On August 25, the SEC adopted proxy access rules giving qualified shareholders or shareholder groups the right to require most publicly traded U.S. companies to include their director candidates in the companies’ annual meeting proxy materials. The right operates in a manner similar to the way that shareholders include proposals in company proxy materials. The proxy access rules make it possible for shareholders to advance their own nominees without the cost of circulating proxy materials.
Highlights of the rules are as follows:
• The first annual meetings to which the rules will apply will be the 2011 meetings of companies that mailed their 2010 proxy statements after March 15, 2010
• Only shareholders or groups who hold at least three percent of a company’s voting power, and have held it continuously for at least three years, will be eligible to submit nominees
• The rules contemplate that shareholders will reach out to other shareholders to satisfy the three percent threshold and provide relief under the proxy rules for such efforts
• The maximum number of nominees that a company must include is the greater of one director or 25 percent of the entire board; for classified boards, the 25 percent limit is based on board seats for all director classes
Proxy access will be mandatory. There is no requirement to “opt in” and there is, in essence, no way for a company to “opt out.” The access rules are a non-exclusive way by which a shareholder’s nominee may be put to a vote and will apply even if a company is engaged in a concurrent proxy contest.
The authors of this article–Phillip M. Goldberg, Patrick G. Quick and John K. Wilson–are partners with the national law firm of Foley & Lardner, practicing in the Transactional & Securities practice. The transcript is based on a recent webcast conducted by the law firm.
In connection with the new access rules, the SEC created two new exemptions from proxy solicitation requirements. The first is for solicitations in connection with the formation of a nominating shareholder group. Any activities trigger a SEC filing, and written communications are limited.
The second makes it easier for a nominating shareholder to pursue solicitation activities in support of its access nominees (or opposing company nominees) without filing and circulating more complete proxy materials.
A related rule change allows shareholders to seek different sets of rules for access to company proxy materials at individual companies by expressly empowering shareholders to pursue their own shareholder proposals on the subject.
Foley hosted a Web conference on September 15, 2010 to explore the SEC’s new proxy access rules. The moderators and panelists included:
• Phillip M. Goldberg, partner at Foley & Lardner
• Patrick G. Quick, partner at Foley & Lardner (moderator)
• John K. Wilson, partner at Foley & Lardner (moderator)
• Richard H. Grubaugh, senior vice president, D.F. King & Co.
• Seth W. Hamot, managing member, Roark Rearden & Hamot Capital Management
• Gail L. Hanson, deputy executive director, State of Wisconsin Investment Board
• Steven H. Shapiro, general counsel and corporate secretary, Taylor Capital Growth
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Wilson: Let’s talk about how common it will be for there to be proxy access nominees and what types of companies investors would be targeting for these nominations.
Hamot: I think this is going to be used a lot and I think it’s going to be used a lot soon. I think it’s going to be slowed down a little bit by litigation to clarify some of the rules, specifically the ones regarding communication with other shareholders. I’m thinking off the top of my head what companies might be targets for such nominations, and it appears to me that the things that I’d be most concerned about right off the bat are companies where management owns a few shares and the board owns a few shares and they never buy. Often when you speak to these managers and these board members, you hear the discussion of what the shareholders want and it’s pretty funny because, of course, they’ve never spoken to a shareholder. They’re not really certain how to do that given the insider information rules, etc. And I think that those kind of hurdles, when you see low ownership right off the bat, and a company that’s doing strategically poorly compared to its competitors, will be good targets for people to say, “Enough already.”
Shapiro: Just to follow up on that… People who may not have surfaced before as directors are going to have to disclose a lot of information about themselves that they hadn’t had to disclose before. They’re likely to be challenged, perhaps unfairly, in a very public forum. The ultimate victory is for them to serve as a minority board member in a board that would be antagonistic to them. So that even if they have good ideas–and that assumes they’re acting with the best interest of the company and not their own pocketbook in mind–that individual would be satisfied after spending all that money, putting themselves through that process to be [part of a] board of directors that can outvote them at any time. In addition, and if you think this through, what’s to say that the best directors on that board won’t basically say, “Look, if this is going to happen, I’m out of here. The liability, the stakes are too high. I have too much at risk. I’m not being paid that much. Why don’t I just take off?” Leaving the company with fewer qualified directors. I think all of that needs to be thought through … And for people to jump in [that quickly]. I think I would be surprised by that.
Quick: Are the rules likely to have a greater impact on smaller companies because of the three percent requirement, as many have surmised?
Hamot: That’s my opinion, that they will affect smaller companies. The three percent hurdle is a high one for a large Fortune 500 or 100 company. Additionally, you just have questions of liquidity. In larger companies you have a lot of liquidity and people trading in and out of them and there’s always a new statistic every year how short a time frame the aggregate investor owns a share of stock. That’s less the case in small companies, where people tend to invest or tend to hold those stocks longer. It’s also because people tend to like stories and stick around.
Shapiro: I would have to agree that [small companies] are more likely to be the subject of these rules than larger companies for the reasons that Seth mentioned. I think one of the unintended consequences might be the reaction of smaller companies, particularly the dedication of resources in response to these items both in terms of outlay of funds as well as management and board time to respond to them, particularly since, at least at the outset, so many of these rules will be untested.
