Proxy access

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SEC issues Concept Release on proxy advisory firms

The U.S. Securities and Exchange Commission (SEC) recently issued a concept release on the US proxy voting system in the United States that discusses, among other topics, the role and regulation of proxy advisory firms and proposed regulatory reforms related to them.

The SEC is considering and has requested comments as to whether the voting recommendations of proxy advisory firms serve the interests of investors, and whether the SEC should clarify existing regulations or propose additional regulations to address concerns such as conflicts of interest and the accuracy and transparency of proxy advisors' development of voting recommendations.

The SEC is seeking additional information from stakeholders on which to base its policy decisions, its assessment of the current regulatory environment, and its proposed solutions to the issues highlighted in the concept release.

The concept release is relevant not only for proxy advisors and US issuers, but also for Canadian issuers and their boards of directors for the following reasons:

  • As many Canadian proxy advisory firms are owned by US parents, new regulations in the US that affect the role or operations of proxy advisors will have an impact on how such firms conduct business in Canada.
  • Although they have not addressed the role and regulation of proxy advisory firms, the Canadian Securities Administrators are currently considering changes to the proxy voting system in Canada through proposed amendments to Communication with Beneficial Owners of Securities of a Reporting Issuer. Due to this scrutiny of the proxy voting system, together with recent attention paid to proxy advisory firms in the media and potential impacts of US regulation, Canadian stakeholders and regulators will follow with interest the progress of the concept release and comments thereto.

Reliance on proxy advisory firms on the rise

The release notes a significant increase in investors' reliance on recommendations from proxy advisory firms over the last 25 years. The SEC cites the growth in the percentage of shares owned by large institutional investors and their fiduciary duty to vote the shares they hold on behalf of beneficiaries as reasons for this increase. Due to the high volume of resolutions to vote on annually, the complexity of significant policy and corporate governance issues on which votes are cast, and the lack of time and resources to meet their fiduciary duties, institutional investors are increasingly reliant on proxy advisory firms for policy analysis and voting recommendations. As a result, proxy advisory firms have come to exert significant influence over voting.

Concerns regarding the role of proxy advisors

Two concerns discussed in the concept release are: (i) potential conflicts of interest or perceived conflicts of interest; and (ii) the level of accuracy and transparency in the manner in which voting recommendations are formulated.

Conflicts of interest

The concept release notes that the business models of some proxy advisory firms may give rise to the following conflicts:

The proxy advisory firm provides proxy voting recommendations to institutional investors and also provides consulting services to corporations seeking assistance with proposals to be presented to shareholders.

The proxy advisory firm provides corporate governance ratings on issuers to institutional clients while offering consulting services to issuers to help improve those ratings. Owners or executives of the proxy advisory firm have significant ownership interests in or sit on the boards of directors of issuers with shareholder matters on which the proxy advisor is making voting recommendations.

In any of these situations there is the potential for conflicts of interest or the appearance thereof. If such conflicts are not adequately disclosed and managed, they can result in shareholders being misled, which could impair informed shareholder voting. Proxy advisors currently deal with this problem by creating firewalls between their investor and consultancy business lines and by disclosing general disclaimers that they may provide consultancy services to issuers on which they also provide proxy voting recommendations. However, the concept release considers whether additional measures are required.

In the concept release, the SEC outlines potential approaches it is considering to address perceived or actual conflicts of interest. These proposals include:

  • requiring more detailed disclosure by proxy advisory firms regarding the presence of a potential conflict of interest;
  • providing more guidance to proxy advisory firms who are also investment advisors regarding their fiduciary duty as investment advisors; and
  • adopting regulations similar to those that apply to credit rating agencies; for example, prohibiting certain conflicts of interest or requiring periodic disclosure of conflicts of interest and procedures to manage them.

The SEC specifically requested comment on whether it should revise the rule requiring proxy advisors to disclose to clients "any significant relationship" they have with issuers by requiring more specific disclosure regarding the presence of a potential conflict with respect to a particular proposal.

Lack of accuracy and transparency in formulating voting recommendations

The SEC noted that some commentators have expressed concerns related to accuracy or transparency in the formulation of voting recommendations by proxy advisory firms, including that:

  • voting recommendations by proxy advisory firms may be made based on materially inaccurate or incomplete data;
  • the analysis provided to an institutional client may be materially inaccurate or incomplete; or

recommendations may be based on a one-size-fits-all governance approach. Without addressing differences among issuers, a policy that would benefit some issuers but is less suitable for others may not receive a positive recommendation, thereby making it less likely to be approved by shareholders.

If voting recommendations are developed and made without adequate transparency and accountability for accuracy, informed shareholder voting may be impaired.

