SEC Adopts Final Rules Regarding Nominating Committee Functions and Communications Between Security Holders and Boards of Directors

Introduction

The SEC has adopted final rules that require disclosure in proxy statements regarding the operations of board nominating committees and the means, if any, by which security holders may communicate with members of the board of directors. The new rules enhance the disclosure requirements for proxy statements regarding the director nominating process and add a new disclosure requirement concerning communications between security holders and boards of directors. The rules, as adopted, are in most respects, the same as those proposed on August 8, 2003. Companies must comply with the new disclosure requirements in proxy statements or information statements that are first sent or given to security holders on or after January 1, 2004. The new disclosure requirements also apply to proxy statements relating to the election of directors of investment companies. The release containing these proposed rules can be found on the SEC Web site at http://www.sec.gov/rules/final/33-8340.htm.

Enhanced Nominating Committee Disclosure

Currently, companies must disclose in their proxy statements whether they have a nominating committee and, if so, whether the committee considers nominees recommended by security holders and how any such recommendations can be submitted. The new rules expand the current disclosure requirements to require companies to disclose the following information:

• Nominating Committee Existence. A statement as to whether or not the company has a standing nominating committee or a committee performing similar functions, and, if the company does not have such a committee, a statement of the specific basis for the board's view that it is appropriate for the company not to have such a committee and identification of each director who participates in the consideration of potential director nominees.
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• Nominating Committee Charter. If the nominating committee has a charter, whether a current copy of the charter is available to security holders on its Web site and, if so, its Web site address. If the charter is not available on the company's Web site, the charter must be included as an appendix to the company's proxy statement at least once every three years and in those years in which the charter is not included as an appendix to the proxy statement, the company must disclose the prior fiscal year in which the charter was so included as an appendix. If the company has a nominating committee and it does not have a charter, a statement to that effect is required.
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• Nominating Committee Independence. If the company's securities are listed on a national securities exchange or in an automated inter-dealer quotation system of a national securities association (such as Nasdaq) that has independence requirements for nominating committee members, whether the nominating committee members satisfy the standard for independence defined in the applicable listing standards. If a company's securities are not so listed or quoted, disclosure of whether each nominating committee member is independent. In that case, the company must use the independence standard of a national securities exchange or national securities association that has been approved by the SEC and state which standard it used. With regard to investment companies, the rules require disclosure as to whether or not the members of the investment company's nominating committee are "interested persons" of the investment company as defined in Section 2(a)(19) of the Investment Company Act.
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• Security Holder Recommendations. If the nominating committee has a policy with regard to the consideration of any director candidates recommended by security holders, a description of the material elements of that policy, including a statement as to whether the committee will consider director candidates recommended by security holders. If there is no such policy, a statement to that effect and the basis for the view of the board of directors that it is appropriate for the company not to have such a policy.
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• Procedures for Submitting Candidates. If the nominating committee will consider candidates recommended by security holders, a description of the procedures to be followed by security holders in submitting such recommendations.
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• Minimum Qualifications, Necessary Qualities and Skills. A description of (i) any specific, minimum qualifications that the nominating committee believes must be met by a nominee in order to be considered for nomination by the committee to the company's board of directors and (ii) any specific qualities or skills that the nominating committee believes are necessary for one or more of the company's directors to possess.
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• Processes for Identifying and Evaluating Director Nominees. A description of the nominating committee's process for identifying and evaluating nominees for director, including nominees recommended by security holders, and any differences in the manner in which the nominating committee evaluates nominees for director based on whether the nominee is recommended by a security holder.
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• Source for Each Nominee. With regard to each nominee approved by the nominating committee for inclusion on the company's proxy card (other than nominees who are executive officers or directors standing for re-election), a statement as to which one or more of the following categories of persons or entities recommended that director nominee: security holder, non-management director, chief executive officer, other executive officer, third-party search firm, or other, specified source.
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• Compensation to Third Parties for Identifying or Evaluating Potential Nominees. If the company paid a fee to any third party or parties (e.g., executive search firms) to identify or evaluate or assist in identifying or evaluating potential nominees, the function performed by each such third party.
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• Certain Nominees Recommended by Large Security Holders. If the nominating committee receives, by a date not later than the 120th calendar day before the date that the company's proxy statement was released to security holders in connection with the previous year's annual meeting, a recommendation from a security holder or group of security holders who individually, or in the aggregate, beneficially owned greater than 5% of the company's voting common stock for at least one year as of the date of the recommendation, identification of:
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  • the candidate and the security holder or security holder group who recommended the candidate; and
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  • whether the nominating committee chose to nominate the candidate.

However, the company will not be required to provide such identification and disclosure without the written consent of both the security holder or security holder group and the candidate to be so identified. A security holder or group that seeks to require a company to provide disclosure related to a recommendation also will need to provide proof of ownership.

Disclosure Regarding Security Holders' Communications with the Board of Directors

The SEC also adopted new disclosure standards regarding the ability of security holders to communicate with boards of directors. Companies will be required to provide the following information in their proxy materials where action is to be taken with respect to the election of directors:

• A statement as to whether or not the company's board of directors has established a process for security holders to send communications to the board of directors. If there is no such process, a statement of the specific basis for the view of the board of directors that it is appropriate for the company not to have such a process. The SEC clarified that communications with the board from an officer or director of the company will not be viewed as security holder communications for purposes of the disclosure requirement. In addition, communications from an employee or agent of the company will be viewed as security holder communications for purposes of the disclosure requirement only if those communications are made in such employee's or agent's capacity as a security holder.
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• The process for security holder communications to the board, if there is such a process, including:
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  • a description of the manner in which security holders can send communications to the board and, if applicable, to specified individual directors; and
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  • if all such communications are not sent directly to board members, a description of the company's process for determining which communications will be relayed to board members. Companies are not required to identify the department or group responsible for determining which security holder communications are forwarded to directors. The company also is not required to disclose the company's process for collecting and organizing such security holder communications, provided that the company's process is approved by a majority of the independent directors.

In addition, a company must disclose a description of the company's policy, if any, with regard to board members' attendance at annual meetings and a statement of the number of board members who attended the prior year's annual meeting.

In lieu of providing the foregoing disclosure in the company's proxy statement, the company may instead post such information on its Web site, provided that the company discloses in its proxy statement the Web site address where such information may be found.

Finally, the SEC adopted new disclosure standards that require companies to report any material changes to the procedures for security holder nominations as disclosed in the company's proxy statement in their Exchange Act report (i.e., Form 10-Q or 10-K) for the period in which the material change occurs.

The Corporate Governance, Securities Litigation and M&A attorneys at Goodwin Procter keep current on these matters. We are available to help advise public companies and their officers and directors on specific issues as well as to provide educational presentations to help them understand and meet their responsibilities under both current and proposed rules and regulations. Please contact us either directly or through your regular Goodwin Procter contact if we may be of assistance.

Suzanne D. Lecaroz, Esq. contributed to the preparation of this Advisory.

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