The Securities and Exchange Commission has proposed a highly controversial set of rules granting shareholders greater ability to nominate directors through a company's proxy process by requiring a company to include in its proxy materials information on director candidates nominated by eligible shareholders.

Many commentators immediately criticized the proposed rules, citing the potential to turn annual meetings into contested elections, divert management's attention and corporate resources from the company's business, and allow special interest groups to elect directors who may not represent the best interests of all the company's shareholders.

Comments on the proposed rules, which contain an extensive list of questions regarding the proposed rules and various alternatives, are due to the SEC by December 22, 2003. In light of the extensive list of questions and amount of controversy surrounding the proposed rules, the final rules on this topic may not be released prior to the start of the 2004 proxy season.

The following questions and answers outline the material terms of the proposal:

Q: Would the New Nomination Procedures Apply to All Companies?

A: No.

Only companies subject to the proxy rules of the Securities Exchange Act of 1934 would be subject to the new shareholder nomination procedures in the proposal. Investment companies registered under Section 8 of the Investment Company Act would be subject to similar procedures.

The SEC is considering limiting the initial application of the new nomination procedures to "accelerated filers" and investment companies in order to avoid disproportionately affecting smaller companies.

Q: Are There Certain Events That Would Trigger the New Procedures?

A: Yes.

The proposed shareholder nomination procedures would be triggered upon the occurrence of either of the following two "triggering events" at an annual meeting of shareholders held after January 1, 2004:

• A company nominee for the board of directors receives "withhold" votes from at least 35% of the votes cast at the meeting; or

• A shareholder, or group of shareholders, submits a "direct access" proposal providing for the company to be subject to the new nomination procedures and provides evidence that they have held more than 1% of the company's securities entitled to vote on the proposal for a period of at least one year from the date of the proposal; and the proposal receives more than 50% of the votes cast on that proposal at the meeting.

The SEC is also considering whether to include a third triggering event – failure of the board of directors to implement any proposal by a shareholder under Exchange Act Rule 14a-8 that received the support of a majority of the votes cast at a prior meeting by the 120^thday prior to the anniversary of the date the company mailed its proxy materials.

Once a triggering event has occurred, the new nomination procedures remain in effect for approximately two calendar years, through the annual meeting held during the second calendar year.

Q: Does the Company Have to Publicly Disclose a Triggering Event?

A: Yes.

A company would be required to disclose the occurrence of any triggering events, and inform its shareholders, on its Form 10-Q, 10-QSB, 10-K, or 10-KSB for the period in which the event occurred.

Q: Must a Shareholder Who Wants to Nominate a Director Notify the Company?

A: Yes.

Eligible shareholders must notify the company of their intention to nominate a director for election at least 80 days prior to the anniversary of the date on which the company mailed its annual meeting proxy materials for the prior year, and must include:

• a copy of the nominating shareholders' Exchange Act Schedule 13G, indicating ownership of more than 5% of the company's securities entitled to vote;

• specific information about the nominee;
• a number of representations, including representations that the nominating shareholders and their nominees each meet the eligibility requirements set forth in the new rules;
• the nominee's consent to serve on the board if elected; and
• a description of the methods by which the nominating shareholders may solicit shareholders.

This notice must also be filed with the SEC as soliciting material within two days after the notice is provided to the company.

Q: Must the Company Include All Shareholder Nominees in Its Proxy Materials?

A: No.

The company would have to include between one and three nominees in its proxy materials, depending on the number of directors on its board.

The company would have to present all candidates in an impartial manner, but if the company includes any statement supporting or opposing any nominees, other than a recommendation that shareholders vote in favor of, or withhold votes from, certain specified candidates, the company would have to permit the nominating shareholders to include a supporting statement for their nominees of less than 500 words.

A company would be permitted to determine that it is not required to include a nominee in its proxy materials if:

• The company is not subject to the direct access procedures;

• The nominee does not meet the requirements of the procedures;
• Any representation required to be included in the notice to the company is false in any material respect; or
• The company has received more nominees than it is required to include under the proposed rules.

The company would need to provide prompt notice to the shareholders of this determination, and include the basis for the company's determination. This information would also need to be included in the proxy statement.

Q: Are There Limits on Which Shareholders Are Eligible to Nominate a Director?

A: Yes.

Any shareholder, or group of shareholders, who desires to nominate a director for inclusion in the company's proxy statement must:

• not be seeking control of the board of directors, and therefore be eligible to file a short form beneficial ownership report on Exchange Act Schedule 13G designed for passive investors;

• beneficially own, individually or in the aggregate, more than 5% of the company's securities eligible to vote for the election of directors at the next annual or special meeting of shareholders;
• have held such securities continuously for a period of at least two years from the date of the nomination;
• intend to continue to own such securities through the date of the annual or special meeting; and
• have filed a beneficial ownership report for such securities on Exchange Act Schedule 13G before or on the date of submission of the nomination certifying that they have held the 5% beneficial ownership for the two-year holding period.

Q: Are There Limits on Who Can Be an Eligible Nominee?

A: Yes.

The company can exclude any nominee that would violate controlling state law, federal law or the rules of a national securities exchange or association (excluding certain aspects of the rules on independence) or who would not be independent from the nominating shareholder or shareholders under standards set forth in the rules.

Text of the Proposal

This Update is only a summary of the proposal. You can find the full text of the proposal at http://www.sec.gov/rules/proposed/34-48626.htm.

You can find a general discussion of related proposals and of other recent laws, regulations and rule proposals of interest to public companies on our website.

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