Potential regulatory measures being considered by the SEC to address the stated concerns include
  • requiring proxy advisory firms to disclose the extent of research they conducted in making a particular voting recommendation, as well as the extent and effectiveness of controls and procedures in ensuring accuracy of issuer data;
  • requiring proxy advisory firms to disclose a communication policy that governs their interactions with issuers (both before the recommendation is made and afterward, allowing for an appeal process); and
  • requiring proxy advisory firms to file their voting recommendations with the SEC.
Request for Comment

The SEC has requested that comments be submitted on or before October 20, 2010, and does not place any restrictions on who may provide comments. The full text of the concept release can be found at http://www.sec.gov/rules/concept/2010/34-62495.pdf, with the relevant sections found on pages 104 to 126. While the SEC has made a general request for comments, it has also requested comments on a list of 19 questions that include questions about services provided by proxy advisory firms, conflicts of interest, governance standards, the competitive structure of the proxy advisor market, use of voting recommendations by institutional investors, criteria and processes used in formulating voting recommendations and corporate governance ratings, and the form any additional oversight, if needed, should take. We will continue to monitor the progress of the release and the implementation of any related reforms

SEC proposes "say on pay" and proxy vote reporting

The Securities and Exchange Commission today proposed rules that would enable shareholders to cast advisory votes on executive compensation and "golden parachute" arrangements. The rules are called for by Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Additional Materials

Under the proposed rules, public companies subject to the federal proxy rules would be required to:

  • provide their shareholders with an advisory vote on executive compensation and an advisory vote on the desired frequency of these votes;
  • provide shareholders with an advisory vote on compensation arrangements and understandings in connection with merger transactions, known as "golden parachute" arrangements; and
  • provide additional disclosure of "golden parachute" arrangements in merger proxy statements.

The proposed rules would also require that institutional investment managers report their votes on executive compensation and "golden parachute" arrangements at least annually, unless the votes are otherwise required to be reported publicly by SEC rules.

Last year, the Commission adopted rules requiring public companies with outstanding obligations under the Troubled Asset Relief Program to provide a shareholder vote on executive pay in their proxy solicitations. The Commission also adopted rules requiring enhanced disclosure of executive compensation by public companies in their proxy statements.

Required Say-on-Pay Votes and Additional Disclosure Requirements
Shareholder Approval of Executive Compensation

Under the proposed rules implementing the Dodd-Frank Act, companies subject to the federal proxy rules would be required to provide shareholders with an advisory vote on executive compensation. Section 14A(a) of the Exchange Act, which was added under the Dodd-Frank Act, specifies that these votes, generally known as say-on-pay votes, are required at least once every three years beginning with the first annual shareholders' meeting taking place on or after Jan. 21, 2011.

The SEC's proposal requires companies to provide disclosure about the say-on-pay vote in the annual meeting proxy statement, including whether the vote is non-binding. The proposal also would require the company to disclose in the Compensation Discussion and Analysis, or CD&A, whether, and if so, how companies have considered the results of previous say-on-pay votes.

Shareholder Approval of the Frequency of Shareholder Votes on Executive Compensation

Under the proposal, companies subject to the federal proxy rules also would be required to allow shareholders to vote on how often they would like to cast a say-on-pay vote, namely: every year, every other year, or once every three years.

Shareholders would be allowed to cast this non-binding "frequency" vote at least once every six years beginning with the first annual shareholders' meeting taking place on or after Jan. 21, 2011.

The proposals would require companies to provide disclosure about the frequency vote in the annual meeting proxy statement, including whether the vote is non-binding.

Shareholder Approval and Disclosure of Golden Parachute Arrangements

Under the proposal, companies also would be required to provide additional information about the compensation arrangements with executive officers in connection with merger transactions. Disclosures of these "golden parachute" arrangements would be required of all agreements and understandings that the acquiring and target companies have with the named executive officers of both companies.

This "golden parachute" disclosure also would be required in connection with going-private transactions and third-party tender offers, so that the information is available for shareholders no matter the structure of the transaction.

Further, the proposed rules would require companies to provide a shareholder advisory vote to approve certain "golden parachute" compensation arrangements in merger proxy statements.

Institutional Investment Manager Reporting of Votes

The SEC also proposed rules that would require institutional investment managers to annually file with the SEC their votes on say-on-pay, frequency of say-on-pay votes, and "golden parachute" arrangements.

The proposal would generally apply to every institutional investment manager that manages certain equity securities having an aggregate fair market value of at least $100 million.

The manager would be required to identify securities voted, describe the executive compensation matters voted on, disclose the number of shares over which the manager held voting power and the number of shares voted, and indicate how the manager voted.

The proposal would require institutional investment managers to report these votes annually not later than August 31 of each year, for the twelve months ended June 30.

The SEC will seek public comment on the proposals. The comment period will close on Nov. 18, 2010.

SEC adopts “proxy access” rules

The Securities and Exchange Commission (the “Commission”), by a 3-2 vote, adopted fundamental changes to the federal proxy rules that will require public companies to include shareholder director nominees in their proxy materials. These new “proxy access” rules will be effective 60 days after they are published in the federal register.

The Commission’s release adopting the proxy access rules is available here.

The Amendments to the Federal Proxy Rules

New Rule 14a-11

New Rule 14a-11 will require any company that is subject to the proxy rules under Section 14(a) of the Securities Exchange Act of 1934 (including investment companies but excluding smaller reporting companies) to include shareholder nominees to the board of directors in its proxy materials. Application of Rule 14a-11 to “smaller reporting companies” will be deferred for three years. Under new Rule 14a-11, any subject company that receives a notice from an eligible shareholder (or group of shareholders) regarding its intent to nominate directors for election at a company’s meeting will be required to include those nominees in the company’s proxy materials. The inclusion of shareholder nominees will not be required if the nominees are otherwise prohibited by the company’s governing documents or applicable state law. The number of such shareholder nominees that a company will be required to include in its proxy materials will be limited to the greater of one director or 25% of the number of directors on the company’s board.

