The Securities and Exchange Commission (the “SEC”) has adopted amendments to the federal proxy rules of the Securities Exchange Act of 1934 (the “Exchange Act”) intended to facilitate shareholder access to a company’s proxy materials, including the rights of shareholders to nominate directors to a company’s board.
APPLICATION
The new proxy access rules apply to all Exchange Act reporting companies, including investment companies and controlled companies, with a limited exception for companies whose only public securities are debt securities. Companies may not “opt out” of the rules, either in favor of a different framework or no framework, unless the company’s governing documents prohibit a shareholder from nominating a candidate for election altogether. This latter exception is very narrow because it will not likely apply to companies’ incorporated in jurisdictions, including Delaware, where a shareholder’s right to vote includes the right to nominate a contesting slate.
PHASE-IN PERIOD FOR SMALLER REPORTING COMPANIES
Smaller reporting companies (i.e., those with a public float of less than $75 million) will not be subject to the new rules for three years. This delay is intended to allow such companies to better prepare for implementation by providing a chance to observe how the rules operate for others. It will also allow the SEC to make a more informed determination as to whether the rules should be adjusted for these companies.
SHAREHOLDER DIRECTOR NOMINATION
New Exchange Act Rule 14a-11 requires companies to include shareholder nominees for director in the company’s proxy materials if the nominating shareholders meet the following conditions and if the shareholders are not otherwise prohibited from nominating a candidate for election as a director either by applicable state or foreign law, or by the company’s governing documents.
- The nominating shareholder must hold both investment power and voting power of securities representing at least 3% of the votes entitled to be cast at the meeting for the election of directors. Shareholders may aggregate shares to meet this threshold. In some circumstances, loaned securities may be counted towards the ownership threshold. Certain other securities sold in a short sale or borrowed for purposes other than short sale must be excluded. The rule does not, however, require exclusion of shares hedged by other methods, such as through derivatives or swaps. Thus, a nominating shareholder may satisfy the voting and investment power requirements while still hedging economic risk.
- A nominating shareholder (or in the case of a group, each member of the group) must have held the qualifying amount of securities continuously for at least three years as of the date notice is given of the intent to nominate the directors, must continue to own the qualifying amount of securities through the date of the meeting at which the directors are elected, and must provide disclosure regarding any intentions to sell the securities after the election of the directors.
The ownership requirement may cause small and mid-cap companies to be impacted more than companies having large capitalizations because the 3% ownership hurdle will require a lower capital investment. In addition, because hedge funds often comprise a larger percentage of the big investors in smaller-cap companies, the new rules may precipitate more shareholder activism by hedge funds with respect to these companies.
Where even a single shareholder nominee is included in a company’s proxy materials, the resulting election will be contested. Since majority voting policies apply only in uncontested elections, shareholder nominee inclusion will have the effect of causing the election to revert to a plurality vote. A company should consider conforming its bylaws to the new rule to ensure that majority voting policies are disabled in a proxy access situation.
Given these new rules, companies should evaluate their shareholder base and consider initiating outreach programs, or reevaluating existing programs, to engage shareholders most likely to initiate or be asked to support a proxy access nomination. Companies should also review other issues that could emerge during a campaign, such as director qualification standards. Though these may not be an effective basis for excluding nominees, such standards may be beneficial to the extent that they provide a record of board deliberation on the subject. Further, a thoughtful discussion of the principles underlying board composition may be helpful for advocacy purposes if the removal of a targeted director would leave the board lacking certain skill sets or expertise. Although directors are charged with representing the interests of all shareholders, it is more likely under the new rules that board seats will be held by directors with a bias toward certain shareholder constituencies. A company may wish to underscore the directors’ obligations to maintain the confidentiality of board deliberations by having directors sign confidentiality agreements or by adopting corporate confidentiality, Regulation FD and conflict of interest policies that include directors.
RULE 14a-11 NOTICE REQUIREMENTS
To nominate a director in reliance on Rule 14a-11, the nominating shareholder or group must give notice by submitting a Schedule 14N to the SEC and the company no earlier than 150 days and no later than 120 days before the date that the company mailed its proxy materials for the prior year’s annual meeting.
