DC Circuit’s Proxy Access Decision to Stand, but SEC to Allow “Private Ordering” of Proxy Access
As we previously reported, in July 2011 a three-judge panel of the United States Court of Appeals for the District of Columbia Circuit (DC Circuit) vacated Securities Exchange Act Rule 14a-11, known as the proxy access rule. The rule would have allowed qualifying long-term shareholders to nominate a limited number of directors and to include them in the proxy materials of public companies and investment companies. The Securities and Exchange Commission (SEC) had until September 6, 2011 to seek a rehearing of the DC Circuit’s decision. On September 6, 2011, the Chairman of the SEC, Mary Schapiro, announced that the SEC would not seek a rehearing or a United States Supreme Court review of the decision. As a result, public companies and investment companies will not be faced with mandatory proxy access for the 2012 proxy season—although based on Chairman Schapiro's announcement the SEC may seek to adopt a mandatory proxy access rule again in the future.
While the DC Circuit’s decision blocks the mandatory proxy access rule for the time being, the “private ordering” era of proxy access will commence with the 2012 proxy season. The lawsuit before the DC Circuit did not challenge, and the DC Circuit’s decision did not extend to, the SEC’s amendments to the shareholder proposal rule, Securities Exchange Act Rule 14a-8, which were adopted in tandem with Rule 14a-11. Chairman Schapiro’s announcement indicated that the stay previously imposed on the Rule 14a-8(i)(8) amendments would expire absent further SEC action when the DC Circuit's decision was finalized, which occurred on September 14, 2011.
On September 15, 2011, the SEC issued a release indicating that the Rule 14a-8(i)(8) amendments, along with related rule changes adopted concurrently with the Rule 14a-8(i)(8) amendments, will be effective on September 20, 2011, the date of the release’s publication in the Federal Register. The Rule 14a-8(i)(8) amendments will allow shareholders, under certain circumstances, to include in a company’s proxy materials proposed modifications to the company’s governing documents to establish proxy access procedures (sometimes referred to as the “private ordering” of proxy access). As a result, companies, including investment companies, should prepare for the receipt of shareholder proposals seeking proxy access beginning with the 2012 proxy season.
What Will the Private Ordering of Proxy Access Mean for Public Companies?
End to “election exclusion.” Before the effectiveness of the Rule 14a-8(i)(8) amendments, the rule allowed companies to exclude from their proxy materials any shareholder proposal that related to a nomination or an election for board membership or a procedure for such nomination or election (generally referred to as the “election exclusion”). Under the amendments, companies will generally be unable to exclude proposals submitted by qualifying shareholders (owning at least $2,000 in market value, or 1%, of a company’s stock for more than one year) that would amend, or that request an amendment to, a company’s governing documents to facilitate director nominations by shareholders or disclosures related to shareholder nominations. Accordingly, in the absence of a mandatory or universal proxy access regime as contemplated by Rule 14a-11, activist shareholders may seek proxy access on a company-by-company basis using the amended shareholder proposal rule.
Other avenues to seek director nominations. The Rule 14a-8(i)(8) amendments will not preclude shareholders from otherwise nominating directors for election under state law or launching proxy contests under existing SEC rules that require dissidents to file their own separate proxy statement.
Shareholder proposal submission deadline unchanged. Under Rule 14a-8, a shareholder proposal must generally be submitted to a company no later than 120 days in advance of the anniversary of the mailing date for the prior year’s proxy statement. For many calendar year companies, this deadline means that any proxy access or other shareholder proposals would need to be received in November or December 2011 to be included in 2012 proxy materials.
Potential no-action relief for proxy access proposals. Just as with other shareholder proposals, companies may attempt to exclude a proxy access proposal from the proxy statement on a procedural or substantive basis pursuant to Rule 14a-8. For example, as the power to amend a company’s governing documents is a function of state law a proxy access proposal may be excludable through the usual SEC no-action process if it is improper under, or is in violation of, applicable state law. However, only time will tell how the SEC will treat Rule 14a-8 no-action requests to exclude proxy access proposals. In addition, the Rule 14a-8(i)(8) amendments expressly allow companies to exclude any director election proposal that:
- would disqualify a nominee who is standing for election;
- would remove a director from office before his or her term expired;
- questions the competence, business judgment or character of one or more nominees or directors;
- seeks to include a specific individual in the company’s proxy materials for election to the board of directors; or
- otherwise could affect the outcome of the upcoming election of directors.
Creation of a two-step process. The Rule 14a-8(i)(8) amendments will generally result in a two-step process for establishing proxy access. First, shareholders would submit a binding or non-binding proposal asking a company to seek a shareholder vote on amendments to the company’s governing documents that would allow for proxy access. Any such shareholder proposal may seek a lower ownership threshold, reduced holding period requirements or different qualifications or representations than those included in Rule 14a-11 (which required, among other things, that eligible shareholders own at least 3% of the voting power of a company’s securities for at least three years). If a binding proposal is approved by the shareholders and is otherwise proper under applicable state law, proxy access will be permitted in accordance with the company's governing documents. Non-binding shareholder proposals would not necessarily have the same two-step result, but, if approved, could put pressure on a company to address proxy access.
ISS policies and recommendations. Only time will tell, but ISS and other proxy advisory firms may support shareholder proposals seeking proxy access, either as a policy or on a case-by-case basis. If so, they may adopt policies and guidelines that link private ordering of proxy access to other voting recommendations on important company proposals such as director elections, say-on-pay and equity incentive plans. Depending on the positions taken by activists and proxy advisory firms, companies may come under pressure to consider their own proxy access procedures to avoid negative voting recommendations on other ballot measures.
Which Public Companies Should Prepare for Proxy Access Proposals?