Eligibility Requirements. To be eligible to nominate directors for inclusion in a company’s proxy materials, a shareholder (or group of shareholders) will be required to satisfy the following requirements:

  • The nominating shareholder (or group of shareholders) must have both investment and voting power over 3% of the company’s securities that are entitled to vote on the election of directors at the company’s meeting of shareholders.
  • The nominating shareholder (or group of shareholders) must have held the requisite percentage of securities for at least three years at the time of providing notice to the company of its intent to nominate directors, must certify its intent to hold those securities continuously through the meeting at which directors will be elected, and must disclose its intentions about whether it will retain those securities after the meeting at which directors will be elected.
  • The nominating shareholder (or group of shareholders) must certify that it has no intent to seek a change in control of the company or to gain a number of board seats that is more than the number of nominees a company could be required to include in its proxy materials under Rule 14a-11.

Notice Requirements. The nominating shareholder (or group of shareholders) will be required to provide notice to the company indicating that it satisfies the above eligibility and certification requirements. The nominating shareholder also must file a copy of the notice with the Commission under cover of a new Schedule 14N. Specifically, the notice must include the following information:

  • disclosure of the amount of securities held by the nominating shareholder (or group of shareholders) and the length of time those securities have been held;
  • a statement of the shareholder’s intent to hold those securities through the meeting at which directors will be elected and disclosure regarding the shareholder’s intent to hold those securities after the meeting at which directors will be elected (which may be contingent on results of the election of directors);
  • a certification that the shareholder does not intend to seek to gain control of the board or to gain a number of seats on the board that is more than the number of nominees a company could be required to include in its proxy materials under Rule 14a-11;
  • information about the nominating shareholder and nominees that is based upon the information required to be provided to shareholders in a proxy contest (including disclosure as to whether the nominee meets the company’s director independence and director qualification standards); and
  • a statement of support for the nominee that is no longer than 500 words.

This notice must be submitted to the company and the Commission no more than 150 days and no less than 120 days before the first anniversary of the date that the prior year’s proxy materials were first released to shareholders. The deadline required by this timing is consistent with the timing for the submission of shareholder proposals in Rule 14a-8.

If the company does not believe that the nominating shareholder (or group of shareholders) or the nominee meets all of the Rule 14a-11 eligibility requirements, the company must provide notice to the nominating shareholder (or group of shareholders) of the deficiency and a chance to respond. If the company continues to believe that the nominating shareholder (or group of shareholders) or the nominee does not meet the eligibility requirements, the company must submit notice of its intention to exclude the nominee from its proxy materials no later than 80 days before the company files its proxy statement with the Commission. There will be a process through which companies can seek the informal views of the Commission’s staff with regard to its intention to exclude a nominee.

If separate shareholders (or separate groups of shareholders) submit director nominees and the total number of nominees covered by the notices exceeds the greater of one director or 25% of the number of directors on the company’s board, the company will be required to include the nominees submitted by the shareholder (or group of shareholders) holding the highest percentage of the company’s securities that are entitled to vote on the election of directors at the company’s meeting of shareholders.

Conditions Applicable to Nominees. A shareholder (or group of shareholders) may not nominate an individual for election to the company’s board of directors unless the following conditions are satisfied:

  • the nominee’s candidacy and board membership (if the nominee is elected) must be consistent with applicable laws and regulations;
  • the nominee must satisfy any applicable exchange listing standards regarding director independence; and
  • the nominating shareholder (or a group of shareholders) must have no direct or indirect agreement with the company regarding nomination of the nominee prior to the shareholder’s submission of notice to the company.

There is no limitation on the extent of relationships between the nominating shareholder and the nominee (as a result, the shareholder could nominate herself or himself for director).

Exemption from the Proxy Solicitation Rules. To facilitate the operation of Rule 14a-11, the Commission adopted conditional amendments to the federal proxy rules that provide an exemption from those rules for both solicitations in support of a shareholder nominee for director and solicitations by a shareholder that is seeking to form a nominating group. These exemptions will be based, in part, on the filing of any such soliciting materials. Further, the proposals would make clear that a shareholder (or group of shareholders) would not lose eligibility to file beneficial ownership reports on Schedule 13G as a result of such shareholder’s (or shareholder group’s) nomination of director nominees for election to the company’s board, such shareholder’s (or shareholder group’s) solicitation in favor of such a nominee, or the election of such a nominee to the company’s board.

Amendments to Rule 14a-8

The Commission also amended Rule 14a-8(i)(8), which is often referred to as the “election exclusion” provision of the shareholder proposal rule. Amended Rule 14a-8(i)(8) will require the inclusion of shareholder proposals that would amend or request an amendment to a company’s governing documents regarding a shareholder’s right to nominate directors or that relate to other disclosure or procedural matters concerning that nomination right, so long as the proposals do not conflict with applicable law (including proposed Rule 14a‑11). As a result, the shareholder proposals that will be required to be included in a company’s proxy materials may go beyond Rule 14a-11, but may not limit the operation of that rule.

