• SEC Proposes Revised Proxy Rules to Facilitate Shareholder Nominations of Directors
  • July 9, 2009 | Author: Douglas P. Long
  • Law Firm: Faegre & Benson LLP - Minneapolis Office
  • The SEC recently published a release proposing new shareholder access rules that would fundamentally change the current proxy process so as to facilitate director nominations by shareholders. This proposal represents the third significant attempt by the SEC this decade to address the issue of shareholder access. The first two attempts, one in 2003 that if adopted would have provided shareholders with direct access to company proxy materials and the other in 2007 that was adopted and clarified the types of director nomination and election proposals of shareholders that could be excluded by companies under existing SEC rules, did not produce any significant change to the director-nomination landscape. However, in announcing a proposal to add a new Rule 14a-11 and amend Rule 14(a)-8(i)(8), Chairman Mary L. Shapiro indicated that she believes that a change to the federal process must be made and must be made now. Chairman Shapiro argues that without such significant changes, the "fundamental" right of shareholders to nominate directors will continue to be illusory, and the ability of shareholders to hold directors accountable through the exercise of such right will continue to be frustrated and impeded.

    And the Commission is not alone in this endeavor.

    • The Shareholder Bill of Rights Act of 2009, introduced in the U.S. Senate in May, provides, among other things, for the SEC to act to grant shareholders access to the corporate proxy and proxy materials for nominations to the board.
    • The Shareholder Empowerment Act of 2009, introduced in the U.S. House of Representatives in June, provides, among other things, for similar action by the SEC to grant shareholders direct access to the proxy machinery of management (with the added twist of requiring such actions to be effective for the 2010 proxy season).
    • Certain states, such as Delaware and North Dakota, have enacted legislation that permits shareholders to propose amendments to a company's governing documents addressing nomination and election processes and procedures.

    Proposed Rule 14a-11

    Proposed Rule 14a-11 would, in non-change-in-control situations, require nearly all Exchange Act reporting companies to include in company proxy materials and proxy cards one or more board nominees proposed by shareholders, subject to the satisfaction of certain eligibility requirements. Currently, shareholders can submit recommendations to the nominating committee for consideration, but seldom does this result in shareholder-recommended candidates being part of the management slate of nominees. Shareholders also can run their own slate of directors by disseminating their own proxy statement with their alternative proxy card. However, going it alone, outside of the company's proxy process, is logistically difficult, time-consuming and expensive.

    Eligible Shareholders. A shareholder (or group of shareholders) that meets the following ownership thresholds and who has held such shares for at least one year would be able to include their director nominations in the company's proxy statement and proxy card under the proposed rule:

    • owning 1 percent of outstanding voting securities for large accelerated filers (public float in excess of $700 million);
    • owning 3 percent of outstanding voting securities for accelerated filers (public float between $75 million and $700 million); and
    • owning 5 percent of outstanding voting securities for all other public companies.

    If adopted, the proposed rule change in 2003 would have provided direct shareholder access only after the occurrence of certain "triggering events." These triggering events – if in the preceding year more than 35 percent of voting shareholders had withheld votes from at least one of the company's nominees or if a shareholder proposal to endorse a shareholder nomination procedure had received more than 50 percent of the votes cast – were essentially surrogates for identifying governance breakdowns. Only companies that experienced such breakdowns would have been required to open up the proxy process directly to their shareholders. There are no triggering events in the 2009 proposal, consistent with the SEC's newly articulated position that the ability to make director nominations is a fundamental right of shareholders.

    Number of Permitted Nominees. A qualifying shareholder or group would be permitted to include in the company's proxy statement and proxy card the greater of one nominee or that number of nominees constituting no more than 25 percent of the board's total membership. For purposes of determining the number of board positions available for shareholder nominations, any incumbent director previously nominated by a shareholder under the Rule 14a-11 procedures whose term extends beyond the annual meeting date would be deemed to take one of the positions available for shareholder nominations.

    If multiple shareholders or shareholder groups properly submit director nominees and the total number of such nominees exceeds the maximum, the first nominees properly submitted would be the ones required to be included in the company's proxy materials and proxy card.

    Principal Mechanics/Timing of Nomination Process. To submit a nominee, the nominating shareholder or group would provide notice on a new Schedule 14N to the company of its intent to require the company to include such nominee in the company's proxy materials. The deadline for the notice would be the date specified in the company's advance notice provision or, where no such provision is in place, no later than 120 calendar days before the date the company mailed its proxy materials for the prior year's annual meeting (presuming the current year's annual meeting date is within 30 days of the anniversary date of the prior year's meeting).

    The new Schedule 14N would require information regarding the nominating shareholder or group, including the number of shares owned, a verification of the holding period, the shareholder's intent to hold shares through the annual meeting (and intent with respect to continued ownership of shares after such meeting) and a certification that the shares are not being held for change-in-control purposes. The Schedule 14N would also address the elements of the shareholder's or group's eligibility to submit such nominations and certain information regarding the nominees, including, if desired by the shareholder or group, a supporting statement with regard to the nominees (not to exceed 500 words) to be included in the company's proxy statement. In addition, the Schedule 14N would need to be filed with the SEC and would be subject to the liability provisions of Rule 14a-9 for false or misleading statements.

    After receipt of a Schedule 14N, the company would determine whether any of the events permitting exclusion of the shareholder nominee or nominees has occurred. If not all of the shareholder nominees are excludable, the company would notify the nominating shareholder or group at least 30 calendar days before the company files its definitive proxy statement that it will include the nominee or nominees.

