Shareholder Access to Director Elections Changes Are Likely

August 2009

Current Developments

There are several concurrent, and some might say conflicting, proposals pending that, if any are adopted or enacted, will significantly alter how directors of public companies are nominated and elected:

Legislation has been introduced in both the U.S. Senate and House that deals with the topic. S. 1074, introduced by Sens. Charles Schumer and Maria Cantwell on May 19, 2009, would direct the Securities and Exchange Commission to adopt shareholder proxy access rules. The bill would also confirm the authority of the SEC to impose a federal proxy access scheme, which would presumably preempt conflicting state law. On the House side, H.R. 2861, introduced by Rep. Gary Peters on June 12, 2009, would give any shareholder(s) who have owned at least 1% of a company’s voting stock for at least one year the right to make nominations for director elections.
At the state level, some states have adopted changes in their laws intended to provide the opportunity for greater shareholder access to the director nomination and election process. Delaware, for example, has added Section 112 to the Delaware General Corporation Law effective August 1, 2009, to allow, but not require, corporations to amend their bylaws to give shareholders, under certain conditions, access to the corporation’s proxy statement for the purpose of nominating directors. Another recent example of activity at the state level are the changes in the North Dakota corporation law, which received quite a bit of publicity.
Finally, on July 1, 2009, the SEC issued SEC Rel. No. 34-60215, approving changes to New York Stock Exchange Rule 452 and corresponding Section 402.08 of the NYSE Listed Company Manual, to eliminate broker discretionary voting in all elections of directors. In other words, with respect to stock held in street name, the broker would have to receive specific instructions from the beneficial owner in order to vote the stock in any election of directors. That is now only required in contested elections. The rule changes will apply to shareholder meetings held on or after January 1, 2010. These rule changes could have as significant an impact on director elections as any of the other pending proposals because of the importance of broker discretionary voting in many director elections, especially for companies with higher concentrations of retail investors.
An SEC rulemaking proposal that is discussed in more detail below.

The SEC Proposal

Another very recent development on this front is a proposal by the SEC to amend its proxy rules to give shareholders of public companies greater access to the director nomination and election process. The proposed rule changes were approved by a 3 - 2 SEC vote on May 20, 2009. The SEC release (SEC Rel. No. 33-9046; the “Proxy Release”) reporting the proposed rule changes was issued on June 20, 2009.

The Proxy Release is the SEC’s fourth foray into this arena in six years. In 2003 (SEC Rel. No. 34-48626) and 2007 (SEC Rel. No. 34-56161), the SEC proposed amendments to the proxy rules with more or less the same objectives as are stated in the Proxy Release. Comments for and against those proposals were extensive, and the SEC did not adopt any of the significant proposed rule changes (the SEC did adopt a couple of technical rule changes). In a separate action, in December 2007, the SEC amended one of its proxy rules (Rule 14a-8) to provide that companies could exclude from their proxy materials any shareholder proposal related to elections or director nomination procedures. While that rule change seems inconsistent with the other proposed rules, the SEC stated that it adopted the rule change in order to provide certainty following a court decision that held that shareholder election/nomination procedures proposals could not be excluded under the rule in question. It is also worth noting that the majority of SEC commissioners at the time were Republican appointees.

The SEC Proxy Release is a behemoth, totaling about 250 pages. The substantive discussion of the proposed rule changes is about 145 pages. The basic objective of the proposed rule changes is simple: to permit shareholders, under certain conditions, to make director nominations and, if the nomination qualifications and procedures have been properly satisfied and followed, to have their nominees included the company’s proxy materials. The premises of the proposed rule changes are, according to the Proxy Release, “to improve the corporate proxy process so that it functions, as nearly as possible, as a replacement for an actual in-person meeting of shareholders” and “to remove impediments so shareholders may more effectively exercise their rights under state law to nominate and elect directors at meetings of shareholders.” To achieve the SEC’s stated purposes, the Proxy Release proposes the adoption of a new Rule 14a-11 and an amendment to Rule 14a-8, as well as some collateral, conforming amendments to other rules (which are beyond the scope of this article).

