On June 10, 2009, the Securities and Exchange Commission proposed amendments to the federal proxy rules to expand access to the board of director nomination process for eligible shareholders.  As proposed, the rule changes would make it possible, under certain circumstances, for eligible shareholders to nominate directors for inclusion in the company proxy materials and to use shareholder proposals to modify the company's nomination procedures or disclosure requirements for shareholder nominations.

The SEC has solicited comments on all aspects of the proposed rules.  The comment period for the proposed rules ends on August 17, 2009, and rapid finalization of the proposed rules by the SEC could allow the rules to be in place for the 2010 proxy season.  However, the Business Roundtable, the National Association of Corporate Directors and five other corporate groups have submitted a joint letter asking the SEC to extend the comment period by at least another 30 days, given the number and complexity of issues raised in the rule-making release.

In this Update, we summarize the proposed rule changes and offer practical tips.  Annex A to this Update highlights some of the key comment requests contained in the SEC's release.  We invite your feedback as we consider a comment letter to the SEC on the proposed amendments to the proxy rules.  Please click here to contact us with your thoughts and concerns on the proposed amendments to the proxy rules.

Background on Proxy Access

SEC Has Previously Proposed Amendments.  Shareholder access to a company's proxy materials has been hotly debated for most of this decade.  Since 2003, the SEC has twice recommended changes to the proxy rules related to the nomination and election of directors in order to increase shareholder access.  However, after significant comment, neither rule proposal was adopted.

Current Proxy Rules Are Burdensome for Shareholders.  Currently, shareholders wishing to participate in a company's nomination and election process have two options under the federal proxy rules:

  • mount a proxy contest with its attendant costs; and
  • conduct a "withhold vote" or "vote no" campaign against one or more directors.

SEC Proposals Would Give Shareholders Greater Access.  Building on its 2003 and 2007 proposals, the SEC has proposed amendments to the federal proxy rules that are designed to enable shareholders to more effectively exercise their rights to nominate and elect directors and to remove "impediments" in the federal proxy process that may inhibit the effective exercise of shareholders' state law voting rights.

Under Proposed Rule 14a-11, Shareholders Could Nominate Candidate for Inclusion in the Company’s Proxy Materials

Proposed Rules Would Affect Most Reporting Companies.  Proxy access under proposed Rule 14a-11 is intended to give shareholders the ability to have their director nominees included in the company's proxy materials (proxy statement and form of proxy) unless shareholder nominations are prohibited by state law or the company's governing documents (charter or bylaws).  The proposed rule would apply to all companies subject to the proxy rules, including investment companies.  Foreign private issuers and companies that have only a class of debt registered under Section 12 of the Securities Exchange Act of 1934 would not be subject to the proposed rule.

Highlights of the proposed rule include:

  • Nominating Shareholders Must Meet Minimum Holding Requirements to Be Eligible to Include their Nominee But Would Have Greater Ability to Communicate to Aggregate Shareholdings.  A shareholder or group of shareholders may have its nominee included in the proxy materials if the shareholder or group had beneficial ownership, for at least one year prior to the required nomination notice, of:
  • at least 1% of the voting securities of a large accelerated filer or a registered investment company with net assets of $700 million or more;
  • at least 3% of the voting securities of an accelerated filer or a registered investment company with net assets of between $75 million and $700 million; and
  • at least 5% of the voting securities of a non-accelerated filer or a registered investment company with net assets of less than $75 million.
    Shareholders may aggregate their holdings to meet the minimum ownership threshold.  Pursuant to proposed Rule 14a-11, written, but not oral, communication with other shareholders in an effort to form a nominating shareholder group would be exempt from the federal proxy rules, including the requirement to disseminate a proxy statement.  Written communications must be limited in content and filed with the SEC on the date of first use.  Shareholders may also communicate by methods that are compliant based on current exemptions from the federal proxy rules, including the exemption for oral or written communications made to no more than 10 shareholders.  The SEC proposed another exemption from the federal proxy rules for solicitations by or on behalf of a nominating shareholder or group in support of a shareholder nominee included in the company's proxy materials under proposed Rule 14a-11 or against the company's nominees.  Under the proposed exemption, a shareholder may not seek to act as proxy for another shareholder or furnish or otherwise request a form of revocation, abstention, consent or authorization and must file written communications with the SEC on the date of first use.  

