By: Cydney Posner
The SEC has just posted its new proposal that would provide a mechanism for the inclusion in company proxy statements of nominees by long-term significant shareholders. The proposed rules would not provide shareholders with the right to nominate directors where it is prohibited by state law. The rule would apply only in those instances where "evidence suggests that the company has been unresponsive to shareholder concerns as they relate to the proxy process."
Companies Subject to New Rules
Proposed Rule 14a-11 would apply to all companies that are subject to the Exchange Act proxy rules, including investment companies and excluding foreign private issuers. As proposed, a company would become subject to the shareholder nomination procedure unless applicable state law prohibits shareholders from nominating a candidate. If state law permits companies incorporated in that state to prohibit nominations through provisions in companies' articles of incorporation or bylaws, the proposed procedure would not be available where the company had validly included a provision of this type in its governing instruments. The SEC is also considering, at least as a first step, adding a requirement that proposed Rule 14a-11 apply only to those companies that are subject to accelerated deadlines for filing all of their Exchange Act periodic reports.
The procedure would become operative for a company only after the occurrence of at least one of the nomination procedure triggering events described below. The procedure would then remain operative for any annual or special meetings held during:
The remainder of the calendar year in which the triggering event occurs;
The calendar year following the calendar year in which the triggering event occurs; and
The portion of the second calendar year following the calendar year in which the triggering event occurs, up to and including the annual meeting (or special meeting in lieu of an annual meeting) held during that calendar year.
(The SEC's intent is that the procedure remain available for the two annual meetings following the occurrence of a nomination procedure triggering event. Because there are a number of variables that could affect this application, such as special meetings being held instead of annual meetings or a delay in the date of a later annual meeting, the SEC proposed that the procedure be operative during the period described. Not to mention that it represents a good opportunity to make things more complicated.)
As proposed, the following events would trigger the nomination procedure:
At least one of the company's nominees for the board of directors received "withhold" votes from more than 35% of the votes cast at an annual meeting of shareholders held after January 1, 2004 at which directors were elected (excluding contested elections to which Rule 14a-12(c) applies or an election in which the procedure in Rule 14a-11 already applies); or
A shareholder proposal submitted pursuant to Rule 14a-8 providing that the company become subject to the nomination procedure in proposed Rule 14a-11
was submitted for a vote of shareholders at an annual meeting held after January 1, 2004 by a shareholder or group of shareholders that held, for one year as of the date the proposal was submitted, more than 1% of the company's securities entitled to vote on the proposal and provided evidence of such holding to the company; and
received more than 50% of the votes cast on the proposal at that meeting (including only votes for and against the proposal).
Under Rule 14a-8, a shareholder or shareholder group must provide evidence to the company at the time it submits the proposal that it meets the more-than-1% and one-year thresholds in order to have the proposal, if adopted, be a nomination procedure triggering event. The SEC is also proposing an amendment to Rule 14a-5 that would require the company, where a shareholder proposal is submitted by a more-than-1% shareholder who has held its securities for at least one year, to advise shareholders of this fact in the proxy statement. The SEC recommends that companies make this identification even prior to adoption, suggesting that omission could have implications under Rule 14a-9. (The SEC is proposing to amend Rule 14a-8(i)(8) to make clear that a company may not rely on the proceduresexclusion for proposals relating to the election of directors to exclude a proposal that the company become subject to the procedure in proposed Rule 14a-11. The remainder of Rule 14a-8 would continue to apply to the shareholder proposal, including prior positions of the Staff regarding the application of Rule 14a-8(i)(8) to shareholder proposals that would have the effect of creating a shareholder nomination procedure, other than a direct access proposal.)
