Shareholder Proxy Access

Rule 14a-8 Amendments

On Oct. 4, 2010, the SEC agreed to delay all aspects of its recently adopted rules ” both Rule 14a-11 and the amendments to Rule 14a-8 ” in order to “avoid[ ] potentially unnecessary costs, regulatory uncertainty, and disruption that could occur if the new rules were to become effective during the pendency of a challenge to their validity.”

2011: D.C. Circuit Vacates Rule 14a-11

On July 22, 2011, in Business Roundtable and Chamber of Commerce of the United States of America v. SEC (No. 10-1305 (D.C. Cir. 2011)), the Federal Court of Appeals for the D.C. Circuit struck down Rule 14a-11, holding that the SEC had acted “arbitrarily and capriciously for having failed once again ” adequately to assess the economic effects of a new rule.” In so ruling, the D.C. Circuit agreed with Rule 14a-11 opponents that the SEC had “neglected its statutory responsibility to determine the likely economic consequences of Rule 14a-11 and to connect those consequences to efficiency, competition, and capital formation.” In fact, the D.C. Circuit used particularly harsh language in declaring that the SEC had “inconsistently and opportunistically framed the costs and benefits of the rule; failed adequately to quantify the certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments; contradicted itself; and failed to respond to substantial problems raised by commenters.”

Because the D.C. Circuit found that the SEC had acted contrary to the requirements of the Administrative Procedure Act, it had “no occasion to address the petitioners” First Amendment challenge to the rule” or address states” rights concerns.

In a somewhat unexpected turn of events, the SEC responded to the D.C. Circuit ruling by publicly stating on Sept. 6, 2011 (see Statement by SEC Chairman Mary L. Shapiro on Proxy Access Litigation, which can be obtained on the SEC website at http://sec.gov/news/press/2011/2011-179.htm.) that it would neither seek a rehearing nor appeal the decision to the U.S. Supreme Court. On the other hand, the SEC”s statement indicated that it was by no means abandoning the effort to implement shareholder proxy access as contemplated by Dodd-Frank, and in fact would press forward with the effort. In the Chairman's own words:

[P]roviding a meaningful opportunity for shareholders to exercise their right to nominate directors at their companies is in the best interest of investors and our markets. It is a process that helps make boards more accountable for the risks undertaken by the companies they manage. I remain committed to finding a way to make it easier for shareholders to nominate candidates to corporate boards. At the same time, I want to be sure that we carefully consider and learn from the Court's objections as we determine the best path forward. I have asked the staff to consider reviewing the decision as well as the comments that we previously received from interested parties.

2012 Proxy Season: Will Activists Turn Back to SEC Rule 14a-8?

Narrowing the ”Election Exclusion”

The D.C. Circuit”s decision returned the SEC”s efforts to mandate proxy access to a state of limbo. Companies that had been gearing up to comply with the new proxy access rule ” including by making conforming amendments to their advance notice bylaws ” were faced with the reality that an impasse once again had been reached.

Notably, the D.C. Circuit”s ruling did not impact the SEC”s narrowing of Rule 14a-8”s “election exclusion.” Shortly after the ruling became final on Sept. 14, 2011, and contrary to what some commentators speculated would happen, the SEC published a release (see Release No. 33-9259 entitled “Facilitating Shareholder Director Nominations,” which can be obtained on the SEC website at http://sec.gov/rules/final/2011/33-9259.pdf.) declaring that because “[t]he Court”s order did not affect the amendment to Rule 14a-8,” such amendment would become effective on Sept. 20, 2011. In an open invitation to corporate governance activists, the SEC Chairman observed that “[t]hrough this procedure, shareholders and companies have the opportunity to establish proxy access standards on a company-by-company basis ” rather than a specified standard like that contained in Rule 14a-11.”

Accordingly, with the “election exclusion” narrowed, and unless and until the SEC again seeks to implement proxy access, Rule 14a-8 would seem to be the only avenue open to corporate governance activists to pursue proxy access. There are already some signs that this might be the case during the 2012 proxy season. On Nov. 10, 2011, United States Proxy Exchange (“USPX”), a group that
represents retail investors, issued a “Model Shareowner Proposal for Proxy Access” (available at http://proxyexchange.org/standard_003.pdf), which contains a model bylaw proxy access provision, together with instructions for submitting a proxy access proposal to a target company. USPX”s model is framed similar to, but has more lenient eligibility thresholds than, Rule 14a-11. Perhaps most notably, this model ” in contrast to Rule 14a-ll ” would permit shareholder-nominated directors to constitute a majority of a company's board of directors. Shortly thereafter, a USPX member submitted proxy access proposals based on the USPX model to both MEMC Electronic Materials and Textron.

