Shareholder Access: The SEC, Delaware & Congress Advance the Ball
Jane K. Storero & Jeffrey M. Taylor
Wall Street Lawyer
The highly publicized executive compensation debacle at AIG and several egregious investment advisory scandals were the impetus for the latest round of closer scrutiny by the Securities and Exchange Commission of public companies and their corporate governance practices. Focusing on shareholder discontent with public company corporate governance, the SEC has once again fueled the debate over shareholder access, which has been ongoing for years. These debacles and scandals have arrived on the heels of the country’s attempts to re-stabilize in the midst of an ongoing economic crisis and have created a political undercurrent in favor of public companies reforming and “adopt[ing] higher standards of corporate governance, accountability, and transparency.”
The momentum from the financial crisis and ensuing scandals propelled the SEC, the Obama Administration and Congress to seek to empower public company shareholders with greater access and a greater voice in the matters of corporate governance. State legislatures, such as
The SEC Access Proposal
Accordingly, on May 20, the SEC, by a narrow 3-2 vote, approved a proposed rule that would provide shareholders of public companies (including mutual funds) with access to the public company’s proxy statement to nominate their own director (including mutual fund trustee) candidates, continuing the heated debate over shareholder access. This action by the SEC also delivers on the promises made by newly appointed SEC Chairwoman Mary Schapiro to provide shareholders with greater input on key corporate governance issues, such as compensation of senior executives and the nomination of public company directors. Unlike the shareholder access proposals the SEC issued in 2003 and 2007, this proposal appears to possess broad-based support across the political spectrum. President Barack Obama has previously expressed his support for giving shareholders a greater voice in corporate governance and sponsored legislation to such effect when he was in the U.S. Senate.
Requirements to be Nominated
Currently, shareholders of public companies can nominate their own director nominees, but they may only do so through proxy contests of public companies in which a shareholder must, at its own expense, prepare, file with the SEC and disseminate its own proxy materials. Under proposed Rule 14a-11 under the Securities Exchange Act of 1934 (the “Exchange Act”), shareholders can nominate directors if they have held the requisite number of shares for one year.
Under the proposed rule, shareholders that have held their shares for at least one year would be eligible to have their director nominee included in the company’s proxy materials if they meet the following share ownership threshold requirements, which vary based on the company’s size. Shareholders must own: (i) 1% of the company’s voting securities for “large accelerated filers” (generally companies with public float of $700 million or more); (ii) 3% of the company’s voting securities for “accelerated filers” (generally companies with public float greater than $75 million but less than $700 million); or (iii) 5% of the company’s voting securities for “non-accelerated filers” (generally companies with public float below $75 million). The proposed rule would permit shareholders to aggregate their holdings to meet the applicable thresholds. The proposal provides shareholders the opportunity to propose a short slate of no more than one director or 25% of the board (whichever is greater). For example, if a board of directors is comprised of three members, one shareholder nominee could be included in the company’s proxy materials, and on the other hand, if a board of directors is comprised of eight members, two shareholder nominees could be included in the company’s proxy materials. The proposing shareholders are also required to state that neither they nor their nominees have an agreement or relationship with the company or management of the company. Where more than one shareholder submits nominees, the shareholder who submits its nomination first will be accepted. How this first-come, first-served rule will work in practice remains to be seen. This change could have the potential of encouraging the nomination of potentially unqualified director nominees solely on the basis that the first shareholder who satisfies the rule and submits a nomination will be accepted.
New Schedule 14N
Under the proposed rule, a nominating shareholder would be required to file with the SEC and submit to the company a new Schedule 14N containing certain disclosures (including securities owned, length of ownership and intent to continue to hold the securities through the meeting date) and a certification that it is not seeking to change control of the company or gain more than a limited member of seats on the board of directors. The company would include disclosure in its proxy concerning the nominating shareholder and shareholder nominee for director that is similar to the disclosure currently required in a contested election. The deadline for submitting nominees, under the proposed rule, would be the deadline established by a company’s advance notice bylaw or, in the absence of such a bylaw, 120 calendar days before the first anniversary of the date the company’s proxy statement was released in connection with the previous year’s annual meeting (which also is the deadline for submitting shareholder proposals under SEC Rule 14a-8).
