Expanded Corporate Governance Proposals Take Form
May 28, 2009
Introduction
Over the past few years, corporate governance reform and enhanced “shareholder democracy” have been hot topics among politicians, regulators and, unsurprisingly, institutional investors and their advisors. Proponents argue that giving shareholders more direct and immediate power to influence company policy and to reward, punish or dismiss officers and directors is vital to promoting ethics and transparency in our public companies and to making their managers responsive to the companies’ true owners, their shareholders. The recent financial crisis, which many influential people attribute to a systemic failure of corporate governance, has given new impetus to the drive for a wide, federal, expansion of shareholder rights and substantive corporate governance requirements, and in recent days two concrete proposals have come from Congress and the Securities and Exchange Commission.
First, on May 19, 2009, New York Senator Charles Schumer introduced the “Shareholder Bill of Rights Act of 2009,” which would, among other things, require public companies to give shareholders access to company proxy materials for director nominations; abolish classified boards for all public companies; require all public companies to have a separate, independent chairperson and an independent “risk committee” of the board of directors; and require advisory shareholder “say on pay” votes on senior executive compensation and severance pay. Second, in an open meeting on May 20, 2009, the SEC announced and solicited public comment on proposed rule changes that would amend the federal proxy rules to give shareholders access to company proxy materials for director nominations and certain election-related proposals. In a related development, the New York Stock Exchange has proposed and is awaiting SEC approval of long-delayed rules that would eliminate brokers’ discretionary voting in uncontested director elections.
This bulletin summarizes the key provisions of each of these proposals. Because these proposals may result in significant changes to the way many public companies govern themselves and interact with their shareholders (and may impose significant new costs on these companies), it is important that public companies’ officers, directors and legal teams understand these proposals and their likely effects. Moreover, because the proposed rules are still in nascent form, public companies that take the time to consider these proposals today will still have the chance to voice their concerns about them to rule-makers and, potentially, to influence the final form of the rules.
The Shareholder Bill of Rights Act of 2009
Citing a “widespread failure of corporate governance” as one of the “central causes of the financial and economic crises,” Senator Schumer’s proposed Shareholder Bill of Rights Act of 2009 (the “Act”) would remedy this failure by requiring that all public companies, regardless of their size, business and state of incorporation, adopt a laundry-list of the more popular recent proposals for corporate governance reform, including:
Although shareholder proxy access has been a recurring topic of SEC and public debate for the better part of the last decade, like Senator Schumer’s proposal, SEC Release 2009-116 cites the current financial crisis as evidence of a national failure of corporate governance and prescribes increased shareholder democracy as the solution to this failure. Because the SEC has not released a draft of the proposed rules as of the date of this bulletin, this section summarizes the SEC’s press release regarding the proposed rule revisions and the comments of the Commissioners and the Staff at the May 20 open meeting.
Proposed Rule 14a-11: Proxy Access for Shareholder Nominees. Proposed Rule 14a-11 under the Securities Exchange Act of 1934, which would apply to all companies with public equity securities, would require a company to include in its proxy statement one or more shareholder nominees for director, subject to the holding and other requirements described below.
A shareholder or group of shareholders seeking to include a nominee in the company’s proxy statement must have held a minimum percentage of the company’s shares for at least one year and must publicly declare their intent to hold such shares until the applicable annual meeting. The minimum holdings are as follows: (i) 1% of the voting securities of a large accelerated filer, (ii) 3% of the voting securities of an accelerated filer or (iii) 5% of the voting securities of a non-accelerated filer. In addition, nominating shareholders would be required to certify publicly that they are not holding their shares for the purpose of changing control of the company or to gain more than minority representation on the company’s board of directors. Nominating shareholders would be required to file with the SEC and furnish to the company a new Form 14N, which would include the holding information and certifications described above, and the company’s proxy materials would be required to include disclosure about the nominating shareholder and nominee “similar to the disclosure currently required in a contested election.”
Shareholder nominees would be required to be independent under the standards of the stock exchange on which the company’s shares are listed, and the nominee’s candidacy and election must not violate applicable state law. The nominating shareholder and the company may not have entered into any “direct or indirect agreement” regarding the nomination.
The proposed rule limits the number of shareholder nominees that must be included in a company’s proxy statement to the greater of one or 25% of the company’s then-current number of directors. There appears to be no separate limit on the number of candidates a particular shareholder or group may nominate, and if a company receives more nominees that it is required to include in the proxy, the company would be required to include the nominees of which it was first notified.