With respect to the first trigger, the SEC estimates that, based on a sample of 2,227 director elections over the past two years, approximately 1.1% of companies had total withhold votes in excess of 35% of the votes cast; however, the data are not on a candidate-by-candidate basis. With regard to the more-than-1% threshold with a one-year holding period that would be required of a direct-access shareholder proponent to trigger operation of the nomination procedure, the SEC estimates that most companies have at least one eligible shareholder. The SEC recognizes, however, that the submission of proposals by shareholders that own 1% of the shares outstanding is currently relatively rare; nevertheless, shareholders could aggregate their shares to reach the 1% threshold. With regard to the requirement that a direct access proposal receive more than 50% of the votes cast, samples of proposals submitted between 2000 and 2003 indicated that between 28% and 31% of shareholder proposals in the sample received 50% of the votes cast on those proposals.
The SEC is also considering a third trigger based upon a company's not implementing (by the 120th day prior to the date the company mailed its proxy material for the annual meeting) a Rule 14a-8 shareholder proposal (whether mandatory or precatory) that receives support from the majority of votes cast. (As is currently required in Rule 14a-8, this date would be calculated by determining the release date disclosed in the previous year's proxy statement, increasing the year by one, and counting back 120 calendar days.) The SEC believes that the most appropriate manner for determining implementation likely would be to have the board provide a representation on Form 8-K to the effect that, in its good faith judgment, the board has implemented the shareholder resolution. The SEC is, however, concerned that the inclusion of this third possible triggering event could affect a board's determination of how to react to or implement a proposal or how to evaluate that proposal under state law. Just in case the SEC were to adopt this trigger, the SEC recommends that companies identify in their proxy materials any proposal that would, if adopted, be a nominating process triggering event.
Company Notice of Triggering Event
Under the proposed rules the company would be required to make shareholders aware when a nomination procedure triggering event has occurred by disclosures in its Exchange Act Form 10-Q, 10-QSB, 10-K or 10-KSB. Each company would be required to disclose the vote with regard to either of the nomination procedure triggering events in its quarterly report for the period in which the matter was submitted to a vote of shareholders (or, where the event occurred during the fourth quarter, in the annual report), as well as the fact that the company would be subject to the shareholder nomination procedure as a result of the vote, if applicable.
Shareholders Eligible for Proxy Access
To be eligible to submit a nomination under Rule 14a-11, a shareholder or group of shareholders would be required to:
Beneficially own, either individually or in the aggregate, more than 5% of the company's securities that are eligible to vote for the election of directors at the next annual meeting of shareholders (or special meeting in lieu of an annual meeting), with each of the securities used for purposes of calculating that ownership having been held continuously for at least two years as of the date of the nomination;
Intend to continue to own those securities through the date of that annual or special meeting;
Be eligible, as to the shareholder or each member of the shareholder group, to report beneficial ownership on Schedule 13G, rather than Schedule 13D, in reliance on Rule 13d-1(b) or (c); and
Have filed a Schedule 13G or an amendment to Schedule 13G reporting beneficial ownership as a passive or institutional investor (or group) before or on the date of the submission of the nomination to the company, which Schedule must include a certification that the shareholder or shareholder group has held more than 5% of the subject securities for at least two years.
The SEC estimates that approximately 42% of filers have at least one shareholder that can meet this threshold individually, while roughly 50% of filers have two or more shareholders that each have held at least 2% of the shares outstanding for the appropriate period and, thus, could more easily aggregate their shares to meet the threshold ownership requirement.
Director Eligibility Requirements
A company would not be required to include a shareholder nominee in its proxy materials if the nominee's candidacy or, if elected, board membership, would violate controlling state law, federal law or applicable SRO rules (other than independence). The SEC has instead proposed a separate requirement regarding independence standards under which a nominating shareholder would be required to represent that the nominee meets the objective criteria for "independence" (not audit committee super-independence) in any applicable national securities exchange or national securities association rules. To the extent a rule imposes a standard regarding independence that requires a subjective determination by the board or a group or committee of the board (for example, requiring that the board of directors or any group or committee of the board of directors make a determination regarding the existence of factors material to a determination of a nominee's independence), this element of an independence standard would not have to be satisfied.
