BUSINESS DEPARTMENT E-NEWS ALERT — NOVEMBER 13, 2003
The Securities and Exchange Commission (the “SEC”) recently proposed rules that would require companies to include in their proxy materials director nominees designated by shareholders.
1 The
proposed rules provide a mechanism for outside nominees to be included in company proxy materials where the proxy process has been ineffective or the company has been unresponsive to shareholder concerns as they relate to the proxy process.
2 To prevent use of the rules as a means to effect a
change of control, the proposed nomination and proxy access rules would only be available to longterm shareholders that have significant holdings in the company. The proposed rules would enable such shareholders or shareholder groups to engage in limited solicitations in support of their nominees without disseminating their own proxy materials in a separate and costly proxy battle. Instead, eligible shareholders would be entitled to use the same proxy statement and proxy card that the company uses to nominate its own slate of directors.
The proposed rules represent a significant departure from the long-established process for nominating and electing directors of public companies. Public comments on the proposed rules are due by
December 22, 2003. The proposed rules, if adopted, would likely become effective for shareholder meetings held after January 1, 2004.
The SEC also proposed rules to require enhancements to existing disclosure requirements regarding the operation of board nominating committees and a new disclosure proxy statement disclosure about a company’s nominating process and the means by which shareholders may communicate with the board of directors.
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PROPOSED RULES REGARDING SHAREHOLDER ACCESS TO PROXIES FOR DIRECTOR
ELECTIONS
Companies Subject to Proposed Rules
The proposed rules generally apply to all companies that are subject to the SEC’s proxy rules. The proposed rules would not apply if (a) applicable state law prohibits a company’s shareholders from
1 The proposed rules can be found at http://www.sec.gov/rules/proposed/34-48626.htm.
2 Currently shareholders dissatisfied with the leadership of a company are required to undertake a proxy contest, along
3 with its related expenses to place their nominees before the shareholders for a vote.
The SEC proposed the rules on August 8, 2003, which can be found at www.sec.gov/rules/proposed/34-48301.htm.
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nominating a candidate for election as director or (b) a company’s charter documents prohibit shareholder nominations and state law permits such a prohibition.
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Events Triggering a Shareholder Right to Include a Nominee in the Company’s Proxy Materials
The focus of the proposed rules has been on companies for which there is evidence that the proxy process have been ineffective or that shareholders are dissatisfied with the process. Accordingly, the nomination procedures proposed in new Exchange Act Rule 14a-11 would only apply (assuming it is not prohibited by state law) after one of the following triggering events occurs:
• At least one of the company’s nominees for the board of directors received “withhold” votes from more than 35 percent of the votes cast; or
• A shareholder proposal providing that the company become subject to the shareholder nomination procedure of proposed Exchange Act Rule 14a-11 (referred to as a “direct access” proposal) was (a) submitted by a shareholder or shareholder group that held at least 1% of a company’s outstanding shares for at least one year and (b) that “direct access” proposal received more than 50 percent of the votes cast.
After a triggering event occurs, the nomination procedure would apply to any shareholder meetings held (a) during the remainder of the calendar year in which the triggering event occurs, (b) the next calendar year and (c) that portion of the following calendar year through the date of the shareholder meeting which was held during that calendar year.
Notice to Shareholders of an Event Triggering the Nomination Procedures
If a triggering event occurs, the company would be required to disclose the results of the shareholder vote with regard to the nomination procedure triggering event in its next quarterly report on Form 10-Q or 10-QSB (or Form 10-K or 10-KSB if the triggering event occurred during the fourth quarter) and disclose that the company is now subject to the shareholder nomination procedure.
Eligibility Requirements of Shareholders or Shareholder Groups that may Submit Nominees
Once the shareholder nomination procedure is triggered, shareholders must meet certain criteria to be eligible to submit a nomination for inclusion in the company’s proxy materials. To be eligible, a shareholder or shareholder group must certify that it has beneficially owned (individually or in the aggregate) more than 5% of the company’s voting securities for a continuous period of at least two years as of the date of nomination and must intend to continue to own those securities through the date of the shareholder meeting. In addition, the shareholder or shareholder group must be eligible to report beneficial ownership on Schedule 13G, rather than Schedule 13D (if a shareholder group, this requirement applies to each member, even though on an individual basis they would not otherwise be required to file) and must have filed a Schedule 13G or an amendment to Schedule 13G reporting its beneficial ownership as a passive or institutional investor (or group) on or before the date that it submits the nomination to the company.
4 Although the rules as proposed would apply to all companies that are subject to the proxy rules, the SEC is seeking comment on whether the rule should apply only to those companies that are subject to accelerated deadlines for filing
Securities Exchange Act of 1934 (the “Exchange Act”) periodic reports (generally, companies with a public float of at least $75 million that have been filing periodic reports for at least a year), and investment companies registered under
Section 8 of the Investment Company Act of 1940 (the “Investment Company Act”).
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Eligibility Requirements of Nominees
A company would not be required to include a shareholder nominee in its proxy materials if the nominee’s candidacy or election would violate state or federal law or the rules of a national securities exchange or association (other than director independence standards that require a subjective determination by the board of directors or a board committee as to the nominee’s independence).
