On August 25, 2010, the SEC adopted, by a partisan 3-2 vote, final rules on proxy access. These rules will require most public companies to include, at the companies’ expense, shareholder nominees for director in their proxy materials. The new rules also will reduce substantially companies’ ability to exclude shareholder proposals relating to elections from their proxy materials. The rules will become effective sixty days after publication in the Federal Register, which we expect shortly, so most public companies will have to contend with them in the 2011 proxy season.
The final rules are largely similar in form and content to the proxy access rules the SEC proposed in June 2009. Most importantly, although the SEC received many comments on the proposed rules asking it to add some mechanism to allow companies and their shareholders to opt-out of the federal proxy access regime or negotiate their own access arrangements, the final rules are mandatory for all public companies and do not permit any form of private ordering. The final rules differ from the proposed rules in a number of important ways. Among other things:
- the proposed rules’ shareholding thresholds based on company size have been replaced with a uniform requirement that shareholders (or groups) hold at least 3% of the company’s voting stock to be eligible for proxy access;
- to be eligible for proxy access under the final rules, shareholders must have held their shares continuously for three years, rather than the one year in the proposed rules;
- the proposed rules’ “first to file” mechanism for establishing priority among shareholder nominees has been replaced by a system that gives priority based on the percentage voting power held by the nominating shareholders; and
- the final rules will not apply to “smaller reporting companies” until 2013.
Exchange Act Rule 14a-11 – Shareholder Nominees
New Rule 14a-11 under the Exchange Act establishes mandatory access to the company proxy for certain shareholder nominees for director. Rule 14a-11 will apply to all public companies subject to the federal proxy rules, including investment companies and controlled companies, with very few exceptions. The rule will not apply to companies whose only publicly traded securities are debt securities, and the rule’s application to smaller reporting companies will be delayed until 2013. In addition, the rule will not apply when applicable state law, foreign law, or a company’s governing documents prohibit shareholders from nominating candidates for election as a director.
Eligibility and Procedures. Shareholders (or groups of shareholders acting together to meet the rule’s minimum holding requirement) seeking proxy access under Rule 14a-11 must meet certain requirements for eligibility under the rule and follow the procedures set forth in the rule. The shareholder or group must:
- hold securities representing at least 3% of the voting power of the company’s securities entitled to vote at the shareholders’ meeting (securities loaned to a third party may be counted towards the 3% under certain circumstances, but securities sold short do not);
- have held the qualifying amount of securities continuously for at least three years as of the date the nominating shareholder or group submits notice of its intent to use the rule;
- continue to own the qualifying amount of securities through the date of the meeting;
- disclose whether they intend to continue to hold the qualifying securities after the election of directors;
- provide the required notice and disclosures on new Schedule 14N;
- not hold 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 the company would be required to include under the rule;
- propose nominees who meet the applicable securities exchange’s standards for director independence; and
- not have a direct or indirect agreement with the company regarding the nomination prior to announcing its intent to use the rule.
A company is not required to include nominees in its proxy materials if it believes they or their proponents fail to satisfy these eligibility requirements. A company that intends to exclude a nominee must notify the SEC of this intent and the basis for it at least 80 days before filing of the definitive proxy statement.
Schedule 14N. A nominating shareholder or group must provide notice to the company of its intent to use the rule on new Schedule 14N. The Schedule 14N must include disclosures about the nominating shareholder, the amount and duration of its shareholdings, its intentions with respect to its shares and the company, the identity and qualifications of its nominee, and the relationship between the nominating shareholder, the nominee and the company. The Schedule 14N must be filed with the SEC no more than 150 days and no less than 120 days prior to the anniversary of the mailing of the company’s proxy statement for the prior year.
Number and Priority of Nominees. The number of shareholder nominees that a company is required to include on its proxy is limited to the greater of (i) one and (ii) 25% of the total number of directors on the company’s board. When the number of nominees proposed by shareholders under the rule exceeds the maximum, the company must include in its proxy materials the nominee(s) nominated by the shareholder or group that holds the highest percentage of the company’s voting power.
Amended Exchange Act Rule 14a-8(i)(8) – Election-Related Proposals
The SEC also adopted amendments to Rule 14a-8 under the Exchange Act. Currently, Rule 14a-8(i)(8) permits companies to exclude all shareholder proposals related to the nomination and election of directors from the company’s proxy materials. Under the amended rule, shareholders will be allowed to propose procedures providing greater (but not lesser) access to company proxy materials for shareholder nominees than is provided by Rule 14a-11.
The current eligibility standards and procedures for shareholders submitting proposals pursuant to Rule 14a-8 will continue to apply: a shareholder submitting a proposal for inclusion in the company’s proxy materials must have held, continuously, for one year prior to submitting the proposal, at least $2,000 in market value or 1% of the company’s securities, whichever is less.
Implications of the New Regime
While only time will tell how much the new proxy access rules will change the relationship between public companies and their shareholders, it is certain that the new rules will provide cheap and powerful new weapons to activist investors. In particular, because they will typically be most able to satisfy Rule 14a-11’s holding requirements and benefit from its priority system, large institutional investors such as public and union pension funds and mutual funds are unlikely to be shy about using the rule to advance their interests. Rule 14a-8’s lower shareholding requirements make it a more realistic vehicle for activism by smaller shareholders, and the elimination of the “election exclusion” will only make it more effective. In light of these changes, public companies would be well advised to consider carefully whether they are likely to be attractive and vulnerable targets for shareholder activism and, where possible, begin taking remedial steps well in advance of the 2011 proxy season. In particular, companies will want to consider the relationship between their performance and their executives’ compensation, how they have addressed previous shareholder proposals and votes on governance, compensation and “social” issues, whether the results of recent elections have identified any directors as particularly vulnerable, and the overall quality and modernity of their corporate governance. Moreover, because the new regime makes it more likely that companies will face contested elections in the next few years, they should start working now on a long-term strategy for managing and improving their relationships with their investors.