To avoid concerns regarding the potential disruptive effect of "special-interest" or "single-issue" directors, the SEC proposes that, to be eligible to nominate a candidate under the proposal, a nominating shareholder may not have specified relationships with the nominee. As proposed, each shareholder nominee would be required to meet the following standards of independence from the nominating shareholder:
If the nominating shareholder or any member of the nominating shareholder group is a natural person, the nominee may not be the nominating shareholder, a member of the nominating shareholder group or a member of the immediate family of the nominating shareholder or any member of the nominating shareholder group;
If the nominating shareholder or any member of the nominating shareholder group is an entity, neither the nominee nor any immediate family member of the nominee may have been an employee of the nominating shareholder or any member of the nominating shareholder group during the then-current calendar year nor during the immediately preceding calendar year;
Neither the nominee nor any immediate family member of the nominee may have, during the year of the nomination or the immediately preceding calendar year, accepted directly or indirectly any consulting, advisory or other compensatory fee from the nominating shareholder or any member of the group of nominating shareholders or any affiliate of any such holder or member, provided that compensatory fees would not include the receipt of fixed amounts of compensation under a retirement plan (including deferred compensation) for prior service with the holder or member (provided that the compensation is not contingent in any way on continued service);
The nominee may not be an executive officer, director (or person fulfilling similar functions) of the nominating shareholder or any member of the nominating shareholder group, or of an affiliate of the nominating shareholder or any member of the nominating shareholder group; and
The nominee may not control the nominating shareholder or any member of the nominating shareholder group (or in the case of a holder or member that is a fund, an interested person of the holder or member as defined in Section 2(a)(19) of the Investment Company Act).
To address concerns regarding independence, the SEC is also proposing that each nominating shareholder or each member of the group of nominating shareholders be required to represent to the company that:
The nominee satisfies the applicable standards of a national securities exchange or national securities association regarding director independence, if any, except that, where a rule imposes a standard regarding independence that requires a subjective determination by the board or a group or committee of the board (for example, requiring that the board of directors or any group or committee of the board of directors make a determination regarding the existence of factors material to a determination of a nominee's independence), this element of an independence standard would not have to be satisfied; and
Neither the nominee nor the nominating shareholder (or any member of the nominating shareholder group, if applicable) has a direct or indirect agreement with the company regarding the nomination of the nominee.
To address concerns that use of the procedure itself would result in the shareholder's being deemed an affiliate of the company, the proposed rule would include an instruction making clear that a nominating shareholder will not be deemed an "affiliate" of the company under the Securities Act or the Exchange Act solely as a result of nominating a director or soliciting for the election of a director nominee or against a company nominee pursuant to the shareholder nomination procedure. In addition, where a shareholder nominee is elected and the nominating shareholder or nominating shareholder group does not have an agreement or relationship with that director, otherwise than relating to the nomination, the nominating shareholder or nominating shareholder group would not be deemed an affiliate solely by virtue of having nominated that director under the proposed rules.
Number of Nominees
The proposed rules are not intended to be available to those seeking control. As proposed, a company would be required to include one shareholder nominee if the total number of members of the board of directors is eight or fewer, two shareholder nominees if the number is greater than eight and less than 20, and three shareholder nominees if the number is 20 or more. Where a company has a classified board, the same aggregate limitations would apply (so that the company could avoid including a nominee if it already has satisfied the applicable number limitation). Where more than one shareholder or group of shareholders would be eligible to make a nomination, the company would be required to include only the nominees of the shareholder or shareholder group with the largest beneficial ownership (as reported on Exchange Act Schedule 13G) at the time of the delivery of the notice of intent to nominate a director pursuant to the rule, up to and including the total number required to be included by the company.