Wilson: How [are] pension funds and institutional investors planning to use the proxy access rules?
Hanson: We would use them sparingly and only after an effort to engage management. So I suspect, for example, in instances where directors have received the majority of withhold votes and yet continue to serve, that might be a situation where an alternative candidate, through proxy access, would be, “set up against one of the directors.”
Wilson: Do we think shareholders will gear up in a hurry to use proxy access?
Grubaugh: I fully expect there will be a handful of large cap companies that will receive 14N nominations. Those companies probably won’t be surprised… “When it comes to both Seth and Steven’s point to the smaller companies, there are a number of smaller companies that have three percent shareholders or small groups thereof. It will take a long time for this to kind of work its way through the system so that those shareholders are mindful of it. So I don’t anticipate a lot of those shareholders to be ready to go for this coming proxy season…”
Goldberg: I’m not sure I agree with Rick on this one. Already within a week or two of the proxy access rules coming out, there was a 13D filed on a Nasdaq company indicating that once the rule becomes effective, they intend to proceed under 14a-11. I thought that was a pretty quick trigger pulled on the new rule. I also think that what we’ve seen in the last several years is shareholders owning significant positions in companies whose stock performance has either stagnated or underperformed relative to their peer group, and [proxy access] is going to be a less costly way for them to release some value through activism.
Wilson: Are there disadvantages to using 14a-11?
Goldberg: When several clients started talking about the new rules, their concern was whether they’d be signaling a lack of seriousness or commitment to the investment by pursuing 14a-11 versus a greater investment in doing a full-blown proxy contest. I think the concern oftentimes in the small cap and small mid cap companies is that you’re trying to win that institutional vote and those institutions are looking at that [financial] commitment on your part to determine whether you’re in for the long run and they’re prepared to support you. If they look at you as taking a flier, are you likely to get that proxy advisory firm support?
Quick: If a shareholder is using this process, they don’t have access to voting information the company would have access to, information that the company would be not obligated to share with the sponsor. So the typical proxy contest approach gives the shareholder a little bit more control.
Grubaugh: I don’t see any hedge fund or activist that has waged proxy contests in the past to be using this in the future. It doesn’t give the dissident the same tools and ammo that they would like as part of their arsenal.
Quick: Do you think there will be a flood of shareholder proposals to set other rules for accessing a company’s proxy statement?
Wilson: Can’t say whether there will be a flood of them or not, but certainly I would expect that there will be those types of proposals to either lower the voting threshold from three percent to something lower or shorten the time period from three years. I think the real question here is going to be what positions the proxy advisory firms take on these.
Grubaugh: I agree. There’s already rumors in the marketplace that there are several 14a-8 proponents out there crafting various proposals. The proxy advisory firms have not formulated any position on it yet – whether they would support a proposal that would be lowering it. To some degree, this has the ability to take what would be considered a win for the people who have lobbied for proxy access, created a win to a loss if they can’t get the support to lower [the access requirements]. I believe it’s hard for the institutional investors to support lowering a triggering mechanism that hasn’t even yet been tested.
Wilson: How difficult do you think it’s going to be for shareholders to get the three percent necessary for the three-year period, or will it be common that there will be notices filed for forming a group for these purposes?
Grubaugh: First of all, there’s only a handful of investors that have three percent for three years in the majority of companies, and it’s the handful of the index funds – BlackRock, Vanguard, State Street. We don’t expect that those firms are changing their stripes overnight and will be commencing any 14a-11 campaigns. However, we’ve analyzed just the Dow 30 that have an average of over three percent of public pension funds money. Now that’s not to say they’re all held for a three-year period, but obviously they’re pretty stable investors. So it’s not such a challenge to get three percent even at the largest companies by grouping a number of those public pensions along with, maybe one or two other long-only investors.
Hanson: I think that Rick is underestimating, particularly on large cap stocks. Public pension plans may in aggregate hold three percent, but you’re talking about a lot of different agencies with different objectives and different governance perspectives. There are a lot of things that we, as public plans, will have to determine on how we meet the three percent three-year holding requirements and how you can verify that, and then whether or not we want to collaborate on a certain issue and a certain candidate.
Wilson: Are there pitfalls to avoid in shareholder communications with other shareholders when trying to form these types of groups?
Goldberg: This area more than any is going to give rise to the greatest risk of litigation. From a shareholder perspective, it’s an opportunity to go out there and explore with other shareholders their willingness to consider being part of a nominating group. At the same time, there’s going to be lots of accusations perhaps made by the companies that, “You’re really not forming a nominating group, you’re really forming a group under 13D and why didn’t you file a 13D,” etc.? So the wise approach for the shareholder is to develop a script so they can evidence later on, when challenged, that they specifically asked certain questions of the shareholders such as, “Are you willing to consider [being part of my nominating group]?” Not, “Will you vote for me if I run for election?”
Quick: What types of people might be proposed as access nominees?