SEC solicits comments on new proxy access rule

Today the Securities and Exchange Commission issued a concept release to seek public input on the reform of the proxy solicitation and voting system in the U.S. As noted by Chairman Mary Schapiro and Meredith Cross, Director of the Division of Corporation Finance, the U.S. proxy system governs the voting of over 600 billion shares at over 14,000 shareholder meetings each year, yet it has not undergone a substantial review in almost thirty years. Public comment will be sought for a period of ninety days. The Concept Release is available here.

The Concept Release, organized by the three general topics on which the Commission is seeking public input, requests comment on

  1. ensuring the accuracy, transparency, and efficiency of the voting process,
  2. enhancing shareholder communication and participation, and
  3. addressing the relationship between voting power and economic interest.

Ensuring the Accuracy, Transparency, and Efficiency of the Voting Process

1. Over-Voting and Under-Voting of Shares -- Securities intermediaries (such as brokers) on occasion may cast greater or fewer votes than the number of shares they are entitled to vote, depending on the method of allocation each intermediary employs for recording transactions and for matching the accounts of their customers to the shares held for those customers. The Commission is seeking comment on whether over-voting or under-voting of shares is a problem and, if so, whether the Commission should require securities intermediaries to disclose the method of allocation or reconciliation they employ to address concerns about the potential for over-voting and under-voting or whether the Commission should regulate which allocation or reconciliation methods may be used.

2. Vote Confirmation -- The Commission is seeking comment on market participants’ ability to assess whether their votes were timely received and accurately recorded, as well as issuers’ ability to assess whether third-party voting accurately reflects the instructions of beneficial owners. Further, the Commission is seeking comment on whether vote tabulators should be required to provide access to their voting data.

3. Proxy Voting by Institutional Securities Lenders -- Institutional shareholders often loan the shares they hold to third parties and may find themselves unable to vote such shares if there is insufficient time to recall the shares on loan once notice of an upcoming vote is received. The Commission is seeking comment on (a) whether issuers should identify the items that will be presented for a vote earlier to allow institutional shareholders sufficient time to recall their shares on loan in order to vote such shares; and (b) whether registered management investment companies (mutual funds) should be required to disclose the number of shares that they vote in addition to the current requirement that they disclose how they vote.

4. Proxy Distribution Fees -- The Commission is seeking comment on whether it continues to be appropriate to have the self-regulatory organizations establish the fee structure for forwarding proxy materials. In this regard, the Commission is seeking comment on whether the fee amounts should be revised or eliminated to allow for free market determination of the appropriate fee amount.

Enhancing Shareholder Communication and Participation

5. Communications with Shareholders -- Brokers and banks report the names of non-objecting beneficial owners (“NOBOs”) to issuers, but remain the sole parties who may directly contact objecting beneficial owners (“OBOs”). The Commission is seeking comment on methods of improving corporate communications and whether the NOBO/OBO system remains useful and appropriately balances shareholder privacy concerns.

6. Voting Participation -- The Commission is seeking comment on possible means by which it could increase individual shareholder voting participation, including: (a) improving investor education; (b) enhancing broker internet platforms; (c) allowing client-directed voting in advance of meetings; (d) increasing investor-to-investor communications; and (e) improving the use of the internet for delivery of proxy materials.

7. Data Tagging -- The Commission is seeking comment on whether requiring issuers to tag proxy-related data (e.g., executive compensation, director qualifications, etc.) would enable shareholders to make more informed voting decisions.

Addressing the Relationship Between Voting Power and Economic Interest

8. Role of Proxy Advisory Firms -- In response to concerns that proxy advisory firms may be subject to undisclosed conflicts of interest or may fail to conduct adequate research before issuing their voting recommendations, the Commission is seeking comment on whether to enhance regulatory oversight of such advisory firms and the appropriateness of requiring disclosure regarding conflicts of interest and the manner in which their voting recommendations are made.

9. Dual Record Dates -- A shareholder may sell its shares after the record date for a meeting of shareholders and still maintain the right to vote at that meeting, despite its lack of continuing economic interest in the well-being of the issuer. Certain states now provide for the establishment of dual record dates -- one record date for receiving notice of the meeting and one record date for the right to vote at that meeting. The Commission is seeking comment on the adoption of a system of dual record dates that would address concerns in this area and align the federal requirements with these state law developments.

10. Empty Voting -- The Commission is seeking comment on whether empty voting -- such as when a shareholder maintains ownership and voting rights with regard to shares but hedges its economic interest in those shares or when a shareholder sells its shares after the voting record date but before the meeting date -- may be improperly impacting votes. In this regard, the Commission is seeking comment on whether it would be appropriate to require disclosure in situations where voting rights are decoupled from economic interest and other possible responses to empty voting.

Corporate governance provisions added to bill

Senator Dodd unveiled his 1,136-page financial reform bill discussion draft today, which proposes a variety of new financial industry regulations and regulatory agencies. While the bill focuses on these wide-ranging and controversial financial reform proposals, a number of corporate governance reforms are also buried in the bill on pages 755 to 762, and are largely taken, albeit in somewhat weakened form, from Senator Schumer’s proposed Shareholder Bill of Rights Act.