Many companies have advance notice bylaws for director nominations that typically require a minimum notice period and information about the nominee and the nominating shareholders.The new proxy access rules exist alongside any other director nomination procedure provided for in the company’s bylaws and cannot be changed or limited by advance notice provisions.
A company may ensure that its bylaws are consistent with Rule 14a-11 by including a saving clause providing that a valid notice under the Rule will be valid under the bylaw. It is not advisable that a company align its advance notice period with Rule 14a-11 because in some jurisdictions, including Delaware, a notice period deemed unreasonably long (often said to be a period of more than 120 days from the meeting date) may not be enforceable.
NEW FORM 8-K ITEM
If a company did not hold an annual meeting during the prior year, or if the date of the meeting has changed by more than 30 days from the prior year, the company must file a Form 8-K within four business days of determining the anticipated meeting date and disclose the date by which a nominating shareholder or group must submit notice to include a nominee in the company’s proxy materials pursuant to Rule 14a-11. The date disclosed as the deadline for such shareholder nominations must be a reasonable time before the company mails its proxy materials. A company, therefore, should establish a control procedure so that when the annual meeting date is established a determination will be made as to whether a Form 8-K must be filed.
SCHEDULE 14N DISCLOSURES AND CERTIFICATIONS
Schedule 14N requires disclosures concerning (1) the amount and percentage of the voting power of the securities held by the nominating shareholder and the length of ownership; (2) biographical information about the nominating shareholder similar to the disclosure currently required in a contested election; and (3) whether or not a nominee satisfies the company’s director qualifications, if any.
Schedule 14N also requires that (1) the shareholder intend to continue to hold the securities through the date of the meeting; (2) that the shares are not held with the purpose or effect of changing control of the company or to gain seats on the board in excess of the maximum number of shareholder nominees that the company may be required to include in its proxy materials; and (3) each shareholder nominee satisfies the requirements of Rule14a-11. A nominating shareholder may also elect to include a statement of support for its nominee, not to exceed 500 words.
A nominating shareholder relying on Rule 14a-11 is liable for any false or misleading statements in disclosures made in connection with a nomination, regardless of whether such information is included in the company’s proxy materials. The company, conversely, is not responsible for statements provided by the nominating shareholder and then reproduced in the company’s proxy materials.
SHAREHOLDER DIRECTOR NOMINEES
A company is not required to include a shareholder nominee in its proxy materials if the nominee’s candidacy or membership on the board would violate applicable state, federal or foreign laws or the applicable standards of the national securities exchange or national securities association. Further, a shareholder nominee must meet the objective independence standard that relies on a subjective determination by the board.
Under Rule 14a-11, a company is required to include in its proxy materials the greater of one shareholder nominee or the number of nominees that represents up to 25% of the company’s board of directors. Where a company has a classified board, previously-elected shareholder nominees count towards the 25% maximum in future years to the extent the term of office of a previously elected nominee extends past the date of the pending shareholder meeting. Thus, companies with classified boards are not disadvantaged by the rule.
Neither the nominating shareholder nor the nominee may have a direct or indirect agreement with the company regarding the inclusion of a shareholder nominee on the board of directors unless (1) the agreement was reached after the shareholder filed the Schedule 14N and (2) the company did not have any discussion with the shareholder prior to filing. This prohibition discourages a company from negotiating with a dissident shareholder that has held at least 3% of its voting securities for at least three years until the Schedule 14N is filed. The rule is intended to prevent nominating shareholders from acting as a substitute for the company and blocking the use of the 25% allowance by other shareholders.
In the event of multiple shareholder director nominations, the nominating shareholder or group with the highest percentage of the company’s voting power would have its nominees included in the company’s proxy materials, up to the 25% ceiling. This is a departure from the SEC’s proposed rules, which gave preference to the “first to file”.
INCLUDING AND EXCLUDING SHAREHOLDER DIRECTOR NOMINATIONS
On receipt of a Schedule 14N notice, a company must, in the absence of grounds to exclude a shareholder nomination, include the nominee in its proxy material disclosures and, if provided, a statement in support of the nominee. A company may indentify any shareholder nominees as such, but is otherwise required to present the nominees in an impartial fashion as per Exchange Act Rule 14a-4.