In addition, to be eligible to nominate a candidate under the proposal, a nominating shareholder or shareholder group may not have any of the following relationships with the nominee:
• The nominee may not be the nominating shareholder, a member of the nominating shareholder group, or a member of the immediate family of the nominating shareholder(s);
• Neither the nominee nor any of his or her immediate family members may have been employed by, or have accepted any consulting, advisory or other compensatory fee from, the nominating shareholder or any member of the nominating group or any affiliate of such shareholder or member during the then-current calendar year or the immediately preceding calendar year;
• The nominee may not be an executive officer or director (or person fulfilling similar functions) of the nominating shareholder or member of the nominating group or an affiliate of such nominating shareholder or any group member; and
• The nominee may not control the nominating shareholder (or be an interested person of a nominating shareholder that is a fund under the Investment Company Act).
Finally, to prevent potential use of the process by nominating shareholders acting as surrogates for the company, neither the nominee nor the nominating shareholder (or any member of a nominating shareholder group) may have any direct or indirect agreement with the company regarding the nomination of the nominee.
Maximum Number of Nominees
The proposal is not intended to be available for any shareholder or shareholder group that is seeking control of a company. Existing procedures regarding contested elections of directors are intended to continue to fulfill that purpose. Accordingly, the proposed rules limit the number of shareholder nominees that must be included by a company in its proxy materials based on the size of that company’s board of directors, requiring:
• One nominee for boards consisting of 8 or fewer directors;
• Two nominees for boards consisting of 9 to 19 directors; and
• Three nominees for boards consisting of 20 or more directors.
For companies with classified or “staggered” boards, current directors who were elected through this procedure but who are not up for re-election at the current annual meeting would be counted for purposes of these limitations.
If more than one shareholder or shareholder group is eligible to nominate a director pursuant to the proposed rule, the company would only be required to include in its proxy materials the nominee(s), up to the prescribed limits, of the shareholder or shareholder group with the largest beneficial ownership, as reported on Schedule 13G at the time the shareholder or shareholder group delivers its nomination notice to the company.
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Notice to the Company and SEC of Nominating Proposal
Pursuant to the proposed rules, nominating shareholders would be required to provide notice to the company of their intent to submit a nominee no later than eighty (80) days before the anniversary of the date that the company mailed its proxy materials for the prior year’s annual meeting.
5 The nominating
shareholder would also be required to file the notice with the SEC no later than two (2) business days after delivering the notice to the company.
The Company’s Responsibilities After Receiving Notice
Procedures for Excluding a Shareholder Nominee
• When a company receives a shareholder nomination, it is not required to include the nominee in its proxy materials if:
• The proposed rules are not applicable to the company because of state law or provisions in the company’s governing documents;
• The nominating shareholder or shareholder group has not complied with the procedures of
Rule 14a-11;
• The nominee does not meet the requirements of the rules;
• Any representation required to be included in the notice to the company is false in any material respect; or
• The company has received more nominees than it is required to include.
If such case the company would be required to notify the nominating shareholder of its determination not to include the shareholder nominee, citing the specific rules that permit the exclusion, and the specific basis for the exclusion of the nominee. The company would also be required to include a similar disclosure in its proxy statement.
Procedures for Including a Shareholder Nominee
If a company determines that it must include a nominee in its proxy materials, it would be required to inform the nominating shareholder or shareholder group of the inclusion. If a company elects to include any statements in the proxy materials supporting company nominees and/or opposing shareholder nominees (other than a mere recommendation to vote in favor of, or to withhold votes from, a particular candidate) then the company must also provide the nominating shareholder or shareholder group with the opportunity to similarly include a statement of support for the shareholder nominee, which statement may not exceed 500 words. The supporting statement of the nominating shareholder or shareholder group would be viewed as soliciting material and, would be required to be filed with the
SEC as such by the nominating shareholder or shareholder group.
Liability Under Federal Securities Laws
The proposed rules provide that the nominating shareholder would be responsible for any false or misleading statements included in the notice provided by the nominating shareholder to the company.
However, to the extent that the company specifically incorporates that information by reference in any
5 Among other things, the notice would be required to contain representations and supporting documentation regarding the eligibility of the nominating shareholder or group to submit a nominee, the nominee’s eligibility, the absence of any prohibited relationship between the nominating shareholder and the nominee or any agreement with the company regarding the nomination.
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future SEC filing, the information would be treated as being made by the company for purposes of the antifraud and civil liability provisions of the Securities Act of 1933 and the Exchange Act.
Application of the Proxy Rules to Solicitations by Nominating Shareholders
To facilitate communications among shareholders seeking to form nominating shareholder groups, the proposed rules would provide a limited exemption from the proxy rules for communications that might otherwise be deemed solicitations subject to the proxy rules. As proposed, most of the proxy rules would not apply to any solicitation by or on behalf of any shareholder in connection with the formation of a nominating shareholder group, provided that:
• Either: a. the total number of persons solicited is not more than 30; or b. each written communication includes no more than:
• A statement of intent to form a nominating shareholder group in order to nominate a director under the proposed rule;
• The percentage of shares that the shareholder beneficially owns or the aggregate percentage owned by any group to which the shareholder belongs;
• The means by which shareholders may contact the soliciting party; and
• Any soliciting material published, sent or given to shareholders is filed with the SEC by the nominating shareholder no later than the date the material is first published, sent or given to shareholders.