Proposed Revision to Rule 14a-8(i)(8): Election-related Proposals. Currently, Rule 14a-8(i)(8) permits companies to exclude from their proxy materials shareholder proposals that “relate to an election.” The proposed revisions to Rule 14a-8(i)(8) would limit this “election exclusion” to permit shareholder proposals to amend the provisions of a company’s governing documents that relate to nomination procedures and “director nomination disclosure provisions.” Shareholders seeking to have such proposals included in a company’s proxy would have to satisfy the current holding requirements for proponents under Rule 14a-8(i)(8): they must have held the lesser of one percent or $2,000 in market value of the company’s voting securities for at least one year.
Broker Discretionary Votes
In February 2009, the New York Stock Exchange resubmitted to the SEC a long-delayed proposal that would prohibit brokers from casting discretionary votes in uncontested director elections. Under current NYSE Rule 452, brokers that do not receive voting instructions from their clients may cast discretionary votes on “routine” matters, which include uncontested director elections. Traditionally, these votes have been cast in favor of management’s slate of directors, which made it more likely that director candidates subject to majority voting requirements would receive the requisite votes. The proposal to amend Rule 452 would remove uncontested director elections from the list of routine matters and thereby prohibit brokers from voting uninstructed shares. If the SEC approves the new rule before August 31, the proposed amendments would apply to proxy voting for shareholder meetings held on or after January 1, 2010.
Although the proposal may seem unimportant and “technical” at first glance, critics argue that it would increase the costs of uncontested elections because companies will have to spend more money and effort to reach shareholders who previously did not vote, particularly in circumstances where the votes of retail shareholders are necessary for nominees to obtain a required majority vote or even a quorum. Critics also warn that the amended rule could consolidate voting power in institutional shareholders or other special interest groups.
Conclusion
Public reaction to these proposals has ranged from vigorous applause to equally vigorous opposition. Observers have raised concerns that the proposals impinge on states’ traditional prerogative to regulate the governance of their corporations; that broad, substantive federal corporate law requirements will put an end to states’ historic role as “laboratories” for corporate innovation;1 that market forces are highly and demonstrably effective at inducing companies to adopt the governance changes that their shareholders actually believe are necessary; and that the corporate governance structure of most U.S. public companies did nothing to trigger the current financial crisis. More pragmatic observers have also expressed concern that American public companies are much too diverse to be served well by “one-size-fits-all” corporate governance requirements; that making it easier for shareholders to reward and punish officers and directors on an annual basis will reinforce a growing and dangerous tendency of executives to manage their companies for short-term results only; and that these proposals will advance the interests of institutional and particularly “activist” investors at the expense of smaller retail investors and the companies as a whole.
Reasonable minds may differ as to whether these proposals are desirable, likely to work as advertised or even, in some cases, constitutional. What is not in dispute, however, is that if they are enacted in their current form, these proposals have the potential to profoundly change the way public companies run their businesses, select, retain and compensate their most important decision-makers, and respond to the demands of powerful shareholders. With the stakes so high, it is vital that officers, directors and corporate legal teams understand these proposals and carefully assess the effects they are likely to have on the companies they serve. Decision-makers at smaller public companies in particular should consider whether there is room in their budgets (and on their directors’ and officers’ schedules) to absorb the increased costs and time demands that the proposed new requirements are likely to impose upon them.
These proposals have not yet been enacted, so companies and individuals that have concerns about them still have the opportunity to make their voices heard. Once the SEC publishes the text of its proposed revisions to the proxy rules, which we expect it will do soon, the SEC will be actively soliciting public comments on the proposed new rules for a period of 60 days. In the past, public comments have often had a significant effect on the final shape and application of SEC rules, so companies that have significant concerns about particular aspects of the proposed rules would be well advised to take advantage of the comment process. Likewise, the Shareholder Bill of Rights is in the early stages of the legislative process, and there remain opportunities to influence its final form, if any. Companies with concerns about the bill would do well to communicate their concerns to their Congressional representatives as clearly, forcefully, and, above all, promptly as possible.
If you have questions about these proposals or would like assistance preparing a response to them, please do not hesitate to contact one of the attorneys listed in this bulletin.
1Among other things, these proposals would pre-empt recent changes that states have made to their own corporate governance regimes, including the newly adopted proxy access provisions of the Delaware General Corporation Law and the North Dakota Publicly Traded Corporations Act, and the recent amendment to the Indiana Business Corporation Law that will require public companies that do not expressly elect otherwise to have classified boards.
Over the past few years, corporate governance reform and enhanced “shareholder democracy” have been hot topics among politicians, regulators and, unsurprisingly, institutional investors and their advisors. Proponents argue that giving shareholders more direct and immediate power to influence company policy and to reward, punish or dismiss officers and directors is vital to promoting ethics and transparency in our public companies and to making their managers responsive to the companies’ true owners, their shareholders. The recent financial crisis, which many influential people attribute to a systemic failure of corporate governance, has given new impetus to the drive for a wide, federal, expansion of shareholder rights and substantive corporate governance requirements, and in recent days two concrete proposals have come from Congress and the Securities and Exchange Commission.