Slate or group voting for or against all nominees for director is impermissible where a shareholder nominee is included in the proxy materials. There is no limit to the number of times a person may stand for election as a shareholder nominee.
Grounds for excluding a shareholder nominee include the following:
- Rule 14a-11 is not applicable to the company;
- The nominating shareholder or nominee failed to satisfy the eligibility requirements for Rule 14a-11; or
- The company has already reached the maximum number of shareholder nominees required to be included in its proxy materials.
If the company desires to exclude a shareholder nominee, and it has legal grounds to do so, the company must give notice to the SEC of its intent to exclude and must also notify the nominating shareholder of any deficiencies in the Schedule 14N notice and afford the nominating shareholder 14 calendar days to cure such deficiencies. In determining whether a nomination must be included in the proxy materials, the company should submit a request for an informal opinion from the SEC, commonly referred to as a “no-action” request.
COMMUNICATIONS RELATED TO SHAREHOLDER DIRECTOR NOMINATIONS
The new rules carve out two narrow exceptions to the prohibition against solicitations prior to the filing and dissemination of a proxy statement. Written and oral solicitations by shareholders seeking to form a nominating shareholder group are exempt where (1) the shareholder is not holding the securities for the purpose or effect of changing control of the company or to gain seats on the board in excess of the maximum number of shareholder nominees that the company may be required to include in its proxy materials and (2) any written communication is limited to a statement of the shareholder’s intent to form a group and certain other limited information, and is filed with the SEC with the Schedule 14N. A shareholder making oral solicitations in reliance on this rule must file a notice of such on the Schedule 14N.
Written and oral solicitations by or on behalf of a nominating shareholder in support of a nominee are also permitted if the nominating shareholder has received notice that the nominee will be included in the proxy materials and the shareholder is not seeking proxy authority. Written materials would need to be filed with the Schedule 14N and must include the identity of the nominating shareholder, disclosures regarding securities holdings and must advise shareholders to read the company’s proxy statement.
SCHEDULE 13G REPORTING
A shareholder or group that owns more than 5% of a class of equity securities and is a passive investor may report that ownership by filing a Schedule 13G. The formation of a shareholder group for the purpose of nominating a director under Rule 14a-11 or soliciting activities in connection with such a nomination will not result in the nominating shareholder or group losing eligibility to report their ownership on a Schedule 13G. Should the nominee be elected to the board, the nominating shareholder would, however, have to reevaluate whether it continues to be a passive investor.
SHAREHOLDER NOMINEES PURSUANT TO STATE OR FOREIGN LAW OR A COMPANY’S GOVERNING DOCUMENTS
A nominating shareholder relying on a procedure under state or foreign law or a company’s governing documents to include a director nominee in a company’s proxy materials is required to provide disclosure to the company regarding the nominating shareholder and nominee on Schedule 14N and file the same with the SEC. The disclosures are largely the same as those required under rule 14a-11.
SHAREHOLDER PROPOSALS RELATED TO NOMINATING PROCEDURES
Under amended Exchange Act Rule 14a- 8(i)(8), companies, under certain circumstances, are required to include in their proxy materials shareholder proposals that seek to establish a procedure in the company’s governing documents for the inclusion of shareholder director nominees in the proxy materials. This is an important departure from the old rule, which allowed companies to exclude such proposals. Any provisions adopted by the shareholders under this rule will serve as an additional avenue for shareholders to submit nominees for inclusion in the proxy materials, and will not displace the availability of Rule 14a-11.
The amendments to Rule 14a-8, codifying certain prior SEC positions, permit exclusion of a proposal to amend nomination procedures if it:
- Would disqualify a nominee who is standing for election;
- Would remove a director from office before his or her term expired;
- Questions the competence, business judgment or character of any nominee;
- Seeks to include a specific individual in the company’s proxy materials for election to the board of directors; or
- Could otherwise affect the outcome of the upcoming election of directors.
EFFECTIVE/ COMPLIANCE DATE
The new rules are scheduled to take effect on November 15, 2010. Compliance with the amendments is required beginning on the effective date, except for smaller reporting companies subject to the phasein period, discussed above.