Sunday, September 26, 2010
PROXY ACCESS: SUMMARY AND RECOMMENDED ACTION ITEMS
On August 25, 2010, the Securities and Exchange Commission (the “SEC”) approved final rules providing stockholders with access to company proxy statements for the nomination of director candidates. These “proxy access” rules will be effective on November 15, 2010, for most U.S. public companies. New Rule 14a-11 under the Securities Exchange Act of 1934 (as amended, the “Exchange Act”) will enable long-term substantial stockholders, acting alone or in concert, to nominate candidates for up to 25% of a company’s board, and to include those nominees in the company’s own proxy statement in competition with the incumbent board’s nominees. This contrasts with the current practice under which stockholders must pay for the preparation and mailing of materials to campaign for their own nominees in a proxy contest. The SEC also amended Rule 14a-8 under the Exchange Act to allow for shareholder proposals that would broaden proxy access.
The new rules apply to all companies subject to the SEC’s proxy rules, including investment companies registered under the Investment Company Act of 1940. The proxy access rules provide for a three-year delay in effectiveness for “smaller reporting companies,” and, like other proxy rules, they do not apply to foreign private issuers. Below is a summary of the new rules and a proposed plan of action that companies should observe now to be prepared for the 2011 proxy season and the new challenges that will arise due to proxy access.
Summary of the New Rules
Rule 14a-11: The New Proxy Access Scheme
- Stockholder Eligibility: The new rules afford proxy access to stockholders, or groups of stockholders, who have continuously held at least 3% of the voting power of a company’s securities for at least three years prior to the time that the stockholder or group notifies the company of its intent to nominate director candidates. The stockholder or stockholder group must also continue to hold the securities through the date of the stockholder meeting. The instructions to Rule 14a-11 and the SEC’s adopting release provide detailed rules for calculating the 3% voting power threshold and for determining whether the securities used to satisfy the minimum ownership threshold have been held continuously for the three-year holding period. Among other things, stockholders may only count shares over which they have both voting and investment control, either directly or through a third person. Additionally, stockholders cannot count securities that merely may be acquired, such as shares underlying stock options that are currently exercisable but have not been exercised.
- Maximum Number of Nominees: Rule 14a-11 caps the maximum number of stockholder proposed nominees that a company must include in its proxy statement at 25% of the company’s total number of board members (with a minimum of one nominee). This cap applies regardless of whether the company has a classified board. If the 25% cap on proxy access nominees does not result in a whole number based on the board’s size, the SEC’s rules provide that the cap rounds down to the closest whole number of nominees below 25%. Therefore, if a company has a classified board with nine total board members and three directors elected each year (with no other 14a-11 nominees serving on the board), then stockholders could nominate two directors under Rule 14a-11. If the total number of nominees from all stockholders would exceed the cap, the nominee from the stockholder or stockholder group with the largest ownership stake has priority.
- Nominee Requirements: Rule 14a-11 requires stockholder nominees to meet specific eligibility requirements: (i) if the company’s securities are listed on a national securities exchange, the nominee must satisfy the “objective” portion of the applicable stock exchange’s director independence standards; (ii) the nominee, stockholder or stockholder group must not have an agreement with the company regarding the nomination prior to the nominator’s notice of its intent to put forward a nominee (to prevent collusion between the company and affiliated nominees, but also potentially impeding early negotiated settlements between stockholders and companies); and (iii) the nominee’s candidacy and board membership, if elected, must not violate applicable federal or state law or stock exchange rules. If a company believes that a nominee would not meet the “subjective” portion of the applicable stock exchange’s director independence standards, the company may address the issue in the proxy statement but may not exclude the nominee from the proxy statement on this basis.
- Schedule 14N: Under Rule 14a-11, the nominating stockholder or group must comply with certain certification, disclosure and other requirements. The certifications and disclosures must be made on a Schedule 14N, which must be filed with the SEC and provided to the company during a prescribed 30-day window period, which is no earlier than 150 calendar days, and no later than 120 calendar days, before the anniversary of the date that the company mailed its prior year’s proxy materials (subject to exceptions if the company did not hold an annual meeting during the prior year or has changed the meeting date by more than 30 days from the prior year).