First, on May 19, 2009, New York Senator Charles Schumer introduced the “Shareholder Bill of Rights Act of 2009,” which would, among other things, require public companies to give shareholders access to company proxy materials for director nominations; abolish classified boards for all public companies; require all public companies to have a separate, independent chairperson and an independent “risk committee” of the board of directors; and require advisory shareholder “say on pay” votes on senior executive compensation and severance pay. Second, in an open meeting on May 20, 2009, the SEC announced and solicited public comment on proposed rule changes that would amend the federal proxy rules to give shareholders access to company proxy materials for director nominations and certain election-related proposals. In a related development, the New York Stock Exchange has proposed and is awaiting SEC approval of long-delayed rules that would eliminate brokers’ discretionary voting in uncontested director elections.
This bulletin summarizes the key provisions of each of these proposals. Because these proposals may result in significant changes to the way many public companies govern themselves and interact with their shareholders (and may impose significant new costs on these companies), it is important that public companies’ officers, directors and legal teams understand these proposals and their likely effects. Moreover, because the proposed rules are still in nascent form, public companies that take the time to consider these proposals today will still have the chance to voice their concerns about them to rule-makers and, potentially, to influence the final form of the rules.
The Shareholder Bill of Rights Act of 2009
Citing a “widespread failure of corporate governance” as one of the “central causes of the financial and economic crises,” Senator Schumer’s proposed Shareholder Bill of Rights Act of 2009 (the “Act”) would remedy this failure by requiring that all public companies, regardless of their size, business and state of incorporation, adopt a laundry-list of the more popular recent proposals for corporate governance reform, including:
- Advisory “Say On Pay” Votes. Under the Act, public companies would be required to include in their annual proxy statements a shareholder resolution approving the compensation of company executives. Similarly, proxy statements relating to mergers, acquisitions and similar transactions would be required to include a resolution approving executive severance pay and other compensation related to the transaction. Although both votes would be non-binding and advisory in nature, recent experience suggests that public companies that ignore shareholders’ advice on matters of compensation do so at their peril.
- Proxy Access. The Act would require the SEC to establish rules requiring companies to include shareholder nominees in their proxy materials. Under this proposal, a shareholder or group of shareholders that has held at least one percent of a company’s shares for at least two years would have the right to include director nominees in the company’s proxy statement.
- Election of Directors. The Act would abolish classified boards for all public companies and require that all directors be elected annually. It also would require the resignation of any director who does not receive at least a majority of the votes cast in an uncontested election.
- Independent Board Chairperson. The Act would require all public companies to split the positions of chief executive officer and chairperson of the board of directors. The chairperson must be “independent” under the rules of the stock exchange on which the company’s shares are listed and, additionally, must never have served as an executive officer of the company.
- Independent Risk Committee. The Act would require all public companies to establish a “risk committee,” composed solely of independent directors, to oversee the company’s “risk management practices”.
Although shareholder proxy access has been a recurring topic of SEC and public debate for the better part of the last decade, like Senator Schumer’s proposal, SEC Release 2009-116 cites the current financial crisis as evidence of a national failure of corporate governance and prescribes increased shareholder democracy as the solution to this failure. Because the SEC has not released a draft of the proposed rules as of the date of this bulletin, this section summarizes the SEC’s press release regarding the proposed rule revisions and the comments of the Commissioners and the Staff at the May 20 open meeting.
Proposed Rule 14a-11: Proxy Access for Shareholder Nominees. Proposed Rule 14a-11 under the Securities Exchange Act of 1934, which would apply to all companies with public equity securities, would require a company to include in its proxy statement one or more shareholder nominees for director, subject to the holding and other requirements described below.
A shareholder or group of shareholders seeking to include a nominee in the company’s proxy statement must have held a minimum percentage of the company’s shares for at least one year and must publicly declare their intent to hold such shares until the applicable annual meeting. The minimum holdings are as follows: (i) 1% of the voting securities of a large accelerated filer, (ii) 3% of the voting securities of an accelerated filer or (iii) 5% of the voting securities of a non-accelerated filer. In addition, nominating shareholders would be required to certify publicly that they are not holding their shares for the purpose of changing control of the company or to gain more than minority representation on the company’s board of directors. Nominating shareholders would be required to file with the SEC and furnish to the company a new Form 14N, which would include the holding information and certifications described above, and the company’s proxy materials would be required to include disclosure about the nominating shareholder and nominee “similar to the disclosure currently required in a contested election.”
Shareholder nominees would be required to be independent under the standards of the stock exchange on which the company’s shares are listed, and the nominee’s candidacy and election must not violate applicable state law. The nominating shareholder and the company may not have entered into any “direct or indirect agreement” regarding the nomination.
