Quick Jumps: Executive Summary Suggested Action Items
On August 25, 2010, the Securities and Exchange Commission (the “SEC”), in a 3-2 vote, adopted fundamental changes to the federal proxy rules that provide shareholders of a public company means of having the shareholders’ nominees included in the company’s proxy materials. These new “proxy access rules” will become effective on November 15, 2010.
The process by which directors are nominated and elected has been criticized by some investors for affording shareholders little ability to exercise their rights as owners of corporations. Although shareholders who are dissatisfied with the company’s slate of directors can mount a proxy context under the SEC’s proxy rules, the costs and procedural challenges of a proxy contest are prohibitive for all but the most sophisticated and well-capitalized investors. Accordingly, few shareholders use this process.
Although the SEC made a similar proxy access proposal in 2003, it largely abandoned it in 2007. Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act enacted on July 21, 2010, however, the SEC was granted explicit authority to make rules addressing shareholder access to company proxy materials and the SEC used this authority to adopt the following rules and amendments. The complete text of the SEC’s adopting release, as published in the Federal Register, can be viewed at http://www.sec.gov/rules/final/2010/33-9136fr.pdf.
I. Executive Summary
Timing and Effectiveness of Rule 14a-11, Shareholder Nominations, and Amendments to Rule 14a-8, Shareholder Proposals
- Proxy access for shareholders’ nominees is embodied in new Rule 14a-11, Shareholder Nominations
- Rule 14a-11 becomes effective on November 15, 2010
- There is a three-year delay before Rule 14a-11 applies to “smaller reporting companies”
- Rule 14a-8, Shareholder Proposals, was amended to allow shareholder bylaw proposals on proxy access, including proposals for greater access than is permitted by Rule 14a-11
- The Rule 14a-8 changes also becomes effective November 15, 2010, including for smaller reporting companies
- Rules 14a-11 and 14a-8 supersede any conflicting properly brought business or advance notice bylaw provisions
- Form 8-K was also amended, effective November 15, 2010, to require companies to disclose if the date of their annual meeting has changed
- Nominating shareholders must have owned a minimum of 3% of a company’s securities continuously for at least 3 years, continue to hold the securities through the meeting date and disclose their intent with respect to continued ownership of their shares after the election
- Shareholders may not utilize Rule 14a-11 with the purpose or effect of changing control
- In the event multiple shareholders or groups submit director nominees, the shareholder or group with the highest qualifying voting percentage will be given priority
Number of Shareholder Nominees
- Shareholders may include in a company’s proxy materials the greater of one nominee or a number of nominees representing 25% of a company’s board of directors
Shareholder Notice Requirements
- Notice of intent to use Rule 14a-11 must be filed with the SEC on Schedule 14N via EDGAR
- Notice on Schedule 14N must be filed 120 to 150 days before the mailing date for the annual meeting proxy statement
Company Notice Requirements and Liability
- Certain notice procedures are required before a company may exclude a director nominee from its proxy materials for failure to satisfy the requirements of Rule 14a-11
- Companies will not be liable for information provided by a nominating shareholder or group that is reproduced in the proxy materials
II. Effectiveness and Timing of Proxy Access Rules
The deadline for eligible shareholders to submit nominations under the new proxy access rules is 120 days before the anniversary date of the mailing of the company’s proxy statement in the prior year. Accordingly, shareholders will be allowed to submit director nominees for inclusion in the 2011 proxy statement if the 120-day deadline falls on or after November 15, 2010. Therefore, shareholders would generally have a proxy access right if a company mailed its proxy materials for its 2010 annual meeting on or after March 15, 2010. If a company mailed its proxy materials for its 2010 annual meeting before March 15, 2010, Rule 14a-11 would not be applicable for the company’s 2011 annual meeting.
III. Summary of Rule 14a-11, Shareholder Nominations
Right to Include Shareholder Nominees. New Rule 14a-11 generally provides that a shareholder or group of shareholders that complies with the eligibility and other requirements of the rule may include one or more director nominees in a company’s proxy materials and on the company’s form of proxy card.
