Update as of October 5, 2010:
On October 4, 2010, the Securities and Exchange Commission granted a stay on effectiveness of the “proxy access” rules discussed below, pending judicial review of a lawsuit challenging the rules filed by the Business Roundtable and U.S. Chamber of Commerce with the U.S. Court of Appeals for the D.C. Circuit. While the length of the delay in effectiveness depends on the timing of the court's review and its decision, it is quite possible that the rules will not be applicable to 2011 proxy materials for calendar year-end companies. The SEC's order granting the stay can be found at http://www.sec.gov/rules/other/2010/33-9149.pdf.
Summary
On August 25, 2010, as expected, the SEC, by a 3-2 vote, adopted “proxy access” rules, which will permit shareholders or groups of shareholders who hold at least 3% of the voting power of a U.S. public company (which includes investment companies) and who have held their shares continuously for at least three years, to include a limited number of alternate director nominees in the company’s proxy materials. Companies may not “opt-out” of the new rules, even with shareholder approval, and for most calendar year-end companies, the new regime will be in place for the 2011 proxy season.
Covered Companies
New Rule 14a-11 will apply to all companies that are subject to the Exchange Act proxy rules, including registered investment companies, controlled companies and voluntary filers. They will not apply to foreign private issuers or companies with only registered debt. Smaller reporting companies (generally, companies with a public float of less than $75 million) will be subject to the new rules, but not for three years. Certain types of companies, such as investment companies and asset-backed issuers, are not considered smaller reporting companies. The rules will apply even if a company is engaged in a traditional proxy contest.
Who Can Use Rule 14a-11?
To be eligible to use the new Rule, a nominating shareholder or group must:
An unsuccessful attempt by a nominating shareholder or group to get a nominee elected under Rule 14a-11 will not affect that shareholder’s or group’s ability to use the rule again in subsequent years.
Calculating the 3% Threshold
To be eligible to use the new Rule, the nominating shareholder or group must hold, on the date of the Schedule 14N, at least 3% (in the aggregate, in the case of a group) of the voting power of the company’s shares that are entitled to vote on the election of directors at the upcoming shareholders meeting.
The shareholder or group must hold both voting and investment power in the shares, either directly or through a person acting on its behalf (including banks or brokers). Shares which the shareholder has only the right to acquire, such as shares underlying options or warrants, may not be counted toward the threshold. Shares lent to a third party may, however, be included in the ownership calculation if the shareholder (i) may recall the loaned shares, and (ii) will recall them when notified that its nominee(s) will be included in the company’s proxy materials.
Shares sold short must be excluded, as must all borrowed shares. It does not appear, however, that hedging practices other than short sales would reduce a shareholder’s eligible holdings.
Three-Year Holding Period
Eligible shareholders or aggregated groups must have held the requisite number of shares continuously for at least three years prior to the date of the Schedule 14N, and must state an intention to continue to hold the shares through the date of the meeting. (As proposed, only a one-year period would have been required.)
Maximum Number of Shareholder Nominees
Companies will not be required to include more than one shareholder nominee, or the number of nominees equal to 25% of the number of board members, whichever is greater. For companies with staggered boards, current directors elected as shareholder nominees whose terms extend past the date of the meeting will count toward the limit and the 25% limit is calculated based on the total number of board seats. If shareholders have the right to elect only a subset of the full board, the maximum is based on the number of board members the class of shares held by the nominating shareholder is entitled to elect. If a shareholder or group files a Schedule 14N and the company subsequently agrees to include the shareholder’s nominee in its proxy materials as a “company” nominee, that nominee will still count towards the maximum.
In cases where a company receives multiple shareholder nominations, it must include in its proxy materials the nominee or nominees of the shareholder or group with the highest qualifying voting power percentage as of the date of filing Schedule 14N, up to the maximum. Likewise, if a nominating shareholder or group withdraws or is disqualified, the company must include the nominee of the shareholder with the next highest voting power percentage that timely filed a Schedule 14N. This process continues until the number of nominees is exhausted or the maximum number of nominees is reached. If a nominee withdraws or is disqualified, the company must include any other eligible nominee submitted by the nominating shareholder or group. A shareholder or group gains no advantage by being first to file — a change from the proposal.
Eligible Director Nominees — Independence and Qualifications
Board nominees under Rule 14a-11 must satisfy the objective independence standards of the exchange on which the company is listed, or, in the case of registered investment companies, must not be “interested persons” of the registrant under Section 2(a)(19) of the Investment Company Act. Candidates are not required to satisfy any additional director qualifications that the company may have established. Schedule 14N will, however, require nominating shareholders to state whether a candidate meets any such additional qualifications as set forth in the company’s governance documents.
There is no requirement that a nominee be independent of or unaffiliated with the shareholder or group nominating the candidate.
