The Securities and Exchange Commission may have lost the battle on mandatory shareholder proxy access, but it did quietly enact a new rule that paves the way for investors to put director nominees on the proxy at companies via shareholder resolution.
On the same day earlier this month that the SEC announced it will not seek a rehearing on the D.C. Circuit Court of Appeals' decision to vacate the highly publicized proxy access rule, it announced that a second rule on proxy access would soon be taking effect.
Under Rule 14-a(8), shareholders who own $2,000 in stock or more for at least one year can submit proposals on changes to a company's bylaws relating to governance issues. In effect, the rule allows shareholders to procure proxy access at individual companies by first getting a resolution on the proxy statement and then winning a majority vote on it. In the past, companies were able to ignore such proposals.
The rule comes with a few stipulations. First, shareholders must submit the proposals at least 120 days before the scheduled release date of the proxy materials. (Companies will have the burden to inform shareholders of the deadline in their previous-year proxy statements.) Second, the proposal must be under 500 words.
Still there's no guarantee that companies will automatically accept shareholder proposals on proxy access. Companies can still reject such proposals by notifying the SEC within 80 days before filing a final proxy statement, but they must explain why they are rejecting them. Acceptable reasons include if the proposals contain misleading statements, are designed to benefit personal interest of a single shareholder, conflict with one of the company's own proposals, or fall into nine other exemptions as outlined by the SEC.
A company can ask for permission to ignore the proposal by requesting a no-action letter from the SEC. If a company chooses to heed the regulator's advice to include a revised proposal from a shareholder, the company is still entitled to issue a statement in opposition to the proposal five days after receiving the revised proposal.
According to Michael Littenberg, a partner at law firm Schulte Roth & Zabel, the rule is a better approach compared to the mandatory proxy access rule. “It allows for private ordering, coming up with proposals specific to a company instead of using the one-size-fits-all approach,” he says.
Already, though, some say that Rule 14-a(8) could be open to the same legal challenges of the mandatory proxy access rule. The litigation could challenge the SEC's compliance with the Administrative Procedure Act, since the SEC did not do a separate cost-benefit analysis on the rule. “At a practical level, there is not sufficient time for companies and investors to react responsibly and to engage constructively,” says Stanley Keller, a partner at law firm Edwards Angell Palmer & Dodge.
“The governance activists generally know what they are doing. Companies will find that they have limited ground to reject these proposals.”
—Michael Littenberg,
Partner,
Schulte Roth & Zabel
A court challenge would have to come soon, however. “As the timeline is relatively short to comply with the 120 days proposal filing requirement, shareholders will be able to start submitting proposals sometime between November and December,” says Colin Diamond, a partner at law firm White & Case agrees.
Even after checking all the boxes on the list, activists can only recommend a by-law amendment to allow the particular issue to be addressed in the following proxy season, Littenberg says. “As an example, what this rule says is that shareholders cannot propose specific candidates as directors' nominees but can propose that companies adopt by-law changes that will allow for shareholders to nominate directors later,” he says.
Littenberg warns companies not to take lightly the prospects of facing a shareholder proposal on proxy access. Given the extensive requirements, the assumption would be that most such proposals won't clear all the hurdles. Not so, he says. “The governance activists generally know what they are doing. Companies will find that they have limited ground to reject these proposals.”
RULE 14a-8 COMPONENTS
The following chart from the Securities and Exchange Commission illustrates the many provisions of Rule 14a-8:
Substantive Basis
Description
Rule 14a-8(i)(1)
The proposal is not a proper subject for action by shareholders under the laws of the jurisdiction of the company's organization.
Rule 14a-8(i)(2)
The proposal would, if implemented, cause the company to violate any state, federal or foreign law to which it is subject.
Rule 14a-8(i)(3)
The proposal or supporting statement is contrary to any of the Commission's proxy rules, including rule 14a-9, which prohibits materially false or misleading statements in proxy soliciting materials.
Rule 14a-8(i)(4)
The proposal relates to the redress of a personal claim or grievance against the company or any other person, or is designed to result in a benefit to the shareholder, or to further a personal interest, which is not shared by the other shareholders at large.
Rule 14a-8(i)(5)
The proposal relates to operations that account for less than 5% of the company's total assets at the end of its most recent fiscal year, and for less than 5% of its net earnings and gross sales for its most recent fiscal year, and is not otherwise significantly related to the company's business.
Rule 14a-8(i)(6)
The company would lack the power or authority to implement the proposal.
Rule 14a-8(i)(7)
The proposal deals with a matter relating to the company's ordinary business operations.
Rule 14a-8(i)(8)
The proposal relates to an election for membership on the company's board of directors or analogous governing body.
Rule 14a-8(i)(9)
The proposal directly conflicts with one of the company's own proposals to be submitted to shareholders at the same meeting.
Rule 14a-8(i)(10)
The company has already substantially implemented the proposal.
Rule 14a-8(i)(11)
The proposal substantially duplicates another proposal previously submitted to the company by another shareholder that will be included in the company's proxy materials for the same meeting.
Rule 14a-8(i)(12)
The proposal deals with substantially the same subject matter as another proposal or proposals that previously has or have been included in the company's proxy materials within a specified time frame and did not receive a specified percentage of the vote. Please refer to questions and answers F.2, F.3 and F.4 for more complete descriptions of this basis.
Rule 14a-8(i)(13)
The proposal relates to specific amounts of cash or stock dividends.
Source: Securities and Exchange Commission.
Littenberg anticipates numerous proposals on by-law amendments to adopt proxy access procedures since the courts have vacated the direct proxy access rule. He says although the number of proposals in 2012 will be fairly limited since it is a new process, activists will target large companies that they perceive to be lacking in governance standards.
“Large companies will be the first targets of governance activist, which will serve as a learning curve. They will also use these high-profile companies to send a message to others,” says Littenberg.
Keller adds that companies will most likely encounter problems when prioritizing proposals suggested by shareholders. As some classes of stocks come with larger voting rights, companies will have to adopt some procedures now to determine the priority of proposals. “The problem is the $2,000 threshold is too low. Now companies have to deal with free riding issues,” he says.
Prepare Now
In the upcoming season, companies will be subject to proposals that call for a by-law change on nominating directors, those seeking reimbursement of reasonable expenses incurred by shareholder groups to prepare proposals, and other governance-related issues, Diamond says.
“Companies should start to educate their board members now on what private ordering means. They should also reach out to large shareholders and start preparing for situations where they will have to oppose proposals submitted by certain groups,” he adds.
Hopefully, companies have learned from the initial implementation on say-on-pay votes during the last proxy season, Littenberg adds.
“We saw only 41 negative SOP votes out of thousands. It shows that they are taking a rather conservative approach when a law is newly implemented,” he says. How many shareholders will pursue proxy access proposals remains unclear for now. “It is one thing to have the right to access, another to put it in practice,” he says.
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