Which Proposal For The Next Proxy Season?

In an unusual move, the Securities and Exchange Commission unveiled two competing proposals for its proxy rules governing shareholder proposals and shareholders’ ability to propose bylaw procedures for the nomination of directors.

As it has in the past, the thorny issue again has the SEC commissioners split along party lines, with its Republican chairman, Christopher Cox, serving as the swing vote.

Democratic commissioners Annette Nazareth and Roel Campos voted to publish for comment a proposal that would amend Exchange Act Rule 14a-8, the shareholder proposal rule, to permit the inclusion of shareholder nomination bylaw proposals in the company proxy materials if the shareholder (or group of shareholders) has held more than five percent of the company’s securities for at least one year and the proposals comply with applicable state law.

Casey

Republican commissioners Paul Atkins and Kathleen Casey, however, expressed support for a second, shorter proposal that would codify the SEC’s long-standing interpretation regarding proposals related to elections under Rule 14a-8(i)(8), and which would permit companies to exclude from their proxy materials all shareholder-proposed bylaws concerning director nominations.

That interpretation was invalidated last September by the U.S. Court of Appeals for the Second Circuit, creating uncertainty about the application of the rule by the courts and thrusting the issue of proxy access back into the spotlight.

Cox said the effect of applying the court’s decision generally “would be to permit director election contests without the disclosures required by the election contest rules.”

By publishing two releases for comment simultaneously, the SEC hopes to get a full range of public comment and quickly adopt a final rule. At last Wednesday’s meeting, Cox repeated his previous intention to have “a clear, unambiguous rule” in place in time for the next proxy season.

Cartwright

If the SEC doesn’t adopt a final rule, SEC General Counsel Brian Cartwright noted, “We could end up with litigation by private parties … in other circuits and great uncertainty.”

DUELING PROPOSALS

Below is an excerpt from SEC Release No. 34-56160, to allow shareholder nominations to the board to be included in the proxy statement.

To achieve the mutually reinforcing objectives of vindicating shareholders’ state law rights to nominate directors, on the one hand, and ensuring full disclosure in election contests, on the other hand, we are proposing revisions to Rule 14a-8(i)(8) that would permit a shareholder who makes full disclosure in connection with a bylaw proposal for director nomination procedures, including a proposal such as that in the AFSCME case, to have that proposal included in the company’s proxy materials. The basis for the disclosure that we are proposing is the familiar Schedule 13G regime, under which certain passive investors that beneficially own more than 5 percent of a company’s securities, report their ownership of a company’s securities. We believe that using this well-understood system of disclosure should reduce compliance costs for companies and shareholders. In addition, because shareholders eligible to file under Schedule 13G must not have acquired or held their securities for the purpose of or with the effect of changing or influencing the control of the company, the opportunity to use Rule 14a-8 to inappropriately circumvent the disclosure and procedural regulations that are intended to apply in contested elections should be minimized.

Under the proposed amendments, if the proponents of a bylaw to establish a procedure for shareholder nominations of directors do not meet both the threshold for required filing on Schedule 13G, and the eligibility requirements to file on Schedule 13G, the proposal could then be excluded from the company’s proxy materials under Rule 14a- 8(i)(8). In this way, shareholders will be guaranteed the disclosure necessary to evaluate such proposals.

In light of the need for full disclosure where the possibility of control over a company is present, we believe that our decision to link the ability to include a bylaw proposal for director nominations in a company’s proxy materials to the 5 percent threshold set by Section 13(d) of the Exchange Act addresses the basic policy concerns previously articulated by both Congress and the Commission. Moreover, because the proposed expansion of shareholders’ ability to submit proposals under Rule 14a-8 would be limited to specific situations in which shareholders would be assured of appropriate disclosure and procedural protections, if the proposal did not meet the eligibility requirements of the amended rule, the Commission’s staff would continue to interpret the rule to permit companies to exclude the proposal.

Below is an excerpt from SEC Release No. 34-56161, clarifying that shareholder nominations to the board can be excluded from the proxy.