Schedule 14N — Timing and Content
A nominating shareholder or group must file with the SEC and transmit to the company a notice on a new Schedule 14N during the period starting 150 days and ending 120 days before the anniversary of the date the company mailed its proxy materials for the prior year’s annual meeting. Companies will be required to disclose the deadline for submitting nominees for the next annual meeting in their proxy materials. If a company did not hold an annual meeting in the prior year, or if the date of the meeting has changed by more than 30 days from the date it was held in the prior year, the nominating shareholder must provide the Schedule 14N notice a reasonable time before the company mails its proxy materials. In that case, the company must disclose by a Form 8-K the date of required notice, within four business days after the company determines the date of the current year’s meeting. Although investment companies are generally not required to file Form 8-K, investment companies will be required to file an 8-K to provide notice of the anticipated date of a shareholder meeting, the deadline for submitting nominees, and the number of shares outstanding and entitled to vote for the election of directors as of the end of the most recent calendar quarter.
Schedule 14N requires the following information about the nominating shareholder or group and/or the nominee, in addition to items mentioned above and certain other information:
The Company’s Response
When a company receives a nomination submitted under Rule 14a-11, it must determine whether to include the nominee in its proxy materials or whether it has a basis upon which to exclude the nominee. If the company decides to include the nominee, it must notify the nominating shareholder or group in writing no later than 30 days before it files its definitive proxy statement with the SEC. If the company believes that it can properly exclude the nominee, it must notify the nominating shareholder or group within 14 days after the close of the window period for the submission of nominations. The nominating shareholder or group then has 14 days to respond. Within 80 days before the company files its definitive proxy statement, it must provide notice to the SEC of its intent to exclude the nominee and the basis for exclusion. The company may also avail itself of the SEC no-action process, as with shareholder proposals under Rule 14a-8.
The SEC’s adopting release includes the following procedural timeline:
| Due Date | Action Required |
|---|---|
| No earlier than 150 calendar days, and no later than 120 calendar days, before the anniversary of the date that the company mailed its proxy materials for the prior year’s annual meeting | Nominating shareholder or group must provide notice on Schedule 14N to the company and file the Schedule 14N with the Commission |
| No later than 14 calendar days after the close of the window period for submission of nominations | Company must notify the nominating shareholder or group (or its authorized representative) of any determination not to include the nominee or nominees |
| No later than 14 calendar days after the nominating shareholder’s or group’s receipt of the company’s deficiency notice | Nominating shareholder or group must respond to the company’s deficiency notice and, where applicable, cure any defects in the nomination |
| No later than 80 calendar days before the company files its definitive proxy statement and form of proxy with the Commission | Company must provide notice of its intent to exclude the nominating shareholder’s or group’s nominee or nominees and the basis for its determination to the Commission and, if desired, seek a no-action letter from the staff with regard to its determination |
| No later than 14 calendar days after the nominating shareholder’s or group’s receipt of the company’s notice to the Commission | Nominating shareholder or group may submit a response to the company’s notice to the Commission staff |
| As soon as practicable | If requested by the company, Commission staff would, at its discretion, provide an informal statement of its views to the company and the nominating shareholder or group |
| Promptly following receipt of the staff’s informal statement of its views | Company must provide notice to the nominating shareholder or group stating whether it will include or exclude the nominee |
Information Required in Proxy Statement and the Form of Proxy
A company must include with its proxy statement disclosures about the nominating shareholder or group and the nominee that will be taken largely from the Schedule 14N. The company will not be liable for any false or misleading statements included in this information. Inclusion of a shareholder nominee will not result in a company being required to file a preliminary proxy, if it is not otherwise required.
There does not appear to be any requirement that companies provide in advance “statements in opposition” to a Rule 14a-11 nominee, either to the SEC or to the nominating shareholder(s), nor to be a word limit on such statements.
The common practice on proxy cards of allowing shareholders to vote for or withhold authority to vote for the company nominees as a group will be prohibited. All candidates must be voted for individually, but the company will be permitted to identify clearly company nominees and shareholder nominees.
Formation of Nominating Groups
Shareholders communicating with each other to form a nominating shareholder group that could aggregate their holdings to meet the 3% ownership requirement will have a new exemption from the restrictions on solicitations under the proxy rules. Written communications will be exempt if the shareholder group is not holding the company’s shares with a purpose or effect of changing control of the company, or gaining a number of board seats in excess of the Rule 14a-11 limit. Moreover, the communication must be filed under cover of Schedule 14N, with the appropriate box checked on the cover page, on or before the date it is first used. In addition, the communication must include only:
Oral solicitations in connection with Rule 14a-11 are also exempt and are not limited in content. However, the shareholder must file a Schedule 14N notice of intention to commence the oral solicitation, checking a specified box on the cover page.