This proposed SEC rule would likely serve to preempt state corporate law with respect to public companies in the nomination area as the company’s articles and bylaws could not be utilized to add more restrictions on the nomination process than what is provided for in the proposed amendments to the SEC’s proxy rules. It appears that this proposed rule effectively eliminates the potential for public companies to use the recent amendments to the Delaware General Corporation Law, described below, to eliminate or restrict the shareholder access provided for at the federal level. Clearly, the SEC proposal shifts the balance of power between state and federal authority over the nomination process.
The proposed rule requires that the proposed nominees must be independent as defined under the listing standards of the applicable stock exchange. This rule change, if adopted as proposed, would effectively require shareholders to determine whether their nominee is independent under the applicable exchange listing standards.
In addition, a nominating shareholder is not permitted to have an agreement, directly or indirectly, with the company regarding the nominee’s nomination for director. In addition, the SEC proposed to amend Rule 14a-8(i)(8) to allow shareholders, under certain circumstances, to require companies to include proposals in their proxy materials that would amend, or request an amendment to, the company’s governing documents to address the company’s nomination procedures or other director nomination disclosure provisions that do not conflict with the SEC’s rules.
Changes to SEC Shareholder Proposal Rule
Currently, Rule 14a-8(i)(8) permits companies to exclude shareholder proposals that “relate to an election.” Under the proposed rule, this so-called “election exclusion” would be narrowed to allow for the inclusion of more shareholder proposals regarding elections in company proxy materials. Specifically, shareholder proposals by qualifying shareholders that would propose an amendment to provisions of a company’s governing documents concerning the company’s nomination procedures or other director nomination disclosure provisions (so long as those disclosure provisions do not conflict with proposed Rule 14a-11 above) would not be excludable. The current eligibility provisions of Rule 14a-8 would continue to apply under the new rules. This rule change, if adopted, could launch a new series of requests by activist shareholders to adopt bylaws that go beyond the limitations of Rule 14a-11 without the company’s ability to exclude them from the company’s proxy statement.
This access proposal, like those that came before it, pits Corporate America against large pension and hedge funds, as well as other activist investors. Those that support the status quo in this area fear that the adoption of any access proposal would empower special interest groups to promote their agendas that may not be in the best interest of all shareholders. Proponents of the access proposal have argued that greater access would provide for better corporate governance.
On April 10, Delaware Gov. Jack Markell signed into law a bill which amends the Delaware General Corporation Law (DGCL) to provide shareholders the opportunity for access to a company’s proxy statement. Among the changes spurring much debate are the additions of the new DGCL Sections 112 and 113, which deal with shareholder access to proxy solicitation materials and proxy expense reimbursement provisions. These amendments will be effective on August 1, 2009.
DGCL Section 112
New Section 112 of the DGCL permits
- Ownership Requirements: A minimum record or beneficial ownership requirement, as well as a duration of ownership requirement for the nominating shareholder. The bylaws may define beneficial ownership to take into account options or other rights in respect or related to the corporation’s stock;
- Submission of Information: Submission of specified information concerning the shareholder and the shareholder’s nominees, including information concerning ownership by such persons of shares of the corporation’s capital stock, or options or other rights in respect of or related to such stock;
- Conditioned Eligibility on Number of Nominations: Eligibility based upon the number or proportion of directors nominated by the shareholder or whether the shareholder previously sought to require access to the corporation’s proxy materials;
- Limit on Voting Power: Preclusion of nominations if the shareholder, its nominee, or any affiliate or associate of either the shareholder or its nominee has acquired or publicly proposed to acquire shares constituting a specified percentage of the voting power; and
- Indemnification: A requirement that the shareholder indemnify the corporation for false or misleading statements provided by the shareholder.