Shareholder Notice to Company
The nominating shareholder would be required to provide notice to the company of its intent to require that the company include its nominee on the company's proxy card no later than 80 days before the date that the company mails its proxy materials for the annual meeting. This notice would be required to be filed with the SEC and to include representations regarding eligibility, disclosure about the nominee, identifying information about the shareholder or group, a copy of the Schedule 13G and a description of the methods by which the shareholder may conduct its solicitation, including any website address on which the nominating shareholder may publish soliciting materials. This notice would be viewed as soliciting material of the nominating shareholder, subject to Rule 14a-9. The SEC contemplates that this solicitation would be made in accordance with the exemption set out in the proposed rule.
Company Procedure Upon Receipt of Notice
If a company receives a nomination under the proposed rules, it would be required to determine whether the nominating shareholder has complied with proposed Rule 14a-11 and whether the nominee satisfies each of the eligibility requirements. If the company determines that it is required to include a nominee, it would be required to include in its proxy statement information regarding the nominee, including the website address on which the nominating shareholder intends to solicit in favor of its nominee, and to include the name of the nominee on its proxy card. In addition to required disclosures related to each director candidate, companies could include statements in the proxy statement supporting company nominees and/or opposing shareholder nominees, provided that they comply with Rule 14a-9. If a company includes such a statement in its proxy materials, other than a mere recommendation to vote in favor of or withhold votes from specified candidates, a nominating shareholder would be given the opportunity to include in the proxy statement a statement of support for its nominees, not to exceed 500 words in length. Under the proposed rules, inclusion of a shareholder nominee in the company's proxy materials would not, by itself, require the company to file a preliminary proxy statement. Both the company and the nominating shareholder would be able to solicit in favor of its nominees outside the proxy statement, for example on a designated website, provided that the solicitations were made within the applicable proxy rules.
With regard to the company's proxy card, the company could identify any shareholder nominees as such and recommend that shareholders vote against, or withhold votes from, those nominees and in favor of the management nominees on the form of proxy. The company must otherwise present the nominees in an impartial manner in accordance with Rule 14a-4. A company would not be permitted to provide shareholders the option of voting for or withholding authority to vote for the company nominees as a group, but must instead require that each candidate be voted on separately. However, the SEC anticipates that companies would continue to be able to solicit discretionary authority to vote for the company nominees, as well as to cumulate votes for the company nominees in accordance with applicable state law.
A company may conclude that it is not required to include a shareholder nominee if it determines any of the following:
The procedure in proposed Rule 14a-11 is not applicable to the company;
The nominating shareholder has not complied with the requirements of the procedure;
The nominee does not meet the requirements of the procedure;
Any representation required to be included in the notice to the company is false in any material respect; or
The company has received more nominees than it is required to include by the proposed rule and the nominating shareholder is not entitled to have its nominee included in that situation.
The nominating shareholder must be advised promptly in writing of the company's determination whether or not to include the nominee, but in no event less than 30 calendar days before the date of the company's proxy statement released to shareholders in connection with the previous year's annual meeting (where the company did not hold an annual meeting in the previous year, or if the date of this year's annual meeting has been changed by more than 30 days from the date of the previous year's meeting, then the notice must be provided a reasonable time before the company mails its proxy materials for the current year). If the company determines that it is entitled to exclude the nominee, the notice must include the following information regarding the company's determination:
A description of the determination made by the company's board of directors, including an affirmative statement of its determination not to include that specific nominee;
A discussion of the specific requirements of the rule that the company's board has determined permit the company not to include that specific nominee; and
A discussion of the specific basis for the belief of the company's board that the company is permitted to exclude that specific nominee.
The company would be required to include in its proxy statement a statement that it has made this determination, as well as disclosure of the information relating to the determination that the company included in the notice to the nominating shareholder.
If the company determines that it must include the nominee, it would be required to advise the nominating shareholder of this determination and state whether the company intends to include in its proxy statement disclosure opposing the nominee and/or supporting company nominees. If the company intends to include such a statement, it must advise the nominating shareholder of its right to submit a statement by a specified date, which could not be less than 10 business days from the date of the company's notice to the shareholder. The nominating shareholder's supporting statement would be viewed as soliciting material and would therefore be required to be filed as such with the SEC on or about the date that the company's proxy statement is first released to shareholders.
