Compliance Clarified: Addressing The New Proxy Access Rules
In passing the Dodd-Frank Act, Congress resolved a long-running debate over whether the Securities and Exchange Commission has the power to adopt requirements that companies give shareholders access to issuers' proxies for the purpose of nominating their own directors. Dodd-Frank gave the SEC rulemaking authority to require that proxy solicitations by an issuer include board nominees submitted by shareholders, except in certain circumstances. In its first substantive rulemaking after Dodd-Frank's passage, the SEC in August approved new shareholder proxy access rules that are scheduled to become effective in November this year and enter into force for the spring 2011 proxy season for all but the smallest companies. (Implementation of the proxy access rules is deferred for three years for smaller public companies.)
The Key Provisions
The SEC's new rules require companies to include in their proxy materials the director nominees of certain qualified shareholders. To nominate a director candidate, a shareholder or group of shareholders must have an investment of at least 3% of the voting power of the company and must have maintained this investment continuously for at least three years. The nominating shareholder or group is limited to nominating the greater of one director or 25% of the board's total membership.
The nominating shareholder or group must submit the nomination no earlier than 150 days, and no later than 120 days, before the anniversary date of the company's mailing of the prior year's proxy statement. On its Schedule 14N filing, the nominating shareholder must express whether it intends to hold the securities after the shareholder meeting and certify that they do not have a change in control intent or plan to gain more than the maximum number of board seats permitted. Moreover, the nominee must be eligible for election under applicable laws and regulations, such as objective independence standards. If more than one shareholder submits a Schedule 14N, priority must be given to the shareholders or groups with the largest voting stake.
The SEC's new proxy access rules provide a narrow process for excluding a shareholder nominee if the company determines that the shareholder or its nominee does not meet the requirements for inclusion. But a company may not exclude a proposal based on a belief that the proposal contains materially misleading information. Once notified of any issues, shareholders have 14 days to cure any defects, but may not nominate a substitute director. If the company determines that the shareholder or the nominee still does not meet the requirements, the shareholder and the SEC are to be notified at least 80 days before filing its definitive proxy materials. The shareholder has 14 days to respond and, if unable to reach agreement, the company can ask the SEC to express its views.
Gearing Up for the Proxy Season
Shareholder proxy access will have a major impact on a company's approach to this year's proxy process and in the long term, may affect the board's working relationship as more "outsiders" are introduced on to the board. While challenges to the SEC's proxy access rules are likely, possibly by the U.S. Chamber of Commerce and others, those challenges are unlikely to be resolved before the 201 1 proxy season is underway. Companies should therefore prepare for the possibility of shareholder nominees by establishing an internal process, such as a committee, for considering and determining the eligibility of shareholders to make nominations and for determining the eligibility of any nominees.
Companies should identify in advance of this proxy season those shareholders, or known groups of shareholders, that hold at least 3% of its voting power and consider which of those shareholders may want to make a director nomination. It may be far better for a company to agree in advance with a shareholder on a candidate than to have the shareholder nominate its own candidate. With the proxy access rules as well as with the new say-on-pay rules, strong investor relations and open communication with shareholders are more important than ever.
Authored by Haynes and Boone Partners Kit Addleman, Bruce Newsome and Mike Halloran. First published in Compliance Reporter, September 27, 2010.