As we have previously commented, these governance reforms, while presented as a means of enhancing corporate governance and restoring stability to American companies, are likely to have just the opposite effect. See the Wachtell, Lipton, Rosen & Katz memoranda “A Crisis Is a Terrible Thing to Waste: The Proposed ‘Shareholder Bill of Rights Act of 2009’ Is a Serious Mistake,” posted on the Forum here, and “Corporate Governance in Crisis Times,” posted on the Forum here.

The corporate governance provisions of the discussion draft would:

  • require
  1. a majority voting standard in uncontested elections of directors,
  2. that any director who does not receive a majority vote submit a resignation, and
  3. that the board accept the resignation or vote unanimously to reject it, in which case the company must disclose the reasons for the rejection and why the rejection was in the best interests of the company and its shareholders;
  • require the SEC to adopt proxy access rules within 180 days, under which shareholders would be permitted to nominate directors using the company’s proxy materials on terms to be determined by the SEC;
  • require companies to disclose in their annual meeting proxy statements why they have chosen either to separate or not to separate the positions of the chairman and CEO of the company;
  • and prohibit staggered boards unless adopted or ratified by the shareholders of the company.

In our view, the intrusion of this type of federal legislation into areas of corporate governance traditionally governed by state law is unwarranted and dangerous. While some of the provisions of the Dodd discussion draft are improvements over the Schumer approach – for example, requiring disclosures regarding the company’s choice on whether to separate the chairman and CEO positions, rather than mandating separation and requiring an independent chairman – other provisions, such as mandated proxy access, are likely to increase the ability of shareholder activists and hedge funds to exert the kind of short-term pressures that helped create the current economic crisis.

Moreover, we believe that allowing state law and individual companies and their shareholders to address these issues at the company level, which they have been doing, is far preferable to the federally mandated “one-size-fits-all” approach represented by the Dodd and Schumer proposals (and other legislative proposals such as the Shareholder Empowerment Act of 2009).

Finally, we believe there is enough to debate in the financial industry reforms proposed by Senator Dodd’s discussion draft. The effort to tack on these types of corporate governance proposals is simply a mistake.

SEC chair uses bully pulpit

"The top U.S. securities regulator on Wednesday called on Corporate America to upgrade its proxy voting practices to ensure shareholders a greater voice in governing the companies they own.

“It is imperative that our proxy voting process work,” Securities and Exchange Commission Chairman Mary Schapiro told the Practising Law Institute conference in New York.

“The failure to reform the shareholder voting process in the past has, in my view, affected company and board responsiveness to shareholder concerns,” Schapiro said.

Schapiro said her agency was eyeing the mechanics for shareholder voting and vowed to give shareholders an easier and cheaper way to nominate corporate directors.

Investors have long clamored for a way to influence the composition of the corporate board — an issue known as proxy access. Those demands increased after the government used billions of dollars in taxpayer funds to prop up companies including insurer AIG and Bank of America.

The SEC has proposed giving investors who own as little as 1 percent of a large company’s shares the ability to nominate directors. Schapiro said she hoped the SEC would consider final rules early next year and that the proxy access “goes to the heart of good corporate governance.”

Democratic lawmakers hope to underpin Schapiro’s efforts by affirming the SEC’s authority to grant investors access to the proxy."

SEC issues an adopting release for e-proxy rules


  • Amends Proxy Rules to Offer “E-Proxy” Flexibility
  • Launches New Web Page Dedicated to Educating Investors About Proxy Matters

"The Securities and Exchange Commission today announced a series of steps to educate investors about proxy voting and support greater investor participation in corporate elections.

The series of measures include amending the SEC’s e-proxy rules, issuing an Investor Alert, and creating new Internet resources that explain the proxy voting process in plain language.

“Investor participation in elections at companies they own is critical to effective corporate governance,” said SEC Chairman Mary L. Schapiro.

Last year, the Commission approved a change to the New York Stock Exchange rule that previously allowed brokers the discretion to vote shares held in customer accounts in an uncontested election of directors without receiving voting instructions from those customers. Now, brokers can only vote those shares in elections at companies if they are instructed by their customers. The change does not apply to mutual funds or certain closed end funds.

“The recent changes to the voting rules for the election of directors have increased the importance of voter participation,” added Chairman Schapiro.

To support shareholder participation in corporate elections and help educate investors about how the voting process works, the Commission has:

Amended the SEC’s proxy rules to clarify and provide additional flexibility when companies and other persons are relying on the “e-proxy rules.” Those rules allow a notice to be sent to shareholders indicating that the proxy materials are online and available upon request, rather than requiring a full package of materials containing a proxy card, annual report and proxy statement be sent. The new rule amendments will, among other things, allow shareholders to be provided with additional materials explaining the e-proxy rules. The Commission issued an adopting release related to the amended rules.

  • Published a new Investor Alert entitled New Shareholder Rules for the 2010 Proxy Season. The Alert provides investors with information related to the recent changes to broker voting rules and the impact of those new rules on proxy voting.
  • a new Spotlight page that provides investors with information on the mechanics of proxy voting, the e-proxy rules, corporate elections and proxy matters generally.