    Shareholders also must represent their intent to hold the securities through the date of the meeting, as well as their intent with respect to continued ownership after the election.  In addition, shareholders must certify that they do not hold the securities for the purpose of or with the effect of changing control of the company or to gain more than a limited number of board seats.

  • Shareholder Nominees Would Be Limited in Number.  The nominating shareholder or group may nominate at least one director or up to 25% of the board, rounded down to the closest whole number below 25%.  If a company has a staggered board, the term of any director who was elected as a shareholder nominee pursuant to proposed Rule 14a-11 and whose term extends past the meeting date will count in computing the number of shareholder nominees that may be included in the company proxy materials.  For example, if a company with a 10 director board has two directors that were nominated and elected pursuant to proposed Rule 14a-11 whose terms will continue after the meeting, no shareholder nominees would need to be included in the company's proxy materials.

    If a nominee, nominating shareholder or member of a nominating shareholder group has any agreement with the company or any of the company's affiliates to nominate a candidate for director, then the nominee or any nominee of the nominating shareholder or group will not count against the number of nominees permitted by proposed Rule 14a-11.

    A first-in-time rule also applies—if more shareholder nominations are received than permitted under proposed Rule 14a-11, the first shareholder nomination received must be included in the company proxy materials, and subsequent shareholder nominations would be included in order of receipt, up to the maximum number.

  • Shareholder Nominees Must Meet Certain Independence Criteria.
  •   If the company is subject to the rules of a national securities exchange or association, the shareholder or group must make a representation that the nominee satisfies the generally applicable objective independence standards of the exchange or association.  The nominee is not required to satisfy any subjective independence standard of the exchange or association (for example, a general determination that the nominee has no material relationship with the company), the independence standard applicable to audit committee members or any additional independence standards established by the board or nominating committee.

  • The Nominee May Not Have an Agreement Regarding Nomination.  The shareholder or group must represent that neither the shareholder, any member of the group, nor the nominee have an agreement with the company regarding the nomination.

  • Nominating Shareholders Must Give Notice on Proposed Schedule 14N.  A shareholder or group seeking to nominate a candidate, whether under the proposed Rule 14a-11 or otherwise (such as through procedures established by state law or a company's governing documents), must provide a notice on the proposed Schedule 14N of its intent to require a company to include its nominee in the company proxy materials.  The notice will include representations and provide information regarding the nominating shareholder or group and the nominee.  For example, the proposed Schedule 14N would require the shareholder to represent that it is eligible to submit a nominee under proposed Rule 14a-11, and that nomination or service on the board by the nominee would not violate applicable state law, federal law, or listing standards (other than standards related to independence).

    The Schedule 14N must be provided to the company and filed with the SEC by the date specified in the company's advance notice provision or, if none, no later than 120 days before the mail date of the prior year's annual meeting proxy materials.  If an annual meeting was not held in the prior year or if the meeting date has changed by more than 30 days from the prior year, the notice must be provided a reasonable time before the company mails its proxy materials.  In such an event, the company must disclose the deadline for shareholders to submit the notice by filing a Form 8-K under a proposed Item 5.07 within four business days after the company sets the anticipated meeting date.

    The shareholder or group must amend the Schedule 14N promptly for any material change in the facts set forth in the notice, as well as file a final amendment within 10 days of the announcement of the final election results by the company.  The final amendment must indicate the shareholder's or group's intention with regard to continued ownership of their securities.  The shareholder or group would be liable for any false or misleading statements in the Schedule 14N and any amendments that are then included in the company's proxy materials.  This proposed liability standard is substantially similar to the current antifraud rule for proxy contests.
  • The Company Has Limited Bases On Which to Exclude a Shareholder Nominee.  A company may challenge a shareholder nomination pursuant to proposed Rule 14a-11 through a dispute resolution process if the company believes:
    • proposed Rule 14a-11 is not applicable to the company (e.g., applicable state law prohibits the company's shareholders from nominating a director candidate);
    • the nominating shareholder or group has not complied with the proposed
      Rule 14a-11 requirements (e.g., the shareholder or group has not held the requisite amount of securities for the required time period);
    • the nominee does not meet the proposed Rule 14a-11 requirements (e.g., the nominee's candidacy or board membership would violate applicable state law or the company's governing documents);
    • any representation in the Schedule 14N is false or misleading in any material respect; or
    • the company received more nominees than it is required to include under proposed
      Rule 14a-11.

