On June 10, 2009, the Securities and Exchange Commission ("SEC") released a proposal to amend the SEC's proxy rules to permit shareholders to nominate directors in a company's proxy materials (also known as "proxy access"). This significant proposal has the potential to dramatically change the manner in which corporate directors are nominated and elected. The proposal contains extensive requests for comment, and the SEC Commissioners have urged interested parties to provide feedback on the proposal. This alert discusses significant aspects of the proposal upon which companies and directors may wish to comment. The comments received on these issues are likely to have a substantial effect on any final rules adopted by the SEC. Accordingly, given the potential impact of this proposal, we encourage you to review the proposal and submit comments to the SEC. Comments are due by August 17, 2009.
The Proposed Rules
If adopted, the proposed rules would (1) establish a federal proxy access right pursuant to proposed Rule 14a-11 and related amendments, and (2) permit proxy access shareholder proposals pursuant to an amendment to Rule 14a-8.
Proposed Rule 14a-11
Proposed Rule 14a-11 would create a federal law process for a shareholder or group of shareholders to nominate one or more directors and have those nominees included in a company's proxy materials if the shareholder or group beneficially owned a certain percentage of the company's voting shares for at least one year prior to submitting the nomination. The ownership requirements would vary depending on a company's size:
- at least 1% of voting shares for large accelerated filers and registered investment companies with net assets of $700 million or more;
- at least 3% of voting shares for accelerated filers and registered investment companies with net assets of $75 million or more, but less than $700 million; and
- at least 5% of voting shares for non-accelerated filers and registered investment companies with net assets of less than $75 million.
Nominating shareholders would be required to file a new Schedule 14N disclosing the percentage of the company's shares beneficially owned, the period of time the shares have been beneficially owned, the shareholders' intent to hold their shares through the date of the meeting and certain other information similar to that currently required in a contested election. Each year, shareholders would be permitted to include in a company's proxy materials the greater of one director nominee or a number of director nominees that equals up to 25% of the company's board. Notably, the proposed rule would not restrict the ability of shareholders to nominate directors with whom they have a relationship, and shareholder nominees would only have to satisfy the objective independence standards in applicable securities market listing standards. In addition, the SEC is proposing an exemption from the proxy rules for communications made in connection with using proposed Rule 14a-11.
Proposed Amendments to Rule 14a-8
Rule 14a-8(i)(8) currently permits companies to exclude shareholder proposals related to director elections. In 2007, the SEC amended this rule to specifically permit the exclusion of proxy access shareholder proposals. Proposed amendments to Rule 14a-8(i)(8) would eliminate this basis for exclusion and require companies to include in their proxy materials proxy access shareholder proposals. These shareholder proposals would be excludable from company proxy materials if they conflicted with state law or proposed Rule 14a-11; that is, a shareholder proposal could not have the effect of preventing a shareholder or group meeting the requirements of proposed Rule 14a-11 from having its nominee included in a company's proxy materials. In addition, if the proponent of a proxy access shareholder proposal failed to satisfy the current Rule 14a-8 eligibility requirements, the proposal could be excluded.
Suggested Areas for Comment
At the SEC's May 20 open meeting, the Commissioners emphasized the large number of questions on which they were seeking input and indicated that they were looking forward to the comments. Moreover, SEC Commissioners Kathleen Casey and Troy Paredes expressed reservations about the proposal, particularly its preemption of state law and private ordering. This suggests that the comments will be very important in determining the details of any proxy access rules that the SEC ultimately adopts. Accordingly, it is important that companies and their directors provide the SEC with comments on the proxy access proposal. Below are some of the significant issues where the comments of companies and their directors may be particularly important.
1. Rule 14a-11
At the outset, companies should consider whether they wish to oppose the adoption of Rule 14a-11 in any form. Corporate governance has undergone dramatic changes since the adoption of the Sarbanes-Oxley Act of 2002; for example, numerous companies have adopted majority voting in uncontested elections, which has resulted in greater board accountability. Moreover, Delaware recently enacted amendments to its General Corporation Law that would facilitate the adoption of proxy access bylaws by individual companies, and the American Bar Association is considering similar amendments to the Model Business Corporation Act. In contrast to these state law-based proxy access initiatives, proposed Rule 14a-11 would substitute the SEC's judgment for that of shareholders, boards of directors and state legislatures through the imposition of minimum thresholds for proxy access on all public companies and their shareholders. Significantly, the SEC has proposed proxy access rules twice before in the past ten years and received extensive comments on the negative implications of the proposals. Commenters noted that the proposed rules would, among other things, facilitate the election of "special interest" directors, politicize the director election process, discourage qualified directors from serving on boards, disrupt and polarize boards, encourage the likelihood of costly election contests and increase the influence of proxy advisory services.
In addition, companies may wish to comment on key details of proposed Rule 14a-11, including the following:
Triggering Events: As proposed, Rule 14a-11 does not require the occurrence of any triggering events before proxy access applies to a particular company, as did the 2003 SEC proxy access proposal. Requiring the occurrence of a triggering event--e.g., a director's receipt of a certain percentage of "withhold" or against votes in an election--would limit the application of the proxy access rules to instances in which it has been demonstrated that the traditional proxy process is ineffective. Companies should consider whether the proposed rule should include triggering events, and, if so, what they should be.
Ownership Requirements: In order to be eligible to submit a nomination for inclusion in a company's proxy statement under proposed Rule 14a-11, a shareholder or group of shareholders must meet certain ownership requirements, as described above. Companies should consider whether these ownership requirements are appropriate.
