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The 2004 Proxy Season Takes Shape

In the October 2003 SEC Watch, I outlined proposed Securities and Exchange Commission amendments requiring proxy disclosure of nominating committee practices, and establishing procedures for shareholder communications with the board of directors.

In November 2003, the SEC adopted the proposed rules substantially in the form proposed. Also in November, the NYSE and NASDAQ amended their governance rules relating to increased board independence for companies whose shares are traded over the facilities of these self-regulatory organizations (SROs).

I will highlight below certain refinements the SEC made in adopting the amendments. I will also examine the last piece of the SEC’s proposed corporate governance overhaul: The opening of the proxy process to direct shareholder participation.

SEC Rule-Making Refinements

Effective Jan. 1, public company proxy solicitation must disclose (i) nominating committee procedures, (ii) the independence of its nominating committee, and (iii) policies concerning shareholder recommendations for directorships.

In its final rule-making, the SEC:

  • Added a new requirement that companies must disclose their policy concerning director attendance at annual meetings, as well as the number of directors who attended last year’s meeting (thus reporting on attendance at a meeting held prior to the SEC even proposing its new rule).
  • Mandated periodic disclosure of any changes to nominating committee procedures.

    Required that nominating committee charters be posted on the company website, or periodically attached to proxy statements.

  • Increased to 5 percent the triggering level of shareholdings required to mandate public disclosure of any nominee (and of the nominating shareholder), where the nominating committee determines not to propose such shareholder’s candidate for election.
  • Eliminated the onerous proposed proxy statement description of any “material actions” taken by the company as a result of shareholder communication.
  • Eliminated the required disclosure of the company’s process for “collecting and organizing” shareholder communications to the board, provided a majority of the company’s independent directors approves such process.

    In separate action, the SEC on Nov. 4, 2003 approved various amendments to the SRO rules. One New York Stock Exchange amendment requires instituting a method for interested parties to communicate directly to the presiding director of the non-management directors (who are required to meet separately and periodically), or with all the non-management directors as a group. (The NASDAQ rules do not have a similar communication requirement.)

    Counsel to NYSE companies now must integrate the stockholder communication mechanics as a whole (under the SEC rules) with the NYSE communication mechanics for independent board members. It also is likely that best practices for NASDAQ companies will include a similar approach, particularly since separate board meetings for NASDAQ independent directors are indeed mandated.

    Proposed Shareholder Access To Proxy Process

    The SEC has issued a proposed amendment requiring public companies to include within their proxy materials the names of and information about shareholders’ nominees for directors. The emphasis is to facilitate shareholder representation. The proposals do not apply to shareholder efforts to effect a change in control, which are specifically excluded.

    The comment period on these proposed rules expired Dec.22, 2003. Although the expectation had been that all proxy rule changes, including these, would be applicable to the 2004 proxy season, this result now seems unlikely, given the number of open issues upon which comment has been solicited and the manner in which these proposed rules are conceptualized by the SEC.

    While no in-house counsel should be denied the pleasure of plowing through the SEC’s 107-page proposal, complete with 238 footnotes (see www.sec.gov/rules/proposed/34-48626.htm), the proposed regulatory scheme can be summarized as follows.

    The new rule applies to all companies except for foreign private issuers, regardless of size, provided the companies are incorporated in states (such as Delaware) whose laws permit shareholder nominations.

    The new rule would not apply unless a “triggering event” has occurred: Either 35 percent or more votes cast on any management director nominee are “withheld,” or a shareholder (holding at least 1 percent for one year) submits a demand for proxy access under existing SEC Rule 14a-8, and which receives support of a majority of the votes cast.

    The SEC has also asked for comment on a possible third triggering event – the company’s failure to implement a shareholder proposal made by a shareholder holding 1 percent for one year, and which was supported by a majority of the votes cast.

    If a triggering event might occur after Jan. 1, the company’s proxy statement must disclose that such event may in turn trigger the new nomination procedure.

    For the two years following any triggering event, a shareholder or shareholder group owning at least 5 percent of the company’s voting securities will be permitted to nominate between one and three directors (depending on current board size), and the company would be required to include in its own proxy materials (and on its own proxy card) the nominees’ names and certain information about them.

    The 5 percent interest must have been held for at least two years as of the date of the nomination, the shares must not be held for the purposes of effecting or changing or influencing control, and the shareholder (if not institutional) cannot own beneficially 20 percent or more of all shares.

    The nominee must meet the objective (not subjective) independence standards of the company’s SRO, must be independent of the nominating shareholder, and there must be no agreements with the company concerning the nomination.

    The proxy solicitation rules will be relaxed to allow shareholders to communicate among themselves for the limited purpose of effecting such nomination without complying with the existing proxy solicitation regime.

    Companies with eight or fewer board members would be subject to one shareholder nominee, companies with between nine and 19 board members would be subject to two, and companies with boards of 20 or more could be required to include three. There are mechanics for dealing with staggered boards, with competing shareholder groups, and with inclusion of statements supporting or opposing the nomination.

    Nominations would be required no later than 90 days prior to the anniversary of the mailing date of the prior year’s proxy statement, and would be accompanied by typical nominee information. It is unclear what happens if a company nonetheless omits a shareholder nominee from filed proxy material, perhaps based upon a belief that the technical requirements for such nomination had not been met.

    Since annual meeting proxy statements typically are filed with the SEC only contemporaneously with mailing to shareholders, and thus are not subject to pre-mailing review by the SEC, any final rule should contain some mechanism to protect nominating shareholders. Otherwise, shareholders might be forced to bring suit to enjoin the meeting, presumably in the 30-day period prior to proxy mailing (by which time the company is required to give notice of rejection of the nomination).

    Another potential problem not addressed in the proposed rule arises upon election of a shareholder nominee who fails to meet SRO independence requirements; such election could cause an unintended violation of the SRO requirement for a majority of independent directors, or might result in there being too few independent directors qualified to serve on committees.

    Conclusion

    The Sarbanes-Oxley governance scheme is substantially in final form in advance of the 2004 proxy season. Modest changes to the SEC proxy rules as adopted in November 2003 preserve the general regulatory outline anticipated by the August 2003 proposals.

    The last and most complex piece, the October 2003 proposals to open the proxy mechanics to major shareholders upon the occurrence of a “triggering event,” while reflecting the impetus for shareholder democracy, is likely to suffer substantial reshaping before final promulgation – if indeed the proposal has enough legs even to emerge from the rule-making process in identifiable form.

    Stephen M. Honig is a member of Duane Morris’ corporate department, and is a resident in its Boston office. His practice includes counseling public companies in matters of SEC compliance and corporate governance.

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