The Securities and Exchange Commission has recently proposed proxy rule revisions that would require public companies to include in their proxy materials shareholder nominees for director for two years following specified trigger events indicating “unresponsiveness" to shareholder concerns. If adopted, these revisions would for the first time give shareholders mandatory access to company proxy materials to promote their own board nominees. Such access would mark a major departure in proxy regulation with potentially far-reaching corporate governance impact.
As proposed, the shareholder nomination rules would apply to all public companies subject to proxy rules under the Securities Exchange Act of 1934, including registered investment companies. Foreign private issuers are exempt from SEC proxy rules and would not be subject to the proposed shareholder nomination provisions. The SEC is considering limiting the rules to public companies that are "accelerated filers" (i.e., those with a public float of at least $75 million and at least one year of Exchange Act reporting history). See SEC Release No. 34-48626, which you can access at http://www.sec.gov/rules/proposed/34-48626.htm.
The comment period on the proposal ends December 22, 2003.
Under the proposed revisions to Exchange Act Rule 14a-11, shareholders would be entitled to nominate directors for inclusion in a company’s proxy statement for a two-year period (up to the annual meeting in the second year) following occurrence of one of the following triggers at an annual meeting held after January 1, 2004:
- at least one of the company’s nominees for director receives “withhold” votes from more than 35% of votes cast (other than in connection with a contested election subject to Exchange Act Rule 14a-12).
- a shareholder proposal under Exchange Act Rule 14a-8 calling for the company to adopt the nomination procedure contained in Rule 14a-11 is approved by more than 50% of votes cast. To be a trigger, such proposal must be submitted by a proponent or proponent group that has held more than 1% of the company’s outstanding voting securities for at least one year.
The SEC has requested comment on whether the nomination procedure should also be triggered when a board fails promptly to implement any Rule 14a-8 proposal approved by more than 50% of votes cast if submitted by a proponent or proponent group which has held more than 1% of the company’s outstanding voting securities for at least one year.
When a triggering event occurs, the company would be required under the proposal to give notice to shareholders in its next Form 10-Q or Form 10-K filing.
Eligible Nominating Shareholders and Nominees
The proposed shareholder nomination procedure, once triggered, would give eligible shareholders or shareholder groups the right to include a limited number of eligible director nominees in company proxy materials.
Number of Nominees. The number of eligible shareholder nominees required to be included in a company proxy solicitation under the proposal is based on the size of the company’s board. The company must include one shareholder nominee if its board has eight or fewer members, two nominees if its board has nine to 19 members, and three nominees if its board has 20 or more members. If a company has a staggered board with a shareholder nominee already serving, that person would decrease the number of shareholder nominees otherwise required for inclusion. If a company receives more shareholder nominees than it is required to include, the company must include the nominee or nominees of the shareholders with the largest beneficial ownership at the time of nomination.
Eligible Nominating Shareholders. In order to be eligible to submit a director nominee under the proposed revisions to Rule 14a-11, a shareholder or shareholder group must:
- beneficially own, on a continuous basis for at least two years, more than 5% of the company’s outstanding securities eligible to vote for directors and intend to continue owning such securities through the shareholder meeting date;
- be eligible to report such ownership on Exchange Act Schedule 13G, rather than Schedule 13D. Schedule 13G is available to certain institutional investors and other “passive” investors owning less than 20% of a company’s outstanding equity securities. Schedule 13G filers must certify that they have no intent to effect a change in, or influence, control of the company; and
- file a Schedule 13G by the date of the nomination that includes a certification that the two-year-5%-ownership requirement has been met.
To prevent collusion intended to undermine the shareholder nomination procedure, nominating shareholders under Rule 14a-11 must represent that they are not acting pursuant to a direct or indirect agreement with the company in making a nomination.
Eligible Nominees. To be eligible, a nomination must not violate controlling state or federal law or relevant exchange or NASDAQ rules (other than those relating to independence of directors). Delaware and other state corporation statutes generally permit shareholder nomination of directors.
In addition, a nominee must meet designated independence requirements both with respect to the nominating shareholder and the company:
- The nominee cannot be the nominating shareholder or any member of the nominating shareholder group or a member of the immediate family of the nominating shareholder or any group member.
- During the calendar year of nomination and the preceding calendar year, neither the nominee nor any member of his or her immediate family may have (1) been an employee of the nominating shareholder or any member of the nominating shareholder group, (2) accepted directly or indirectly any consulting, advisory or other compensatory fees from any of them or any of their affiliates, or (3) been an executive officer or director of any of them or any of their affiliates.
- The nominee cannot control the nominating shareholder or any member of the nominating shareholder group.
- The nominating shareholder must represent to the company that the nominee satisfies the standards for director independence of the applicable stock exchange or NASDAQ, other than any independence standard that requires a subjective determination by the company’s board.
- There must be no direct or indirect agreement with the company regarding the nomination of the nominee.
Notice of Nomination. To include a nominee in the company’s proxy materials under the proposal, a nominating shareholder or group must provide notice to the company no later than 80 days before the date the company mails its proxy materials (calculated in the same manner as under Rule 14a-8). The notice must include representations regarding eligibility of the nominating shareholder or group and the nominee, as well as a copy of the nominating shareholder’s or group’s Schedule 13G, a consent signed by the nominee and information about the nominee sufficient to meet proxy disclosure requirements. The notice must also describe the methods by which the nominating shareholder or group may solicit shareholder support, including any website address on which the nominating shareholders may publish soliciting materials. The notice must also be filed with the SEC.
Company Response. The company must either include the nominee in its proxy materials or inform the nominating shareholder or group, no later than 30 days before the previous year’s mailing date, that inclusion is not required due to inapplicability of Rule 14a-11, ineligibility of the nominee or nominating shareholder or group or misrepresentation in the notice to the company.
Absent grounds for exclusion, relevant information must be included in the company’s proxy statement, and the nominee’s name must be included in an impartial and neutral manner on the related proxy card. Under the proposal, a company would not be able to provide shareholders the option of voting for or withholding authority to vote for the company’s nominees as a group if a shareholder nominee is included in the proxy materials. Instead, shareholders would have to vote separately on each candidate.
If a company chooses to make a statement (beyond a simple recommendation) supporting company nominees or opposing shareholder nominees, it must notify the nominating shareholder or group and afford them an opportunity to include a statement of support for their nominee, not to exceed 500 words. The nominating shareholder must file any such statement with the SEC as soliciting material. Both the company and the nominating shareholders would be able to solicit in favor of their nominees outside of the proxy statement, for example on a designated website, as long as solicitations were made in compliance with applicable proxy rules.
This proposal, which follows recommendations made by the SEC staff in its July 15, 2003 report, Review of the Proxy Process Regarding the Nomination and Election of Directors, marks a bold departure in SEC proxy regulation. If adopted, rules giving shareholders mandatory access to company proxy materials for purposes of promoting board nominees may ultimately have a far-reaching effect on both the law and the day-to-day practicalities of corporate governance.
The proposal indicates that, if adopted, final rules could be in effect in time for the 2004 proxy season, meaning that trigger events occurring at a company's 2004 annual meeting could put the shareholder nomination procedure in place for annual meetings in 2005 and 2006.