SEC Proposes Proxy Access Rules

May 20, 2009

Today, the Securities and Exchange Commission ("SEC") approved the publication of proposed amendments to the SEC’s proxy rules to permit shareholders to nominate directors in a company’s proxy materials (also known as "proxy access").  The proposals include:  (1) a federal proxy access right that would preempt state law and a company’s charter and bylaws; and (2) an amendment to Rule 14a-8 to permit proxy access shareholder proposals.

The proposals were supported by three commissioners, Chairman Schapiro, Commissioner Elisse Walter, and Commissioner Luis Aguilar, with Commissioner Kathleen Casey and Commissioner Troy Paredes indicating they could not support the proposals.  Chairman Schapiro stated that the SEC needed to address this issue once again in light of the current economic crisis. "This crisis has led many to raise serious questions and concerns about the accountability and responsiveness of some companies and boards of directors, to the interests of shareholders."  Commissioner Casey countered that the proxy access proposals would be imposed not only on the country’s largest banks and Wall Street firms, but also on thousands of other large and small public companies that had little to do with the financial crisis.  While Commissioners Walter and Aguilar were in favor of creating a federal proxy access right, Commissioners Casey and Paredes expressed concern that the proposals overly encroached on decisions of state legislatures that establish state corporate law and private ordering by companies and their shareholders.

This summary is based on information provided at the SEC’s open meeting and therefore may not reflect nuances that appear in the official text of the proposals.  We will prepare an additional memorandum to clients once the proposing release is issued.  The proposed rules will have a 60-day comment period following publication in the Federal Register.  It appears that the SEC wishes to be in a position to adopt final rules that would be in place in time for the 2010 proxy season.  Nevertheless, at the open meeting today, the Chairman and Commissioners stressed that the proposing release would contain extensive requests for comment, and they urged interested parties to review and respond to the questions thoroughly.

Background

The SEC previously proposed amendments to the federal proxy rules regarding proxy access in 2003 and 2007.

The 2003 proposals would have required companies to include in their proxy materials director candidates nominated by shareholders where one of the following two triggers was present:  (1) if at least one of the company’s nominees for the board of directors for whom the company solicited proxies received "withhold" votes from more than 35% of the votes cast at the company’s annual meeting of shareholders; or (2) if a shareholder proposal requesting that the company become subject to the proxy access rule received more than 50% of votes cast.  Upon the occurrence of either trigger, holders of more than 5% of a company’s shares would have been able to include up to three director nominees in the company’s proxy materials.  The 2003 proposals were widely criticized and were never adopted by the SEC. 

In 2007, the SEC again proposed rules regarding proxy access.  The SEC has historically permitted companies to exclude proxy access shareholder proposals from their proxy materials under Rule 14a-8(i)(8) because the shareholder proposals would result in contested elections.  However, in September 2006, the United States Court of Appeals for the Second Circuit held in AFSCME v. AIG that the SEC’s interpretation of Rule 14a-8(i)(8) reflected an unexplained change in interpretation.[1]  In response to this decision, the SEC proposed two amendments to Rule 14a-8(i)(8).  The first proposal was to amend Rule 14a-8(i)(8) to clearly state that proxy access shareholder proposals were excludable from company proxy materials.  The second proposal would have permitted shareholders holding at least 5% of a company’s shares for one year to propose a binding proxy access bylaw.  The SEC adopted the first proposal, which affirmed that proxy access proposals could be excluded under Rule 14a-8(i)(8), but took no action on the second proposal.

Overview of the Proposed Rules

There are two components to the proxy access proposals approved by the SEC today:  (1) creating a federal right, in proposed Rule 14a-11, for shareholders to nominate directors in company proxy statements, with related amendments to other rules;[2] and (2) amending existing Rule 14a-8(i)(8) to permit proxy access shareholder proposals.

Proposed Rule 14a-11 to Permit Director Nominations by Shareholders in Company Proxy Materials