Companies Subject to the New Rule. Rule 14a-11 applies to all companies that are subject to the SEC’s proxy rules under the Securities Exchange Act of 1934, including registered investment companies and controlled companies, but excludes companies subject to the proxy rules solely because they have a class of registered debt. Rule 14a-11 applies to the election of directors at an annual meeting, special meeting or action by written consent in lieu of an annual meeting. The only way for a company to “opt out” of proxy access is if state law or the company’s governing documents completely prohibit shareholders from nominating candidates for election to the board of directors, instead of merely prohibiting the inclusion of shareholder nominees in the company’s proxy materials or instead of merely conditioning the nomination on procedures set out in the company’s bylaws.
Eligibility of Nominating Shareholders. A nominating shareholder or group of shareholders must meet the following eligibility requirements in order to have their director nominees included in a company’s proxy materials under Rule 14a-11:
- Investment Power. On the date the nominating shareholder or group provides notice of a nomination on Schedule 14N, the shareholder individually, or the group in the aggregate, must have both voting and investment power over securities representing at least 3% of the voting power of the company’s securities entitled to vote in the election of directors at the meeting. Securities loaned to third parties are included in the calculation of voting power under Rule 14a-11 if the shareholder has a right to recall the securities, but borrowed securities or securities sold in a short sale are excluded. Also excluded are securities the shareholder or group has a right to acquire in the future (for example, by exercise of options or warrants or conversion of preferred stock). In this way, the calculation of investment power differs from other common methods of calculating share ownership, such as for the purposes of the beneficial ownership table as required under Item 403 of Regulation S-K.
- Holding Period. The nominating shareholder or each member of a nominating shareholder group must have owned the minimum amount of required shares continuously for at least 3 years and continue to own at least the required amount of shares through the date of the meeting at which the directors are elected. The measuring date for ownership is the date on which the shareholder or group provides notice of the nomination.
- Shareholder Intent. Shareholders are not eligible to utilize Rule 14a-11 if they are 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 of directors that exceeds the maximum number of nominees a company is required to include in its proxy materials under Rule 14a-11.
- Agreements with the Company. Neither the nominating shareholder nor any member of a nominating shareholder group may have a direct or indirect agreement with the company regarding the nomination of the nominee. Unsuccessful negotiations between the shareholders and the company, or negotiations that are limited to whether the company is required to include the shareholder nominee in the proxy statement, do not represent a direct or indirect agreement with the company.
- Multiple Shareholder Nominations. If a nominating shareholder or any member of a nominating shareholder group submits additional director nominees to the company or participates in more than one shareholder nominating group for the same company, the nominating shareholder and each respective group will become ineligible under Rule 14a-11 and all their nominees will be excluded from the company’s proxy materials.
Eligibility of Shareholder Director Nominees. A shareholder director nominee must meet the following eligibility requirements in order to be included in a company’s proxy materials under Rule 14a-11:
- Violation of Applicable Laws. A nominee’s candidacy or, if elected, board membership must not violate controlling state, federal or foreign law, including rules of an applicable national securities exchange or association and laws governing board membership in certain regulated industries.
- Independence Standards. A nominee must satisfy the objective independence standards of any applicable national securities exchange or national securities association such as the New York Stock Exchange or The Nasdaq Stock Market. A nominee is not required to satisfy any standards the company may have adopted relating to director nominees, for example background or experience, age limits, or company-specific standards for independence.
- Agreements with the Company. A director nominee may not have a direct or indirect agreement with the company regarding the nomination.
- Additional Standards. A nominee is not required to meet any additional director qualification standards set forth in a company’s governing documents. The nominating shareholder or group must disclose, however, to the best of its knowledge, whether a nominee meets these requirements and a company may disclose in its proxy materials whether a nominee meets the company’s director qualifications. Furthermore, there are no restrictions on the relationship between the nominating shareholders and the director nominees.
