On Friday, Oct. 2, 2009, SEC Chair Mary Schapiro issued a statement indicating that the Commission will not take up the matter of new shareholder proxy access rules until 2010. She indicated it was her hope to finalize rules "early in the new year."
New rules were proposed by the SEC June 10, 2009. In its release "Facilitating Shareholder Director Nominations," the SEC proposed to require public companies to include in proxy materials distributed to shareholders, information relating to, and the capability to vote on, persons nominated by shareholders for election as directors. Also, such companies would be required to similarly include shareholder proposals related to the conduct of the election of directors.
If the SEC does not take action on the proposal until 2010, new rules will not be implemented for the 2010 proxy season. Public corporations on the calendar year will be holding annual meetings beginning in late March and April. The proposed SEC rules contemplate a deadline for shareholder nominees for director of 120 days prior to mailing of the proxy materials.1 For an April 2010 annual meeting, this deadline would be well in advance of SEC action on the rules.2 Although the final rules could impose shorter deadlines for nominations, we believe this is unlikely given the need to afford time for dispute resolution.
The comment deadline for the proposal was Aug, 17, 2009, with the proposal attracting significant comment. Many commenters argued that the proposal to mandate proxy access for shareholder nominees was flawed in that it would preclude "private ordering," that is, the federal requirement as proposed would override inconsistent provisions that a corporation's shareholders might adopt pursuant to their authority to amend the corporation's bylaws under applicable state corporation law, and would preclude a corporation's shareholders from voting to "opt out" of the federal regime. Commenters suggested that if rules were adopted by the SEC in the proposed form, they would be vulnerable to attack as beyond the SEC's regulatory powers. It has been speculated that the SEC is taking additional time on the proposal in order to adequately consider these arguments.
At this juncture, it is not known what form the final rules will take, or when such rules may be adopted. The SEC could adopt rules substantially as proposed, in which case shareholder proxy access for director nominees will be mandated under specified terms and conditions. This would leave no room for private ordering.
However, we believe that, given the compelling arguments in favor of private ordering made during the comment process, there is a reasonable likelihood that the final version of these rules will in some fashion permit variations from the federal regime. The delay in SEC action in our view suggests that these arguments are receiving serious consideration, which indicates that there very likely will be room for some form of private ordering in the rules as ultimately adopted. For example, it is possible that the final rules will mandate a default requirement, which may be varied by corporations in light of their particular circumstances. If such variance is permitted, it is likely that shareholder approval of the variance from the federal mandate will be required.
In light of the heightened possibility that private ordering will be permitted under the final rules, we suggest that, while awaiting the issuance of final rules by the SEC, it would be prudent for public corporations to begin to consider now what type of shareholder access mechanism may make sense for them, in their particular circumstances. Depending upon a particular company's annual meeting schedule, and the timing of SEC rulemaking, this could allow a board, if permitted under the final SEC rules, to act promptly to submit an opt-out resolution, together, if desired, with a proposed bylaw amendment on shareholder access, for shareholder approval at its 2010 annual meeting. Devoting attention to this question now may permit a more thorough consideration than if the issue is taken up only after the SEC issues final rules. Even if a board determined to make no proposal for the 2010 meeting, the consideration of these issues will enable a company to be better prepared to react to SEC rulemaking, which we continue to believe will ultimately create a right of shareholder proxy access, though likely allowing shareholder-approved variation.
Here are the principal areas that we believe should be a part of a company's consideration of these matters.
Just say no to access?
It is possible that the final rule could permit a shareholder opt-out from the rule's requirements. Given the history of most public corporations, where the election of directors not nominated by the existing board has been a rarity, and in light of concerns that the election of such persons may impair the effective functioning of the board, some companies may consider this to be an appealing alternative to be taken up if offered.
However, shareholder approval of an opt-out could prove difficult to obtain. In seeking such approval, shareholders would be asked to approve the maintenance of the status quo, where a shareholder must launch his own proxy contest to have any practical chance of electing his nominee. Over the past year, this topic has received unprecedented public attention, which will only increase upon the SEC's issuance of a final rule. In many circles, the absolute denial to shareholders under any circumstances of the ability to use the company's proxy materials for their director nominees has come to be viewed as a mark of poor corporate governance. This has resulted in pressure being brought to bear on the SEC for rulemaking, and it can well be anticipated that similar pressure will be felt by corporations from an investor relations standpoint, even in the absence of a mandated requirement. In these circumstances, a board would do well to carefully consider the risk that a proposal to opt out of the rule's requirements would be defeated by shareholders, unless the company, with shareholder approval, has implemented or is implementing its own shareholder proxy access program.
In addition, it is highly likely that the final rules will facilitate the ability of shareholders to make their own proposals for a plan to permit proxy access for shareholder nominees for director. After the new rules are adopted, such proposals will no longer, in all likelihood, be excludible from the company's proxy materials under Rule 14a-8(i)(8).3 Any such proposals by shareholders bear the risk of not being well thought through and containing undesirable features. A campaign by management to oppose such a proposal could be enhanced if the company has implemented, or is implementing, a reasonable alternative to the shareholder proposed mechanism.
Important access features
In light of these considerations (and if the final rules allow) a public corporation may wish to consider crafting its own shareholder access provision. In doing so, determinations will need to be made about the following principal features:
- Should the access provisions be immediately operative?
- Which shareholders should be permitted to nominate directors for inclusion in the company's proxy materials?
- How many directors should a shareholder be permitted to nominate?
- What should be the maximum number of all shareholder-nominated directors who may be included in the company's proxy materials?
- If qualifying shareholders nominate more than the maximum allowed, which nominees should be included?