Some companies may receive proxy access proposals for the 2012 proxy season simply because activists have already mastered the shareholder proposal process, and many can meet the comparatively low Rule 14a-8 eligibility thresholds. The first round of proxy access proposals may focus on those companies with well-known governance, compensation or performance issues—companies who might normally expect to receive shareholder proposals on governance matters. Like previous hot button governance issues such as majority voting, board declassification and shareholder action by written consent, proxy access shareholder proposals will likely evolve over time as activist investors develop standard private ordering proposals designed to win shareholder approval. However, all public companies should prepare for proxy access proposals for the 2012 proxy season, especially those public companies incorporated in Delaware, where state law explicitly allows (but does not require) bylaws to include proxy access provisions and grants shareholders the power to adopt, amend or repeal bylaws.
How Should Public Companies Prepare for Proxy Access Proposals?
No universal set of steps will prepare a company for proxy access proposals. When preparing for possible proxy access proposals, companies should consider their particular board composition, governance policies and procedures, shareholder base and past concerns expressed by shareholders, including prior shareholder proposals and voting results. Companies may want to focus on related governance policies, such as:
- Board communications—educating the board and the nominating committee about the Rule 14a-8(i)(8) amendments, assessing the probability of the receipt of a proxy access proposal and developing general responses to a possible proxy access proposal;
- Shareholder communications—engaging shareholders on a year-round basis to identify and address, among other things, any concerns related to director nominations, governance, executive compensation and performance, with the goal of proactively addressing any concerns and possible proxy access proposals;
- Bylaw review—reviewing and, if appropriate, amending bylaws to provide an effective advance notice mechanism, and amending conduct-of-meeting bylaw provisions; and
- Nomination procedures—reviewing and, if appropriate, amending the nominating committee charter’s procedures for consideration of shareholder-nominated directors as well as any director qualifications included in a company’s relevant governance policies or guidelines, and fully describing these nomination procedures and director qualifications in the company's proxy statement and any changes to these nomination procedures in the company's annual or quarterly reports.
Should Public Companies Proactively Adopt Proxy Access Provisions?
Depends on company’s circumstances. Although not necessarily appropriate for every company, some companies may assess their specific circumstances and consider proactively adopting proxy access provisions in their governing documents (if permitted by applicable state law). Any proxy access provisions adopted by the board would not need to mirror, and may be more specific than, those found in Rule 14a-11, including stock ownership thresholds and holding periods, the number of times a shareholder may nominate a candidate, the number of directors a shareholder may nominate and nominee qualifications, as well as detailed disclosures regarding the nominating shareholder and its director nominee(s), including stock ownership and relationships between the nominating shareholder and the director nominee. Any proxy access provisions adopted should be reasonable and may be subject to challenge under applicable state law. Companies should be aware that applicable state law and their governing documents could allow shareholders to subsequently amend or repeal the proxy access provisions.
Timing of adoption is critical. If a company decides to proactively adopt proxy access provisions (or amend its governing documents, committee charters or other governance policies and guidelines to facilitate proxy access), the timing of adoption is critical. Any changes to a company’s governing documents or governance policies and guidelines that are adopted in anticipation, or upon notice, of an election contest, potentially including a proxy access proposal, may be challenged in the courts or may influence shareholders to side with activists rather than the company on any proxy contest or "vote no" campaign. Accordingly, companies should consider whether to adopt any proxy access bylaw provision or other amendments to governing documents well in advance of the cut-off date for shareholder proposals and director nominations, and disclose any changes in the company's public filings as required.
Questions remain regarding conflicting shareholder proposals. A company that adopts its own proxy access provisions may seek to exclude from the proxy statement any shareholder proposal on proxy access as “substantially implemented” pursuant to Rule 14a-8(i)(10) or as conflicting with a company proposal to be submitted to shareholders at the same meeting pursuant to Rule 14a-8(i)(9). However, it remains unclear how the SEC staff will treat such requests. Like other requests to exclude a shareholder proposal under Rule 14a-8, the SEC staff’s determination will depend on the facts and circumstances and will remain uncertain until no-action letters are issued during upcoming proxy seasons.
Will the SEC Restart the Proxy Access Rulemaking Process?
Most likely, but not in the near future. Although the SEC’s decision not to seek review of the DC Circuit’s decision means that mandatory proxy access is shelved for the near term, Chairman Schapiro indicated in her announcement that the SEC does not intend to drop its pursuit of a mandatory proxy access rule. The SEC may seek to re-propose a mandatory proxy access rule that attempts to address the DC Circuit’s criticisms—as indicated by Chairman Schapiro’s statement that “I remain committed to finding a way to make it easier for shareholders to nominate candidates to corporate boards.”1 Despite the SEC’s statements and pressure from activist investors to restart the proxy access rulemaking process, any potential rulemaking will likely not occur in the near future, as the SEC is overextended on other rulemaking projects mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act.
SEC review of DC Circuit’s decision and comment letters.Before restarting the rulemaking process, Chairman Schapiro wants the SEC to “carefully consider and learn from the [DC Circuit]'s objections as we determine the best path forward,”2 and she has instructed SEC staff to “continue reviewing the decision as well as the comments that we previously received from interested parties.”3 The SEC may use empirical data gathered from the private ordering of proxy access, as well as past comments to proxy access rulemaking projects, to address the DC Circuit’s concerns and inform potential rulemaking efforts in the future.
Any new rule would likely differ from Rule 14a-11. In view of the SEC’s 3-2 vote when it originally adopted Rule 14a-11, and the broad opinion by the DC Circuit questioning the cost-benefit analysis of proxy access (among other things), any new mandatory proxy access rule would likely differ significantly from Rule 14a-11 as previously adopted by the SEC—in particular, by addressing the burden imposed by proxy access on public companies.