After years of debate, on August 25, 2010 the Securities and Exchange Commission (the “SEC”) adopted proxy access rules in a 3-to-2 vote.1 While the SEC proposed proxy access rules last year,2 the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act confirmed the SEC’s authority to adopt proxy access rules. The new rules are intended to assist shareholders in their ability to nominate and elect directors to a company’s board of directors. New Rule 14a-11 requires a company to include a shareholder nominee for director in its proxy materials, subject to certain conditions as set forth in the rule. New amendments to Rule 14a-8 limit the ability of a company to exclude certain shareholder proposals from its proxy materials.
Applicability and Timing
No Opt-Out Provision The rules apply to all companies subject to the Exchange Act’s proxy rules. Companies are not permitted to opt out of new Rule 14a-11.3
Investment companies and companies who voluntarily register securities under Section 12(g) are also subject to the new rules, but companies with debt securities as their only public securities are excluded.
Effective For Many Companies For 2011 Proxy Season
The rules will become effective on November 15, 2010 and will apply to many companies for the 2011 proxy season.4 Smaller reporting companies that have a public float of less than $75 million will have three years before the rules regarding director nominations will apply to them; there is no such grace period for the amendments to Rule 14a-8 regarding exclusion of shareholder proposals. The deadline for submission by shareholders of director nominees is 120 days before the anniversary date of the mailing of the prior year’s proxy statement (but no earlier than 150 days before such anniversary date). For example, if a company mailed last year’s proxy statement on April 15, 2010, the deadline for submission of shareholder nominations would be December 16, 2010. Similarly, shareholder proposals under Rule 14a-8 must be received by the company not less than 120 days before the anniversary date of the release of the prior year’s proxy statement.
3% Voting Power Threshold
In order to nominate a director, an individual shareholder, or a group of shareholders acting together, must hold (individually or in the aggregate) at least 3% of the company’s outstanding voting power.5 Nominating shareholders must possess both voting and investment power for the shares. Shares that are loaned to a third party may be counted toward this threshold if the shareholder has the right to recall the shares (and the shares must be recalled if the nominee is included). However, borrowed shares and shares sold in a short sale cannot be counted toward the voting power threshold.
3 Year Holding Period
Shareholders must have held their shares continuously for at least three years when they file Schedule 14N to give notice of their nomination.6 In addition, the shareholders must continue to hold at least the required minimum amount of shares through the date of the applicable company shareholder meeting.
Limits on Nominations
Number of Nominees
Companies are only required to include in their proxy statements the number of shareholder nominees that represents no more than 25% of the entire board, but no less than one director. For companies with staggered boards, the 25% calculation must be made based on the total number of board seats, not the number of seats to be voted on at the upcoming meeting. If a company receives more shareholder nominations than it is required to include in its proxy statement, priority is given to the shareholder or shareholder group with the highest voting power percentage.7
No Intent of Changing Control
Proxy access is only available to nominating shareholders who are not holding company shares for the purpose, or with the effect, of changing control of the company or to gain more seats on the board than permitted under Rule 14a-11.
No Violation of Federal or State Law
Companies are not required to include a nominee if their candidacy would violate federal or state law or applicable exchange requirements (other than those related to director independence), subject to a cure period.
Must Satisfy Objective Independence Standards
Shareholder nominees must meet relevant securities exchange objective independence standards (as opposed to any subjective standards), but the nominee does not need to be independent from the nominating shareholder. In addition, there cannot be any agreements between the company and the nominee regarding the individual’s nomination.
Required Disclosures and Liability
New Schedule 14N to be Filed by Nominating Shareholders
Nominating shareholders must file a Schedule 14N with the SEC (and submit a copy to the company on the same day) disclosing their intent to require a company to include shareholder nominees in the company’s proxy materials.8 This schedule must include information about the nominees and the nominating shareholders as would be required in a traditional proxy contest. It must also include certain representations and additional information relating to the proxy access eligibility requirements, as well as a certification regarding no intent to change control of the company. A statement of support for the nominee of no more than 500 words may be provided by the nominating shareholder for inclusion in the company’s proxy statement.
Companies Not Liable For Information Provided by Nominating Shareholders
Companies will not be liable for information that they receive from nominating shareholders and include in their proxy statements. Nominating shareholders will be liable for any false or misleading statements made in connection with the nomination, regardless of whether such statements are included in the company’s proxy materials.
Exclusion of Nominees by the Company
A company seeking to exclude a shareholder nominee for failure to satisfy the eligibility requirements must notify the nominating shareholders and provide them with 14 days to respond and correct any eligibility deficiencies. Thereafter, the company must provide notice to the SEC and the nominating shareholder of the basis for the intended exclusion no later than 80 days before the definitive proxy is filed the company. The proxy access rules also outline procedures for dispute resolution through the SEC staff in connection with shareholder nominations.
Limits on Exclusion of Shareholder Proposals Under Rule 14a-8
Previously, Rule 14a-8 permitted companies to exclude shareholder proposals that related to director elections. The new amendments to Rule 14a-8 limit this exclusion, allowing shareholders to propose amendments to a company’s governing documents to establish procedures for inclusion of shareholder nominees.9 Shareholders will be able to propose, and it will be difficult for companies to exclude, proposals with more lenient shareholder access eligibility requirements (e.g., a 2% ownership threshold).
The extent to which shareholders will avail themselves of these new proxy access rules, and the extent to which corporate governance activists will utilize the proxy access rules to facilitate shareholder proposal campaigns, will unfold in upcoming proxy seasons.10 It remains to be seen whether shareholder access will result in shareholder excess. In the meantime, companies may wish to take the following steps in anticipation of the potential practical effects of the new rules:
Review Advance Notice Bylaws
Board corporate governance/nominating committees should review their advance notice bylaws since the new rules allow shareholders to submit nominees no more than 150 days and no fewer than 120 days before the anniversary date of the mailing of the company’s prior proxy statement.
Reexamine Existing Agreements Regarding Shareholder Nominees
Companies should review any existing agreements with activist shareholders regarding director nominees. If the company re-nominates a director pursuant to an agreement with a shareholder, that shareholder may be able to separately propose director nominees under Rule 14a-11 absent any standstill or similar provisions in the agreement. If that shareholder or other activist shareholders also propose nominees pursuant to Rule 14a-11, then more than 25% of the board could potentially consist of directors who were initially proposed by activist shareholders (taking into account directors re-nominated by the company pursuant to an agreement with an existing shareholder).
Reexamine Shareholder Nomination Procedures and Nominating Committee Processes
Board corporate governance/nominating committees should review their director nomination procedures to determine whether revisions are necessary in light of the new rules. In addition, corporate governance/nominating committees should review their nominating processes and whether and how they will negotiate with a nominating shareholder to avoid a proxy contest.11
Prepare for Possible Engagement With Shareholders
Companies may wish to prepare to engage in shareholder relation efforts before the deadline for submitting nominees.