DGCL Section 113
The new Section 113 of the DGCL allows
- Shareholder Eligibility: Conditioning eligibility for reimbursement upon the number or proportion of persons nominated by the shareholder seeking reimbursement or whether the shareholder previously sought reimbursement for similar expenses;
- Limits on Reimbursements: Limiting the amount of reimbursement based upon the proportion of votes cast in favor of the persons nominated by the shareholder, or upon the amount spent by the corporation in soliciting proxies in connection with the election; and
- Cumulative Voting: Limitations concerning elections of directors by cumulative voting.
Effect of Sections 112 and 113
Generally, new Sections 112 and 113 of the DGCL bring no practical changes to
New Sections 112 and 113 do, however, preclude the ability to successfully challenge SEC proxy access proposals on the basis that such action is not permitted under state law. Corporations have previously challenged the SEC’s attempts to expand proxy access by asserting that such proposals are not consistent with the intent of state law. With the adoption of new Sections 112 and 113 of the DGCL,
Interplay Between Proposed Rule 14a-11 and Section 112 of the DGCL
Rule 14a-11, if adopted, would significantly overlap with Section 112 of the DGCL. The two main conflicts between the two provisions are first, Section 112 allows, but does not require, the corporation to permit shareholder proxy access, while Rule 14a-11 gives shareholders a direct right to proxy access; and second, Section 112 permits the bylaws to set any ownership threshold for access, while Rule 14a-11 specifies ownership thresholds, both as to amount and duration of ownership.
By proposing Rule 14a-11, the SEC has been accused of improperly encroaching on matters of corporate governance and corporate law, which are more appropriately and perhaps constitutionally left to the states. First, opponents have raised the issue of whether the SEC even has the jurisdictional authority to adopt or enforce such a rule. The argument that the regulation of proxy access is outside the jurisdiction of the SEC seems to be a relatively weak one given the fact that the SEC already regulates the proxy solicitation process of public companies and requires certain information in their proxy materials, including regarding certain shareholder proposals. Some commentators have argued that Rule 14a-11 simply expands the SEC’s current regulations and does not intrude upon any other areas of internal corporate affairs traditionally viewed as the province of the states.
While the SEC expressly recognizes the complicated interplay between state and federal law in this matter,2 the SEC argues that it is acting within its congressional mandate. The SEC views its current action as enhancing “director accountability” in response to the current economic crisis and, therefore, within the scope of Section 14(a) of the Exchange Act, which authorizes the SEC to regulate the use of proxies “as necessary or appropriate in the public interest or for the protection of investors . . . .”
Some opponents also object to the SEC’s latest access proposal on the grounds that a federal requirement applicable to all reporting companies is not currently the most effective approach. With active corporate law states like Delaware just beginning to address these governance issues, it has been argued that passing Rule 14a-11 would prematurely end the search for effective state or other comprehensive approaches to increasing director accountability—which could take place by allowing individual states and individual corporations to craft their own system. The method of reform taken by
In light of proposed Rule 14a-11, the adoption of which is all but assured given the Obama Administration’s support, it remains to be seen what long-term impact, if any, Section 112 will have.
The comment period on the SEC’s proposed proxy access rules expires August 17, 2009. While comments will likely be substantial, the SEC intends to adopt final rules in time for the 2010 proxy season, which is almost around the corner.
Proposed Changes to NYSE Rule 452
New York Stock Exchange Rule 452 gives brokers discretion to vote shares of stock they own of record for the election of directors and other “routine” matters in the absence of instructions from the beneficial owners of the shares. The NYSE has proposed to amend this rule to eliminate broker discretionary voting for the election of directors. Among other things, the SEC is planning to consider whether to approve this change at its July 1 open meeting.