Subsequently, on Nov. 22, Norges Bank Investment Management, manager of the Norwegian Government Pension Global Fund (“NBIM”), submitted Rule 14a-8 proposals to seek shareholder proxy access bylaw amendments at six U.S. companies “that have demonstrated poor governance or unsatisfactory performance” ” Charles Schwab, CME Group, Pioneer Natural Resources, Staples, Wells Fargo and Western Union. According to the press release issued by NBIM announcing its submissions, the proposed bylaw amendments would grant access for nominations to shareholders owning at least 1% of the outstanding shares for at least one year, but limited to a maximum of 25% of a company”s board of directors. NBIM also explained that shareholder access to management proxy materials is necessary because the existing regime, in which “shareholders must submit alternative agendas at annual general meetings and distribute documentation among investors,” is “cumbersome and costly.”

Finally, Institutional Shareholder Services (“ISS”) recently announced that it will follow a case-by-case approach in advising its clients with respect to shareholder access proposals. Thus, ISS will not be simply recommending a vote in favor of all such proposals, but rather will evaluating each particular proposal, in the context of the circumstances of the targeted company, on its own merits.

While it remains to be seen whether a significant number of proxy access proposals will be submitted during the 2012 proxy season, company boards and governance committees must be prepared to receive and react to such proposals. Companies will have the option to seek to exclude such provisions from their proxy materials based on Rule 14a-8 exclusions other than the “election exclusion,” negotiate with the proponent for a watered-down proposal or allow the proposal to appear in the company proxy materials but actively lobby shareholders to reject it. Also, it should be mentioned that it is not at all certain that the Rule 14a-8 “election exclusion” amendment is immune to the same type of challenge that resulted in the invalidation of Rule 14a-11.

Determining Record Ownership

In a related development, on Oct. 18, 2011, the SEC issued a Staff Legal Bulletin (see Staff Legal Bulletin No. 14F (CF) entitled “Shareholder Proposals,” which can be obtained from the SEC website at http://sec.gov///f.htm) providing guidance on, among other topics, the manner by which beneficial owners of shares can establish the requisite ownership thresholds under Rule 14a-8. Of course, when the proponent of a Rule 14a-8 proposal is the registered owner of the shares, the process of verifying eligibility is relatively simple as the company “can independently confirm that the shareholder's holdings” are sufficient by merely looking at the share registry maintained by its transfer agent.

The waters get murkier in the case of shares held on behalf of investors by banks and brokers and ultimately owned of record by the Depositary Trust Company (“DTC”). DTC, the only remaining SEC-authorized registered clearing agency, is the record owner (in the name of its nominee, Cede & Co.) of the “vast majority” of shares beneficially owned by investors in U.S. public companies. The SEC permits such investors to provide the requisite proof of ownership by submitting a written statement “from the 'record' holder of [the] securities (usually a broker or bank),” verifying that the investor in fact owns the required amount of shares for the requisite period. Confusion has arisen, however, due to the fact that there are two types of brokers for this purpose: 1) “clearing brokers” who are authorized, among other things, to hold “custody of client funds and securities”; and 2) “introducing brokers,” who “engage in sales and other activities involving customer contact,” but are not allowed to maintain custody of customer funds and securities. Accordingly, shares beneficially owned by clients of introducing brokers must be held through clearing brokers, who in turn are entitled to be “DTC Participants” and, as such, their holdings can be verified from DTC's securities position listings.

Previously, the SEC required companies to accept proof of ownership letters from either clearing brokers or introducing brokers. However, according to the Staff Legal Bulletin, challenges to this position arose as companies were “unable to verify the positions [held through introducing brokers] against [their] own or [their] transfer agent”s records or against DTC”s securities position listing.” To address this concern, the recent Staff Legal Bulletin provides that, going forward, the SEC will only view clearing brokers, but not introducing brokers, as “record holders” of securities that are deposited at DTC for purposes of verifying satisfaction of the Rule 14a-8 ownership requirements. This policy will require investors who are customers of introducing brokers to present two certifications along with their Rule 14a-8 proposals, one from the introducing broker and another from the clearing broker. The Staff believes this change will provide “greater certainty to beneficial owners and companies.”

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. David Schwartz is Of Counsel and Roxana Azizi is an associate in Milbank”s Global Corporate Group.

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Last month, we discussed the fact that proxy access remains a “hot-button” corporate governance issue and the outcome of the debate remains uncertain. This discussion continues herein.