The Schedule 14N must include, among other things:
- information about the 3% voting power calculation and proof of share ownership
- a statement from the nominating stockholder or stockholder group that it intends to hold the required minimum amount of securities through the date of the annual meeting
- disclosure about the nominating stockholder or stockholder group’s intent to hold the securities after the annual meeting
- information on the nominee’s business experience and the relationship between the nominee and the nominating stockholder or group
- a statement that the nominating stockholder or group does not intend to change control of the company.
Nominees put forward by stockholders pursuant to the new access rules are not required to meet a company’s director qualification standards; however, the nominating stockholders must provide a statement in the Schedule 14N disclosing their analysis as to whether their nominees meet those standards (so long as such standards appear or are referenced in the company’s charter or bylaws). Nominating stockholders are also permitted to provide a statement in support of their nominees, not to exceed 500 words, which the company must include in its proxy statement. Nominating stockholders or groups will be liable for any false or misleading statements provided to the company, and the company will not be responsible for those statements when they are included in the company’s proxy materials.
- Procedure for Attempting to Exclude a Nominee: Upon receipt of a Schedule 14N, a company must determine whether it can exclude the nominee. If the company is not able to exclude the nominee, it must notify the stockholder or group no later than 30 days before the company files its definitive proxy statement with the SEC that it will include the nominee. If a company determines that it may exclude a nominee, the company must notify the nominating stockholder or group within 14 calendar days after the close of the Rule 14a-11 nomination window period. The nominating stockholder or group then has 14 calendar days after receipt of the company’s deficiency notice to correct any eligibility or procedural deficiencies and to respond to the company. If the company determines that the stockholder’s response does not remedy the deficiency, the company must notify the SEC of its intent to exclude the nominee (and the basis for its determination) no later than 80 calendar days before the company files its definite proxy statement. At this time, the company may also choose to file a no-action request with the SEC soliciting the SEC’s views on the matter. The nominating stockholder or group has the right to respond to the company’s notice by submitting a letter to the SEC staff within 14 calendar days. The company bears the burden of demonstrating that a nominee may be excluded. If requested, the SEC staff will provide an informal statement with its views to the company and the stockholder or group. Promptly following receipt of the SEC’s informal views, the company must provide the nominating stockholder or group with final notice of whether it will include or exclude the stockholder’s nominee.
A number of other conforming rule and form changes were made in connection with Rule 14a-11, which are not described in this Alert.
Stockholder Proposals under Amended 14a-8(i)(8)
Rule 14a-8(i)(8) was amended by repealing the provision that allowed a company to exclude proposals that related to a nomination or election, or a procedure for a nomination or election. As a result of the amendment, a company may exclude proposals relating to the election of directors under Rule 14a-8(i)(8) only if the proposal: (i) would disqualify a nominee who is standing for election, (ii) would remove a director from office before his or her term expired, (iii) questions the competence, business judgment or character of a nominee, (iv) seeks to include a specific individual in the company’s proxy materials for election to the board or (v) otherwise could affect the outcome of the upcoming election of directors.
As a result of these amendments to Rule 14a-8(i)(8), stockholders will be permitted to propose charter and bylaw amendments to expand proxy access even beyond what Rule 14a-11 allows, but not to narrow it. For example, stockholders could propose lowering the percentage threshold to make nominations from 3% to 1% or shortening the three-year holding period. Companies may not opt out of Rule 14a-11. Please be aware that there is no three-year delay to the effectiveness of the changes to Rule 14a-8(i)(8) for “smaller reporting companies.” Accordingly, it is possible that a smaller reporting company could receive a 14a-8 stockholder proposal for the 2011 proxy season seeking to amend the company’s bylaws to implement a proxy access regime similar to that imposed under Rule 14a-11.
