Shareholder Proxy Access: An Idea Whose Time Has Not Yet Come

This article reviews the developments surrounding proxy access over the last decade, and explains where we are today. Despite a decade-long effort by the SEC and shareholder activists, proxy access remains a “hot-button” corporate governance issue and the outcome of the debate remains uncertain.

2003: SEC Proposes Proxy Access Rule

Proxy access grabbed center stage in 2003 when the SEC first proposed new Rule 14a-11. That rule would have required public companies for the first time, albeit under limited circumstances, to include in their proxy materials the names of shareholder-nominated director candidates. (See Release Nos. 34-48626; IC-26206 entitled “Proposed Rule: Security Holder Director Nominations,” which can be obtained on the SEC website at www.sec.gov/rules/proposed/34-48626.htm.) This proposal was designed to create a mechanism for “long-term” shareholders (or groups of “long-term” shareholders) with “significant” holdings to include director nominees in the proxy materials of companies whose shareholders had demonstrated a degree of dissatisfaction with the responsiveness of current directors to their concerns.

Proposed Rule 14a-11 attributed shareholder dissatisfaction with an unresponsive board to the occurrence of either of two triggering events:

• A “Director No Confidence Triggering Event,” deemed to occur if at least one management nominee for election to the board of directors received “withhold” votes from more than 35% of the votes cast at an annual shareholders meeting; and
• A “Shareholder Direct Access Triggering Event,” deemed to occur if a shareholder (or shareholder group) owning more than 1% of the company's voting stock for at least one year submitted a Rule 14a-8 proposal requesting that the company become subject to proposed Rule 14a-11, and that proposal received support from more than 50% of the votes cast at an annual shareholders meeting.

At either of the two annual meetings following the occurrence of a triggering event, a shareholder (or shareholder group) owning more than 5% of the company's voting stock for at least two years (among other requirements) would be entitled (subject to certain exceptions) to require the company to include the names of a limited number of shareholder nominees for election as directors in the company's proxy materials, based on the formula below.

This proposal sparked significant debate and faced sharp criticism from those on each side of the issue. In a pattern to be repeated in subsequent attempts by the SEC to mandate proxy access, shareholder activists found the changes to be too limited, while many corporate executives and their advisers believed that the SEC had gone too far. Ultimately, the intensity of the public debate, as well as a sharp division among SEC Commissioners and Staff members, caused the SEC to withdraw the proposed rule.

With the SEC's effort to mandate proxy access thwarted, shareholder activists continued to pursue another avenue to gain access to company proxy materials for their director candidates ” Rule 14a-8 shareholder proposals.

2006-2007: SEC Expands Rule 14a-8 Election Exclusion

Rule 14a-8 under the Exchange Act regulates the process by which shareholders who wish to submit proposals for a vote at annual shareholders meetings may include such proposals in company proxy materials. Rule 14a-8 requires that a proposing shareholder must have continuously held at least $2,000 in market value, or 1%, of the company's voting stock for a period of at least one year prior to submitting the proposal. However, clause (i)(8) of Rule 14a-8, the so-called “election exclusion” generally allows companies to exclude from their proxy materials shareholder proposals that seek to nominate individual director candidates.

Beginning in 1976, the SEC Staff, based on a literal reading of the “election exclusion,” interpreted clause (i)(8) to apply solely to shareholder proposals that would result in an immediate election contest (i.e., proposals that relate to a particular election, not to elections generally). On the strength of this interpretation, shareholder activists sought to utilize the Rule 14a-8 proposal process to gain access to company proxy materials (typically through shareholder-approved bylaw amendments) for the purpose of nominating director candidates. However, beginning in 1990, the Staff essentially reversed itself by, in a series of no-action letters, allowing companies to exclude shareholder proposals that related to election procedures generally
(including shareholder access proposals) and not just to a particular election.

Then, in late 2006, in AFSCME v. AIG (462 F.3d 121 (2nd Cir. 2006)), the Federal Court of Appeals for the Second Circuit, in a ruling that foreshadowed recent criticism of SEC-rulemaking, held that the SEC Staff's reversal of its earlier no-action position was undertaken without “offer[ing] sufficient reasons for its changed interpretation.” On that basis, the court ruled, consistent with the Staff's pre-1990 position, that a shareholder-proposed bylaw amendment relating to director election procedures generally may not be excluded from a company's proxy materials.