Rule 14a-11

Rule 14a-11 and the amendments to Rule 14a-8 initially were scheduled to become effective on Nov. 15, 2010 and to be operative for most companies during the 2011 proxy season. It came as no surprise, however, when on Sept. 29, 2010, the U.S. Chamber of Commerce and the Business Roundtable filed a Federal lawsuit seeking to overturn the proxy access rule, and asking the SEC to delay its effectiveness. The lawsuit labeled Rule 14a-11 as “arbitrary and capricious,” and cited First Amendment arguments and states” rights concerns as grounds, among others, for overturning the new rule.

Rule 14a-8 Amendments

On Oct. 4, 2010, the SEC agreed to delay all aspects of its recently adopted rules ” both Rule 14a-11 and the amendments to Rule 14a-8 ” in order to “avoid[ ] potentially unnecessary costs, regulatory uncertainty, and disruption that could occur if the new rules were to become effective during the pendency of a challenge to their validity.”

2011: D.C. Circuit Vacates Rule 14a-11

On July 22, 2011, in Business Roundtable and Chamber of Commerce of the United States of America v. SEC (No. 10-1305 (D.C. Cir. 2011)), the Federal Court of Appeals for the D.C. Circuit struck down Rule 14a-11, holding that the SEC had acted “arbitrarily and capriciously for having failed once again ” adequately to assess the economic effects of a new rule.” In so ruling, the D.C. Circuit agreed with Rule 14a-11 opponents that the SEC had “neglected its statutory responsibility to determine the likely economic consequences of Rule 14a-11 and to connect those consequences to efficiency, competition, and capital formation.” In fact, the D.C. Circuit used particularly harsh language in declaring that the SEC had “inconsistently and opportunistically framed the costs and benefits of the rule; failed adequately to quantify the certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments; contradicted itself; and failed to respond to substantial problems raised by commenters.”

Because the D.C. Circuit found that the SEC had acted contrary to the requirements of the Administrative Procedure Act, it had “no occasion to address the petitioners” First Amendment challenge to the rule” or address states” rights concerns.

In a somewhat unexpected turn of events, the SEC responded to the D.C. Circuit ruling by publicly stating on Sept. 6, 2011 (see Statement by SEC Chairman Mary L. Shapiro on Proxy Access Litigation, which can be obtained on the SEC website at http://sec.gov/news/press/2011/2011-179.htm.) that it would neither seek a rehearing nor appeal the decision to the U.S. Supreme Court. On the other hand, the SEC”s statement indicated that it was by no means abandoning the effort to implement shareholder proxy access as contemplated by Dodd-Frank, and in fact would press forward with the effort. In the Chairman's own words:

[P]roviding a meaningful opportunity for shareholders to exercise their right to nominate directors at their companies is in the best interest of investors and our markets. It is a process that helps make boards more accountable for the risks undertaken by the companies they manage. I remain committed to finding a way to make it easier for shareholders to nominate candidates to corporate boards. At the same time, I want to be sure that we carefully consider and learn from the Court's objections as we determine the best path forward. I have asked the staff to consider reviewing the decision as well as the comments that we previously received from interested parties.

2012 Proxy Season: Will Activists Turn Back to SEC Rule 14a-8?

Narrowing the ”Election Exclusion”

The D.C. Circuit”s decision returned the SEC”s efforts to mandate proxy access to a state of limbo. Companies that had been gearing up to comply with the new proxy access rule ” including by making conforming amendments to their advance notice bylaws ” were faced with the reality that an impasse once again had been reached.

Notably, the D.C. Circuit”s ruling did not impact the SEC”s narrowing of Rule 14a-8”s “election exclusion.” Shortly after the ruling became final on Sept. 14, 2011, and contrary to what some commentators speculated would happen, the SEC published a release (see Release No. 33-9259 entitled “Facilitating Shareholder Director Nominations,” which can be obtained on the SEC website at http://sec.gov/rules/final/2011/33-9259.pdf.) declaring that because “[t]he Court”s order did not affect the amendment to Rule 14a-8,” such amendment would become effective on Sept. 20, 2011. In an open invitation to corporate governance activists, the SEC Chairman observed that “[t]hrough this procedure, shareholders and companies have the opportunity to establish proxy access standards on a company-by-company basis ” rather than a specified standard like that contained in Rule 14a-11.”

Accordingly, with the “election exclusion” narrowed, and unless and until the SEC again seeks to implement proxy access, Rule 14a-8 would seem to be the only avenue open to corporate governance activists to pursue proxy access. There are already some signs that this might be the case during the 2012 proxy season. On Nov. 10, 2011, United States Proxy Exchange (“USPX”), a group that
represents retail investors, issued a “Model Shareowner Proposal for Proxy Access” (available at http://proxyexchange.org/standard_003.pdf), which contains a model bylaw proxy access provision, together with instructions for submitting a proxy access proposal to a target company. USPX”s model is framed similar to, but has more lenient eligibility thresholds than, Rule 14a-11. Perhaps most notably, this model ” in contrast to Rule 14a-ll ” would permit shareholder-nominated directors to constitute a majority of a company's board of directors. Shortly thereafter, a USPX member submitted proxy access proposals based on the USPX model to both MEMC Electronic Materials and Textron.