“The right to vote in corporate elections is a key investor right,” said Lori Schock, Director of the SEC’s Office of Investor Education and Advocacy. “We designed these new resources to help investors better understand the materials they will receive in connection with annual meetings of shareholders and how to vote by proxy in corporate elections.”

SEC won't finalize proxy access until early 2010

Finalizing a controversial proposal to give U.S. investors a cheaper and easier way to nominate corporate directors is taking longer than expected and securities regulators will not vote on it until early in 2010.

"It is my hope to finalize the rules early in the new year," SEC Chairman Mary Schapiro said in a statement on Friday.

The SEC had widely been expected to move forward with its so-called proxy access proposal this year. But the agency needs more time to craft a regulation that will not be knocked down by a federal court, according to one source familiar with the SEC's thinking. The source requested anonymity because he was not authorized to speak on behalf of the SEC.

In May, a divided SEC proposed rules aimed at giving shareholders an easier way to influence the selection of directors. Currently, shareholders can nominate their own slate of directors but only through expensive proxy fights.

Corporate executives now tightly control the annual proxy statement sent to shareholders before the annual meeting and they fear easier access could give special interest groups too much influence. Business groups are expected to challenge the SEC in federal court if the regulator adopts such a rule.

Nevertheless, Schapiro said on Friday: "I am committed to bringing final rules before the commission regarding the ability of shareholders to nominate directors."

"We have received hundreds of comments that we are reviewing to ensure our rules are fair and appropriate," she said.

The SEC proposal would give investors owning as little as 1 percent of a large company's shares the ability to nominate directors. A larger ownership stake would be required for smaller companies under the plan, which was backed by Schapiro and the agency's two Democratic commissioners and opposed by the two Republican commissioners.

The proposal would effectively overturn a 2007 SEC decision made under the leadership of then-Chairman Christopher Cox allowing companies to exclude shareholder proposals for director nominations from corporate ballots.

Cox acted after a federal appeals court in September 2006 overturned the SEC's long-standing practice in which corporations had routinely been allowed to exclude certain shareholder proposals from proxies. The ruling from the U.S. 2nd Circuit Court of Appeals triggered confusion in the corporate governance world.

Proxy solicitation through the Internet

On February 22, 2010, the SEC adopted amendments to the Internet proxy delivery rules in order to increase retail shareholder participation in the proxy voting process and to improve the notice and access model. The amendments will:

  • provide flexibility regarding the format and content of the Notice of Internet Availability of Proxy Materials;
  • permit issuers and other soliciting persons to accompany the Notice of Internet Availability of Proxy Materials with an explanation of the reasons for the use of the notice and access model and the process of receiving and reviewing proxy materials and voting; and
  • permit a soliciting person other than the issuer to use the notice and access model and send its Notice of Internet Availability of Proxy Materials by the later of 40 days before the shareholders meeting,
  • or the date on which the soliciting person files its definitive proxy statement if the soliciting person’s preliminary proxy statement is filed within 10 days of the issuer’s filing of its definitive proxy statement.

The amendments, which were adopted largely as proposed in October 2009, become effective 30 days following publication in the Federal Register. The SEC staff has indicated to us informally that they are considering whether early compliance with the new rules will be permitted.


Background

In 2006, the SEC adopted rules permitting issuers and other soliciting persons to distribute proxy materials through the Internet on a voluntary basis. In 2007, the SEC adopted rules that mandated all proxy materials to be made available through the Internet. These rules established the notice and access model for the distribution of proxy materials, under which issuers and other soliciting persons may elect to deliver proxy materials to shareholders through either the “notice-only option” or the “full set delivery option.” [1]

Since the effectiveness of the Internet proxy delivery rules, the SEC has noted confusion among shareholders regarding the instructions contained in the required Notice of Internet Availability of Proxy Materials (the “Notice”) with respect to the proxy solicitation process. In particular, the SEC is concerned about a decline in the percentage of “retail shares” [2] voting at meetings when the notice-only option is utilized, as indicated by statistical data recently published by Broadridge Financial Solutions, Inc. [3] The SEC indicates that the data may reflect shareholder confusion due to the strict requirements regarding the content and format of the Notice and the inability of issuers under the current rules to accompany the Notice with other explanatory materials. In October 2009, the SEC proposed amendments to Rule 14a-16 designed to mitigate shareholder confusion and facilitate shareholder participation by creating flexibility in the content and format of the Notice and permitting explanatory materials to accompany the Notice. [4] The SEC adopted these rules on February 22, 2010, with some modifications made in response to public comment to provide additional flexibility to explain the reasons for use of the notice-only option. [5]

In addition, existing Rule 14a-16 requires that, in order for a soliciting person other than the issuer to use the notice-only option, the person must send its Notice to shareholders by the later of 40 days prior to the shareholders meeting or 10 days after the issuer first sends its Notice or proxy statement to shareholders. Such a soliciting person, however, cannot send its Notice to sharhttp://freerisk.org/wiki/skins/common/images/button_bold.pngeholders until it files its definitive proxy statement. Because a soliciting person may miss the 10-day deadline due to SEC staff review of its preliminary proxy materials, the SEC amended the rule, consistent with its proposal, to allow sufficient time for the completion of SEC staff review of the preliminary proxy materials.