The Second Circuit's ruling in AFSCME v. AIG created significant uncertainty regarding the scope of the “election exclusion,” prompting the SEC to undertake a comprehensive review of Rule 14a-8 as it related to director elections. Following this review, on Nov. 28, 2007, the SEC promulgated an amendment to Rule 14a-8(i)(8) (see Release No. 34-56914 entitled “Shareholder
Proposals Relating the Election of Directors,” which can be obtained on the SEC website at www.sec.gov/rules/final/2007/34-56914.pdf) that expanded the scope of the “election exclusion” to permit companies to exclude not only shareholder proposals relating to “a nomination or an election for membership on the company's board of directors,” but also any proposal relating to “a procedure for such nomination or election.”

While the SEC viewed this amendment as nothing more than a clarification of its then-current no-action position, not surprisingly, its announcement further fueled the already red-hot debate over shareholder proxy access.

2009: Delaware Enters the Proxy Access Debate

Historically, the Delaware Corporation Law Council of the Delaware State Bar Association has been relatively nimble in proposing, and the Delaware General Assembly in adopting, amendments to Delaware's General Corporation Law (“DGCL”) that either anticipate, or respond to, judicial and regulatory developments and changing trends in corporate governance. To some extent, this reflects a desire by Delaware to head off possible pre-emption by Federal lawmakers or regulators in areas traditionally handled at the state level. Seemingly in anticipation of the SEC adopting proxy access rules or corporations adopting shareholder access procedures, either voluntarily or under pressure from investors and corporate governance activists, the DGCL was amended in 2009 to create a mechanism for corporations to voluntarily adopt proxy access procedures.

Specifically, the amendments created DGCL section 112, which provides that if a corporation solicits proxies with respect to a director election, its bylaws may require the corporation to include shareholder-proposed nominees in management's proxy materials. DGCL section
112 also sets forth a non-exclusive list of conditions upon which the corporation may limit proxy access, including:

• requiring minimum record or beneficial ownership levels or duration of ownership by the nominating shareholder (which may define beneficial ownership “to take into account options or other rights in respect of or related to such stock”);
• requiring information concerning the nominating shareholder and the nominating shareholder's nominees;
• conditioning access on the number or proportion of directors nominated by the shareholders or on whether the nominating shareholder has previously sought access;
• precluding access if the nominating shareholder (or any affiliate or associate) has acquired, or publicly proposed to acquire, a specified percentage of the corporation's outstanding voting stock within a specified period before the election;
• requiring that the nominating shareholder agree to indemnify the corporation for any loss arising from any false or misleading statement in connection with such shareholder's nomination; and/or
• “[a]ny other lawful condition.”

Despite the enactment of DGCL section 112, Delaware corporations (which represent a large majority of U.S. publicly traded companies) have not warmly embraced proxy access. Accordingly, the focus of the debate shifted back to the SEC following the 2008 financial crisis and Presidential election.

2009: SEC Proposes New Proxy Access Rule

With the ascendance of the Obama administration in 2009, shareholder proxy access once again became a front-burner issue at the SEC. In June, the SEC proposed amendments to its proxy rules to mandate shareholder proxy access. In support of proxy access, the SEC cited the “loss of investor confidence” and “serious concerns about the accountability and responsiveness of some ' boards of directors to the interests of shareholders” that had arisen from “one of the most serious economic crises of the past century.” Specifically, the SEC offered two main proposals: 1) new Rule 14a-11, providing for mandatory access to company proxy materials for “significant” and “long-term” shareholders to nominate a limited number of director candidates; and 2) amendments to Rule 14a-8, exempting from the “election exclusion” shareholder proposals regarding director nomination procedures or disclosures related to shareholder nominations.

The SEC viewed the proposed amendments as consistent with its “mission” of “investor protection,” based on its belief that “investors are best protected when they can exercise rights they have as shareholders, without unnecessary obstacles imposed by the federal proxy rules.” In fact, the SEC characterized the proposed amendments as an effort “to improve the corporate proxy process so that it functions, as nearly as possible, as a replacement for an actual in-person meeting of shareholders.” And, perhaps, in anticipation of criticism that the SEC was usurping “the traditional role of the states in regulating corporate governance,” the proposing release noted that “[t]hese proposed amendments are intended to remove impediments so shareholders may more effectively exercise their rights under state law to nominate and elect directors at meetings of shareholders.”