In addition to the guidance provided in this release regarding our interpretation of Rule 14a-8(i)(8), we are considering whether it would be appropriate to amend that rule to further clarify the meaning of its exclusion. The text of Rule 14a-8(i)(8) currently specifies only that a proposal may be excluded “[i]f the proposal relates to an election for membership on the company’s board of directors or analogous governing body.” To clarify the meaning of the exclusion, consistent with the Commission’s interpretation of that exclusion, we are proposing to revise the exclusion to read:

If the proposal relates to a nomination or an election for membership on the company’s board of directors or analogous governing body or a procedure for such nomination or election.

We believe that the added references to “nomination” and “procedure” in the rule text will reflect more appropriately the purpose of the election exclusion. Further, if adopted, we would indicate clearly that the term “procedures” referenced in the election exclusion relates to procedures that would result in a contested election, either in the year in which the proposal is submitted or in subsequent years, consistent with the Commission’s interpretation of the exclusion.

As discussed above, we are proposing amendments to Rule 14a-8 that would clarify the operation of the exclusion in Rule 14a-8(i)(8) in a manner that is consistent with the Commission’s interpretation of that exclusion. With regard to this proposed amendment, we are soliciting comment as to the following:

Would the proposed amendments to Rule 14a-8(i)(8) provide sufficient certainty regarding the scope of the exclusion? If not, what additional amendments are necessary?

Should the exclusion specify those procedures that the staff historically has ound to fall within the exclusion?

What additional clarification would be helpful and/or appropriate?

Source

SEC (July 25, 2007)

David Mittelman, a former staff member in the SEC’s Division of Corporation Finance and now at the law firm Reed Smith, says the dueling proposal approach is “a novel means of attracting maximum public comment.”

Cartwright noted that the proposal to restate the SEC’s interpretation of 14a-8 is “not highly likely to have an effect on the Second Circuit,” since that court didn’t accept the SEC’s interpretation of 14a-8 last September.

Long vs. Short

Mittelman says shareholder activists “likely will not see either alternative as desirable.” Indeed, institutional investor groups have said the proposed five percent threshold of the shareholder access proposal would be difficult to achieve. Mittelman says activists would likely prefer to default to the existing general standard under Rule 14a-8 for shareholder proposals, an ownership position of $2,000 or one percent of outstanding shares.

The shareholder access plan, known informally as the “long” proposal, would also require new disclosures about shareholder proponents under Schedule 13G and Regulation 14A. There would be no federal limits on the content of the proposals.

By not imposing a federal, “one-size-fits-all” approach, Cox said the proposal “differs sharply” from a controversial failed 2003 rule proposal that would have established a mandated procedure under which companies would have been required to include shareholder nominees in their proxy materials.

The proposal to grant shareholder access to the proxy would also amend the proxy rules to remove current obstacles to electronic shareholder communications, and would clarify that a company or shareholder who maintains an electronic shareholder forum isn’t liable for statements by any other participant in the forum.

While they strongly opposed the proposal to reaffirm the SEC’s earlier interpretation of 14a-8, both Campos and Nazareth expressed concerns about the shareholder access proposal.

Campos

Campos cited concerns that the ownership threshold is too high for such a rule to be useful. Additionally, he said he had reservations about a question in the proposal that “would allow the opting out of the SEC’s 14a-8 procedures for nonbinding precatory proposals.” He questioned whether it’s “good policy” to eliminate a procedure used by shareholders to present “ideas that eventually get traction, get legs, and turn into real proposals that get adopted by the company.”

Mittelman, who describes the proposal to enable companies to exclude nonbinding shareholder proposals under Rule 14a-8 as “intriguing,” says precatory proposals “have long been the bane” of companies. “Allowing companies to exclude nonbinding shareholder proposals would be a welcome relief to public companies as well as the SEC staff who must review no-action requests,” he says.

Nazareth

Commissioner Nazareth raised a concern that the shareholder access proposals could be “turned on its head.” According to her, there is “at least a possibility” that the Commission could “pick and choose” from the competing proposals and “thus put shareholders in a worse position than they are currently.”

For example, she said, it leaves open a possibility that, by combining pieces of both proposals, the commissioners could be asked to consider a final rulemaking that combines the SEC’s previous no-access position with potentially more restrictive precatory proposal procedures discussed in the access proposal.