Subsequently, on Nov. 22, Norges Bank Investment Management, manager of the Norwegian Government Pension Global Fund (“NBIM”), submitted Rule 14a-8 proposals to seek shareholder proxy access bylaw amendments at six U.S. companies “that have demonstrated poor governance or unsatisfactory performance” ” Charles Schwab, CME Group, Pioneer Natural Resources, Staples, Wells Fargo and Western Union. According to the press release issued by NBIM announcing its submissions, the proposed bylaw amendments would grant access for nominations to shareholders owning at least 1% of the outstanding shares for at least one year, but limited to a maximum of 25% of a company”s board of directors. NBIM also explained that shareholder access to management proxy materials is necessary because the existing regime, in which “shareholders must submit alternative agendas at annual general meetings and distribute documentation among investors,” is “cumbersome and costly.”

Finally, Institutional Shareholder Services (“ISS”) recently announced that it will follow a case-by-case approach in advising its clients with respect to shareholder access proposals. Thus, ISS will not be simply recommending a vote in favor of all such proposals, but rather will evaluating each particular proposal, in the context of the circumstances of the targeted company, on its own merits.

While it remains to be seen whether a significant number of proxy access proposals will be submitted during the 2012 proxy season, company boards and governance committees must be prepared to receive and react to such proposals. Companies will have the option to seek to exclude such provisions from their proxy materials based on Rule 14a-8 exclusions other than the “election exclusion,” negotiate with the proponent for a watered-down proposal or allow the proposal to appear in the company proxy materials but actively lobby shareholders to reject it. Also, it should be mentioned that it is not at all certain that the Rule 14a-8 “election exclusion” amendment is immune to the same type of challenge that resulted in the invalidation of Rule 14a-11.

Determining Record Ownership

In a related development, on Oct. 18, 2011, the SEC issued a Staff Legal Bulletin (see Staff Legal Bulletin No. 14F (CF) entitled “Shareholder Proposals,” which can be obtained from the SEC website at http://sec.gov///f.htm) providing guidance on, among other topics, the manner by which beneficial owners of shares can establish the requisite ownership thresholds under Rule 14a-8. Of course, when the proponent of a Rule 14a-8 proposal is the registered owner of the shares, the process of verifying eligibility is relatively simple as the company “can independently confirm that the shareholder's holdings” are sufficient by merely looking at the share registry maintained by its transfer agent.

The waters get murkier in the case of shares held on behalf of investors by banks and brokers and ultimately owned of record by the Depositary Trust Company (“DTC”). DTC, the only remaining SEC-authorized registered clearing agency, is the record owner (in the name of its nominee, Cede & Co.) of the “vast majority” of shares beneficially owned by investors in U.S. public companies. The SEC permits such investors to provide the requisite proof of ownership by submitting a written statement “from the 'record' holder of [the] securities (usually a broker or bank),” verifying that the investor in fact owns the required amount of shares for the requisite period. Confusion has arisen, however, due to the fact that there are two types of brokers for this purpose: 1) “clearing brokers” who are authorized, among other things, to hold “custody of client funds and securities”; and 2) “introducing brokers,” who “engage in sales and other activities involving customer contact,” but are not allowed to maintain custody of customer funds and securities. Accordingly, shares beneficially owned by clients of introducing brokers must be held through clearing brokers, who in turn are entitled to be “DTC Participants” and, as such, their holdings can be verified from DTC's securities position listings.

Previously, the SEC required companies to accept proof of ownership letters from either clearing brokers or introducing brokers. However, according to the Staff Legal Bulletin, challenges to this position arose as companies were “unable to verify the positions [held through introducing brokers] against [their] own or [their] transfer agent”s records or against DTC”s securities position listing.” To address this concern, the recent Staff Legal Bulletin provides that, going forward, the SEC will only view clearing brokers, but not introducing brokers, as “record holders” of securities that are deposited at DTC for purposes of verifying satisfaction of the Rule 14a-8 ownership requirements. This policy will require investors who are customers of introducing brokers to present two certifications along with their Rule 14a-8 proposals, one from the introducing broker and another from the clearing broker. The Staff believes this change will provide “greater certainty to beneficial owners and companies.”

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. David Schwartz is Of Counsel and Roxana Azizi is an associate in Milbank”s Global Corporate Group.

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