Proposal #1: New Rule 14a-11

Proposed Rule 14a-11 did not follow the complicated 2003 proposal that sought to identify corporate boards that had become unresponsive to the demands of unhappy shareholders. Rather, the new rule was structured to provide holders of “a significant, long-term interest in a company” with the right, under certain circumstances, to include their nominees for election as directors in company proxy materials. Notably, the proposed rule would not be available to shareholders who sought to change control of a board or gain more than a limited number of seats. Moreover, the new rule would not apply where “state law or a company's governing documents prohibits shareholders from nominating directors” (even though, as noted in the proposing release, the SEC was “not aware of any law in any state ' that prohibits shareholders from nominating directors”).

Proposal #2: Amendment of Rule 14a-8

The proposed amendment of Rule 14a-8(i)(8) sought to reverse the 2007 amendments to the “election exclusion,” thereby enabling shareholders to require inclusion in company proxy materials of: 1) proposals to amend (or request amendment of) nomination procedures in the company's governing documents (so long as the proposal did not conflict with proposed Rule 14a-11); or 2) disclosures related to shareholder nominations. Companies would continue to be able to exclude certain specific election-related shareholder proposals, including any that would seek to disqualify a particular nominee, remove a particular director mid-term or question the “competence, business judgment or character” of any particular nominee or director.

As was the case in 2003, the 2009 rule proposals were not especially popular with either corporate governance activists or business interests, and the SEC received voluminous and critical comments from those on either side of the debate. Under the weight of this criticism, the SEC temporarily put the 2009 proposals on the back burner.

2010: SEC Adopts Proxy Access Rules

The passage of Dodd-Frank in 2010 paved the way for the SEC finally to adopt, rather than merely propose, proxy access rules. Dodd-Frank amended Exchange Act Section 14(a) to provide the SEC with a broad mandate (but, notably, not require it) to adopt rules giving shareholders access to company proxy materials to nominate director candidates. It did not contain any mechanics for the implementation of proxy access, other than to note that the SEC may “exempt an issuer or class of issuers” from any proxy access requirements, including by taking “into account, among other considerations, whether the requirement disproportionately burdens small issuers.” Thus, Congress put the proxy access ball back into the SEC's court.

The SEC responded with an Aug. 25, 2010 release (see Release No. 33-9136, titled “Facilitating Shareholder Director Nominations,” which can be obtained on the SEC website at www.sec.gov/rules/final/2010/33-9136.pdf.) in which it adopted proxy access rules. Borrowing heavily from the 2009 round of proposals, but with some key differences, the 2010 rules included both a new Rule 14a-11 providing for mandatory proxy access under limited circumstances as well as amendments to Rule 14a-8(i)(8) narrowing the “election exclusion.” Notably, however, two of the five SEC Commissioners dissented from adoption of the new rules, leading many experts to predict that litigation challenges would ensue.

New Rule 14a-11

New Rule 14a-11 provided holders of “a significant, long term stake in a company” with the right, under certain circumstances, to include their nominees for election as directors in the company's proxy materials in connection with annual shareholders meetings. To demonstrate eligibility, a shareholder or group of shareholders (who would be allowed to aggregate their holdings) must have continuously held “at least 3% of the voting power of the company's securities entitled to be voted for at least three years prior to the date the shareholder or group submits notice of its intent to use the rule.” Such shareholders were required to demonstrate their intent to own such shares until the applicable shareholders meeting. The proponents also would be required to provide detailed information about themselves and their nominees, and would be permitted to submit for inclusion in the company proxy materials a statement of up to 500 words in support of their nominees.

No company would have been required to include in its annual proxy materials more than a number of nominees equal to 25% of the number of directors serving on the board (including, for this purpose, any shareholder-nominated director elected at a previous meeting whose term in office extended beyond the meeting in question). In the case of a classified, or “staggered” board, the 25% calculation was based on the total number of board seats, not just those up for election in a given year. In a situation where “several nominating shareholders are eligible to use Rule 14a-11, the nominating shareholder or group with the highest percentage of the company's voting power would have its nominees included in the company's proxy materials.” Moreover, each nominee was required to satisfy the “objective” independence requirements of the national securities exchange (if any) on which the company's shares were traded.

As noted in the adopting release, “Rule 14a-11 will apply only when applicable state law or a company's governing documents do not prohibit shareholders from nominating a candidate for election as a director.” On the other hand, companies would not be permitted either to opt out of the requirements of the Rule or adopt more restrictive access rules.