Number of Shareholder Nominees. Rule 14a-11 permits a shareholder or group of shareholders to include the greater of (i) one nominee or (ii) a number of nominees that represents up to 25% of a company’s board of directors, rounded down to the closest whole number. The 25% limit is calculated based on the total number of board seats, including vacant seats, because it is the size of the full board that is relevant for considering the effect on control.
Likewise, if a company has a classified board structure, the percentage calculation is based on the total number of director seats, not just the number of seats being voted on at the subject shareholder meeting. Any director who was previously elected to a classified board pursuant to Rule 14a-11, and whose term would continue past the date of the upcoming shareholder meeting electing directors, however, would count against the 25% limit. If multiple shareholders or groups nominate director candidates in excess of the 25% limit, the shareholder or group with the highest qualifying voting percentage will be given priority.
Finally, a company that reaches an agreement to include a shareholder’s or group’s nominee in its proxy materials as a company nominee may count that nominee towards the 25% limit of Rule 14a-11 if the nominating shareholder or group: (i) had priority over any other nominating shareholders or groups; (ii) would otherwise be eligible to have its nominees included in the proxy materials; and (iii) filed its notice of nomination on Schedule 14N before beginning any discussions with the company about the nomination.
Notice on New Schedule 14N. A nominating shareholder or group is required to provide a company with notice of its intent to use Rule 14a-11 and file this notice on the same day with the SEC via EDGAR on new Schedule 14N. 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. Pursuant to Rule 14a-8, a company is required to disclose in its proxy statement the deadline for proxy access nominations in connection with the following year’s shareholder meeting. If the company did not hold an annual meeting during the prior year, the date of the annual meeting has changed by more the 30 days from the prior year, or the company is holding a special meeting or acting by written consent in lieu of an annual meeting, director nominations must be received within a reasonable time before the company mails its proxy materials and that deadline must be disclosed in a Form 8-K filed by the company within four business days of the date it determines the meeting date.
Schedule 14N Disclosure Requirements. A notice on Schedule 14N filed by a nominating shareholder or group must contain the following disclosure items:
- Nominee and Shareholder Information. Biographical and other information about the nominating shareholder or shareholders in a group and the director nominees, similar to the disclosure currently required in a proxy statement relating to a contested election.
- Relationships with the Company. Disclosure regarding any material relationships between the nominating shareholder or group, the director nominee and the company or any affiliates, including any agreement and any pending or threatened litigation.
- Security Ownership Information. Disclosure regarding the amount of securities owned by the nominating shareholder or group, including the percentage of voting power and the length of time the securities have been continually held, including proof that the 3% ownership requirements of Rule 14a-11 have been satisfied.
- Statement of Intent. A statement that the shareholders intend to hold the securities through the date of the shareholder meeting and a statement regarding the shareholder’s or group’s intent with respect to continued ownership following the election of directors.
- Certifications. Certifications confirming that (i) the nominating shareholder or group does not intend to gain control of the board or gain a number of seats that exceeds the number of nominees the company would be required to include in its proxy materials under Rule 14a-11 and (ii) the nominating shareholder or group and its respective director nominees satisfy the requirements of Rule 14a-11.
- Director Qualification Standards. A statement regarding whether, to the best of the nominating shareholder’s or group’s knowledge, the director nominees meet a company’s director qualifications, if any, contained in the company’s governing documents.
- Exchange Independence. A statement that, to the best of the nominating shareholder’s or group’s knowledge, the nominee meets the objective criteria for independence of the stock exchange rules applicable to the company.
- Consent of Nominees. A statement that the nominees consent to be named in the company’s proxy materials and, if elected, serve on the company’s board of directors.
- Website Information. Disclosure of any website address on which the nominating shareholder or group intend to publish any soliciting materials.
- Optional Disclosure. A statement of support for each nominee, not to exceed 500 words per nominee.
