- SEC Adopts Proxy Access
- September 8, 2010 | Authors: David J. Friedman; Marc S. Gerber; Richard J. Grossman
- Law Firms: Skadden, Arps, Slate, Meagher & Flom LLP - New York Office ; Skadden, Arps, Slate, Meagher & Flom LLP - Washington Office ; Skadden, Arps, Slate, Meagher & Flom LLP - New York Office
The Securities and Exchange Commission, by a 3-2 vote, recently adopted “proxy access” - a set of far-reaching amendments to the proxy rules that provide stockholders of public companies an alternative means to nominate candidates for election to a company’s board of directors and to have those nominees included in the company’s proxy materials (proxy statement and proxy card). The SEC’s proxy access rules allow stockholders (or groups of stockholders) holding at least three percent of the voting power of a company’s securities for at least three years to nominate candidates for up to 25 percent of a company’s total number of directors. Proxy access is expected to increase the leverage of activist and other stockholders in their interactions with corporate boards and is likely to result in a greater number of companies facing contested director elections.
In addition, the SEC adopted amendments to the proxy rules that permit stockholders to submit proposals under Rule 14a-8 providing for or requesting even greater access to include stockholder nominees in a company’s proxy statement - for example, additional access rights with lower stock ownership requirements and shorter holding periods or the ability to include nominees for a greater percentage of board seats. This provision operates in only one direction, as stockholders may not propose more stringent requirements on proxy access than those provided by the SEC’s new rules.
The proxy access rules will become effective 60 days after publication in the Federal Register, except that “smaller reporting companies” (generally, those with a public float below $75 million) will not become subject to proxy access until three years later. The deadline for eligible stockholders to submit access nominations under the new rules generally is 120 days before the anniversary of the mailing date of the prior year’s annual meeting proxy statement; for calendar-year companies, this deadline typically falls between mid-November and late December. Accordingly, proxy access will be in place for most companies (other than smaller reporting companies) for the 2011 proxy season.
There are a number of steps that companies should consider taking now. These steps may reduce the risk that a company will receive access nominations and better position a company to respond and react to the receipt of access nominations.
Stockholder Engagement: Companies should review and, if necessary, enhance their engagement with major stockholders. As part of this effort, companies should understand their investors’ hot-button issues and consider their corporate governance and executive compensation practices in light of investor concerns. Where differences of opinion exist, commencing a thoughtful dialogue as part of constructive engagement may decrease the likelihood of the company becoming a target for access nominations.
Board Composition: Fundamentally, the board should ensure (typically as part of its annual self-evaluation process) that its directors have the necessary qualifications, skills and experience, as a group, to exercise effective oversight of management and the company’s business. Any perceived gaps in the skill-sets of a board may present an opening for an access nomination. In addition, in considering optimal board size, a board should be aware of how board size impacts the number of access candidates that may be nominated. For example, a maximum of three access candidates may be nominated to a 12-member board, whereas a maximum of two access candidates may be nominated to an 11-member board.
Coordination With the Nominating/Corporate Governance Committee and the Board: Upon receipt of an access nomination, a company may have only a short window of time to determine whether to challenge the eligibility of the nomination. These decisions may require the nominating/corporate governance committee and the board to meet on short notice. As a result, calendars should be coordinated and directors should be alerted to the possibility of meeting shortly after the deadline for access nominations. Going forward, annual calendars may need to be revised to reflect potential meetings immediately following the access nomination deadline.
Review Bylaws and Board Policies: Companies should review their bylaws and other corporate governance documents to ensure that they function as intended in the event of an access nomination or the election to the board of access nominees. For example, companies should confirm that majority voting bylaws that contain a plurality voting standard in the event of an election contest define a contest so as to include any circumstance in which the number of candidates exceeds the number of board positions up for election. Companies also may want to refresh policies relating to confidentiality of information provided to directors and authority to speak on behalf of the company.
Be Prepared: Companies should have a team ready to respond to an access nomination or other activist event. In addition to appropriate company personnel, the team generally should include legal advisors, financial advisors, proxy solicitors and a public relations firm.
