):
- at least 1% of the voting securities of a “large accelerated filer” (i.e., an issuer with a market value of $700 million or more);
- at least 3% of the voting securities of an “accelerated filer” (i.e., an issuer with a market value of $75 million or more but less than $700 million); or
- at least 5% of the voting securities of a non-accelerated filer (i.e., an issuer with a market value of less than $75 million).
Similar tiers of stock ownership would be applicable to a registered investment company, but would be based on the investment company’s net assets as follows:
- shares representing at least 1% of the net assets of a registered investment company with net assets of $700 million or more;
- shares representing at least 3% of the net assets of a registered investment company with net assets of $75 million or more but less than $700 million; or
- shares representing at least 5% of the net assets of a registered investment company with net assets of less than $75 million.
Shareholders would be able, as a group, to aggregate their holdings to meet the applicable beneficial ownership threshold described above.
In addition to these share ownership requirements, a shareholder must have held its shares for at least one year and stated its intent to continue to own its shares through the meeting at which directors are elected. Furthermore, a shareholder would be required to certify that it is not holding its stock for the purpose of changing control of the issuer, or to gain more than minority representation on the board of directors.
Who Can Be a Director Nominee?
Under new Rule 14a-11, to be proposed by a shareholder, a director nominee’s candidacy or, if elected, board membership, must not violate applicable laws and regulations (e.g., banking laws that prohibit a person from serving as a director of more than one bank in the same community). In addition, the nominee must satisfy objective independence standards of the applicable national securities exchange or national securities association (or, in the case of a registered investment company, not be an “interested person”), and the nominating shareholder may not have any direct or indirect agreements with the issuer regarding the nomination of the nominee. New Rule 14a-11 includes procedures and required timeframes for an issuer to review and respond to a nomination it receives, and places the burden on the issuer to demonstrate that it may exclude a given nominee.
How Many Nominees May a Shareholder Propose?
A shareholder may propose the greater of one nominee or a number of nominees that represents up to 25% of the total number of the issuer’s directors. By way of example, if the board is comprised of from three to seven members, the shareholder could include one nominee in the issuer’s proxy materials. However, if the board is comprised of from eight to eleven members, the shareholder could include up to two nominees in the issuer’s proxy materials; and, at twelve members, the shareholder could include up to three nominees from the issuer’s proxy materials.
Notably, however, these calculations take into account directors who were shareholder nominees elected pursuant to Rule 14a-11, and whose terms extend beyond the applicable meeting at which directors are being elected. As a result, an issuer would not be required to include a shareholder nominee in its proxy materials if the nominee's election would result in the total number of all directors serving on the board that were elected as shareholder nominees being more than the greater of one shareholder nominee or 25% of the issuer’s board of directors. If, in the above example of a board comprised of eight members, one director was elected as a shareholder nominee at the prior year’s annual meeting to serve a three-year term, a shareholder could include only one nominee in the issuer’s proxy materials for the current year’s annual meeting.
What if More Than One Shareholder Proposes Nominees?
New Rule 14a-11 would treat situations where more than one shareholder proposes nominees using a “first-in” standard. The shareholder whose timely notice is first received by the issuer will be eligible to nominate up to the maximum number of shareholder-nominated directors to be included in the issuer’s proxy materials. If such shareholder does not nominate the maximum number of directors, the shareholder whose timely notice is next received by the issuer will be eligible to nominate the remaining number of shareholder-nominated directors, and so on.
Filing Requirements for the Nominating Shareholder
The nominating shareholder would be required to publicly file, and provide to the issuer, certain information regarding itself and its nominee(s) via new Schedule 14N. The Schedule 14N would be required to be provided and filed by the date specified by the issuer’s advance notice bylaw provision (or where there is no such provision, no later than 120 calendar days before the date that the issuer mailed its proxy materials for the prior year’s annual meeting), and would be required to be amended to reflect material changes in the facts set forth therein.
The Schedule 14N would require disclosure of, among other things, the amount and percentage of securities owned by the nominating shareholder, the length of ownership, and a statement regarding the intent of the shareholder to continue to hold the securities through the date of the meeting. The Schedule 14N also would require a certification that the nominating shareholder is not seeking to change the control of the issuer or to gain more than minority representation on the issuer’s board of directors.
What Information Must the Issuer Include in Its Proxy Materials?
Assuming that a nominating shareholder meets all applicable requirements of Rule 14a-11 and has filed its Schedule 14N, the issuer would be required to include in its proxy materials disclosure concerning the nominating shareholder and its director nominee(s) that is similar to the disclosure currently required in a contested director election. The issuer also would be required to include its proxy materials a statement of support (up to 500 words) from the nominating shareholder for its nominee(s).
Do Nominating Shareholders Have Any Potential Liability for Misstatements?
Yes, a nominating shareholder would be liable for any false or misleading statements provided to the issuer that are then included in the issuer’s proxy materials. Proposed Rule 14a-11 provides that the issuer will not be responsible for information provided by the shareholder or shareholder group, unless the issuer knows or has reason to know the information is false or misleading.
Are there special requirements for shareholders who act together in proposing a nominee or slate of nominees?
No, the requirements are the same for shareholders who act together, but the relevant eligibility tests, nomination limitations, disclosure filing, etc., are applied to all such shareholders as a group. For example, each shareholder in the group must meet the one-year stock ownership requirement in order for its stock to count in satisfying the percentage ownership threshold to propose a nominee. It is also important to note, however, that shareholders who act together for this objective would likely be deemed to constitute a “group” for purposes of other securities laws and SEC rules, such as the reporting and related obligations of more than 5% owners under the Securities Exchange Act of 1934.
Amended Exchange Act Rule 14a-8(i)(8)
Currently, Rule 14a-8(i)(8) permits issuers to exclude from their proxy materials shareholder proposals that “relate to an election.” Under the proposed amendments to the Rule, this so-called “election exclusion” would be narrowed, thereby requiring issuers to include more shareholder proposals regarding elections in their proxy materials. Specifically, an issuer could no longer exclude proposals made by qualifying shareholders that would amend, or that request an amendment to, provisions of the issuer’s governing documents concerning the issuer’s nomination procedures or other director nomination disclosure provisions as long as those disclosure provisions don’t conflict with proposed Rule 14a-11 or state law. However, issuers would still be able to exclude proposals related to particular elections where the proposals could result in an election contest (e.g., a proposal that would remove a director from office before his or her term expired).
The current shareholder eligibility provisions of Rule 14a-8 would continue to apply. These provisions require that a shareholder proponent have continuously held the lesser of $2,000 in market value or 1% of the issuer’s securities entitled to be voted on the proposal at the meeting, for a period of one year prior to submitting the proposal.
We expect these proposals to generate significant debate and to be the subject of many comments in the coming weeks. Notably, the SEC has guided potential commenters by providing nearly 500 specific requests for comments in the proposal. Chairman Schapiro herself indicated that this issue of proxy access will be one of the most contentious issues addressed by the SEC. In fact, responses to the proposal were deeply divided at the SEC, where the commissioners voted 3-2 to put the proposal out for comment, with both dissents coming from Republican commissioners. The SEC has requested that comments on the proposed rule amendments be received on or before August 17, 2009.
For More Information
The information in this Legal Alert is based on the proposing release for the rule amendments, and none of the amendments described above are currently effective. The amendments, if adopted, may be significantly different than the proposed amendments that are described in this Legal Alert. If you have questions about the proposed amendments, the SEC’s comment process (including how to submit a comment to the SEC), or want more information about the proposed amendments, please contact any of the attorneys listed below. The full text of the SEC’s proposed rules can be accessed by clicking here.