Critics of the existing rule claim that discretionary voting permits brokers to usurp the stockholder franchise from persons who hold the economic interest in the shares. On the other hand, supporters of the existing rule claim that the change would destabilize the proxy voting system by shifting the balance of the vote to institutional investors. Further, these supporters believe that better alternatives to modifying the 70-year old rule exist, such as proportional and client-directed voting policies. Proportional voting, which has already been adopted by a number of large firms, requires brokers to vote uninstructed shares in the same proportion as the retail vote. Client-directed voting allows beneficial owners to direct how to vote uninstructed shares when they open their brokerage accounts. While many of these alternatives themselves may have potentially material positive and negative implications, the proposed amendments to Rule 452, especially when coupled with the ongoing movement toward majority voting systems for the election of directors, could have profound future effects on the proxy voting system and the shareholder franchise generally.
Proposed Federal Legislation
In addition to these federal regulatory and state actions, on May 19, U.S. Senator Charles Schumer (D.-N.Y.) introduced a bill entitled the “Shareholder Bill of Rights Act of 2009.” The stated central goal of this bill is “to prioritize the long-term health of firms and their shareholders.” This bill requires, among other things, that the SEC adopt new rules giving shareholders greater access to the director nominating process and proxy ballot. The bill, if adopted by Congress, would give shareholders of all public companies additional input on shareholder governance.
“Say on Pay”
Section 3 of the Schumer bill proposes to amend the Exchange Act to give shareholders a non-binding advisory vote on executive compensation at any annual or other meeting at which executive compensation disclosure is required. This is similar to the rights provided under the TARP program to shareholders of bank holding companies that accepted TARP funds.
In addition, proposed Exchange Act Section 14A(c) would give shareholders a non-binding advisory vote on any agreement or understanding providing for “golden parachute” compensation that is based on or otherwise related to an acquisition, merger, sale or other similar transaction that was not already subject to a “say on pay” advisory vote. Both the “say on pay” shareholder approval requirement and the “golden parachute” shareholder approval requirement would take effect one year after enactment of the law. By that time, the SEC would have been required to issue final rules implementing these provisions.
Shareholder Proxy Access
Section 4 of the Schumer bill proposes to amend the Exchange Act to require that the SEC adopt rules that would allow a shareholder (or a group of shareholders acting by agreement) who has owned at least 1% of the voting securities of a company for at least two years “preceding the date of the next scheduled annual meeting of a [company]” to use a company’s proxy solicitation materials for the purpose of nominating members to the board of directors.
The proposed Schumer bill would also amend the Exchange Act by imposing a set of corporate governance standards on all public companies. The SEC would be required to implement rules that prohibit the national securities exchanges from listing the securities of a public company that does not maintain the following standards:
- Independent Board Chair. The chairperson of the board of directors of a public company must be independent, determined by SEC rules that address independent directors as well as rules of the exchange on which the securities of a public company are listed. The rules must also state that the chairperson must not have previously served as an executive officer of a public company. This provision effectively separates the roles of chairperson and CEO.
- Elimination of Staggered Board. Each listed company must provide in its governing documents that every member of the board of directors be subject to annual election by the shareholders, thus precluding the use of a classified board system.
- Majority Voting. In uncontested director elections, directors must be elected by a majority of the votes cast (plurality voting would only be permitted in the event of a contested election) and requiring that if a director is not elected to a new term by a majority vote of shareholders in an uncontested election, that such director must submit his resignation to the board of directors, and the board must accept the director’s resignation within a reasonable period of time as determined by the SEC.
- Risk Committee. Maintain a risk committee made up entirely of independent directors within one year of the SEC instituting rules concerning the establishment of such risk committees. On these committees, independent directors will be responsible for the establishment and evaluation of the public company’s risk management practices.