A description of the SEC’s proxy access rules and related rule changes follows.
Rule 14a-11: Proxy Access for Director Nominations
The cornerstone of proxy access is new Exchange Act Rule 14a-11, which provides that a stockholder or group of stockholders complying with the eligibility and other requirements of the rule can include the stockholder’s or group’s nominees for director in a company’s proxy materials. Rule 14a-11 applies to all companies that are subject to the SEC’s proxy rules, including registered investment companies and controlled companies, but excluding companies subject to the proxy rules solely because they have a class of registered debt. Proxy access does not apply to foreign private issuers as they are exempt from the proxy rules.
Rule 14a-11 applies to the election of directors at an annual meeting (or a special meeting or an action by written consent in lieu of an annual meeting) unless applicable state law or a company’s governing documents (i.e., charter or bylaws) prohibit stockholders from nominating candidates for election to the board. The SEC notes that it is not aware of any state with such a prohibition. In the case of a company’s governing documents, such a prohibition would be unusual and may raise issues of enforceability under applicable state law. Such a prohibition also would be likely to provoke the ire of institutional and activist investors, as well as proxy advisory firms such as ISS. There is no mechanism for a company to “opt out” of proxy access.
Eligible Nominating Stockholders
The principal requirements for a stockholder or a group of stockholders to be eligible to nominate director candidates under Rule 14a-11 are:
Three Percent: On the date that the nominating stockholder or group provides the requisite notice of nomination, the stockholder (individually) or the group (in the aggregate) must hold at least three percent of the total voting power of the company’s securities entitled to vote in the election of directors (that number of shares is referred to in this memorandum as the “minimum number of shares”);
Three Years: The nominating stockholder or group must have held the minimum number of shares continuously for at least three years as of the date of its notice of nomination and must continue to hold at least the minimum number of shares through the date of the meeting at which directors will be elected;
Proof of Ownership: The nominating stockholder or group must include in its notice of nomination proof of ownership of the minimum number of shares for the three-year holding period described above. If the nominating stockholder or each member of the group is not the registered holder of the securities, the proof may be in the form of written statements from the registered holders of the securities (or the brokers or banks through which the securities are held) or it may consist of previously filed Schedules 13D or 13G or Forms 3, 4 or 5 (which may be incorporated by reference into the notice of nomination);
No Change of Control Intent: Neither the nominating stockholder nor any member of the group may be holding the company’s securities with the purpose or effect of changing control of the company or gaining a number of board seats in excess of the maximum number of board seats permitted by Rule 14a-11; and
No Agreement With the Company: Neither the nominating stockholder nor any member of the group may have entered into an agreement with the company regarding the nomination.
In calculating the percentage of voting power held by the nominating stockholder or group, Rule 14a-11 requires that the stockholder or, in the case of a group, each member of the group have both investment power and voting power with respect to the securities (whereas beneficial ownership requires only one or the other, but not both). This requirement is intended to limit the ability to use derivatives or other instruments that separate voting power from the economic risk of owning the securities in order to become eligible to make an access nomination. This method of calculating voting power also excludes securities that the holder merely has the right to acquire, such as securities underlying options that are currently exercisable but have not been exercised.
In addition, Rule 14a-11 provides that securities loaned to third parties are included in the calculation of voting power held only if the nominating stockholder or member of the group has the right to recall the loaned securities and will recall them upon notification by the company that any of the access nominees will be included in the company’s proxy materials. Borrowed securities or securities sold in a short sale are excluded from the determination of voting power held by the nominating stockholder or group.
A nominating stockholder or group will become ineligible, and its nominees excluded from the company’s proxy materials, if the stockholder or any member of the group submits any additional nominations to the company or participates in more than one proxy access nominating group with respect to the same company. The rule also provides for loss of eligibility in certain instances that are intended to avoid the possibility of a nominating stockholder or a member of a nominating group colluding or coordinating with a third party conducting a proxy contest for board seats at the same company.
