In order to enable shareholders to more fully exercise their rights to nominate and elect directors, on June 10, 2009, the SEC proposed adding Rule 14a-11 to the proxy rules under the Securities Exchange Act of 1934 (the “Exchange Act”). Release No. 33-9046; 34-60089; IC–28765; 74 F.R. 29024 (June 18, 2009). The new rules would apply to companies subject to the proxy rules under the Exchange Act, including open-end and closed-end investment companies registered under the Investment Company Act of 1940 (the “1940 Act”). Certain key aspects of the proposed new rules as they apply to registered investment companies are summarized below.  

Proposed Rule 14a-11  

Under the proposed rule, a fund will be required under certain circumstances to include shareholder nominee(s) for director in the fund’s proxy materials. The proposed rule would not apply in circumstances where (a) the shareholder intends to change control of the fund or gain more than a limited number of seats on the board of directors, (b) state law governing the fund does not allow shareholders to nominate candidates to the board or (c) the fund’s governing documents prohibit shareholders from nominating candidates to the board.  

Eligibility to use Rule 14a-11  

In order to take advantage of the proposed rule, a nominating shareholder or group must have a “significant, long term interest” in a fund and meet a minimum ownership threshold that is tiered in accordance with the fund’s size. Thus, such a shareholder or group must:  

  1. Beneficially own, either individually or in the aggregate, any of the following:  
  1. 1% of the fund’s securities entitled to be voted on the election of directors, if the fund has net assets of $700 million or more3;  
  2. 3% of the fund’s securities entitled to be voted on the election of directors, if the fund has net assets of $75 million or more but less than $700 million; or  
  3. 5% of the fund’s securities entitled to be voted on the election of directors, if the fund has net assets of less than $75 million; and  
  1. Have beneficially owned the securities for at least one year as of the date of the shareholder notice on Schedule 14N; and  
  2. Represent an intention to continue to own those securities through the date of the annual or special meeting.  

In addition, to rely on proposed Rule 14a-11 to have disclosure about their nominee(s) included in the fund’s proxy materials, a nominating shareholder or group must:  

  • Not acquire or hold the securities in order to change the control of the fund or gain more than a limited number of seats on the board;  
  • Notify the SEC that it is requiring the fund to include its nominee in the fund’s proxy materials by delivering to the fund, and filing with the SEC, a Schedule 14N; and
  • Include in the Schedule 14N information about the amount and percentage of securities owned by the nominating shareholder or group, the length of ownership of the securities, and a certification that the nominating shareholder or group intends to continue to hold the securities through the date of the meeting as well as after the election and is not seeking to change the control of the company or gain more than a limited number of seats on the board of directors, as well as other disclosures required by proposed Rule 14a-18.  

Shareholder Nominee Requirements  

The nomination of a candidate for the board must be consistent with applicable law and regulation. A company would not be required to include a shareholder nominee in the company’s proxy materials if the nominee’s candidacy or, if elected, board membership would violate controlling state law, federal law, or rules of a national securities exchange or national securities association, and such violation could not be cured.  

The nominating shareholder or group must further declare in its Schedule 14N the following: (a) that the nominee is not an “interested person” of the company as defined in Section 2(a)(19) of the 1940 Act, and (b) that no relationships or agreements exist between the nominee and the fund and its management, and between the nominating shareholder or group and the fund and its management.  

A nominating shareholder or group does not become an “affiliate” of the fund solely as a result of nominating a director, nor as a result of the nominee becoming elected as a director.  

Maximum Number of Shareholder Nominees

In order to ensure that shareholders do not take advantage of this new rule to take control of a fund, a fund would be required to include no more than one shareholder nominee or the number of nominees that represents 25% of the fund’s total number of directors, whichever is greater. Furthermore, at any given time the number of shareholder nominees serving as members of the board should not be greater than one or the number of nominees that represents 25% of the company’s total number of directors, whichever is greater.  

The inclusion of a nominee in a fund’s proxy statement will be based on a first-in standard, which means that the fund would be required to include the nominee(s) of the first nominating shareholder or group from which it receives a timely notice on Schedule 14N.  

Schedule 14N Timing  

The Schedule 14N notice must be provided by the date specified in a fund’s advance notice bylaw provision (if any), or, where no such provision exists, no later than 120 calendar days before the anniversary of the date that the fund mailed its proxy materials for the prior year’s annual meeting. If no annual meeting was held, or if the date of this year’s meeting has changed by more than 30 days from last year’s meeting date, then the nominating shareholder or group should provide the Schedule 14N notice “a reasonable time” before the fund mails its proxy materials, as specified by the fund in a Form 8-K filed within four business days after the fund determines the anticipated date of its annual meeting (this is a new Form 8-K requirement, Item 5.07).  

What a Fund that Receives a Schedule 14N Notice Should Do  

If a shareholder or group files a Schedule 14N notice, the fund should first determine whether any of the events permitting exclusion of the shareholder nominee(s) has occurred. If there are none, the fund must notify in writing the nominating shareholder or group that it will include the nominee or nominees in the fund’s proxy materials, and should do so no later than 30 calendar days before the fund files its definitive proxy materials with the SEC. Nominating shareholders may include a statement of support for their nominees in the proxy statement as long as the statement does not exceed 500 words (the statement in support of the nominee(s) must be included as part of the Schedule 14N notice). When the fund includes the name of the shareholder nominee on its form of proxy card, it may identify those nominees as having been nominated by a shareholder or group and it could also include management’s recommendation as to how shareholders should vote for or against, or withhold their vote on each nominee. In order to comply with the requirement of Rule 14a-4 that nominees be presented on the proxy in an impartial manner, when a shareholder nominee is included the proposed rule would not allow a fund to provide shareholders with the option of voting for or withholding authority to vote for the fund’s nominees as a group, and the proposed rule will require that each nominee be voted upon separately.  

On the other hand, a fund may exclude a shareholder director nomination that does not comply with the requirements of Rule 14a-11. Such a situation would arise if (a) Rule 14a-11 is not applicable to the fund, (b) the nominating shareholder or group has not complied with the requirements of Rule 14a-11, (c) the nominee does not meet the requirements of Rule 14a-11, (d) a materially false or misleading representation was included in the notice to the fund or (e) the fund has received more nominees than it is required to include by Rule 14a-11 and the nominating shareholder of group is not entitled to have its nominee included under the criteria in Rule 14a-11(d)(3).  

Application to other proxy rules  

The SEC is also proposing to exempt from the proxy rules any communications among shareholders made in connection with the formation of a group to use the provisions of proposed Rule 14a-11 provided that the communications are limited in content and are filed with the SEC. The filing must be made no later than the date on which the communication material is first published, sent or given to shareholders and must include a cover page in the form of Schedule 14N’s cover page, with the appropriate box checked.