To muddy the shareholder access waters further, on June 12, U.S. Representative Gary Peters (D.-Mich.) and others introduced yet another piece of shareholder rights legislation entitled “The Shareholder Empowerment Act of 2009.” The Peters bill, if adopted, provides an even more expansive list of shareholder rights than the Schumer legislation. This bill would, if enacted, require the SEC to adopt rules:
- requiring the national securities exchanges to prohibit the listing of any security of a company that does not: (i) elect its directors by majority (as opposed to a plurity) vote in uncontested elections; (ii) maintain a resignation policy for directors not elected by a majority, if permitted by state law; (iii) require an independent board chairperson (and providing a specific definition of “independent”); (iv) have a policy for reviewing unearned bonus payments, incentive payments or equity payments that were awarded to executive officers as a result of fraud, a financial restatement, or other similar cause, and requiring recovery or cancellation of any unearned payments to the extent that it is feasible and practical to do so; and (v) have a policy prohibiting the company from entering into agreements providing for severance payments to a senior executive officer who is terminated because of poor performance as an executive, as determined by the company’s board of directors;
- requiring that public companies provide shareholders with access to the company’s proxy statement;
- eliminating broker discretionary voting on routine matters;
- imposing a non-binding shareholder vote on executive compensation;
- requiring the board of a public company to retain an independent adviser in connection with the negotiation of executive employment agreements and compensation arrangement; and
- requiring additional disclosure of specific performance targets that are used by issuers to determine a senior executive officer’s eligibility for bonuses, equity and incentive compensation.
Certain of the requirements in this proposed legislation currently apply to bank holding companies that accepted TARP funds from the U.S. Treasury. The Peters bill generally implements the corporate governance oversight issues raised in the letter to Congress by the Council of Institutional Investors.
The recent corporate governance and executive compensation scandals riding on the coattails of the recent economic downturn have only served to quicken the drumbeat for regulatory reform of the proxy solicitation, voting and corporate governance systems, all of which are inextricably intertwined. Many of the changes to this conglomerate of systems have been proposed or suggested by a number of disparate voices, including members of Congress, the SEC, stock exchanges, institutional investor and shareholder activism groups, proxy advisory firms, state legislatures and members of academia, just to name a few. It should be noted that these increased and wide-ranging calls for reform are being overlaid upon an already existing movement toward a more shareholder-oriented corporate governance system, as evidenced by the adoption by many public companies of majority voting bylaw provisions and the implementation of non-binding “say on pay” proposals, as well as the adoption by the SEC of a notice and access system for proxy statement disclosures.
While it is recognized that the present amalgam of proxy solicitation, voting and corporate governance systems may have inherent flaws, the many different voices calling for change to the system have yet to be coalesced to support a comprehensive and uniform approach to proxy access reform. The overall effects and impact of the patchwork of proxy-based, shareholder access and corporate governance reforms being proposed as a result of increased calls for regulatory scrutiny of public companies should be considered in their totality and not in isolation. Further, as has been recognized by many in the wake of adoption of the Sarbanes-Oxley Act of 2002, a “one size fits all” approach to corporate governance and proxy access may have harmful effects upon mid-size and smaller public companies, many of whom do not share the same governance and executive compensation challenges as large Wall Street and financial firms. Thus, a careful, cautious approach to the combined proxy access, voting and corporate governance systems should be considered, including a comprehensive examination of the various components of the current system and the effects that these various changes may have on the components and the system as a whole. Otherwise, the unintended consequences of adopting these reforms could effectively break the back of the very system that its critics seek to reform.
1. Brendan Sheehan, Greetings From Delaware, Corporate Secretary, May 2009, available at http:// www.thecrossbordergroup.com/pages/1006/ May+2009.stm?article_id=13420; see also Posting of Delaware Adopts DGCL Amendments to http:// blogs.law.harvard.edu/corpgov/2009/05/05/ delaware-adopts-dgcl-amendments/ (May 5, 2009, 9:00 EST) (“Adoption of these provisions does nonetheless clarify that under Delaware law, issuers may impose restrictions on proxy access and proxy expense reimbursement bylaws, which may influence, as a practical or legal matter, any future federal legislation or rule-making on the subject.”)
2. Facilitating Shareholder Director Nominations, SEC Release Nos. 33-9046, 34-60089, at 7-9 (June 10, 2009) available at http://sec.gov/rules/proposed/2009/33-9046.pdf.
3. SEC Release Nos. 33-9046, 34-60089, at 27-28.
Reprinted from the Wall Street Lawyer. Copyright © 2009 Thomson Reuters/West. For more information about this publication please visit www.west.thomson.com.