To be eligible, an access nominee must satisfy the objective independence standards of the securities exchange on which the company is listed (or, in the case of an investment company, must not be an “interested person”). In addition, the nominee’s candidacy and, if elected, board membership must not violate applicable law (such as those laws governing board membership of companies in certain regulated industries).
Nominees do not have to satisfy any additional director qualification standards set forth in a company’s governing documents, although the nominating stockholder or group must disclose in its notice of nomination whether, to the best of its knowledge, the nominee meets any such qualifications.
Also, the nominee must not have entered into any agreement with the company regarding the nomination.
Number of Access Nominees
Nominating stockholders or groups may nominate candidates representing up to 25 percent of the total number of the company’s board of directors (rounded down to the closest whole number, but not less than one). This same calculation is applicable in the case of a staggered board in which one-third of the directors are elected each year, so that in any single year a majority of the class of directors standing for election (i.e., a majority of the one-third of the board) could face a challenge from access nominees. However, any access nominee previously elected to the staggered board whose term extends beyond the upcoming election of directors will count towards the 25 percent limit.
In an attempt to avoid proxy access being an impediment to negotiations between companies and nominating stockholders or groups, the rules provide that an access nominee of an eligible nominating stockholder or group (with priority over other nominating stockholders or groups, as described below) whom a company agrees to include in its proxy materials as a company nominee would count towards the 25 percent limit so long as the nominating stockholder or group filed its notice of nomination before beginning any discussions with the company about the nomination. In other words, settling with the nominating stockholder or group under those circumstances would not open the door to an alternative access nominee.
Priority Among Multiple Nominating Groups
In a change from the “first to the mailbox” system proposed by the SEC in 2009, the final rules provide that if there are multiple nominating stockholders or groups priority is given to the nominating stockholder or group holding the greatest percentage of voting power (based on the voting power percentages contained in the initial nomination notices). If that nominating stockholder or group nominated fewer than the maximum number of nominees permitted by Rule 14a-11, the company would include additional access nominees (up to the maximum number of nominees permitted by Rule 14a-11) nominated by the stockholder or group with the next highest percentage of voting power, and so on.
Where a company has received nominations from multiple stockholders or groups, the disqualification or withdrawal of a nominating stockholder or group or its nominee or nominees opens the door to the access nominees of the nominating stockholder or group with the next highest percentage of voting power, unless the disqualification or withdrawal occurs after the company begins printing its proxy materials. If the company has begun printing its proxy materials by the time of a disqualification or withdrawal, the company does not have to include a substitute access nominee.
Notice of Nomination: Timing and Disclosure Requirements
A nominating stockholder or group must submit notice of the nomination to the company on new Schedule 14N, and file the Schedule 14N on the same day with the SEC via EDGAR (which will result in the notice becoming publicly available). The notice must be sent to the company and filed with the SEC no earlier than 150 days and no later than 120 days before the anniversary of the mailing date for the prior year’s annual meeting proxy statement (which, generally, will be the same deadline as the Rule 14a-8 deadline for submission of stockholder proposals for inclusion in the company’s proxy materials1). As is the case with submission deadlines under Rule 14a-8 and under a company’s advance notice bylaws for the presentation of new business, the company is required to disclose in its proxy statement the deadline for proxy access nominations in connection with the following year’s meeting.
In the event that the company did not hold an annual meeting during the prior year, or if the date of the annual meeting has changed by more than 30 days from the prior year, or if the company is holding a special meeting or acting by written consent to elect directors (in lieu of an annual meeting), nominations must be received a reasonable time before the company mails its proxy materials. That deadline must be set forth in a Form 8-K filed by the company within four business days of determining the anticipated meeting date.