The nominating shareholder, not the company, would be liable for any false or misleading statements included in its notice provided to the company. Any information that is provided to the company in the notice from the nominating shareholder and then included in the company's proxy materials would not be incorporated by reference into any filing under the Securities Act or the Exchange Act unless the company determines to incorporate that information by reference specifically into that filing. However, to the extent the company does so incorporate that information by reference, the SEC would consider the company's disclosure of that information as the company's own statement for purposes of the antifraud and civil liability provisions of the Securities Act or the Exchange Act, as applicable.
Application of Proxy Rules to Solicitations
Under the proposed rule, shareholders would be permitted to form groups that aggregate their securities in order to meet the minimum ownership threshold of more than 5% to nominate a director candidate under the rule. Shareholder solicitations to form these groups would be subject to a limited exemption from certain of the proxy rules to enable shareholders to communicate for the limited purpose of forming a nominating shareholder group without filing and disseminating a proxy statement. To qualify for the exemption, shareholders would have two options. The communications would be made either to no more than 30 shareholders or, in the alternative, to an unlimited number of shareholders, provided that the communication is limited in content, as provided under the rules, and filed with the SEC no later than the date the material is first published, sent or given to shareholders.
The company ultimately would file a proxy statement and could therefore rely on the existing proxy rules to solicit outside the proxy statement. Solicitations by or on behalf of a nominating shareholder in support of a nominee would not be subject to rules 14a-3 to 14a-6(o), 14a-8, and 14a-10 to 14a-15, provided that:
The soliciting party does not, at any time during the solicitation, seek, directly or indirectly, either on its own or another's behalf, proxies and does not furnish or otherwise request, or act on behalf of a person who furnishes or requests, a form or revocation, abstention, consent or authorization;
Each written communication includes specified information; including a prominent prescribed legend; and
Any soliciting material published, sent or given to shareholders must be filed with the SEC no later than the date the material is first published, sent or given to shareholders and the applicable SROs.
Changes to Beneficial Ownership Reporting Requirements
The SEC is proposing to add an instruction to Schedule 13G to make clear that a beneficial owner who acquires or holds a company's securities in connection with a nomination, soliciting activities or election of a nominee under proposed Rule 14a-11 should not be deemed to have a purpose or effect of changing or influencing the control of the company solely by virtue of making the nomination or engaging in such activities. Any activity other than those provided for under the proposed Rule 14a-11 would make these instructions inapplicable.
The SEC is also proposing to amend Schedule 13G to require that the shareholder or shareholder group certify that they have owned at least the required more-than-5% amount for the minimum time period of two years required in proposed Rule 14a-11. A shareholder or group of shareholders that previously had filed a Schedule 13G would be required to amend that Schedule to provide the required certification to make a nomination under the proposed rule. Upon termination of the nominating shareholder group, the group would file a final amendment to the Schedule 13G. The group would be required to file as such only so long as the shareholders constituting that group continue to have an agreement to act together for the purpose of acquiring, holding, voting or disposing of the company's equity securities.
Changes to Rules under Section 16
The SEC is proposing to amend Rule 16a-1(a)(1), the rule that defines who is a 10% owner for Section 16 purposes, to exclude a Rule 14a-11 nominating shareholder group from the definition. These groups would remain subject to the general condition of the rule that they not have the purpose or effect of changing or influencing control of the issuer. The SEC is not proposing to exclude from the definition of beneficial ownership for purposes of Section 16 shareholders whose individual ownership exceeds 10% and are not otherwise excluded under the current rule. In addition, proposed Rule 14a-11 includes standards for establishing the independence of the nominee from the nominating shareholder. Therefore, the SEC believes that, under these independence standards, the "deputization" theory, where the beneficial ownership of a shareholder or group is imputed to a "deputized" director (and director status imputed to the shareholder or shareholder group), should not apply.