- What qualifications should be required for the nominated directors?
Conditional effectiveness. The SEC's rules, if adopted in the proposed form, will operate for all public corporations without preconditions. If shareholder-approved variation from the rules is permitted, one possible variation would be to impose preconditions upon a shareholder access mechanism. In particular, many public corporations have already implemented majority voting requirements in the election of directors. The rationale for these requirements is that they facilitate the ability of shareholders to express dissatisfaction with the board's nominees for election as directors, with such expression having an impact on the election. These requirements have permitted the waging of "just say no" campaigns, and as such can be considered as representing a currently available vehicle for exercise of the shareholder franchise. Of course, a majority vote requirement does not permit shareholders to vote for a non-management nominee; it simply provides that where a management candidate fails to receive a majority vote, he or she will not be elected.
In light of these considerations, it could be reasonably argued that there should be no need for a shareholder proxy access mechanism for a company that has already implemented majority voting, until shareholders have demonstrated dissatisfaction with management nominees. Thus it could be provided that the shareholder access provisions allowing shareholder nominees to be included in the company's proxy materials would only take effect after a meeting in which a board nominee is not elected because of a failure to receive a majority vote.
Shareholder qualifications. The proposed rules specify that only a shareholder or group of shareholders that have owned a specified percentage of the company's voting stock (1 percent for the largest companies) for a continuous period of one year may nominate directors for inclusion in the company's proxy materials. In the event the final rules permit private ordering, a shareholder-approved provision could specify ownership amount requirements that make sense for the particular corporation. These requirements presumably would be expressed in terms of a percentage of the outstanding shares (though other measures would also be possible) and could be set as high as the board may propose and shareholders approve to prevent undue disruption resulting from frequent contested elections. Similar variation in particular circumstances would be possible from the SEC's proposed one-year ownership duration requirement.
The proposed rules allow shareholders to form groups so as to aggregate their share ownership for the purpose of meeting the required ownership amount. Under the rule, there is no limit upon the number of shareholders who may constitute such a group. Under a private ordering approach, a company could require that share ownership could not be aggregated by group, or could place a limit on the number of holders who could form such a group.
In addition, a company could include other requirements for nominating shareholders, such as a requirement that if a shareholder has had a nominee included in the company's proxy materials in a prior year, and the nominee has received less than a specified measure of voting support, the shareholder is prohibited from nominating that or any other nominee in the subsequent year.
Number of nominees. The proposed rules specify that the maximum number of nominees from all qualifying shareholders would be 25 percent of the size of the existing board. A company-adopted private ordering approach could impose its own limitation on the maximum number of nominees, which could be less than 25 percent of the size of the existing board and, in the case of a classified board, could be limited to a percentage of the number of directors to be elected at a particular meeting. In addition, the company's provision could impose a sublimitation for the permitted number of nominees for any single shareholder (or group, if groups are permitted), such as providing that any single shareholder or group could nominate only a single nominee. This could open up the nominating process to more qualifying shareholders.
Over-nominations. The proposed rule provides that if more nominees are offered by qualified shareholders than the maximum number permitted by the rule, the nominees would be included based upon which nominees were offered earliest. This approach was widely criticized in the comments as encouraging a race to make nominations. In a private ordering arrangement, a provision limiting any single qualifying shareholder or group to a single nominee would reduce this problem somewhat. In addition, the provision could provide for other means of selecting among nominees, such as by the size of shareholding of the nominating shareholder or group.
Nominee qualifications. Under the proposed rule, a nominee would need to meet the objective director independence standards of the relevant stock exchange, but would not need to satisfy any subjective independence standards or any company-specific independence standards. A private ordering scheme could impose additional independence standards along with the stock exchange requirements. In addition, the scheme could impose a requirement that the nominee be independent of the nominating shareholder or group, on the basis that nominees should represent the interests of all shareholders. Moreover, a private ordering scheme could impose a qualification excluding a nominee who had previously been nominated and failed to receive a specified level of voting support.
Reimbursement of proxy expenses
A private ordering scheme could offer an alternative to access to the company's proxy materials for qualified nominees of qualified shareholders. A principal rationale for requiring shareholder access to the company's proxy materials is the perceived cost burden that a shareholder is required to shoulder if the shareholder must prepare and disseminate its own proxy materials to solicit proxies to vote for the nominee. This issue could be addressed directly by a scheme that would authorize the company to pay the shareholder's reasonable expenses in conducting such a solicitation. Reimbursement would be available only for solicitations where the requirements of the type outlined above for shareholder proxy access were met, including qualifications of the shareholder and the nominee, and a limitation on the number of nominated persons. It is even possible to envision a provision that would allow the board to determine on a case-by-case basis whether to include nominees in the company's proxy materials or reimburse the shareholder for costs of a separate solicitation.
A consideration of what features a corporation would deem desirable in a privately crafted shareholder access regime could prove beside the point if the SEC's final rules do not permit private ordering. Even in that event, a number of comments to the proposal suggested grounds for a possible legal challenge to the rules. We believe the compelling arguments in the comments make the possibility sufficiently high that the final rules will accommodate private ordering, that it makes sense for corporations to consider these matters now. It is possible that such consideration could make it possible to request shareholders to opt out of the rules at the 2010 annual meeting, and if desired, to ask shareholders to approve a privately ordered plan at that meeting. The alternative of waiting until the issuance of final rules could unduly compress the time for appropriate board review of this issue.
We have summarized here what we view as the fundamental features to be considered for a company's shareholder access plan. More detailed work would be required in the drafting of bylaw provisions to implement the plan, including provisions to protect against the abuse of shareholder access in the context of a possible proxy contest for control of the board.