In addition to containing disclosures about the nominating stockholder or group and the access nominees comparable to the disclosure required in a proxy statement relating to a contested election, the notice on Schedule 14N must include the following:
disclosure of the amount of securities held by the nominating stockholder or group and the length of time those securities have been held (including the proof by which to determine that the ownership and duration of holding requirements have been satisfied);
a statement of the intent of the nominating stockholder or members of the group to hold the minimum number of shares through the date of the meeting at which directors will be elected and a statement of intent with respect to continued ownership after the election (which may be contingent on the results of the election);
disclosure as to whether, to the best knowledge of the nominating stockholder or group, the access nominees satisfy the director qualification standards, if any, contained in the company’s governing documents; and
certifications by the stockholder or each member of the group that, to such person’s knowledge, it is not holding the company’s securities with the purpose or effect of changing control of the company or gaining a number of seats on the board that exceeds the maximum number permitted under Rule 14a-11, and that the nominating stockholder or group and access nominees satisfy the requirements of Rule 14a-11.
Also, the Schedule 14N must include the website address on which the nominating stockholder’s or group’s soliciting material will be posted and may, at the option of the nominating stockholder or group, include a statement in support of each nominee, not to exceed 500 words per nominee.
Upon the filing and receipt of a Schedule 14N, these disclosures should be evaluated carefully by the company and its counsel to determine whether the nominating stockholder or group or access nominee is eligible under Rule 14a-11.
In the event that stockholders have additional proxy access rights under applicable state law or a company’s governing documents, a modified version of Schedule 14N is required to be filed with the SEC and transmitted to the company.
Excluding an Access Nominee
A company may exclude an access nominee if: (i) Rule 14a-11 is not applicable to the company; (ii) the nominating stockholder or group or access nominee failed to satisfy the eligibility requirements of Rule 14a-11; or (iii) the number of access nominees exceeds the maximum number of nominees permitted under Rule 14a-11. In addition, a company may exclude the statement in support of an access nominee or nominees if the statement exceeds 500 words per nominee. There is no exclusion of a nominee or a supporting statement on the basis that the Schedule 14N or the supporting statement is materially false or misleading, based on the SEC’s view that such disputes will be addressed through disclosure and/or litigation.
Where the company determines it has a basis to exclude an access nominee (including exclusion due to the fact that nominating stockholders or groups with priority resulting from higher percentages of voting power have nominated a full complement of access nominees) or to exclude a supporting statement, the following timeline and process applies:
Within 14 days of the deadline for submitting access nominations, the company must notify a nominating stockholder or group (or its authorized representative) of the company’s determination to exclude a nominee or supporting statement and the company’s basis therefor.
Within 14 days after receipt of the company’s notice, the nominating stockholder or group would have to respond to that notice and, if applicable, correct any eligibility or procedural deficiencies identified in that notice. Neither the composition of the nominating group nor the nominee(s) can be changed to cure any deficiency, other than reducing the number of nominees to comply with the 25 percent limit.
No later than 80 days before the company files its definitive proxy materials with the SEC (and after providing the notice to the nominating stockholder or group described above and either receiving a response from the stockholder or group or allowing the 14-day period for such a response to expire without a response), the company must notify the SEC (with a copy to the nominating stockholder or group) of its intent to exclude the nominating stockholder’s or group’s nominee(s) or supporting statement and the basis for its determination. At this point, the company also may (but is not required to) seek the SEC staff’s concurrence via a no-action letter.
Within 14 days of the nominating stockholder’s or group’s receipt of the company’s notice to the SEC, the nominating stockholder or group may submit a response to the SEC (with a copy to the company).
If the company seeks the SEC staff’s views in a no-action letter, the company must provide the nominating stockholder or group with notice, promptly following receipt of the SEC staff’s no-action response, of whether it will include or exclude the access nominee(s).
As described above, the withdrawal or disqualification of a nominating stockholder or group or a nominee may result in inclusion of a nominee of the nominating stockholder or group with the next highest percentage of voting power. The SEC notes in the release that a company should seek no-action relief with respect to all nominees that it wishes to exclude at the outset and should assert all available bases for exclusion at that time.
Including an Access Nominee
If a company determines that it will include an access nominee in the company’s proxy materials, the company must notify the nominating stockholder or group not later than 30 days before the company files its definitive proxy materials with the SEC. As described below, this notification will permit the nominating stockholder or group to begin soliciting in favor of its nominees and against company nominees. Under the new rules, inclusion of access nominees in the company’s proxy materials will not trigger the requirement to file preliminary proxy materials.