Rule 14a-8 Amendments

Like the 2009 proposals, the Rule 14a-8(i)(8) amendments narrowed the “election exclusion” to enable shareholders to require inclusion in company proxy materials of: 1) proposals to amend (or request amendment of) nomination procedures in the company's governing documents; or 2) disclosures related to shareholder nominations. Any such proposal, however, could not: 1) place greater restrictions on proxy access than those provided in Rule 14a-11; 2) disqualify a particular nominee; 3) remove a particular director mid-term; 4) question the “competence, business judgment or character” of any particular nominee or director; 5) seek to include a specific nominee in the company's proxy materials; or 6) otherwise “affect the outcome of the upcoming election of directors.”

This discussion continues in next month's newsletter.

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Robert S. Reder, a member of this newsletter's Board of Editors, is serving as a consulting attorney for Milbank, Tweed, Hadley & McCloy LLP in New York City since his retirement as a partner in March 2011, and is an Adjunct Professor at Fordham Law School. David Schwartz is Of Counsel and Roxana Azizi is an associate in Milbank's Global Corporate Group, each located in New York City.

Although state corporation law bestows upon shareholders the right to nominate candidates for election as directors, and then to vote their shares in director elections, it is the Securities and Exchange Commission (“SEC”) that regulates the all-important proxy solicitation process by which shareholders of publicly traded corporations exercise their voting rights. In fact, according to the SEC, proxy regulation was one of the original tasks with which the SEC was charged by Congress at the time of the adoption of the Securities Exchange Act of 1934 (“Exchange Act”). Today, reform of the proxy solicitation process is one of the “hot-button” issues for advocates of enhanced rights for shareholders of publicly traded corporations.

On several occasions during recent years, the SEC has sought to amend its proxy rules to provide shareholders with access to company proxy materials for the purpose of nominating individuals for election as directors in opposition to management-backed candidates. The SEC has been motivated by its concern that the Federal proxy rules may not enable shareholders to exercise fully their state law rights to nominate director candidates. Under current SEC rules, shareholders who wish to nominate director candidates in opposition to incumbent directors must clear with the SEC and distribute to shareholders proxy materials in support of their candidates. Although web-based solicitations have made this process somewhat more shareholder-friendly, running a proxy contest remains a relatively complicated, time-consuming and expensive undertaking, pursued for the most part only in connection with hostile takeover bids or by well-heeled, motivated investors. At least a majority of the current SEC Commissioners believes that the inability of shareholders to access company materials to nominate opposition candidates gives a real advantage to incumbent directors and represents a “failure of the proxy process” that has negatively impacted the state law right of shareholders to nominate and elect directors.

Despite the SEC's efforts over the past decade to implement proxy access, each attempt has been thwarted for a variety of reasons, leaving proxy access in a seemingly perpetual state of limbo. One key factor that has hampered the adoption of proxy access has been the concern that the SEC, as an instrument of the Federal government, is not empowered to institute rules so directly impacting the election of directors, an area traditionally reserved for the states. In part to address this concern, included in 2010's Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) was an authorization for the SEC to impose proxy access on publicly traded corporations. However, when a Federal court invalidated a new rule adopted by the SEC pursuant to the Dodd-Frank authorization, the effort to mandate proxy access on a company-wide basis was once again put on hold.

This article reviews the developments surrounding proxy access over the last decade, and explains where we are today. Despite a decade-long effort by the SEC and shareholder activists, proxy access remains a “hot-button” corporate governance issue and the outcome of the debate remains uncertain.

2003: SEC Proposes Proxy Access Rule

Proxy access grabbed center stage in 2003 when the SEC first proposed new Rule 14a-11. That rule would have required public companies for the first time, albeit under limited circumstances, to include in their proxy materials the names of shareholder-nominated director candidates. (See Release Nos. 34-48626; IC-26206 entitled “Proposed Rule: Security Holder Director Nominations,” which can be obtained on the SEC website at www.sec.gov/rules/proposed/34-48626.htm.) This proposal was designed to create a mechanism for “long-term” shareholders (or groups of “long-term” shareholders) with “significant” holdings to include director nominees in the proxy materials of companies whose shareholders had demonstrated a degree of dissatisfaction with the responsiveness of current directors to their concerns.