The SEC announced the adoption of the new rules as part of a broader initiative to educate investors about the corporate election process and support greater investor participation in elections. The press release announcing the adoption [6] also announced a new Investor Alert and a dedicated SEC web page that provide investors with information on the mechanics of proxy voting, the e-proxy rules, corporate elections and proxy matters generally. The SEC’s efforts are a response, in part, to concerns that the elimination of broker discretionary voting in uncontested director elections beginning with the 2010 proxy season makes retail participation in director election more important. [7]

Amendments to Facilitate Shareholder Voting

Under the amended rules, issuers and other soliciting persons will have more flexibility to choose the format and language in the Notice. The Notice will still be required to contain a legend, in bold font, that the Notice provides information regarding the availability of proxy materials for a specific shareholders meeting. However, issuers and other soliciting persons will be able to describe in the language and format of their choice other information required in the Notice, including:

an indication that the Notice is not a form for voting [8] and presents only an overview of the proxy materials, and that shareholders should review the proxy materials before voting; the address of the website containing the proxy materials; and the instructions on how to request a paper or email copy of the proxy materials. The SEC believes that the amendments will allow issuers and other soliciting persons to communicate with shareholders more effectively and provide clearer instructions to shareholders regarding the proxy voting process.

Consistent with the proposal, the amendments will permit issuers and other soliciting persons to include in the Notice an explanation of the process of receiving or reviewing the proxy materials and voting, which is prohibited under current rules. Following the recommendations of a number of commenters (including Sullivan & Cromwell LLP), the amendments will also allow an explanation of the reasons for the use of the notice-only option. Materials designed to persuade shareholders to vote in a particular manner or change the method of delivery would not be permitted as part of such explanation. [9]

Amendments to Facilitate Third-Party Solicitations

The SEC also amended Rule 14a-16 to allow a soliciting person other than the issuer to use the noticeonly option by sending its Notice by the later of:

40 days before the shareholders meeting, or the filing date of the soliciting person’s definitive proxy statement, so long as the soliciting person files a preliminary proxy statement within 10 days of the issuer’s filing of its definitive proxy statement. The current rule requires the soliciting person to send its Notice by the later of 40 days before the shareholders meeting or 10 days after the issuer first sends its Notice or proxy statement to shareholders. The SEC notes that, under its current practice, the SEC staff reviews preliminary proxy materials filed in the case of contested solicitations and that completion of these reviews may exceed 10 calendar days. As a result, due to unresolved SEC staff comments, a soliciting person may not be able to meet the current 10-day deadline for sending the Notice and thereby be excluded from relying on the notice-only option. Under the amended rules, the soliciting person will have sufficient time to respond to SEC staff comments and still use the notice-only option. The amendment does not provide a specific deadline for a soliciting person to send its Notice to shareholders, but the Adopting Release indicates that it should be sent early enough to provide shareholders with “sufficient time” to review the proxy materials and make an informed voting decision.

Endnotes

[1] The previously adopted Internet proxy delivery rules are discussed in our memos to clients, “SEC Adopts Final Rules Permitting the Internet-based Distribution of Proxy Materials and Proposed Rules to Require Internet Delivery of Proxy Materials,” dated February 13, 2007, and “SEC Mandates that Large Accelerated Filers Use the Internet to Distribute Materials for 2008 Proxy Season,” dated June 21, 2007.

[2] Broadridge defines “retail shares” as any shares that are not either managed by an advisor or subject to a consent to electronic delivery of proxy materials.

[3] Broadridge Notice and Access, Statistical Overview of Use with Beneficial Shareholders (as of June 30, 2009) is available here.


[4] The proposed amendments to the Internet proxy delivery rules are discussed in our memo to clients, “SEC Publishes Proposed Amendments to Rules Requiring Internet Availability of Proxy Materials,” dated October 19, 2009.

[5] The SEC’s amendments to the notice and access rules are in Rel. Nos. 33-9108, 34-61560, IC-29131, Amendments to Rules Requiring Internet Availability of Proxy Materials (Feb. 22, 2010), available here.

[6] This press release, dated February 22, 2010, is available here.

[7] The New York Stock Exchange rule changes eliminating broker discretionary voting in uncontested director elections are described in more detail in our memorandum to clients, dated July 2, 2009, entitled “SEC Approves NYSE Rule Eliminating Broker Discretionary Voting in Director Elections and Proposes Rules Expanding Compensation and Corporate Governance Disclosure and Establishing Shareholder Say-on-Pay Requirements for TARP Recipients.”

[8] In response to comments recommending that the Notice should clearly indicate that it is not a proxy card and may not be voted, the final rules require issuers and other soliciting persons to indicate that the Notice is not a form for voting.

[9] In the case of registered open-end investment companies, the SEC amended Rule 14a-16(f)(2)(iii) to permit the delivery of a summary prospectus with the Notice. This change is intended to permit registered open-end investment companies to utilize the SEC’s recent rule change to permit the use of a summary prospectus. See Rel. Nos. 33-8998, IC-28584, Enhanced Disclosure and New Prospectus Delivery Option for Registered Open-End Management Investment Companies (Jan. 13, 2009), available here.

