On August 25th, the SEC voted to adopt proxy access reforms that institutional investors in general, and many public pension plans in particular, have been seeking for years. The Council of Institutional Investors (CII) hailed the action as “historic,” and Ann Yerger, CII’s executive director, said it was “ground-breaking for U.S. shareowners.” “Access to the proxy will invigorate board elections and make boards more responsive to shareowners and more vigilant in their oversight of companies,” she insisted.
Not everyone agreed. David Hirschmann, president and CEO of the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness, called it a “special interest-driven rule” and said it is “a giant step backwards for average investors.” “Using the proxy process to give labor union pension funds and others greater leverage to try to ram through their agenda makes no sense,” according to Hirschmann. SEC Commissioner Kathleen Casey (R) agreed, and voted against the new rule, warning that it “is so fundamentally and fatally flawed that it will have great difficulty surviving judicial scrutiny.” She was joined in voting against the rule by Commissioner Troy Paredes (R), who, in objecting to the fact that shareowners could not vote to “opt out” from under the rule’s requirements, complained that this “displace[s] private ordering and state law and negate[s] the import and effect of shareholder choice when it comes to determining the contours of proxy access.”
The main features of the new rule and the amended rule are as follows:
New Exchange Act Rule 14a-11, requiring companies to include shareholder nominees for director in the company’s proxy materials, if the shareholder and their nominees meet certain conditions:
- Shareholders, either individually or as a group that is aggregating their holdings, will be eligible to have their nominee included in the proxy materials if they own at least 3 percent of the total voting power of the company’s securities that are entitled to be voted on at the election of directors at the annual meeting. Borrowed shares and shares sold short cannot be included in determining the 3 percent threshold, but loaned shares that may be recalled (and will be recalled prior to the annual meeting) may be counted.
- Shareholder(s) must have held their shares continuously for at least three years and will be required to continue to own at least the required amount of securities through the date of the meeting at which directors are elected. Shareholders must not be holding the securities for the purpose of changing control of the company.
- Each shareholder or group of shareholders will be able to include at least one nominee, but no more than 25 percent of the company’s board of directors, whichever is greater. The 25 percent limit will be based on the total directors on the board. Therefore, a company will not be able to limit shareholder nominees by holding staggered elections. If more than one shareholder or group seeks to nominate candidates, and the total would exceed the 25 percent cap, the group with the highest percentage of voting stock will be given priority, and not, as originally proposed last year, the first group to file a notice of intent to seek such nominees.
- Nominating shareholders will be required to file with the SEC, as well as with the company, a new Schedule 14N, which is a Notice of Intent, which will be made available to the public. The new Schedule 14N will require, among other things, disclosure of the amount and percentage of the voting power of the securities owned by the nominating shareholder, the length of ownership, and a statement that the nominating shareholder intends to continue to hold the securities through the date of the meeting. It will also identify the specific nominee or nominees, including biographical information and a description of the nature and extent of the relationships between the nominating shareholder and the nominee(s) and the company. This information will also be included in the company’s proxy materials, similar to the disclosure currently required in a contested election.
- The new rule will apply to all Exchange Act reporting companies, including investment companies, other than companies whose only public securities are debt securities. “Smaller reporting companies”—generally, an issuer that had a public float of less than $75 million—are also subject to the rule, and not exempted. However, they will be given a three-year phase-in period. During that time, the new rule will not apply to them; and the SEC plans to study the potential impact on those issuers and may make further revisions to its rule based on this study. Foreign companies that come within the definition of “foreign private issuer” are not currently subject to the SEC’s proxy rules and would not be subject to these new rules.
- Shareholders must submit nominees no later than 120 days before the anniversary date of the mailing of the company’s proxy statement in the prior year. Initially, shareholders will be able to submit nominees for inclusion in the next proxy statement if the 120-day deadline falls on or after the effective date of the rules. Thus, assuming that the new rule is noticed in the Federal Register very shortly, as expected, it will become effective in early November 2010 (60 days after it is noticed), meaning that it generally would be available for use at companies that mailed their proxy statement for their last annual meeting no earlier than around the second week in March 2010.
- Shareholder proposals by qualifying shareholders that seek to establish such procedures in the company’s governing documents could no longer be excluded. (Before this change, Rule 14a-8(i)(8) permitted companies to exclude shareholder proposals that relate to elections.) However, companies will still be permitted to exclude a shareholder proposal pursuant to Rule 14a-8(i)(8) if it (1)would disqualify a nominee who is standing for election; (2) would remove a director from office before his or her term expired; (3) would question the competence, business judgment, or character of one or more nominees or directors; (4) would seek to include a specific individual in the company’s proxy materials for election to the board of directors; or (5) otherwise could affect the outcome of the upcoming election of directors.
- In order to qualify to offer such proposals, a shareholder must have continuously held at least $2,000 in market value (or 1 percent, whichever is less) of the company’s securities entitled to be voted on the proposal at the meeting, for a period of one year prior to submitting the proposal. (This is the current eligibility rule, and does not change.)
- A company would not be required to include in its proxy materials a shareholder proposal that seeks to limit the availability of the new Rule 14a-11. However, shareholders would be allowed to propose additional means, other than Rule 14a-11, for inclusion of shareholder nominees in company proxy materials. Therefore, under the Proposal, a shareholder proposal that sought to provide an additional means for including shareholder nominees in the company’s proxy materials pursuant to the company’s governing documents would not be deemed to conflict with Rule 14a-11 simply because it would establish different eligibility thresholds or require more extensive disclosures about a nominee or nominating shareholder than would be required under Rule 14a-11. However, as the SEC has noted, a shareholder proposal would conflict with proposed Rule 14a-11 “to the extent that the proposal would purport to prevent a shareholder or shareholder group that met the requirements of proposed Rule 14a-11 from having their nominee for director included in the company’s proxy materials.”
