The SEC has proposed rules that would give a shareholder or group of shareholders owning at least 1%, 3% or 5% (depending on the company’s size) of the outstanding voting shares of a public company (including registered investment companies) the right to include in the company’s proxy statement alternate candidates for up to 25% of the directors to be elected at a shareholders meeting. This is the third time some version of this controversial “proxy access” innovation has been proposed in the last six years, and this time its adoption, in some form, seems a foregone conclusion.
The federal proxy rules have never given shareholders the right to include alternate director nominees in the company’s proxy statement. Thus, to wage an election contest, dissident shareholders have been required to prepare and distribute their own proxy materials. The expenses of doing so make such contests relatively rare.
Proposed New Rule
Under proposed Rule 14a-11, a public company would be required to include in its annual meeting proxy materials alternate nominees of a dissident shareholder or group under the following conditions:
- Ownership Threshold. The shareholder or group must be the beneficial owner(s) of:
- 1% of the voting shares, for large accelerated filers (companies with a “public float” of at least $700 million, measured as of the last day of the second quarter of the prior fiscal year)1; or
- 3% of the voting shares, for accelerated filers (companies with a public float of at least $75 million but less than $700 million)1; or
- 5% of the voting shares, for non-accelerated filers (companies with a “public float” of less than $75 million)1.
- Continuity of Ownership. The shareholder or group must have held the requisite percentage of shares for at least one year. A nominating shareholder or group must also state that it intends to continue to hold the requisite amount of securities through the date of the shareholder meeting.
- Number of Nominees. A qualifying shareholder or group would be able to nominate the greater of one nominee or the number of nominees that represents up to 25% of the board, with “rounding down” if the total number of directors is not divisible by four. Thus, an eligible shareholder or group would be able to nominate one candidate for a board of seven directors, two candidates for a board of nine. For a staggered board that already includes a director (or directors) who was elected pursuant to Rule 14a-11 and is not up for reelection, the company would not need to include additional shareholder nominees if this would raise the total number of shareholder nominated-directors serving on the board above the 25% cap. As the proposed Rule is worded, a company without a staggered board would appear to receive no comparable allowance for shareholder-nominated directors elected at prior meetings and included in the company’s slate, although it is not clear that the SEC intended that result.
- Multiple Nominations. Companies would be required to accept nominations on a first-come first-served basis, until the maximum number of allowable nominees has been reached.
- Deadline for Submitting Nominations. If the company does not have an advance notice by-law for the nomination of directors, nominations must be submitted at least 120 days before the date of first mailing of the company’s proxy statement in the prior year.2 If the company does have an advance notice by-law, the deadline in the by-law will control.
- Schedule 14N. Shareholders or groups nominating director candidates under this rule must file a new Schedule 14N, disclosing the amount of shares owned and certifying that they are not seeking to change control or to gain more than minority representation on the board and providing other information about the shareholder(s) and the candidate(s). The proposed rules do not address a successful shareholder or group later changing its mind about seeking control, although failure to disclose a current intent would be subject to Rule 14a-9. Similar to the existing proxy statement exemption for a withhold-the-vote campaign, a shareholder would be able to solicit support for its nominee as long as it did not seek proxy authority, filed its soliciting material with the SEC on the date of first use and appropriately legended its materials.
- Procedures for Challenging a Nomination. If a company believes that a shareholder or group that has submitted a nomination does not satisfy some condition, it would be required to follow a process similar to what has long been in effect under Rule 14a-8, with respect to shareholder proposals. This could be time-consuming. Many public companies do have advance notice by-laws, which were drafted without a view to “proxy access.” Thus, if this feature of the proposal is not changed, companies will want to reexamine their advance notice by-law.
- Inconsistent Charter or By-Law Provisions Would Be Trumped. Any provision in a company’s charter or by-laws that imposes greater restrictions on shareholder access to the company’s proxy statement for nominations would in effect be invalidated. Thus, a by-law of a large accelerated filer that purported to grant access only to 5% shareholders would not be enforceable.
- Some Conforming Changes to the Proxy Rules and Section 13(d) 5% Reporting Rules. A number of these are proposed. In particular, a group of shareholders exercising its rights under the new rules would not thereby forfeit the right to use Schedule 13G - the short form for “passive investors.” If the shareholders collectively own more than 5%, however, they may still be a “group” that would be required to file a Schedule 13G. Although is it unlikely, this could have collateral consequences under Section 16 (short-swing profits), state antitakeover statutes, “poison pills” or even change-of-control covenants in credit agreements, depending upon the level of aggregate ownership.
Amendment to Rule 14a-8 - Shareholder Proposals
Rule 14a-8(i)(8) permits companies to exclude shareholder proposals that relate to an election for membership on a company’s board. This would be changed to permit any proposal to change the company’s director nomination procedures. Since any proposal calling for more restrictive procedures than new Rule 14a-11 would be invalid, the principal effect of this would probably be to encourage proposals calling for even greater “proxy access.”
This proposal was adopted by a split 3-2 vote of the Commissioners. Since the merits and demerits of this concept have been thoroughly debated for six years, it is perhaps not surprising that the statements each of the Commissioners have made about the proposal show few signs of doubt. Thus, barring a fundamental shift in the thinking of a Commissioner or two, the proposed rules seem likely to be adopted, although there are bound to be some changes based on the voluminous comments that are certain to be submitted. The deadline for submitting comments is August 17, 2009.
Looking beyond the likely adoption of these rules, there would be a serious question whether they represent an unauthorized intrusion by the SEC into state law, which traditionally has governed procedures for the election of directors of corporations. Litigation challenging the new rules on that basis seems likely to follow their adoption. Congress could trump such a challenge, however, by enacting legislation to grant specific authority to the SEC. One such bill is already pending.
For additional information concerning this alert, please contact the following lawyers:
Michael P. O'Brien
Laurie A. Cerveny
David K. Robbins
Janice A. Liu
1 In the case of registered investment companies, the same dollar amounts would apply, but as to net assets rather than “public float.”
2 But if the company moves the date of the meeting more than 30 days from the prior year, the deadline would be “a reasonable time” before the company mails its proxy materials.