Proposed Rule 14a-11 attributed shareholder dissatisfaction with an unresponsive board to the occurrence of either of two triggering events:

• A “Director No Confidence Triggering Event,” deemed to occur if at least one management nominee for election to the board of directors received “withhold” votes from more than 35% of the votes cast at an annual shareholders meeting; and
• A “Shareholder Direct Access Triggering Event,” deemed to occur if a shareholder (or shareholder group) owning more than 1% of the company's voting stock for at least one year submitted a Rule 14a-8 proposal requesting that the company become subject to proposed Rule 14a-11, and that proposal received support from more than 50% of the votes cast at an annual shareholders meeting.

At either of the two annual meetings following the occurrence of a triggering event, a shareholder (or shareholder group) owning more than 5% of the company's voting stock for at least two years (among other requirements) would be entitled (subject to certain exceptions) to require the company to include the names of a limited number of shareholder nominees for election as directors in the company's proxy materials, based on the formula below.

This proposal sparked significant debate and faced sharp criticism from those on each side of the issue. In a pattern to be repeated in subsequent attempts by the SEC to mandate proxy access, shareholder activists found the changes to be too limited, while many corporate executives and their advisers believed that the SEC had gone too far. Ultimately, the intensity of the public debate, as well as a sharp division among SEC Commissioners and Staff members, caused the SEC to withdraw the proposed rule.

With the SEC's effort to mandate proxy access thwarted, shareholder activists continued to pursue another avenue to gain access to company proxy materials for their director candidates ” Rule 14a-8 shareholder proposals.

2006-2007: SEC Expands Rule 14a-8 Election Exclusion

Rule 14a-8 under the Exchange Act regulates the process by which shareholders who wish to submit proposals for a vote at annual shareholders meetings may include such proposals in company proxy materials. Rule 14a-8 requires that a proposing shareholder must have continuously held at least $2,000 in market value, or 1%, of the company's voting stock for a period of at least one year prior to submitting the proposal. However, clause (i)(8) of Rule 14a-8, the so-called “election exclusion” generally allows companies to exclude from their proxy materials shareholder proposals that seek to nominate individual director candidates.

Beginning in 1976, the SEC Staff, based on a literal reading of the “election exclusion,” interpreted clause (i)(8) to apply solely to shareholder proposals that would result in an immediate election contest (i.e., proposals that relate to a particular election, not to elections generally). On the strength of this interpretation, shareholder activists sought to utilize the Rule 14a-8 proposal process to gain access to company proxy materials (typically through shareholder-approved bylaw amendments) for the purpose of nominating director candidates. However, beginning in 1990, the Staff essentially reversed itself by, in a series of no-action letters, allowing companies to exclude shareholder proposals that related to election procedures generally
(including shareholder access proposals) and not just to a particular election.

Then, in late 2006, in AFSCME v. AIG (462 F.3d 121 (2nd Cir. 2006)), the Federal Court of Appeals for the Second Circuit, in a ruling that foreshadowed recent criticism of SEC-rulemaking, held that the SEC Staff's reversal of its earlier no-action position was undertaken without “offer[ing] sufficient reasons for its changed interpretation.” On that basis, the court ruled, consistent with the Staff's pre-1990 position, that a shareholder-proposed bylaw amendment relating to director election procedures generally may not be excluded from a company's proxy materials.

The Second Circuit's ruling in AFSCME v. AIG created significant uncertainty regarding the scope of the “election exclusion,” prompting the SEC to undertake a comprehensive review of Rule 14a-8 as it related to director elections. Following this review, on Nov. 28, 2007, the SEC promulgated an amendment to Rule 14a-8(i)(8) (see Release No. 34-56914 entitled “Shareholder
Proposals Relating the Election of Directors,” which can be obtained on the SEC website at www.sec.gov/rules/final/2007/34-56914.pdf) that expanded the scope of the “election exclusion” to permit companies to exclude not only shareholder proposals relating to “a nomination or an election for membership on the company's board of directors,” but also any proposal relating to “a procedure for such nomination or election.”

While the SEC viewed this amendment as nothing more than a clarification of its then-current no-action position, not surprisingly, its announcement further fueled the already red-hot debate over shareholder proxy access.