Number of Directors: The proposed rule would permit the inclusion of no more than one shareholder nominee or a number of nominees representing 25% of the company's board of directors, whichever is greater, on a company's proxy statement. In addition, if a company were to receive more shareholder nominations than the proposed rule allows, the company would only be required to include the nominees put forth by the first shareholder or group to submit timely notice to the company. Companies should consider whether the proposed number of permitted shareholder nominees and the first-in-time provision for multiple nominations are appropriate.
Nominee Affiliation/Independence: In contrast to the 2003 SEC proxy access proposal, proposed Rule 14a-11 would not restrict the ability of shareholders to nominate directors with whom they have a relationship. Consequently, shareholders could nominate themselves or their employees. Companies should consider whether restrictions on affiliations between nominating shareholders and nominees are appropriate, as the absence of restrictions may encourage the nomination of "special interest" directors. In addition, the proposal would require that a shareholder nominee satisfy only the objective independence standards of the applicable securities market; any additional eligibility criteria imposed by a company on its director nominees would not be applicable to shareholder nominees. Companies should consider whether this proposed limitation on criteria for nominee eligibility is appropriate.
Nominating/Governance Committee: As currently proposed, the rule does not provide a role for a company's nominating/governance committee in the vetting of shareholder nominees. Companies should consider whether it would be appropriate to permit the nominating/governance committee to interview shareholder nominees or otherwise evaluate shareholder nominees for compliance with the applicable independence standards.
Process for Exclusion: The proposed rule would establish detailed procedures (with strict deadlines and SEC staff involvement, similar to the Rule 14a-8 shareholder proposal no-action letter process) that a company would need to follow if it intended to exclude a shareholder nomination on the basis that the requirements of proposed Rule 14a-11 were not met. Companies should consider the workability of the proposed procedures, particularly as they relate to timing and companies' advance notice bylaws.
Companies also may wish to consider whether to suggest that the proposed exemption from the proxy rules be expanded to provide new opportunities for companies to engage in discussions with their shareholders about issues surrounding director selection (free from it being viewed as proxy solicitation).
2. Rule 14a-8(i)(8)
Currently, the SEC's rules permit companies to exclude shareholder proposals related to director elections under Rule 14a-8(i)(8). The proposed amendments to Rule 14a-8(i)(8) would require companies to include proxy access shareholder proposals--proposals that would amend, or request the amendment of, provisions of a company's governing documents to address the company's nomination procedures or disclosures related to shareholder nominations--in company proxy materials, except in limited circumstances. In light of the recently enacted amendments to the Delaware General Corporation Law and other possible state legislative action addressing the issue of proxy access bylaws, as discussed above, companies should consider whether the proposed amendments to Rule 14a-8(i)(8) are appropriate.
Pursuant to the proposed amendments, proxy access shareholder proposals would be excludable if they conflicted with state law or proposed Rule 14a-11. A shareholder proposal thus could not have the effect of preventing a shareholder or group meeting the qualifications of proposed Rule 14a-11 from having its nominee included in a company's proxy materials; for example, a shareholder proposal could not propose higher ownership thresholds than those set forth in proposed Rule 14a-11. Companies should consider whether this limitation on proxy access shareholder proposals is appropriate.
Additionally, under the proposed amendments to Rule 14a-8(i)(8), proponents of proxy access shareholder proposals would be subject to the same eligibility requirements as proponents of other shareholder proposals under Rule 14a-8 (i.e., a shareholder must hold at least $2,000 in market value, or 1%, of the company's shares for at least one year to be eligible to submit a proposal). Companies should consider whether higher eligibility thresholds are appropriate for proxy access shareholder proposals.
3. Effective Date
Although the proposal release does not discuss an effective date for any final proxy access rules, certain SEC Commissioners have suggested that they would like final rules in place for the 2010 proxy season. Given the policy issues and the complexities involved in the implementation of any such rules, and the need for companies to consider and implement any necessary changes to their governing documents, such as their advance notice bylaws, commenters should consider whether a transition period or a later effective date would be appropriate.
Finally, companies may wish to consider alternatives to the SEC's current proposed proxy access rules, such as amendments to SEC rules that would reduce the cost of proxy contests. One of the bases for the proposed proxy access rules is the prohibitive cost involved in mounting a proxy contest under the SEC's current rules. To address this concern, the SEC could mandate the use of a universal ballot (i.e., a single ballot that includes both company nominees and shareholder nominees for director positions) in proxy contests. A universal ballot or other revisions to the SEC's proxy contest rules might address certain of the concerns that prompted the proposed proxy access rules and thus obviate the need for the rules.
The proposed proxy access rules are only one aspect of the SEC's corporate governance agenda. Last week, the SEC approved amendments to New York Stock Exchange Rule 452 to eliminate broker discretionary voting in uncontested director elections and proposed corporate governance disclosure enhancements . In view of these changes, as well as pending legislative proposals, it is critical that companies participate in the corporate governance dialogue through the submission of comments on the SEC's proxy access proposal.
Gibson, Dunn & Crutcher's lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work, or any of the following in the firm's Washington, D.C. office:
John F. Olson (202-955-8522, firstname.lastname@example.org)
Brian J. Lane (202-887-3646, email@example.com)
Ronald O. Mueller (202-955-8671, firstname.lastname@example.org)
Amy L. Goodman (202-955-8653, email@example.com)
Gillian McPhee (202-955-8230, firstname.lastname@example.org)
Elizabeth Ising (202-955-8287, email@example.com)
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