By Cydney Posner
This morning, after almost a decade of failed efforts, the SEC, by a vote of three-to-two, adopted changes to the federal proxy and other rules to facilitate director nominations by shareholders. So-called "proxy access" will allow eligible shareholders to include their nominees in the company's proxy materials. The amendments are designed to address the common complaint that procedures currently available to shareholders for director nominations, such as waging a costly proxy contest, do not afford a practical mechanism for shareholders to participate effectively in the nomination process. The prevalence of plurality voting has also limited the effectiveness of "vote no" campaigns. Failing these efforts, it has been argued, shareholders dissatisfied with board performance may be left with selling their shares as the only option.
The debate among commissioners came down to a battle over states' rights – or rather their different characterization of states' rights. The three Democratic appointees characterized the action as one that "facilitates shareholders' traditional state law voting and nomination rights." The two Republican appointees (Casey and Paredes) objected to what they viewed as a federal mandate that preempted the enabling provisions of state law, thus precluding companies from tailoring rules to the unique attributes of each firm. Commissioner Paredes, for example, made the point that the new rules could negate a shareholder-approved bylaw that would otherwise be effective under state law. The Democratic appointees emphasized that the new rules represented an effort at balance, weighing of competing interests and compromise, taking all comments into account, and attempted to provide shareholders the ability to make a choice among real alternatives. As Commissioner Walter described it, "this process just provides shareholders a genuine alternative to exit." The Republican appointees focused on the potential for discrimination against individual shareholders, the arbitrariness of the criteria, impact on the capital markets and the inadequacy of the empirical data to support the approach taken (perhaps an effort to provide a foundation for anticipated future litigation). Commissioner Casey was clearly the most impassioned about the new rules, stating that she disagreed with everything in the release and nominating the new rules for the pantheon of ill-conceived SEC rules. Interestingly, her psychological analysis was that the SEC staff thinks it has now finally put proxy access behind it; however, in her view, it will be a problem for the staff for years to come, both in the courts and with staff involvement in brokering disputes. She contended that, while the release characterized proxy access as a fundamental right of shareholders, it was incongruous that the new rules denied that right to most shareholders. For example, she cited data that only 1/3 of companies had a shareholder that met the eligibility criteria. Moreover, she argued, it's not appropriate to presume that institutional shareholders represent all shareholders, yet there is nothing to constrain special interests. She and Paredes both also objected that the rules represented an abrupt departure from state corporate law, essentially presuming that shareholders were incapable of privately ordering their own affairs. Casey also argued that the release ignored the potential impact on the capital market, disregarded the foundational weaknesses of proxy plumbing, and was otherwise entirely unnecessary.
The final rules include a significant change from the proposal in the definition of eligible shareholders. To use the new proxy access rules, a shareholder or shareholder group must hold at least 3% of the outstanding voting power as of the date of the shareholders' notice on new Schedule 14N and must have continuously held the shares for at least three years (both voting and investment power). Shareholders can aggregate to reach the necessary level and can include shares loaned out (as long as they may be recalled), but must exclude shares sold short or borrowed. The shareholder or group must continue to hold the shares through the meeting and disclose its intent regarding holding the shares after the meeting. The shareholder or group must not have any intent to control or to nominate more than a limited number of shareholders and may not have any agreement with company about the nomination. The nominee must be a candidate permitted under applicable law and meet the objective (not subjective) standards for independence of the applicable exchange. There is no restriction on any relationships between the nominee and the nominating shareholder or group (i.e., nothing restricting a special interest candidate). Shareholders may nominate up to 25% of the board (viewing staggered boards as a whole, not by class), or one nominee, whichever is greater.
Nominating shareholders would have to file a Schedule 14N notice, which must include disclosure regarding the percentage of voting power, holding period, biographical information about the nominee and the shareholder or group and, in a change from the proposal, whether the nominee satisfies the company's own qualification requirements. The 14N would also disclose whether all Rule 14a-11 requirements were satisfied, as well as a statement in support of no more than 500 words. If there were more nominees than the rule permits, the nominee proposed by the shareholders with the highest percentage of voting power would be entitle to include their nominees (not the "first in" rule originally proposed). The 25% cap may include shareholders that the company nominates under an agreement with proposing shareholders.
If the company receives a notice on Schedule 14N, it must notify the shareholder or group either that it will include the nominee or the basis upon which the nomine fails to satisfy the 14A-11 requirements and allow the proponent an opportunity to respond. If, following the response, the company still objects, the company must notify the SEC and may submit a no-action request. (Note that Corp Fin Director Meredith Cross emphasized that the staff is ready and "up to this task.")
The new rules also include two new exemptions for solicitation conducted by shareholders before the nomination and by shareholders whose nominee will appear in the proxy (as long as no proxies are solicited). Communications will need to be filed with the SEC. There are also conforming changes to 13D and Section 16 providing that groups formed to nominate or elect shareholders are not "groups" under those rules. The proposed safe harbor from the definition of affiliate has been eliminated, and a regular facts-and-circumstances test will apply instead.
Rule 14a-8 is also being amended to narrow the election exclusion to provide that companies must include shareholder proposals if they seek to provide a procedure in governing documents to include nominees in the company's proxy, as long as they do not impose any additional restriction on the SEC's rules. In effect, they would provide an additional avenue for nominees under state or foreign law. Disclosure required would be comparable to that required under Rule 14a-11.
The shareholder or group would be liable for statements made regarding the nominee, and the company would not be responsible for any statements provided by the shareholder or group, eliminating the frightening "knows or has reason to know" standard in the original proposal.
The new rules will be effective 60 days after publication in the federal register. A copy of the adopting release can be found online.
For smaller reporting companies, there is a three-year-delay while the SEC monitors the process.