To enable the nominating shareholder or shareholder group to solicit in favor of its nominees outside of the company’s proxy statement, the proposed rules create a new exemption from the shareholder communication provisions of the proxy rules, which is available if:
• The soliciting party does not seek the power to act as proxy for a shareholder and does not furnish or otherwise request a form of revocation, abstention, consent or authorization;
• Each written communication includes the identity of the nominating shareholders, a description of their security holdings or other interests in the company, and a legend advising shareholders, among other things, that a shareholder nominee is or will be included in the company’s proxy statement and explaining where shareholders can find the proxy statement; and
• Any soliciting material published, sent or given to shareholders is filed with the SEC by the nominating shareholder or shareholder group, under the company’s Exchange Act file number and under a Schedule 14A cover page, no later than the date the material is first published, sent or given to shareholders.
Related Rule Changes
Schedule 13G
In connection with the proposed rules, the SEC proposes to amend Schedule 13G to require that a nominating shareholder (individually) or shareholder group (in the aggregate) certify that they have owned at least 5% of the company’s securities for a minimum of two years in order to be deemed not to have a purpose or effect of changing or influencing the control of the company solely by virtue of
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making the nomination, soliciting in connection with the nomination or having a nominee elected as a director in accordance with the proposed new rules. A shareholder or shareholder group that previously filed a Schedule 13G would be required to amend that schedule to provide the required certification to make a nomination under the proposed rules.
Section 16 Reports
The SEC has proposed an amendment to the Section 16 of the Exchange Act to exclude a nominating shareholder group from the definition of a 10% owner. Thus, members of such a group (who do not individually own more than 10% of a company’s securities) would not become subject to the beneficial ownership reporting requirements (Forms 3, 4 and 5) and short-swing profit provisions of the Section 16 normally applicable to company insiders.
PROPOSED RULES REGARDING NOMINATING PROCESS DISCLOSURE AND SHAREHOLDER
COMMUNICATIONS
Disclosure Regarding Nominating Process
The proposed rules would expand the current proxy statement disclosure regarding a company’s nominating or similar committee to require:
• A statement as to whether the company has a nominating committee or a committee performing similar functions, and if not, a statement as to why the board of directors believes it is appropriate for the company not to have such a committee, and the names of those directors who participate in the consideration of director nominees;
• The following disclosure regarding the nominating process: a. If the nominating committee has a charter, the material terms of the charter and how shareholders may obtain the charter; b. If the nominating committee does not have a charter, a statement regarding that fact; c. If a company whose securities are listed on a national securities exchange or in an automated inter-dealer quotation system of a national securities association which has independence requirements for nominating committee members, a disclosure of any time during the last fiscal year in which the members of the nominating committee did not satisfy the definition of independence; d. If not a listed company, disclosure of whether each of the members of the nominating committee are independent; e. A description of material elements of any policy regarding consideration of nominees recommended by shareholders including, at a minimum, a statement whether the committee or group will consider shareholder recommended nominees; f. A description of any procedures to be followed by shareholders for recommending nominees; g. A description of the process for identifying and evaluating nominees and any differences in evaluating the nominee recommended by a shareholder; h. A description of any specific minimum qualifications that a nominee must meet in order to be recommended for the board of directors, any specific qualities or skills the
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committee or group believes are necessary for directors to possess, and any standards for the overall structure and composition of the board of directors; i. A statement of the specific source, such as the name of an executive officer, director or other individual, of each nominee approved for inclusion in the proxy materials, unless the nominee is an executive officer or director standing for reelection; j. A disclosure regarding the function performed by any third party to which the company pays a fee to identify, or to assist in identifying, potential board nominees; and k. If the nominating committee does not include a nominee recommended by any shareholder or group owning greater than 3% of the company’s voting common stock for at least one year as of the date of recommendation, the company would be required to disclose the name of each shareholder that recommended the candidate and the specific reasons for not including the candidate.
Disclosure Regarding Shareholder Communication with the Board
The proposed rules would require a company to disclose in its proxy materials whether the board of directors provides a process for shareholders to send communications to the board of directors. If the company does not provide for such process, it would be required to disclose the specific basis for that decision.
• If the company provides a process, it would be required to disclose:
• A description of the manner in which shareholders may send communications to the board of directors;
• Identification of those board members to which shareholders may send such communications;
• If all communications are not sent directly to board members, a description of the process of how communications will be relayed to the board members, including a disclosure of the department or group responsible for making the determination; and
• A description of any material action taken by the board of directors during the preceding fiscal year as a result of a communication from a shareholder.
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For more information on this E-News Alert, please contact Stephan Coonrod ( stephanc@prestongates.com
) or any other attorney in the Securities Group at Preston Gates & Ellis LLP.
The enclosed materials have been prepared for general information purposes only and are not intended as legal advice.
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