The proposed rule limits the number of shareholder nominees that must be included in a company’s proxy statement to the greater of one or 25% of the company’s then-current number of directors. There appears to be no separate limit on the number of candidates a particular shareholder or group may nominate, and if a company receives more nominees that it is required to include in the proxy, the company would be required to include the nominees of which it was first notified.
Proposed Revision to Rule 14a-8(i)(8): Election-related Proposals. Currently, Rule 14a-8(i)(8) permits companies to exclude from their proxy materials shareholder proposals that “relate to an election.” The proposed revisions to Rule 14a-8(i)(8) would limit this “election exclusion” to permit shareholder proposals to amend the provisions of a company’s governing documents that relate to nomination procedures and “director nomination disclosure provisions.” Shareholders seeking to have such proposals included in a company’s proxy would have to satisfy the current holding requirements for proponents under Rule 14a-8(i)(8): they must have held the lesser of one percent or $2,000 in market value of the company’s voting securities for at least one year.
Broker Discretionary Votes
In February 2009, the New York Stock Exchange resubmitted to the SEC a long-delayed proposal that would prohibit brokers from casting discretionary votes in uncontested director elections. Under current NYSE Rule 452, brokers that do not receive voting instructions from their clients may cast discretionary votes on “routine” matters, which include uncontested director elections. Traditionally, these votes have been cast in favor of management’s slate of directors, which made it more likely that director candidates subject to majority voting requirements would receive the requisite votes. The proposal to amend Rule 452 would remove uncontested director elections from the list of routine matters and thereby prohibit brokers from voting uninstructed shares. If the SEC approves the new rule before August 31, the proposed amendments would apply to proxy voting for shareholder meetings held on or after January 1, 2010.
Although the proposal may seem unimportant and “technical” at first glance, critics argue that it would increase the costs of uncontested elections because companies will have to spend more money and effort to reach shareholders who previously did not vote, particularly in circumstances where the votes of retail shareholders are necessary for nominees to obtain a required majority vote or even a quorum. Critics also warn that the amended rule could consolidate voting power in institutional shareholders or other special interest groups.
Conclusion
Public reaction to these proposals has ranged from vigorous applause to equally vigorous opposition. Observers have raised concerns that the proposals impinge on states’ traditional prerogative to regulate the governance of their corporations; that broad, substantive federal corporate law requirements will put an end to states’ historic role as “laboratories” for corporate innovation;1 that market forces are highly and demonstrably effective at inducing companies to adopt the governance changes that their shareholders actually believe are necessary; and that the corporate governance structure of most U.S. public companies did nothing to trigger the current financial crisis. More pragmatic observers have also expressed concern that American public companies are much too diverse to be served well by “one-size-fits-all” corporate governance requirements; that making it easier for shareholders to reward and punish officers and directors on an annual basis will reinforce a growing and dangerous tendency of executives to manage their companies for short-term results only; and that these proposals will advance the interests of institutional and particularly “activist” investors at the expense of smaller retail investors and the companies as a whole.
Reasonable minds may differ as to whether these proposals are desirable, likely to work as advertised or even, in some cases, constitutional. What is not in dispute, however, is that if they are enacted in their current form, these proposals have the potential to profoundly change the way public companies run their businesses, select, retain and compensate their most important decision-makers, and respond to the demands of powerful shareholders. With the stakes so high, it is vital that officers, directors and corporate legal teams understand these proposals and carefully assess the effects they are likely to have on the companies they serve. Decision-makers at smaller public companies in particular should consider whether there is room in their budgets (and on their directors’ and officers’ schedules) to absorb the increased costs and time demands that the proposed new requirements are likely to impose upon them.
These proposals have not yet been enacted, so companies and individuals that have concerns about them still have the opportunity to make their voices heard. Once the SEC publishes the text of its proposed revisions to the proxy rules, which we expect it will do soon, the SEC will be actively soliciting public comments on the proposed new rules for a period of 60 days. In the past, public comments have often had a significant effect on the final shape and application of SEC rules, so companies that have significant concerns about particular aspects of the proposed rules would be well advised to take advantage of the comment process. Likewise, the Shareholder Bill of Rights is in the early stages of the legislative process, and there remain opportunities to influence its final form, if any. Companies with concerns about the bill would do well to communicate their concerns to their Congressional representatives as clearly, forcefully, and, above all, promptly as possible.
If you have questions about these proposals or would like assistance preparing a response to them, please do not hesitate to contact one of the attorneys listed in this bulletin.
1Among other things, these proposals would pre-empt recent changes that states have made to their own corporate governance regimes, including the newly adopted proxy access provisions of the Delaware General Corporation Law and the North Dakota Publicly Traded Corporations Act, and the recent amendment to the Indiana Business Corporation Law that will require public companies that do not expressly elect otherwise to have classified boards.
