On August 25, 2010, under the authority granted in Section 971 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the U.S. Securities and Exchange Commission adopted landmark Proxy Access Rules by a 3-to-2 vote.* Before adoption of these rules, a shareholder’s ability to nominate and elect members to the board of directors of a publicly traded company was limited and costly. To elect a candidate or candidates, for example, a shareholder could initiate a proxy contest and prepare and mail its own proxy-soliciting materials to shareholders entitled to vote. Under the adopted Proxy Access Rules, most public reporting companies will be required to include eligible nominee or nominees proposed by an eligible shareholder (or group of shareholders) in the company's proxy materials circulated to solicit proxies in any annual meeting (or special meeting in lieu of an annual meeting). Shareholders will be limited to nominating the greater of one director or up to 25 percent of the company’s total number of board seats (even if the company has a staggered board) in each such annual election of directors.
What companies are subject to the Proxy Access Rules?
The Proxy Access Rules will apply to all companies that file periodic reports under the Securities Exchange Act of 1934 reporting requirements, including investment companies and foreign issuers, subject to the following exceptions. Companies complying with such reporting requirements because they are "debt-only" companies will not be subject to the rules, and the SEC has included a three-year moratorium on applicability of the rules to smaller reporting companies. In addition, if any state law or foreign law prohibits shareholders from nominating a candidate for election as a director, the new rules will not be applicable.
With respect to applicability to smaller reporting companies, in the SEC's Open Meeting at which the rules were adopted, and in the adopting release, the Staff noted that the three-year moratorium is designed to allow those companies and the SEC to observe how the rules will affect larger companies, and provide the SEC with the ability to make appropriate adjustments to the rules before their application to smaller reporting companies.
Companies may not "opt out" of the new rules.
What is the regulatory framework?
Most of the requirements adopted by the SEC in the Proxy Access Rules are found in newly adopted Rule 14a-11 and the related new Schedule 14N. Schedule 14N will be used by nominating shareholders to provide (1) notice of the nomination; (2) biographical information about the nominated candidate; (3) required certifications; (4) if desired, a statement in support of the nominee (not to exceed 500 words); and (5) any notice of withdrawal of the nomination. Schedule 14N will also be used to file any shareholder communications with the SEC.
How will the shareholder nomination process work?
In order to make a nomination, a shareholder, or group of shareholders, needs to:
- Meet the eligibility requirements set forth in Rule 14a-11. Such shareholder (or group) must own at least 3 percent of a company’s voting securities entitled to vote at the applicable meeting; hold both investment and voting power in the securities, either directly or though a person acting on their behalf, and have held such securities for at least three years. Shareholders will be able to aggregate their shares to meet the 3 percent ownership threshold. Significantly, however, shareholders cannot borrow stock to achieve the 3 percent threshold, but they can count stock that they own but have lent to others, as long as they have the right to recall the stock and will do so if the nominee is included in the company’s proxy materials. Securities sold short may not be counted toward the 3 percent threshold.
- Nominate an eligible candidate or candidates. Each shareholder (or group) may nominate the greater of one nominee or the number of nominees equal to 25 percent of the size of the company's board. The 25 percent requirement applies to the entire board membership, even if the company has a staggered board. Each nominee must meet the applicable qualifications under the proxy rules and the rules of the national securities exchange or association on which the company's securities are listed. In addition, the nominee must, to the best of the nominating shareholder's knowledge, meet the director qualification criteria established by the company in its governing documents.
- Provide notice to the company and the SEC on Schedule 14N within the designated window period. All nominations must be submitted during a window period that will begin no earlier than 150 days and end no later than 120 days before the anniversary of the mailing of the prior year’s proxy statement.
- Be able to make certain certifications on its Schedule 14N, including:
- affirmation that the shareholder is not holding shares of the company with the purpose, or with the effect, of changing control of the company;
- a statement of intent to own the shares through the meeting date; and
- certification that the shareholder and its nominee or nominees satisfy the applicable requirements of Rule 14a-11.
A company may only exclude a nomination from its proxy materials if the nomination fails to satisfy the Rule 14a-11 requirements, or if other nominations from shareholders holding a higher percentage of the company’s voting securities have submitted nominations that are accepted by the company in compliance with Rule 14a-11. If the company determines that the nomination does not meet the applicable requirements, it must send notice to the SEC and to the nominating shareholder. The company may avail itself of the SEC’s "no-action" process, but if there are multiple nominations that the company wishes to exclude, all should be the subject of one no-action letter request (in case of the withdrawal or disqualification of other nominations).
Are there requirements with respect to a shareholder-proposed nominee?
Yes. The nominee’s candidacy and possible board membership must not violate applicable federal and state laws and regulations, the applicable standards of the national securities exchange or association on which the company stock is listed, or controlling foreign law. The nominee must meet the objective independence requirements applicable to the company under the standards promulgated by the national securities exchange or association on which the company’s stock is listed. Finally, the nominee must meet, to the best knowledge of the nominating shareholder, the company’s director qualification criteria as set forth in its governing documents. In addition, in advance of any nomination, the company and the nominating shareholder (or group) may not have an agreement regarding the candidacy of the nominee.