    The dispute resolution process is modeled after the SEC's no-action process used in connection with shareholder proposals under Rule 14a-8.

Company Must Include Information About the Shareholder Nominee in its
Proxy Statement

As proposed, a company must include in its proxy statement certain disclosures regarding the shareholder or group and the nominee from the Schedule 14N, including the shareholder's or group's statement of support for the nominee (of up to 500 words), if the supporting statement is included in the Schedule 14N.  The company must also include the name of any nominee on the company's proxy card.  A company will not be responsible for any information in the Schedule 14N that is included in the proxy statement, unless the company knows or has reason to know that the information is false or misleading.  The mere inclusion of a shareholder nominee in the proxy materials would not, by itself, require the company to file a preliminary proxy statement.  In addition, the inclusion of a shareholder nominee in the company proxy materials would not constitute a "solicitation in opposition" even if the company opposes and solicits against the shareholder nominee and in favor of the company nominee.

SEC Proposes Related Changes to Rule 14a-8

Rule 14a-8(i)(8) of the Exchange Act currently allows the exclusion of shareholder proposals related to director elections.  This rule is known as the "election exclusion."  As proposed to be amended, Rule 14a-8(i)(8) would limit the election exclusion by requiring companies to include in their proxy materials certain shareholder proposals or requests to amend the company's governing documents in relation to the election of directors.  Shareholder proposals that conflict with proposed Rule 14a-11 (for example, including a higher ownership threshold) or applicable state law could be excluded.  If adopted as proposed, Rule 14a-8(i)(8) may result in shareholder proposals to establish procedures for nominating directors (and the disclosure related to such nominations) that are different than, but not in lieu of, the requirements of proposed Rule 14a-11.

However, the SEC noted that it believes companies should be able to exclude under Rule 14a‑8(i)(8) certain shareholder proposals that could result in an election contest.  As proposed, a company could exclude a shareholder proposal under Rule 14a-8(i)(8) if the proposal would:

  • disqualify a nominee standing for election;
  • remove a director before his or her term expired;
  • question the competence, business judgment, or character of a nominee or director;
  • nominate a specific individual for election, other than pursuant to proposed Rule 14a-11, an applicable state law provision, or a company's governing documents; or
  • otherwise could affect the outcome of the upcoming election of directors.
Practical Tips
  • Companies Should Discuss Proposed Rules With Their Boards.  Affected companies should begin to consider the impact of the adoption of the proxy access rules, including an increased number of shareholder nominees running in opposition to the company's candidates.  A company should discuss the proposed rules with its board of directors and consider how the proposed rules will impact the company's proxy statement reporting process and disclosure controls.

  • Companies Should Review Governing Documents and State Law.  Companies should consider reviewing their governing documents, nominating committee charter and other corporate policies to determine whether any changes may be necessary if the proposed federal proxy rule amendments are adopted.  For example, the inclusion of a shareholder nominee or nominees under the proposed rules will likely result in a plurality voting standard for those companies that have adopted a majority voting standard because there will be more nominees than board seats.  Companies that have adopted a majority voting standard that reverts to a plurality standard in a contested election will need to examine their governing documents and policies related to contested elections to determine how they will function in connection with the proposed rules.  The American Bar Association's Task Force on Shareholder Proposals has prepared an illustrative bylaw that suggests companies set minimum ownership and time period thresholds.  The task force also suggests that companies consider barring nominees who withdrew or received less than a certain percentage of votes in past elections.

    Additionally, companies should consider any recent or contemplated changes to state corporate law.  For example, effective August 1, 2009, the Delaware General Corporation Law will be amended to permit the adoption of a bylaw regulating shareholder access to the company's proxy materials in connection with the election of directors and authorizing, under certain circumstances, the reimbursement of expenses incurred by a stockholder in soliciting proxies in connection with an election of directors.  You can find these new provisions of the Delaware General Corporation Law here.  
Traps for the Unwary
  • How Many Interested Directors Should Serve?  As proposed, the proxy access rules do not address incumbent directors who were nominated outside of the proposed Rule 14a-11 process, such as pursuant to an applicable state law provision, a company's governing documents, or a proxy contest.  The rules also do not take into account shareholder nominees voluntarily included by the company or any existing contractual obligations to appoint directors.  As noted in the Key SEC Requests for Comments attached as Annex A to this Update, companies should consider whether directors nominated or elected pursuant to these other methods should affect the maximum number of directors allowable pursuant to proposed Rule 14a-11.