Hanson: First and foremost, if we put somebody on the ballot we want them to be electable. Just being on a ballot doesn’t get us to the goal line. You need to have a person that’s on the ballot and electable to move the company forward. CalPERS and CalSTRS are leading an effort to develop a list of qualified, diverse candidates, which is their priority, and so I think you’ll see some of those candidates come forward.
Quick: Could a company make it less attractive for someone to agree to be a shareholder nominee? For example, no compensation to shareholder-nominated directors; no indemnification agreements to shareholder-nominated directors?
Goldberg: I would certainly think that the proxy advisory firms would seriously frown on that type of disparate treatment for a shareholder nominee compared to a hand-picked nominee of the board.
Quick: A board may think, if you have the “enemy” in the room, it’s a little hard to talk about where you’re taking the company. Might a board think about do we now have to put the other directors on committees, so now we run our board business in committees instead of at the full board?
Hanson: If somebody did that lack of indemnification or really changed their board governance because they had an individual, a qualified individual, elected by a majority vote of shareholders, I think that would trigger our investment folks to say, “Is this a company worth investing in?”
Hamot: I would like to concur with Gail in that. If they treat the elected shareholder representative like this, then next year there’s going to be a full proxy fight.
Shapiro: But there’s plenty of stockholders out there that this leaves opportunity for mischief. If companies have not done well over the last couple of years there’s a lot of reasons for it. It could be due to management and it could be due to circumstances beyond the management’s control. If we get a shareholder that has good ideas, ideas a company hasn’t thought of, has the best interest of the company ahead of their pocketbook in mind, that sounds very reasonable, but I don’t think that this is only going to attract those type of investors.
Wilson: Once we have a candidate who’s out there as an access nominee, how will institutional investors decide whether to vote for that access nominee and what roles will the advisory firms play?
Hanson: As long-term shareholders, we want to support the most qualified candidates, and so we will look at their qualifications. If you go on our web site, you’ll see our custom voting guidelines. We want independence, we want someone that’s not overboarded, we want candidates that are qualified based upon the industry knowledge and we will evaluate those candidates. I think the question is raised, will ISS or Glass Lewis be the determining factor based upon their recommendation for a vote? You’ll notice in various contests that institutional investors don’t necessarily follow those recommendations. The larger institutional investors have their own analysis. And so it’s a question of what’s going to be the tipping factor.
Grubaugh: I’d just add that obviously the recommendations from ISS and Glass Lewis and the others will be extremely important for a proxy access candidate to have a chance at getting elected. ISS is still formulating their policy on this because currently, in a proxy contest situation, they have a two-prong test where they first determine, “Is there a reason to and do they need change at a company?” Then they move to, “Is the dissident candidate that is put up for election the best agent for change?”
Quick: If an access nominee attracts support, will there be a corresponding effort to oppose a particular management nominee?
Grubaugh: One of the things about a short slate proxy contest is that the dissident investor targets what nominee on management they are not going to apply any votes to. So it automatically brings down [the vote for] that management nominee. In a proxy access campaign, the same issue will have to apply, in that the access nominee candidate is going to have to recommend to the investors which management nominee not to apply votes to. If they don’t and all the investors kind of pick a different management nominee to vote for, it could have the end effect that the access nominee doesn’t get elected even though he or she could have gotten elected if all the investors picked one management nominee not to apply votes to.
Hamot: I agree wholeheartedly, it fits into the framework of a typical short slate effort that has to target specific directors. As in all proxy contests you have a question of leadership and so the dissident actually has to indicate for the less interested shareholder which management nominee should not be voted.
Quick: Of course, this is where it will get necessarily personal because it’s not just a shareholder trying to get a nominee on the board, but the effort will need to turn directly to incumbents.
Goldberg: While it will get personal, it may very well still protect some directors in the organization. I think a Glass Lewis or an ISS is less likely to agree to shoot the chairman or the head of the audit committee whose seat[s] are up, and so even though that person on that board may be, in the view of the [nominating] shareholder, the greatest obstacle for change, that shareholder is going to appreciate that if they take the position that a specific director must go, they may lose that endorsement by the advisory firm.
Quick: How much will proposing shareholders campaign for their nominees apart from the supporting statement in the proxy statement? How will they do that and how big of a role do you expect web sites to play?
Grubaugh: Considering I believe most of the people who are going to be submitting proxy access nominees are doing it because of cost constraints of a full-blown proxy contest, I totally believe we are going to see the creation of web sites, social media, Twitter, to take full, center stage in getting their message out, and try at the same time to limit what really is costly about proxy contests [which are] the mailings, the newspaper ads, etc.
Hamot: We were one of the first to use our web sites in a proxy contest. It allows you to disseminate information, not just cheaper but more effectively nowadays. Mailing all of these Fed Exes [can] end up taking three days, six days, eight days. It goes away when you use the web.
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Sources: SEC Release No. 33-9136 (http://www.sec.gov/rules/final/2010/33-9136.pdf); Foley & Lardner LLP’s Legal News Alert for a complete summary of the new rules (http://www.foley.com/publications/pub_detail.aspx?pubid=7479)