Plan of Action
Public companies should consider taking the following actions to ensure they are prepared for the 2011 proxy season and the proxy access rules, which become effective on November 15, 2010:
- Assess your vulnerability: It is essential that companies actively monitor their stockholder base and conduct an in-depth vulnerability analysis to determine whether they are at risk for one or more Rule 14a-11 nominations from stockholders. Companies may wish to engage third parties to help them identify long-term stockholders, including stockholders who own less than 3% of the company’s voting stock but who may be inclined to participate in nominating groups. In this regard, we believe that pension funds and unions will be the category of stockholders most likely to utilize the proxy access rules in 2011, although it is possible that institutional investors (e.g., mutual funds) and hedge funds may use 14a-11 as well. Additionally, companies that have been the target of shareholder proposals in the past or that have low GRiD scores in certain governance areas from ISS Governance (formerly RiskMetrics) are likely to be the most vulnerable.
- Engage with stockholders. The proxy access rules heighten the importance of companies communicating and engaging with their major stockholders. Companies will likely want to expand the group of stockholders with whom they regularly engage, using the information gathered from monitoring their stockholder base. The prospect of nominations under 14a-11 might prompt a discussion as to potential changes in governance or other practices that would begin to address stockholder concerns and reduce the chances of a Rule 14a-11 nomination.
- Revisit your advance notice bylaws: Most companies have advance notice bylaws for director nominations, which typically require a minimum notice period and information about the nominee and the nominating stockholders. Companies should take steps to ensure that their advance notice bylaws are consistent with Rule 14a-11, perhaps with a savings clause that provides that a notice that is valid under the rule will be valid under the bylaw.
- Review director qualification standards: While the failure of a stockholder nominee to satisfy a company’s director qualification requirements will not preclude such a nominee from being included in the company’s proxy statement under Rule 14a-11, or from being voted on at an annual meeting, the company may (subject to state law) preclude such nominees from serving as directors for failure to satisfy reasonable qualification requirements. Additionally, nominating stockholders are required to disclose under Rule 14a-11 whether their nominees satisfy the director qualification requirements of the company that are set forth in the company’s governing documents. Companies should therefore carefully review their director qualification standards and consider including references to such standards in the bylaws.
- Update corporate governance policies: Companies will want to review their corporate governance policies and guidelines, codes of conduct and committee charters in response to the proxy access rules. For instance, a company may want the nominating committee to be responsible for reviewing 14a-11 nominees proposed by stockholders. Additionally, companies should review and consider strengthening their policies regarding confidentiality and public statements regarding company and board matters, which will be particularly important if a nominee with close ties to a major stockholder is elected to the board.
- Monitor proxy advisory firms: Companies should stay informed of the policies of the major proxy advisory firms, such as ISS Governance, in order to be aware of issues that could lead to recommendations to vote against board nominees who are facing opposition from Rule 14a-11 nominees proposed by stockholders. The company’s nominating and corporate governance committee should review on a regular basis the criteria that these advisory firms use in determining when to make a “withhold authority” or “vote against” recommendation.
- Confirm majority voting disabled: If your company’s bylaws provide for majority voting in uncontested director elections, confirm that the inclusion of a 14a-11 nominee in the company’s proxy materials will constitute a “contested” election and that plurality voting will therefore be reinstated for the election of directors at that meeting.
- Consider enhancing your stockholder communications: This is a good time to assess how comprehensive your stockholder communication program has been. Affirmative outreach to key stockholders, especially in the period prior to the deadline for proxy access nominations, could be the difference between being a target company and not.
- Develop a calendar and identify a response team: Starting from the mailing date for your most recent annual proxy statement, build a calendar that reflects the 30-day period during which valid notices must be received, the two 14-day periods for dispute resolution and the other milestones reflected in the rule. The schedule should include a very prompt review and conclusion as to the validity of the notice, and, if you do not have a basis to challenge the nomination, you will want to allow time to consider whether there can be a negotiated alternative to the nomination. Depending on your vulnerability assessment, you may wish to begin to assemble a response team, which would include professionals in the proxy solicitation and investor communications fields, as well as your legal team.
This Alert is for information purposes only, is general in nature and should not be construed as legal advice. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. For further information or an explanation about the matters discussed in this Alert, please contact any of the following attorneys in our Securities Regulation and Corporate Finance Practice Group.