    A company may determine that it is not required to include a nominee if it determines any of the following:

    • Rule 14a-11 is not applicable to the company;
    • the nominating shareholder or group has not complied with the requirements of Rule 14a-11;
    • the nominee does not meet the requirements of Rule 14a-11;
    • any representation required to be included in the Schedule 14N is false or misleading in any respect; or
    • the company has received more than the maximum number of nominees and the nominating shareholder or group lost the race for inclusion.

    If the company determines that the shareholder nominees are excludable and it wishes to exclude them, the SEC has proposed the following process:

    1. Within 14 calendar days after it receives the Schedule 14N, the company must notify the nominating shareholder or group of such determination and the basis for exclusion.
    2. The nominating shareholder or group would have 14 calendar days after receipt of the exclusion notice to respond and correct any eligibility or procedural deficiencies.
    3. If, after receiving the shareholder or group response, the company sticks with its exclusion determination, the company would be required to provide notice of the basis for its determination to the SEC and to the nominating shareholder or group no later than 80 calendar days (unless the company demonstrates good cause for missing the deadline and the SEC permits a later submission) before it files its definitive proxy statement.
    4. The nominating shareholder or group could submit a response to the SEC and the company within 14 calendar days after receipt of the company's notice to the SEC.
    5. The Commission staff may then issue a no-action letter regarding the dispute.

    Form of Proxy Card. If shareholder nominees are to be included in the company's proxy materials under Rule 14a-11, the company would be required to present all nominees in an impartial manner on the same proxy card. The company would not be able to provide to shareholders the customary option of voting for all company nominees as a group. However, the company could identify any shareholder nominees as such and recommend how shareholders should vote on those nominees and on management nominees.

    Proposed Amended Rule 14a-8(i)(8)

    Currently, Rule 14a-8(i)(8) allows a company to exclude from its proxy statement a shareholder proposal that relates to a nomination or an election of a director or a procedure for such nomination or election. The proposed amendment to Rule 14a-8(i)(8) would no longer permit such exclusions and instead would require companies to include in company proxy materials shareholder proposals that would amend, or request an amendment to, a company's governing documents regarding nomination procedures or disclosures related to shareholder nominations, unless they would conflict with proposed Rule 14a-11 or applicable state law.

    A company still would be permitted, however, to exclude proposals that "could affect the outcome of the upcoming election of directors," such as proposals disqualifying nominees or removing a director, questioning the qualifications of a director or nominee or nominating a specific candidate.

    Issues to Be Resolved

    The proposing release itself asks hundreds of questions regarding the proposed rules. We expect the answers to these and other questions provided to the SEC during the comment period (which ends August 17, 2009) to be numerous and extremely diverse.

    Some of more the more interesting issues to be resolved include:

    • Do these new rules represent an impermissible usurpation of state corporate law? Even if not, is a one-size-fits-all, federally mandated approach preferable to the multiple state law approach? Through the trial and error of differing state laws, a best practice often develops.
    • Has the SEC properly gauged the costs of direct proxy access? Full-scale nomination contests can be exceedingly expensive. Under the proposed rules, will such contests become an annual occurrence?
    • What about the mechanics of the nomination process? When the number of nominees proposed exceeds the maximum, is "first-come-first-served" really the best approach?
    • If a dispute regarding eligibility or qualifications ensues, the proposed rule has an extensive and time-consuming notice and response dance. But given that most current advance notice provisions have periods much shorter than the default period of 120 days before the previous year's mailing, how will this dance work in practice?
    • How do misrepresentations or other notice defects, discovered after the election of a shareholder nominee, affect the new director? Must he or she resign because of the tainted process?

    Current Considerations and Possible Actions

    Given the strong statements of Chairman Shapiro and the legislative activity noted above, we believe that the SEC will adopt some form of shareholder access rule effective for the 2010 proxy season. However, whether such final rules look like those proposed or include only a portion of the proposal (for instance, the changes to Rule 14a-8(i)(8)), or go in some other direction cannot be predicted.

    While we believe it would be premature to make any changes to a company's governing documents, companies and their boards should consider taking certain steps to prepare for a shareholder access world.

    • Companies should continue to be ever-vigilant in knowing and understanding their existing shareholders. Good communication practices with large shareholders will become even more important.
    • Companies should try to understand why an activist shareholder might be attracted to the company. In reality, because even non-change-in-control election contests are expensive, it is likely to be activist shareholders that will avail themselves of this process and commit the resources necessary to mount an election campaign.
    • Companies should consider how best to prepare for an election contest. In an election contest, the shareholder proponent will not only extol the virtues of the shareholder nominees, but will likely attack every perceived weakness of the incumbent board and management nominees. Therefore, boards should review their board and committee composition, attendance records of incumbent directors and other such matters to determine where they are likely to be most vulnerable to an activist focused on communicating to shareholders all perceived deficiencies.
    • Companies should review their bylaws and charters. For example, a company should understand its current advance notice provisions and be aware of the approvals necessary to make a change. In addition, Delaware corporations need to understand the recent corporate law amendments permitting companies to adopt bylaw provisions addressing access to the proxy process.
    • Companies should review their publicly available criteria for selecting board nominees and consider whether they should be modified.
    • Nominating committees should be in regular contact with potential candidates who the nominating committees believe would be desirable additions to the board if an incumbent director should die or resign.
    • Companies need to understand who their advisors are, including counsel knowledgeable in the proxy access arena and solicitation firms and public relations firms able to assist if a nomination contest arises.