SEC Adopts Shareholder Proxy Access

On August 25, 2010, the SEC adopted Rule 14a-11 which permits eligible shareholders of public companies to nominate candidates for election as directors ("shareholder proxy access"). Director nominations made by shareholders under Rule 14a-11 must be included in the company's proxy statement and form of proxy along with the company's nominees. The new rule will be effective for most companies this year; it does not apply to smaller reporting companies for three years. Whether a shareholder could use Rule 14a-11 to nominate a candidate at a company's 2011 annual meeting of shareholders will depend upon the date the rule is published in the Federal Register and the mailing date of the company's 2010 proxy materials.

The SEC has considered implementing some form of shareholder proxy access since 2003. The Dodd-Frank Act expressly authorizes the SEC to act in this area, effectively pre-empting, or at least making more difficult, a legal challenge to the SEC's authority to affect matters that were historically matters of state law.

To be eligible to nominate a director under Rule 14a-11, a nominating shareholder will have to have ownership of securities representing at least 3% of the voting power of a company for at least three years prior to the time notice of the nomination is delivered and continue to hold those securities through the date of election. Shareholders can form groups to satisfy the ownership requirements and nominate candidates. The nominating shareholder or group must provide a Schedule 14N to the company and the SEC no earlier than 150 days and no later than 120 days before the anniversary of the mailing date of the company's last annual meeting proxy materials. The nominating shareholder or group's Schedule 14N must contain information on ownership of securities and biographic information for the nominating person or group and the nominee. The nominating shareholder or group must also provide a statement of support of each nominee, not to exceed 500 words, to be included in the proxy materials.

A nominating shareholder or group will be required to certify that it is not holding the securities with the purpose of effecting a change in control of the company. A company will not be required to include in its proxy materials more than one nominee or 25% of the entire board, whichever is greater. If the size of the board is eight to eleven members, the number of possible nominees would be two. If the size of the board is twelve or more, then three or more candidates could be nominated. If there is more than one nominating shareholder or group, the person or group with the highest percentage of ownership would have priority.

Rule 14a-11 also provides a process by which a company can exclude a shareholder nominee from its proxy statement or object to the contents of a statement in support if the company believes the nominee is not eligible. The process is similar to the no-action process the SEC has employed in dealing with shareholder proposals.

In addition to Rule 14a-11, the SEC revised Rule 14a-8 to permit shareholder proposals that seek to establish a procedure in a company's governing documents to include one or more shareholder director nominees. Such a process, if established, would be an alternative to Rule 14a-11 for shareholders to nominate directors.

The SEC also adopted exemptions from its proxy solicitation rules which otherwise could have restricted communications necessary to make a nomination under Rule 14a-11. Written or oral communications of a shareholder's intention to form a nominating group and communications made in support of a nominee that is included in a company's proxy materials would be exempt from the proxy solicitation rules. Any written communications made pursuant to these exemptions will have to be limited to specified information and be filed with the SEC to qualify for the exemption.

Many institutional investors are eligible to report ownership in excess of 5% of a public company on Schedule 13G due to the passive nature of their investment rather than Schedule 13D. The SEC has amended its rules to provide that a nominating shareholder will not lose its eligibility to use Schedule 13G by reason of making a Rule 14a-11 nomination.

There are a number of key differences between the final rule and the proposal made in May of this year. The SEC increased the holding period requirement from one year to three years. The SEC also adopted a "one size fits all" 3% ownership threshold rather than the multiple thresholds in the proposed rule which would have depended upon the size of the company. Finally, the proposed rule would have created a "race" to file by allowing the nominating shareholder or group that made its required filing first in time to pursue the process under Rule 14a-11. The final rule provides that, if there is more than one nominating shareholder or group, the company will only be required to include in its proxy materials the nominee or nominees of the nominating shareholder or group with the greatest aggregate voting ownership position.

In recent years, many public companies have adopted a majority voting standard for election of directors either by amending their by-laws or by adopting a director resignation policy. In most instances, the majority voting standard would not apply to elections in which the number of nominees is greater than the number of open board positions. In such cases, the voting standard would typically revert to a plurality and so the nominees receiving the greatest number of votes would be elected to the open positions.

Shareholder proxy access will represent a significant expansion of shareholders' rights to participate in the management of the company. In the past, the only practical alternative available to a shareholder that wanted to secure the election of its nominee would have been to conduct a proxy contest, a process that is expensive and time consuming. In a proxy contest, dissidents have to prepare their own proxy materials, mail a ballot separate from the company's and persuade investors to vote for the dissident slate. The cost of conducting a proxy contest has been a significant barrier. Although dissidents can ultimately recover their out-of-pocket expenses from the company, they must first win the proxy contest.

Shareholder proxy access will remove the greatest barrier to an activist shareholder gaining board representation by virtually eliminating any cost to the shareholder. Insurgent nominees will be given the same prominence and biographic information as the company's nominees. Just last year, the NYSE rule that regulates the ability of brokers to vote shares for which they have not received any direction from their customers was amended to treat the election of directors as "non-routine." This means it will be easier for an insurgent nominee to win the contest because the company's nominees will not have the benefit of the effect of broker non-votes that it enjoyed prior to 2010.

There is virtually no cost or downside to a group of institutional shareholders pooling their ownership and nominating candidates for election under Rule 14a-11. Despite the SEC's attempt to not allow this new mechanism to be used to effect a change in control, it remains to be seen whether directors elected through Rule 14a-11 will pursue an agenda that is based on the views of the nominating shareholder or group.

This is not a complete summary of the provisions of Rule 14a-11. For additional information or specific legal guidance, you should contact legal counsel.