- Final Amendment. A nominating shareholder or group must file a final amendment to their Schedule 14N within 10 days of the final results of the board of directors election, which must disclose their intention regarding continued ownership of their shares.
Excluding a Shareholder Director Nominee. The opportunities for a company to bring a meaningful challenge to a shareholder’s or group’s nominee are primarily limited to the most obvious bases, such as: (i) Rule 14a-11 is not applicable to the company; (ii) the nominating shareholder, shareholder group or director nominee fails to meet the eligibility requirements of Rule 14a-11; or (iii) the number of shareholder director nominees exceeds the maximum number permitted under Rule 14a-11. A company may not exclude a shareholder’s or group’s director nominee, however, on the basis that the Schedule 14N or the supporting statement is false or misleading.
Disclosure Liability. A company will not be liable for information provided by a nominating shareholder or group that is reproduced in the company’s proxy materials. A nominating shareholder or group will, however, be liable for any false or misleading statement contained in a Schedule 14N or any related communication, regardless of whether that information is ultimately included in a company’s proxy materials. Accordingly, a company cannot omit from its proxy materials information provided by a nominating shareholder or group that the company believes is materially false or misleading. The company must instead address the purported false or misleading information through its own disclosures in its proxy materials.
IV. Additional Proxy Access Rules
Shareholder Proposals. Rule 14a-8(i)(8) previously allowed companies to exclude from their proxy statements any shareholder proposal that related to a nomination or election to the company’s board of directors. Amended Rule 14a-8(i)(8) now allows shareholders to submit proposals for inclusion in a company’s proxy statement that seek to establish or amend provisions in a company’s governing documents related to proxy access rights. Proposals may establish proxy access criteria more permissive than Rule 14a-11, such as lowering the 3% ownership threshold or shortening the 3-year holding period. However, any shareholder proposal that seeks to limit or restrict proxy access under Rule 14a-11 would be excluded as conflicting with the SEC’s proxy access rules. The current eligibility provisions of Rule 14a-8 continue to apply. Shareholder proponents must hold an amount of company securities representing the lesser of (i) $2,000 in market value or (ii) 1% of a company’s outstanding securities. Additionally, shareholder proponents must have continuously held the required level of securities for a period of at least one year prior to submitting a proposal. Rule 14a-8, as amended, does not provide a three-year phase-in period for smaller reporting companies, which means that shareholder proposals may be filed during the upcoming 2011 proxy season.
Shareholder Solicitation. New Rule 14a-2(b)(7) permits oral and written solicitation in connection with the formation of a shareholder nominating group under Rule 14a-11. However, shareholders are not eligible for this proxy rule exemption if they are holding a company’s securities with the purpose or effect of changing control of the company or gaining more director seats than the maximum number permitted under Rule 14a-11. Written communication under this exemption is limited to (i) a statement of intent to form a shareholder nominating group, (ii) identification of potential director nominees, (iii) disclosure of the voting power percentage held by the soliciting shareholder or group and (iv) instructions on how others may contact the soliciting shareholder or group. Any written solicitation must be filed with the SEC on the first day of use on Schedule 14N. Even if a shareholder or group intends to use purely oral solicitation and rely on the exemption, it must also file notice on Schedule 14N with the SEC on the commencement date of oral solicitation.
Shareholder Communication. New Rule 14a-2(b)(8) permits oral and written communication by a shareholder or group in support of their nominees and for or against company nominees. This proxy rule exemption is only available after the shareholder or group receives notice from a company that the shareholder director nominees will be included in the company’s proxy materials. In order to remain eligible for the exemption, the soliciting shareholder or group must not seek proxy authority or furnish a proxy card. Any written materials must be filed with the SEC on Schedule 14N on their first date of use and (i) identify the shareholder or group, (ii) disclose details regarding the shareholder’s or group’s security holdings in the company and (iii) contain a legend directing the reader to the company’s proxy statement.