• Proposed Rule 14a-11 would permit shareholders to nominate directors in the proxy materials of  all companies that have a class of equity securities subject to the SEC’s proxy rules, including both operating companies registered under the Securities Exchange Act of 1934 and investment companies registered under the Investment Company Act of 1940, if they meet certain requirements.  Unlike the 2003 and 2007 proposals, proposed Rule 14a-11 does not include any triggers that must occur before this right applies (other than the procedural requirements discussed below). 
• Proposed Rule 14a-11 would create a federal law process for a shareholder or group of shareholders to nominate a director and have that nominee included in a company’s proxy materials if they beneficially owned individually or in the aggregate a certain percentage of the company’s voting shares for at least one year.  The proposed rules would amend the beneficial ownership reporting rules under Section 13(d) and (g) and the proxy solicitation rules to facilitate the formation of groups of shareholders owning the applicable number of shares.  The ownership requirements would vary depending on a company’s size: 
• 1% of voting shares for large accelerated filers (i.e., companies with a public common equity float of $700 million or more) and registered investment companies with net assets of $700 million or more;
• 3% of voting shares for accelerated filers (i.e., companies with a public common equity float of $75 million or more, but less than $700 million) and registered investment companies with net assets of $75 million or more, but less than $700 million; and
• 5% of voting shares for non-accelerated filers (i.e., companies with a public common equity float of less than $75 million) and registered investment companies with net assets of less than $75 million.
•  The nominating shareholders would be required to file a new Schedule 14N reporting the percentage of the company’s shares beneficially owned, the period of time such shares had been beneficially owned, their intent to hold their shares through the date of the meeting and certain other disclosures (i.e., regarding litigation and certain relationships with the company).  Nominating shareholders would have to certify in the Schedule 14N that the nomination is not intended to result in a change in control of the company or result in more than minority representation on the company’s board of directors.  The Schedule 14N disclosure requirements would be less extensive than those proposed in the SEC’s 2007 proxy access proposal (which would have required, for example, information regarding any meetings or contacts between the nominating shareholder and the company that occurred during the prior 12 months). 
• Shareholders would be permitted to include in a company’s proxy materials each year the greater of one director nominee or a number of director nominees that equals up to 25% of the company’s board.  If the number of nominees submitted under the process exceeded the authorized number of permissible nominees, then the company would only need to include the earliest received nominations. 
• The director nominee’s service on the board could not violate state law and the nominee would be required to satisfy the objective independence standards of the applicable national securities exchange or national securities association.  Additionally, the nominating shareholder (including any member of the nominating shareholder group) could not have any direct or indirect agreement with the company regarding the nomination.  However, unlike the 2003 proposed proxy access rules, proposed Rule 14a-11 would not restrict the ability of shareholders to nominate directors with whom they have a relationship, meaning shareholders could nominate themselves or their employees.
• Proposed Rule 14a-11 would defer to a company’s advance notice bylaws provision regarding the deadlines for nominating directors under proposed Rule 14a-11.  If, however, a company did not have an advance notice bylaw, then the deadline for Rule 14a-11 nominations would be 120 days before the one-year anniversary of the date the proxy materials were first distributed in connection with the prior year’s meeting, the same deadline that currently exists for shareholder proposals under Rule 14a-8.
• Proposed Rule 14a-11 would establish a detailed procedure (with strict deadlines and SEC staff involvement, similar to the Rule 14a-8 no-action letter process) that a company would need to follow if it believed that proposed Rule 14a-11’s requirements had not been satisfied and intended to exclude a shareholder nomination on that basis. 
• A company would be required to include in its proxy materials the same information on the nominating shareholder and the director nominee as required in proxy materials related to contested elections.  Additionally, proposed Rule 14a-9(c) would make the nominating shareholder liable for false or misleading statements supplied to a company and provide that a company would not be liable for false or misleading information it received from a nominating shareholder or director nominee, unless the company knew or had reason to know the information was false.  
• The federal right provided in Rule 14a-11 would preempt any proxy access provisions set forth in state law or in a company’s charter or bylaws.  For example, if the bylaws of a large accelerated filer permitted shareholders owning more than 5% of shares to submit director nominations in company proxy materials, Rule 14a-11 would preempt this provision.  Thus, under proposed Rule 14a-11, the company’s shareholders would only need to satisfy the 1% ownership threshold in Rule 14a-11 and its related requirements in order to include a director nominee in the company’s proxy materials.  Proposed Rule 14a-11 would be inapplicable if a company’s governing documents or applicable state law prohibited director nominations by shareholders.   

Proposed Amendments to Rule 14a-8(i)(8) to Permit Proxy Access Shareholder Proposals

The SEC also is proposing to amend Rule 14a-8(i)(8) to require companies to include proxy access shareholder proposals in company proxy materials except in limited circumstances.  Specifically, proxy access shareholder proposals that would amend or request the amendment of provisions of a company’s governing documents to address the company’s nomination rights or the disclosures or procedures related to shareholder nominations would not be excludable unless they conflicted with proposed Rule 14a-11 or state law.  Thus, the proposed rules seek to reverse in part the SEC’s 2007 rulemaking that explicitly affirmed that all such shareholder proposals could be excluded.  Proxy access shareholder proposals would be subject to the same eligibility requirements as 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).  

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, [email protected])
Brian J. Lane (202-887-3646, [email protected]) 
Ronald O. Mueller (202-955-8671, [email protected]) 
Amy L. Goodman (202-955-8653, [email protected])
Gillian McPhee (202-955-8230, [email protected])
Elizabeth Ising (202-955-8287, [email protected])

© 2009 Gibson, Dunn & Crutcher LLP

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