The following is a very brief summary of the substance of proposed Rule 14a-11:

The rule would apply generally to any company with securities registered with the SEC under Section 12 of the Securities Exchange Act of 1934 and to open- and closed- mutual funds registered with the SEC under the Investment Company Act of 1940.
A shareholder or group of shareholders owning a specified amount of a company’s voting securities for at least a year would be entitled to make nominations for director election and have such nominees included in the company’s proxy materials.
The amount of securities required to be owned depends on the status of the company under the Exchange Act or the size of the registered investment company: for large accelerated filers and registered investment companies with $700 million or more in net assets, 1% of the voting securities; for accelerated files and registered investment companies with $75 million or more (but less than $700 million) in net assets, 3%; and for non-accelerated filers and registered investment companies with less than $75 million in net assets, 5%. For groups of shareholders, ownership is aggregated, but the proposed one-year holding period would apply to each member of the group.
A nominating shareholder or group may not have the intention of changing the control of the company or electing more than a limited number of directors.
An eligible shareholder or group may nominate the greater of one nominee or the number of nominees that represents 25% of the company’s Board of Directors. If at the time of an election, a company already has one or more Rule 14a-11 shareholder-nominated directors, those directors are counted towards this limit for purposes of the current election.
Qualifying nominations must be accepted by the company in the order received until the maximum number of nominations is reached (see bullet point above). In one of its earlier proposals, the SEC had used size of ownership as the standard for acceptance of nominations. This time, it is going with a “first in” proposal, which the SEC claims provides more certainty to the company.
The nominating shareholder or group must continue to own the shares that qualified him or them to make the nomination through the date of the election.
The nominating shareholder or group must provide a disclosure statement — new Schedule 14N — to the company and file it with the SEC at the same. Schedule 14N calls for information regarding, among other things, the identity of the nominating shareholder(s), their ownership of company securities, the nominee(s), intent to own their securities through the election; their intention with respect to ownership of the securities after the election, relationships among the shareholder(s), the nominee(s) and the company, and other matters.
The rule includes a detailed timetable for the process.
There is a process to submit to the SEC for determination of any disputes that arise between a company and nominating shareholders.
If the nominating shareholder(s) are eligible, and properly comply with Rule 14a-11, the company must include their nominees in the company’s proxy materials. However, company management may, in its proxy materials, state that it recommends that shareholders vote against the nominee.

If Rule 14a-11 is adopted, shareholders will have two avenues to securing the election of their nominees: the Rule 14a-11 process, and the old-fashioned proxy contest (to which shareholders would have to resort if they want to effect a change of control of the Board of a company).

The second significant proposal in the Proxy Release is to amend Rule 14a-8 to eliminate the provision that permits a company to exclude from its proxy materials any shareholder proposals related to elections or to the director nomination process. This change is obviously required to conform Rule 14a-8 to Rule 14a-11, if it is adopted. If this change is adopted, shareholders would be able to submit proposals to amend a company’s governing documents that deal with the director nomination process, and the company would not be able to exclude such proposals.

For more complete information, please refer to the Proxy Release.

The Prognosis

Given the number of proposals that are being advanced and the fact that they are not necessarily consistent, it is impossible to predict how shareholder access to the nomination/proxy process will take form. For example, any legislation must work its way through both houses of Congress and be acceptable to the White House. As for the SEC proposal, there will be comments (in the Proxy Release, the SEC asked for comment on 171 specific questions and also made a general request for comments) that the SEC must consider before making a final proposal and adopting it. In addition, it has been reported that, if the SEC does adopt rules along the lines proposed, one or more business groups, such as the U.S. Chamber of Commerce, will challenge the rules on theories that the rules exceed the SEC’s rulemaking authority and intrude on substantive corporate governance matters that have historically been within the purview of the states. It will be a while before the dust finally settles on these matters. However, it is reasonable to predict that something (legislation, SEC rulemaking or both) will eventually be adopted that will significantly alter the landscape of shareholder access to the director nomination and election process. We plan to track and report on significant developments.

For additional information on this topic, please do not hesitate to contact Jeffrey P. Somers or any other member of MBBP’s Public Company practice group.

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