Beneficial Ownership Reporting. Under Exchange Act Rule 13d-1, any person who is, directly or indirectly, the beneficial owner of more than 5% of a class of equity securities of a reporting company must, subject to certain exceptions, file a Schedule 13D with the SEC. One principal exception to this requirement provides that beneficial owners of more than 5% of a subject class of equity securities may file a Schedule 13G (which is substantially less onerous than the Schedule 13D) if they acquired the securities with neither the purpose nor the effect of changing or influencing control of the issuer, if they do not beneficially own more than 20% of the specified class of securities. Formation of a shareholder group and other permitted solicitation activities solely for the purpose of nominating a director pursuant to Rule 14a-11 will not cause a nominating shareholder or group to lose their eligibility to file on Schedule 13G. The SEC has not provided any exemption regarding the formation of a group under Section 16, however. Accordingly, the beneficial ownership of shareholders working together to nominate a director under Rule 14a-11 would be analyzed in the same manner as any other group for purposes of determining whether group members are 10% holders subject to Section 16.
V. Suggested Action Items
Assess Vulnerability. Companies should analyze their shareholder base and identify any major shareholders with the requisite share ownership to submit nominations for inclusion in the proxy materials or any activist shareholders that may exercise their right to form a group. Companies should also review past shareholder proposals, including proposals by their shareholders to other companies, to identify any perceived weaknesses and remain informed on the current policies and criteria of proxy advisory services.
Improve Shareholder Communication. Companies should focus on improved communication with shareholders, particularly during the 30-day period prior to the proxy access nomination deadline. Enhanced communication will help companies understand investor concerns and identify any issues that could prompt a Rule 14a-11 director nomination. Companies should also consider requiring shareholders to file a Schedule 14N before discussing any specific director nominee.
Monitor Public Company Filings. In order to comply with Rule 14a-2(b)(7), any shareholder that wishes to solicit other shareholders to form a director nomination group must first file notice on Schedule 14N. Companies should pay close attention to Schedule 14N filings and use this notice as an early warning sign of shareholder activism. Companies should also monitor Schedule 14N filings by their own major shareholders in other public companies.
Review Advance Notice Bylaws. Most companies have advance notice bylaws for shareholder proposals and nominations that require a minimum notice period and certain information about the nominating shareholders and any nominee. Companies should review their advance notice bylaws to ensure they are not inconsistent with proposals or nominations made pursuant to Rules 14a-8 and 14a-11.
Amend Proxy Disclosure. Companies are required to disclose in their proxy statements the procedures for shareholders to submit proposals and nominees for director. Companies should review these procedures and make any changes required by Rules 14a-8 and 14a-11.
Review Majority Voting Provisions. Companies should review their bylaws and other governance guidelines for any majority vote standard and consider the effect a Rule 14a-11 nominee would have on the shareholder vote. The definition of a “contested election” may have different meanings in different contexts and companies may, therefore, need to modify their majority vote standard to clarify that a plurality vote standard will apply where the number of nominees exceeds the number of director vacancies.
Director Qualification Standards. Companies should consider adopting director qualification standards in their governing documents. Although this would not preclude access to the company’s proxy materials under Rule 14a-11, it may highlight a reason for shareholders not to vote in favor of a particular shareholder nominee. Companies should also consider implementing or strengthening their policies on director confidentiality and public statements by directors.
Assess Board Composition. Companies should determine if there are any perceived gaps in the qualifications, skills and experience of their directors. Any perceived gaps may be exploited by shareholders seeking a Rule 14a-11 nomination. Companies should also be aware of how board size affects the 25% calculation for determining the maximum number of shareholder nominees.
Preparation. Once a Schedule 14N is received, companies will have a limited amount of time to determine whether to challenge the eligibility of the nomination. Companies should identify significant milestones and implement appropriate procedures to promptly review and respond to shareholder nominations within the specified timeline of Rule 14a-11, including a potential meeting shortly after the deadline for access nominations.
1 Rule 14a-11 is delayed three years for “smaller reporting companies” generally defined as companies with a market capitalization of less than $75 million.