A company that is including access nominees in its proxy statement will have to include in the proxy statement much of the information contained in the nominating stockholder’s or group’s Schedule 14N (including, if provided, the statements in support of the nominees). In addition, the company will be required to include additional company disclosure of the type typically included in a proxy statement for a contested election.
The rules also provide that the company’s proxy card must list the company nominees as well as the access nominees (and may clearly designate the different groups), but may not include a mechanism to vote for the company nominees as a group.
Access-Related Exemptions From the Proxy Rules
The SEC has created two new exemptions from the proxy rules ¿ one for solicitations to form a nominating group under Rule 14a-11 and the other for solicitations by a nominating stockholder or group in favor of its Rule 14a-11 nominees and for or against company nominees. Neither exemption will apply in the case of solicitations relating to additional proxy access rights under state law or a company’s governing documents.
A person soliciting to form a nominating group under Rule 14a-11 would not be eligible for this new exemption from the proxy rules if the person is holding company securities with the purpose or effect of changing control of the company or gaining more board seats than permitted under Rule 14a-11. Written communications subject to this exemption must be limited in scope to a statement of intent to form a nominating group, identification of potential nominees, the percentage of voting power held by the soliciting stockholder or group and how others may contact the soliciting stockholder or group. Any such written communication must be filed with the SEC under cover of Schedule 14N on the date of first use. In the case of an oral communication relating to the formation of a nominating group, the soliciting person must file a Schedule 14N cover page (with the appropriate box on the cover page marked) with the SEC no later than the date of the first such communication. The SEC notes that this exemption is not exclusive so, for example, a stockholder could rely on the “ten person” soliciting exemption to form a nominating group without triggering a Schedule 14N filing prior to the actual nomination.
A nominating person or group may solicit in favor of its nominees to be included in the company’s proxy materials and for or against the company’s nominees without complying with the proxy rules so long as the soliciting party does not seek proxy authority or furnish a proxy card and any written materials contain a legend directing the reader to the company’s proxy statement and are filed with the SEC under cover of Schedule 14N on the date of first use. This exemption is available only after receiving notice from the company that the stockholder’s or group’s nominee will be included in the company’s proxy materials. A stockholder or group relying on this exemption may not rely on any other exemption from the proxy rules.
The nominating stockholder or group will be liable for any statement in its Schedule 14N or any other related communication that is false or misleading, regardless of whether that information is ultimately included in the company’s proxy statement. Companies will not be liable for information provided by the nominating stockholder or group that the company includes in its proxy statement.
Amendments to Rule 14a-8
SEC rules permit stockholder proposals to be excluded from company proxy statements for a variety of reasons. One such basis for exclusion has been proposals relating to director elections - the so-called “election exclusion” under Rule 14a-8(i)(8).
The new rules amend Rule 14a-8(i)(8) to narrow the scope of the election exclusion and permit stockholders to make proposals requiring or seeking amendments to a company’s governing documents to establish additional bases for proxy access containing more liberal criteria for nominations than under Rule 14a-11 (for example, lower ownership thresholds or shorter holding periods). As described in the SEC’s release, a stockholder proposal relating to an additional proxy access nomination procedure no longer would be excludable (unless there was another basis on which to omit the proposal). On the other hand, a stockholder proposal to limit or restrict proxy access under Rule 14a-11 would be excluded as conflicting with the SEC’s proxy rules. In effect, new Rule 14a-11 operates as a floor, while revised Rule 14a-8(i)(8) leaves open the potential for stockholders to seek and advocate in favor of more expansive proxy access.
1 The two deadlines will vary when the 120th day is a Saturday, Sunday or holiday. Under Rule 14a-11 (unlike Rule 14a-8), if the 120th day is a Saturday, Sunday or holiday, the deadline will be the first business day following the Saturday, Sunday or holiday.