While the courts are now weighing the long-expected legal challenge to the Securities and Exchange Commission’s controversial new proxy access rule, lawyers are advising companies to take no chances and begin preparing for its potential effects on director elections during the next proxy season.
Nobody expects to see a flood of shareholder nominations when Rule 14a-11 takes effect on Nov. 15 anyway. But barring some formal stay from the courts, companies need to plan for its arrival. That means assembling a team to handle the process, reviewing the corporate bylaws for any changes that might be necessary in light of the new rules, and perhaps building extra time into their proxy planning calendars, according to panelists at a Sept. 28 event hosted by law firm Baker & McKenzie.
As of last week, whether the rule would even take effect remained unclear. The SEC adopted the rule by a 3-2 vote on Aug. 25, allowing shareholders to include their director nominees in the proxy statement if they meet certain ownership thresholds. But, as expected, the U.S. Chamber of Commerce and the Business Roundtable filed a lawsuit on Sept. 29 challenging the validity of the rule. The suit also seeks a stay of its effective date while the court considers the challenge.
Tom
Companies must comply with a strict timetable in response to shareholder nominations under Rule 14a-11, so the timing of procedures for a proxy access request is important. “Now is the time to gear up and think about what you need to do if it’s possible you’ll get a [shareholder proxy access request] around Nov. 15,” Roslyn Tom, a partner at Baker & McKenzie, told attendees at the seminar.
Not everyone needs to push the panic button, however. A look-back provision based on the Nov. 15 effective date means proxy access only applies this year for companies that mailed last year’s proxy on or after March 15, 2010. As a result, “a lot of companies dodged a bullet for 2011,” said Tom Ball, senior managing director at proxy solicitation firm Morrow & Co. And smaller reporting companies—those with a public float of $75 million or less—don’t have to comply with the rule for three years.
Companies should also ponder how they will communicate with shareholder groups that are most likely to use proxy access. Morrow & Co.’s Joe Mills advised companies to reach out to those owners he calls “gatekeepers”: shareholders with holdings of 1 or 2 percent who might not initiate a proxy access challenge, but might throw their shares behind someone else who does.
“Now is the time to gear up and think about what you need to do if it’s possible you’ll get a Notice 14N around Nov. 15.”
—Roslyn Tom,
Partner,
Baker & McKenzie
The proxy access rule does work within some narrow confines. Shareholder groups must own 3 percent voting power for at least three years, certify that they have no intent to change control, and promise to hold their shares through the balloting date. That eliminates a lot of the usual suspects unhappy with corporate management. And since stockholders who use Rule 14a-11 can’t send their own mailings to shareholders and can’t get access to the company’s shareholder list, Ball says, “serious dissidents … will still want to run a traditional proxy fight.”
The probable targets of proxy access fights, Ball said, are companies with governance and compensation issues and poor financial performance to boot. While activist hedge funds aren’t likely to make nominations, they could be the nominees in some cases, he said.
Preparing for Proposals
While Rule 14a-11 nominations should be relatively rare, panelists warned that another feature of the proxy access rule could see more action in 2011: the ability to submit shareholder proposals seeking to amend director nomination procedures. Until now, corporations had the right to exclude such proposals from the proxy statement under Rule 14a-8; now they can’t.
That second part of the proxy access rule is actually “a more powerful tool,” Tom said, because the holding period and ownership requirements to submit a shareholder proposal are much lower. Companies could see shareholder proposals seeking more permissive access procedures, such as lowering the 3 percent threshold or the three-year holding period.