2009: Delaware Enters the Proxy Access Debate

Historically, the Delaware Corporation Law Council of the Delaware State Bar Association has been relatively nimble in proposing, and the Delaware General Assembly in adopting, amendments to Delaware's General Corporation Law (“DGCL”) that either anticipate, or respond to, judicial and regulatory developments and changing trends in corporate governance. To some extent, this reflects a desire by Delaware to head off possible pre-emption by Federal lawmakers or regulators in areas traditionally handled at the state level. Seemingly in anticipation of the SEC adopting proxy access rules or corporations adopting shareholder access procedures, either voluntarily or under pressure from investors and corporate governance activists, the DGCL was amended in 2009 to create a mechanism for corporations to voluntarily adopt proxy access procedures.

Specifically, the amendments created DGCL section 112, which provides that if a corporation solicits proxies with respect to a director election, its bylaws may require the corporation to include shareholder-proposed nominees in management's proxy materials. DGCL section
112 also sets forth a non-exclusive list of conditions upon which the corporation may limit proxy access, including:

• requiring minimum record or beneficial ownership levels or duration of ownership by the nominating shareholder (which may define beneficial ownership “to take into account options or other rights in respect of or related to such stock”);
• requiring information concerning the nominating shareholder and the nominating shareholder's nominees;
• conditioning access on the number or proportion of directors nominated by the shareholders or on whether the nominating shareholder has previously sought access;
• precluding access if the nominating shareholder (or any affiliate or associate) has acquired, or publicly proposed to acquire, a specified percentage of the corporation's outstanding voting stock within a specified period before the election;
• requiring that the nominating shareholder agree to indemnify the corporation for any loss arising from any false or misleading statement in connection with such shareholder's nomination; and/or
• “[a]ny other lawful condition.”

Despite the enactment of DGCL section 112, Delaware corporations (which represent a large majority of U.S. publicly traded companies) have not warmly embraced proxy access. Accordingly, the focus of the debate shifted back to the SEC following the 2008 financial crisis and Presidential election.

2009: SEC Proposes New Proxy Access Rule

With the ascendance of the Obama administration in 2009, shareholder proxy access once again became a front-burner issue at the SEC. In June, the SEC proposed amendments to its proxy rules to mandate shareholder proxy access. In support of proxy access, the SEC cited the “loss of investor confidence” and “serious concerns about the accountability and responsiveness of some ' boards of directors to the interests of shareholders” that had arisen from “one of the most serious economic crises of the past century.” Specifically, the SEC offered two main proposals: 1) new Rule 14a-11, providing for mandatory access to company proxy materials for “significant” and “long-term” shareholders to nominate a limited number of director candidates; and 2) amendments to Rule 14a-8, exempting from the “election exclusion” shareholder proposals regarding director nomination procedures or disclosures related to shareholder nominations.

The SEC viewed the proposed amendments as consistent with its “mission” of “investor protection,” based on its belief that “investors are best protected when they can exercise rights they have as shareholders, without unnecessary obstacles imposed by the federal proxy rules.” In fact, the SEC characterized the proposed amendments as an effort “to improve the corporate proxy process so that it functions, as nearly as possible, as a replacement for an actual in-person meeting of shareholders.” And, perhaps, in anticipation of criticism that the SEC was usurping “the traditional role of the states in regulating corporate governance,” the proposing release noted that “[t]hese proposed amendments are intended to remove impediments so shareholders may more effectively exercise their rights under state law to nominate and elect directors at meetings of shareholders.”

Proposal #1: New Rule 14a-11

Proposed Rule 14a-11 did not follow the complicated 2003 proposal that sought to identify corporate boards that had become unresponsive to the demands of unhappy shareholders. Rather, the new rule was structured to provide holders of “a significant, long-term interest in a company” with the right, under certain circumstances, to include their nominees for election as directors in company proxy materials. Notably, the proposed rule would not be available to shareholders who sought to change control of a board or gain more than a limited number of seats. Moreover, the new rule would not apply where “state law or a company's governing documents prohibits shareholders from nominating directors” (even though, as noted in the proposing release, the SEC was “not aware of any law in any state ' that prohibits shareholders from nominating directors”).

Proposal #2: Amendment of Rule 14a-8

The proposed amendment of Rule 14a-8(i)(8) sought to reverse the 2007 amendments to the “election exclusion,” thereby enabling shareholders to require inclusion in company proxy materials of: 1) proposals to amend (or request amendment of) nomination procedures in the company's governing documents (so long as the proposal did not conflict with proposed Rule 14a-11); or 2) disclosures related to shareholder nominations. Companies would continue to be able to exclude certain specific election-related shareholder proposals, including any that would seek to disqualify a particular nominee, remove a particular director mid-term or question the “competence, business judgment or character” of any particular nominee or director.