- In order to have a proposal included in a company’s proxy materials, the rules are similar to the new Rule 14a-11 requirements. That is, a shareholder must submit the proposal no later than 120 days before the anniversary date of the mailing of the company’s proxy statement in the prior year, and shareholders will be able to submit proposals for inclusion in the next year’s proxy statement if the 120-day deadline falls on or after the effective date of the rules.
On the other hand, they do provide for the inclusion of nominees properly nominated by shareholders on a company’s proxy statement, thereby significantly reducing shareholder costs. Also, a company may not choose to “opt out” of the new rule, nor can it increase the percentage and holding thresholds -- even if the shareholders were actually to approve these changes.
And speaking of these thresholds, will the 3-percent/three-year minimum requirement unduly restrict access? First, it could have been worse. During the conference between the House and Senate on what eventually became the Dodd-Frank law, the Senate conferees actually made a proffer to mandate that the SEC issue proxy access rules with thresholds of 5 percent ownership with a two-year holding period.
This percentage of ownership was so high that even the ten largest public pensions plans, combined, would be unlikely to be able to meet it. Eventually, this proffer was rejected, and the new law confirmed the authority of the SEC to issue such proxy access rules as it deemed appropriate, with no mandate to do so.
However, there are those who say that shareholders, even when grouped together, rarely own a 3 percent stake in the largest companies. For example, the 20 biggest public pension plans, combined, reportedly own only 2.8 percent of Goldman Sachs. It is estimated that, for the 20 largest U.S. companies by market cap, the smallest investment shareholders would need in order to qualify to nominate a director is $3.5 billion.
The rule, as originally proposed by the SEC in May of last year, would have provided a tiered ownership threshold with shorter holding periods. For the largest companies, shareholders would only have been required to own at least 1 percent of the voting securities; the percentage would have increased to 3 percent for medium companies, and to 5 percent for the smallest firms. In all cases, the holding requirement would only have been one year.
However, the SEC said that it believed that the 3 percent threshold, while higher for many companies and lower for others than the thresholds originally advanced, “properly balances our belief that Rule 14a-11 should facilitate shareholders’ traditional state law rights to nominate and elect directors with the potential costs and impact of the amendments on companies.” According to the SEC, “The ownership threshold we are establishing should not expose issuers to excessively frequent and costly election contests conducted through use of Rule 14a11, but it is also not so high as to make use of the rule unduly inaccessible as a practical matter.”
As for the increase in the holding period from one to three years—many prognosticators had expected two—the SEC said that it thought a three-year holding period “reflects our goal of limiting use of the rule to significant, long-term holders” and “strikes the appropriate balance in providing shareholders with a significant, long-term interest with the ability to have their nominees included in a company’s proxy materials while limiting the possibility of shareholders attempting to use Rule 14a-11 inappropriately.” By this, the SEC was referring to concerns that hedge funds or private equity funds could use proxy access in lieu of proxy fights. The required three-year period in the final rule should make it less likely that this will be the case.
Then there is the matter of majority voting, another important goal for institutional investors. But requirements for such often do not apply in contested elections for directors. Accordingly, some observers have pointed out that one effect of the new Rule 14a-11 will be to restore plurality voting for directors in most elections where shareholders use the new process for nominating directors. On the other hand, a vote of any sort might not be taking place but for the new rule.
Finally, there is the underlying issue of the rule’s legality. Although institutional investor proponents worked hard to have language included in Dodd-Frank that underscored the SEC’s authority to act in this area, this authority is still likely to be challenged.
The SEC, in approving the final rule, stressed that Dodd-Frank provided the SEC with explicit authority to make rules addressing shareholder access to company proxy materials. As the SEC underscored, not only do they believe they “have the authority to adopt Rule 14a-11 under Section 14(a) as originally enacted,” but that, “[i]n any event, Congress confirmed our authority in this area and removed any doubt that we have authority to adopt a rule such as Rule 14a-11.”
The SEC also made it clear that not only does it believe it has the statutory authority to act, but the new Rule 14a-11 is also constitutional. The Commission insists that proxy regulations do not infringe on corporate First Amendment rights (quoting from the Supreme Court’s decision in Pacific Gas and Electric Company v. Public Utilities Comm’n of California, 475 U.S. 1, 14 n.10 (1986)) both because “management has no interest in corporate property except such interest as derives from the shareholders,” and because such regulations “govern speech by a corporation to itself” and therefore “do not limit the range of information that the corporation may contribute to the public debate.”
Even if statements in proxy materials are viewed as more than merely internal communications, the SEC insists that this communication is of a commercial—not political—nature, and “regulation of such statements through Rule 14a-11 is consistent with applicable First Amendment standards.”
But these definitive assertions are unlikely to keep opponents away from the courthouse. The U.S. Chamber of Commerce has proven itself very willing to challenge SEC rules, and has said that it has retained counsel to review whether to file suit to block access. According to the Chamber’s David Hirschmann, “The Chamber will carefully review the rule that was approved today and will continue to fight this flawed approach using every method available.”
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