ELIGIBILITY
The following excerpt from the Securities and Exchange Commission describes who is eligible to use Exchange Act Rule 141-11:
[A] company will be required to include a shareholder nominee
or nominees if the nominating shareholder or group:
Holds, as of the date of the shareholder notice on Schedule 14N, either individually
or in the aggregate, at least 3 percent of the voting power (calculated as required under
the rule) of the company’s securities that are entitled to be voted on the election of
directors at the annual meeting of shareholders (or, in lieu of such an annual meeting,
a special meeting of shareholders) or on a written consent in lieu of a meeting;
Has held the qualifying amount of securities used to satisfy the minimum ownership
threshold continuously for at least three years as of the date of the shareholder notice
on Schedule 14N (in the case of a shareholder group, each member of the group must
have held the amount of securities that are used to satisfy the ownership threshold
continuously for at least three years as of the date of the shareholder notice on
Schedule 14N);
Continues to hold the required amount of securities used to satisfy the ownership
threshold through the date of the shareholder meeting;
Is not holding any of the company’s securities with the purpose, or with the effect, of
changing control of the company or to gain a number of seats on the board of
directors that exceeds the maximum number of nominees that the company could be
required to include under Rule 14a-11;
Does not have an agreement with the company regarding the nomination;
Provides a notice to the company on Schedule 14N, and files the notice with the
Commission, of the nominating shareholder’s or group’s intent to require that the
company include that nominating shareholder’s or group’s nominee in the company’s
proxy materials no earlier than 150 calendar days, and no later than 120 calendar
days, before the anniversary of the date that the company mailed its proxy materials
for the prior year’s annual meeting; and
Includes the certifications required in the shareholder notice on Schedule 14N.
Ownership threshold
As proposed, a nominating shareholder or group would have been required to beneficially
own 1 percent, 3 percent, or 5 percent of the company’s securities entitled to be voted on the election of directors
at the shareholder meeting, depending on the company’s accelerated filer status or, in the case of
registered investment companies, depending on the net assets of the company. We received
significant comment on this topic … and have made alterations to
the final rule to reflect the concerns expressed by commenters.
As adopted, to rely on Rule 14a-11, a nominating shareholder or group will be required to
hold, as of the date of the shareholder notice on Schedule 14N, either individually or in the
aggregate, at least 3 percent of the voting power of the company’s securities that are entitled to be
voted on the election of directors at the annual (or a special meeting in lieu of the annual)
meeting of shareholders or on a written consent in lieu of a meeting. The nominating
shareholder or group or member of a nominating shareholder group will be required to hold both
the power to dispose of and the power to vote the securities … The nominating
shareholder or member of a nominating shareholder group also will be required to have held the
qualifying amount of securities for at least three years as of the date of the notice on Schedule
14N, and to hold that amount through the date of the election of directors …
Source
Text of SEC Rule on Shareholder Noms (Aug. 25, 2010).
Alexander
Rick Alexander, a partner in the law firm Morris Nichols Arsht & Tunnell, predicts that access proposals will become more commonplace. “I think that’s where the action is going to be for the next few years,” he says. “They are going to be the next majority voting [topic].”
To prepare for (read: discourage) such proposals panelists suggested that companies take a good look at their advance notice bylaws to see whether any should be changed. Companies may want to consider whether to align the timing requirements for director nominations under their advance notice bylaws with the timing of the window period under Rule 14a-11, Alexander said.
“Whatever decision you make about the [advance notice] period, have a good process to back it up,” he added.
Stubblefield
Another consideration: whether to beef up director qualifications requirements, and where those requirements should be stated. Some governance experts recommend moving them to the bylaws to make them a more powerful defense against the nomination of unqualified directors. Most companies house their director qualification requirements somewhere else, such as in their governance guidelines, where they might not apply to Rule 14a-11 nominees, Baker & McKenzie partner Carol Stubblefield noted.
Companies might also consider other director provisions, such as bylaws to limit service on other boards or requirements that directors sign confidentiality agreements. Alexander also advised companies to make it clear that those qualifications aren’t part of the advance-notice process, since the SEC could take the view that Rule 14a-11 trumps an advance notice bylaw.
Companies with majority voting thresholds to elect directors should review their bylaws carefully to ensure that their “reversion provisions” (which specify that the standard reverts to plurality in a proxy contest) and resignation requirements are written in a way that picks up Rule 14-a11 nominees.
Panelists noted that exactly how the rules will affect the director nomination process is still untested, and a number of open questions about the mechanics of the rule still exist. Stubblefield is hopeful the SEC will address some of those questions with additional staff guidance. No-action letters from the staff will also provide more insight about what is and isn’t permissible under the new regime.
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