  • Will Companies Have Adequately Qualified and Compliant Board Members?  Under the proposed rules, consideration will not be given to whether a shareholder nominee satisfies subjective standards for independence even when the company is subject to the independence standards of a national securities exchange or association that include subjective components.  Nor will the shareholder nominee have to comply with more stringent independence standards adopted by a company.  Shareholder nominees also need not comply with the independence or other standards (such as financial literacy and sophistication) required for service on the company's audit committee.  Companies should consider whether additional eligibility criteria should be included in the proxy access rules to ensure proper board composition, should shareholder nominees be elected.

Additional Information

This Update provides only a summary of the proposed regulation.  You can find a copy of the full text of the proposed rules here.  

Annex A

Key SEC Requests for Comment

The SEC's release contains approximately 170 specific comment requests.  The majority of the comment requests contain multiple questions.  Key areas in which the SEC is soliciting comments include the following:

  • Whether revisions to the proxy rules are necessary to facilitate shareholder access in light of changes in corporate governance over the past six years, including the movement from plurality to majority voting, and ongoing developments, including the changes adopted or being considered by states to allow companies to adopt bylaws related to shareholder access and reimbursement;
  • How conflicts, if any, between the proposed rules and any state law, federal law or rule of a national securities exchange or association should be handled;
  • The effect of Rule 14a-11 on any particular group of companies, including smaller reporting companies, and whether the SEC should exclude smaller reporting companies or any other group of companies from compliance with the procedures of Rule 14a-11, either on a temporary or permanent basis;
  • Whether Rule 14a-11 should apply to a company that has or adopts a provision in its governing documents that provides for or prohibits the inclusion of shareholder nominees in the company proxy materials; whether a company's governing documents may render Rule 14a-11 inapplicable only if the shareholders approved the provision addressing inclusion of shareholder nominees in the company proxy materials; whether companies should be able to take steps or actions, including adopting a majority vote standard or a bylaw addressing shareholder access, to prevent application of Rule 14a-11;
  • Whether Rule 14a-11 should apply only after the occurrence of certain triggering events, including a certain percentage of withhold votes for one or more directors, economic performance, being delisted by an exchange, being sanctioned by the SEC or other regulators, having to restate earnings or failing to take action on a shareholder proposal that received a majority shareholder vote;
  • Whether the proposed ownership thresholds (i.e., 1%, 3% or 5%) and the minimum holding period requirement (i.e., one year as of the date of notice) are appropriate;
  • Whether the shareholder should be required to represent that it will hold the securities for some period of time beyond the election if the shareholder's nominee is elected;
  • Whether a shareholder or group should be denied eligibility if it had a nominee included in the company proxy materials and the nominee did not receive a sufficient percentage of the votes; whether a nominee should be denied eligibility if it had been included in the company proxy materials and did not receive a sufficient percentage of the votes;
  • Whether shareholders should be able to aggregate their holdings in order to satisfy the ownership thresholds;
  • Whether shareholders should be required to represent that they will not seek to change the control of the company or to gain more than a limited number of seats on the board for a period of time beyond the election;
  • Whether the nominee should be subject to the subjective independence standards of an exchange or association, the independence standards applicable to audit committee members or a company's more stringent independence requirements; whether the shareholder should bear the burden of determining the effect of the nominee's election on the company's compliance with any independence requirements; whether the company or its nominating committee should have any role in determining whether a shareholder nominee satisfies the applicable objective independence standards;
  • Whether the proposed maximum percentage of shareholder nominees (i.e., 25%) is appropriate and whether the proposed rule should address situations where the governing documents provide a range for the number of directors rather than a fixed number;
  • Whether any limitation on shareholder nominees should take into account incumbent directors nominated outside of the Rule 14a-11 process, including pursuant to state law, a company's governing documents or a proxy contest;
  • Whether it is appropriate to permit the first nominating shareholder or group to provide notice to include its nominee(s) in the proxy materials where there is more than one eligible nominating shareholder or group;
  • Whether the Schedule 14N should contain additional disclosure regarding the shareholder or group or nominee or additional representations (e.g., a representation by the nominee concerning their understanding of his or her fiduciary duties under state law);
  • Whether there should be a prohibition on any affiliation between the shareholder or group and the nominee; and
  • Whether the revisions to Rule 14a-8(i)(8) should be adopted even if Rule 14a-11 were not adopted.