What has changed with respect to existing proxy rules governing solicitations by shareholders?
The Proxy Access Rules include two notable exemptions from the proxy rules related to shareholder solicitations in connection with a Rule 14a-11 nomination. The first exemption relates to written and oral solicitations by a shareholder seeking to form a nominating shareholder group. Such solicitations are acceptable as long as there is no change in control purpose or effect, the solicitation information is limited to the information specified in Rule 14a-11, all written or oral soliciting materials are filed on Schedule 14N before or at the same time the first solicitation is made, and the shareholder group members make no solicitations in connection with the subject election of directors other than pursuant to Rule 14a-11.
The second exemption relates to shareholder communications by the nominating shareholder (or group) in favor of the shareholder’s nominee or against the company’s nominees. In order to rely on this exemption, the shareholder (or group):
- must not seek the power to act as a proxy for any other shareholder;
- must include certain designated information in any solicitation communication, including a prominent legend regarding the availability of proxy materials;
- must file all written soliciting materials on Schedule 14N; and
- must make no solicitations in connection with the subject election of directors other than pursuant to Rule 14a-11.
What is the impact under Section 13 or Section 16 of the Exchange Act?
The new rules amend the beneficial ownership reporting rules so that a shareholder (or group) relying on Rule 14a-11 would not lose eligibility to report holdings on Schedule 13G, rather than Schedule 13D, solely because of activities associated with a Rule 14a-11 nomination. On the other hand, the SEC did not exclude shareholder groups formed solely for the purpose of making a nomination under Rule 14a-11 from the requirements of Section 16 of the Exchange Act and did not adopt a safe harbor exclusion from “affiliate” status.
What else has been changed by the Proxy Access Rules?
In addition to promulgating Rule 14a-11, the Proxy Access Rules amend the applicable shareholder proposal rule (Rule 14a-8(i)(8)) to prohibit companies from excluding shareholder proposals that seek to amend a company’s nominating procedures for the election of directors. To be eligible to submit a shareholder proposal under amended Rule 14a 8(i)(8), a shareholder must satisfy the current eligibility requirements of Rule 14a-8 (i.e., ownership of the lesser of $2,000 in market value or 1 percent of the company’s securities for at least one year before submission of the proposal and intent to hold such stock through the meeting date).
What is the effective date of the Proxy Access Rules?
The Proxy Access Rules will be effective 60 days after their publication in the Federal Register. It is likely, therefore, that these rules will be effective for annual meetings held in 2011 because there will be sufficient time for nominations to be made before the 120-day threshold described above. For example, if the rules become effective on November 1, 2010, they will apply to any proxy materials mailed on or after March 1, 2011.
What should you do now?
Before the effective date of the new rules, we suggest that each public reporting company subject to the rules:
- review its governing documents to ensure that the company does not have restrictions inconsistent with these rules;
- revise its annual reporting schedule to incorporate the requirements of these Proxy Access Rules; and
- review information in its governing documents regarding director qualification criteria, if any.
What changes are most significant as compared to the 2009 proposed rules?
The SEC proposed the Proxy Access Rules on June 10, 2009, and received more than 600 comments on its proposing release. In response to many of these comments, the SEC significantly modified certain parts of the proposed rules. The most significant changes in the final Proxy Access Rules are:
- Eligibility requirements for shareholders. A nominating shareholder (or group) is required to own 3 percent of a company’s voting securities entitled to vote at the meeting and to have held such securities for at least three years. The proposed rules would have required staggered ownership percentages, depending on the company’s accelerated filer status or net assets (for registered investment companies), and proposed a one-year holding period.
- Window period for submitting nominations. An eligible shareholder (or group) must provide notice of its nomination of a director candidate during a window period that will begin no earlier than 150 days and end no later than 120 days before the anniversary of the mailing of the prior year’s proxy statement. The proposed rules would have established a deadline at the 120-day mark but did not provide a window period, leading to a concern from commenters that the proposed rules would lead to a race to present nominees.
- Selection of nominee(s) for inclusion among all eligible nominees. Under the final rules, priority will be given to eligible nominees who are nominated by the shareholder (or group) with the highest percentage ownership of the company’s voting power. The proposed rules would have given priority to the shareholder who submitted its nomination earliest, regardless of ownership stake.
- Compliance with the company’s director qualifications. Under the final rules, the nominating shareholder (or group) will be required to certify that, to the best of its knowledge, the nominee satisfies the director qualifications contained in the company’s governing documents.
- Liability for false or misleading statements. The nominating shareholder (or group) will now be solely responsible for any statement provided by such nominating shareholder(s) in support of its nominee, even if the information is included in the company’s proxy statement. Under the proposed rules, the company would not have been responsible for any such information, except where the company knew or had reason to know that the information was false or misleading.