As was the case in 2003, the 2009 rule proposals were not especially popular with either corporate governance activists or business interests, and the SEC received voluminous and critical comments from those on either side of the debate. Under the weight of this criticism, the SEC temporarily put the 2009 proposals on the back burner.

2010: SEC Adopts Proxy Access Rules

The passage of Dodd-Frank in 2010 paved the way for the SEC finally to adopt, rather than merely propose, proxy access rules. Dodd-Frank amended Exchange Act Section 14(a) to provide the SEC with a broad mandate (but, notably, not require it) to adopt rules giving shareholders access to company proxy materials to nominate director candidates. It did not contain any mechanics for the implementation of proxy access, other than to note that the SEC may “exempt an issuer or class of issuers” from any proxy access requirements, including by taking “into account, among other considerations, whether the requirement disproportionately burdens small issuers.” Thus, Congress put the proxy access ball back into the SEC's court.

The SEC responded with an Aug. 25, 2010 release (see Release No. 33-9136, titled “Facilitating Shareholder Director Nominations,” which can be obtained on the SEC website at www.sec.gov/rules/final/2010/33-9136.pdf.) in which it adopted proxy access rules. Borrowing heavily from the 2009 round of proposals, but with some key differences, the 2010 rules included both a new Rule 14a-11 providing for mandatory proxy access under limited circumstances as well as amendments to Rule 14a-8(i)(8) narrowing the “election exclusion.” Notably, however, two of the five SEC Commissioners dissented from adoption of the new rules, leading many experts to predict that litigation challenges would ensue.

New Rule 14a-11

New Rule 14a-11 provided holders of “a significant, long term stake in a company” with the right, under certain circumstances, to include their nominees for election as directors in the company's proxy materials in connection with annual shareholders meetings. To demonstrate eligibility, a shareholder or group of shareholders (who would be allowed to aggregate their holdings) must have continuously held “at least 3% of the voting power of the company's securities entitled to be voted for at least three years prior to the date the shareholder or group submits notice of its intent to use the rule.” Such shareholders were required to demonstrate their intent to own such shares until the applicable shareholders meeting. The proponents also would be required to provide detailed information about themselves and their nominees, and would be permitted to submit for inclusion in the company proxy materials a statement of up to 500 words in support of their nominees.

No company would have been required to include in its annual proxy materials more than a number of nominees equal to 25% of the number of directors serving on the board (including, for this purpose, any shareholder-nominated director elected at a previous meeting whose term in office extended beyond the meeting in question). In the case of a classified, or “staggered” board, the 25% calculation was based on the total number of board seats, not just those up for election in a given year. In a situation where “several nominating shareholders are eligible to use Rule 14a-11, the nominating shareholder or group with the highest percentage of the company's voting power would have its nominees included in the company's proxy materials.” Moreover, each nominee was required to satisfy the “objective” independence requirements of the national securities exchange (if any) on which the company's shares were traded.

As noted in the adopting release, “Rule 14a-11 will apply only when applicable state law or a company's governing documents do not prohibit shareholders from nominating a candidate for election as a director.” On the other hand, companies would not be permitted either to opt out of the requirements of the Rule or adopt more restrictive access rules.

Rule 14a-8 Amendments

Like the 2009 proposals, the Rule 14a-8(i)(8) amendments narrowed the “election exclusion” to enable shareholders to require inclusion in company proxy materials of: 1) proposals to amend (or request amendment of) nomination procedures in the company's governing documents; or 2) disclosures related to shareholder nominations. Any such proposal, however, could not: 1) place greater restrictions on proxy access than those provided in Rule 14a-11; 2) disqualify a particular nominee; 3) remove a particular director mid-term; 4) question the “competence, business judgment or character” of any particular nominee or director; 5) seek to include a specific nominee in the company's proxy materials; or 6) otherwise “affect the outcome of the upcoming election of directors.”

This discussion continues in next month's newsletter.

[IMGCAP(1)]

Robert S. Reder, a member of this newsletter's Board of Editors, is serving as a consulting attorney for Milbank, Tweed, Hadley & McCloy LLP in New York City since his retirement as a partner in March 2011, and is an Adjunct Professor at Fordham Law School. David Schwartz is Of Counsel and Roxana Azizi is an associate in Milbank's Global Corporate Group, each located in New York City.