The SEC noted that shareholders also would have the option to structure their solicitation to comply with any of the existing exemptions from the proxy rules, including the exemption for solicitations of no more than 10 shareholders under Rule 14a-2(b)(2) and the exemption for certain communications that take place in an electronic shareholder forum under Rule 14a-2(b)(6), which could be used in combination with the new exemption. Thus far the exemption for communications that take place in electronic shareholder forums has been little-used, but this might change for contested elections under Rule 14a-11. This is because the Rule 14a-2(b)(6) exemption does not require communications and notices of intent to communicate to be filed with the SEC, as does the 14a-11 exemption.
Moreover, the 14a-2(b)(6) and Rule 14a-17 exemption is available to companies as well as shareholders seeking to form nominating groups. If a company receives notice via Schedule 14N that a shareholder group is being formed, it can immediately commence statements in opposition in an electronic shareholder forum, outside of the proxy rules. A company-sponsored online forum can be used by management to communicate with shareholders on any matter of shareholder interest, which certainly would include the election of directors, and the SEC adopting release specifically mentions as a legitimate purpose “expressing the views of the company’s management and board of directors.” The ability of both shareholders and the company to rely on the broad exemptions from the proxy rules in connection with an electronic shareholder forum expires 60 days before the date of the annual or special meeting of shareholders.
The new rules will also exempt nominating shareholder or group solicitations in support of a nominee included in a company’s proxy materials, provided the shareholder or group is not seeking proxy authority and the soliciting material includes certain disclosures. Any written soliciting material used under this exemption must be filed with the SEC under cover of Schedule 14N with the appropriate box checked on the cover page. This exemption is lost if the shareholder subsequently engages in a non-Rule 14a-11 nomination or solicitation.
Schedules 13D and 13G; Section 16
It is possible that groups aggregating shares for the purpose of making a Rule 14a-11 nomination may trigger the reporting requirements under Regulations 13D-G, which require reports for beneficial owners and groups with a greater than 5% beneficial ownership of an issuer’s securities. The SEC declined to provide a blanket exemption from these requirements for groups formed to make a Rule 14a-11 nomination. The new rules do, however, allow a group which limits its activities to only those permitted by Rule 14a-11 to report on a short form Schedule 13G, rather than a Schedule 13D. The new rules did not amend Section 16 to provide any relief from the Section 16 10% ownership reporting requirements.
Amendments to Rule 14a-8 — Shareholder Proposals
The shareholder proposal rule has permitted companies to exclude proposals regarding the election of directors, including “proxy access” proposals. Going forward, proposals regarding procedures for inclusion of shareholder nominees in the company’s proxy materials will be permitted, but only if they propose nominating procedures that are “less restrictive” than Rule 14a-11. Thus, a proposal to lower the ownership threshold to 1% would be permitted, while one to raise the threshold to 5% would not.
Effectiveness for 2011 Proxy Season
The effective date of the new proxy access rules is November 15, 2010, which, given the 150-120 day window period for shareholder nominations, means that the rules will apply for the 2011 proxy season to any company that mailed its 2010 proxy statement on or after March 15, 2010. They will also apply to any company holding an annual meeting in 2011 that held no annual meeting in 2010, or that moves the date of its 2011 annual meeting by more than 30 days from the date of the 2010 meeting.
Legal Challenges
The Dodd-Frank Act authorized the SEC to adopt proxy access rules, but legal challenges to the new rules seem distinctly possible, nevertheless. It has been reported that the U.S. Chamber of Commerce has retained counsel to review a potential lawsuit, and the Chamber’s Center for Capital Markets Competitiveness has said that the SEC hasn’t demonstrated a compelling need for the rules or how the capital markets will be more efficient by their adoption. Moreover, SEC Commissioner Casey’s statement in opposition to the new rules outlines arguments that could be made against their validity.
Conclusion
Absent an injunction, the new rules are likely to apply to most U.S. public companies (other than smaller reporting companies) and registered investment companies for their next election of directors. Public reports indicate that some large institutional investors are already searching for qualified board candidates, and some have even created a database of potential nominees. Companies that have done poorly on shareholder proposal votes, had large “withhold” votes for management board nominees, or otherwise have a large and restive constituency of significant shareholders, should consider special efforts to identify and address the concerns of those shareholders.
For additional information concerning this alert, please contact your regular Bingham corporate contact or the following lawyers:
Christopher Cox
Michael P. O'Brien
michael.obrien@bingham.com
617.951.8302
Laurie A. Cerveny
laurie.cerveny@bingham.com
617.951.8527
David K. Robbins
david.robbins@bingham.com
213.680.6560
Barry N. Hurwitz
barry.hurwitz@@bingham.com
617.951.8267
This article was originally published by Bingham McCutchen LLP.