The limits of private ordering

In June 2009, the Securities and Exchange Commission proposed to require public companies, under certain circumstances, to include in the company proxy statement and proxy card the names of director nominees submitted by substantial long-term shareholders (generally referred to as “access to the proxy” or “proxy access”). At the same time, the SEC proposed to amend Rule 14a-8(i)(8), the shareholder proposal rule’s “Election Exclusion”, to reverse a 2007 amendment and allow shareholders to submit proposals seeking the adoption of a proxy access regime. The comment period for the rulemaking expired on August 17, 2009, and the SEC received hundreds of comment letters.

Among commenters opposed to the adoption of Rule 14a-11, a common theme was that the SEC should refrain from imposing a uniform federal access procedure. Instead, these commenters urged, the SEC should facilitate private ordering to permit shareholders at each individual company to decide whether proxy access is desirable and to establish its precise contours. To that end, these commenters generally supported the SEC’s proposal to amend the Election Exclusion.

Two distinct types of private ordering were promoted in comment letters:

Opting in: The default rule would be no proxy access.

A company could opt in to a proxy access regime through

  • (a) a bylaw adopted by the board, either in response to a non-binding shareholder proposal seeking access or on its own initiative; or
  • (b) a bylaw adopted by shareholders. A proposal promoting proxy access, including a shareholder-initiated bylaw amendment, could be included in the company proxy statement—provided the SEC adopts the proposed amendment to the Election Exclusion—or it could be the subject of an independent solicitation.

Advocates of an opt-in approach pointed out that Delaware recently enacted changes to its corporate law clarifying that bylaws establishing a proxy access regime are permissible under Delaware law.

Opting out: The default rule would be proxy access established by SEC rule. A company could opt out of the access procedure if

  • (a) its shareholders approved a management proposal to opt out or
  • (b) its shareholders adopted a bylaw providing that the proxy access procedure would not apply.

In some discussions, the opt-out approach has been framed as including both opt-out and opt-in elements. In this conception, a company would be permitted to opt out of the access procedure established in Rule 14a-11; either at that time or a later time, the company could opt into a proxy access procedure of some kind, at the behest of shareholders using the shareholder proposal process or on the board’s own initiative.

Thus far, the proxy access debate has centered on the legitimacy of federal regulation on this subject, with supporters urging that the proposed access procedure is a logical extension of the SEC’s power over the proxy solicitation process and opponents arguing that the proposed rule represents too much of an incursion on states’ traditional jurisdiction over corporations’ internal affairs. Some attention has been paid to whether the virtues of an enabling approach—allowing companies to adopt a different rule from the default and thus to tailor practices to company circumstances—justify a departure from the mandatory approach seen in all other areas of U.S. securities regulation.

Missing from the discussion, however, is a systematic analysis of the feasibility of private ordering at U.S. public companies. A primary selling point of private ordering in the proxy access context is that it would ensure that the arrangement at a given company reflects the preferences of its shareholders, preferences that are informed by those shareholders’ views on whether proxy access would be value enhancing (and if it would be, the ideal terms of the procedure). Implicit in many of the comments supportive of private ordering are assumptions that shareholders can easily propose appropriate proxy access procedures at individual companies and that the shareholder voting process is free from significant distortions.

Shareholders crack the whip

"In a promising show of force by a company’s owners, three directors at Texas Industries, a construction materials maker with almost $850 million in sales, got the boot last week. Taking their seats at the boardroom table will be directors nominated by Shamrock Holdings, the money management firm best known for helping to oust Michael Eisner from his perch as chief executive of Disney.

The results of the Oct. 22 election at Texas Industries, disclosed last Tuesday, are an example of what happens when shareholders act appropriately — like the company owners that they are. Equally important, Shamrock executives say they believe their win at the company shows that shareholders are becoming increasingly willing to take on entrenched directors.

Directors, of course, have a fiduciary duty to look out for shareholders. Instead, many directors have simply served as rubber stamps for the chief executives they are supposed to be overseeing.

While no single election proves that investor attitudes are a-changing everywhere, the Texas Industries slapdown was unambiguous. More than 80 percent of the shares cast at the meeting were voted against the incumbent directors; more than 90 percent of those shares were voted for three proposals put forward by Shamrock.

One proposal required the company to submit its anti-takeover mechanism, a “poison pill,” to a shareholder vote; the other two argued that directors should be made to stand for elections annually (making it easier to oust an incompetent board member) and that directors in uncontested elections could win their seats only if they received a majority of shares in support.

Shamrock’s executives have taken the activist road for many years, and if they think shareholders are becoming more active then it’s time to cheer.

“I cannot remember where a significant corporation of this size got an 80 percent turndown from its own shareholders,” said Stanley Gold, chief executive of Shamrock. “People are beginning to think like owners.”

A LITTLE background: Texas Industries’ stock has underperformed its peers consistently over one-year, three-year and 10-year periods. Not surprisingly, its shareholders are anxious, and over the past two years a growing number of them have expressed displeasure to Texas Industries’ directors.

For example, director elections in 2007 didn’t go well for two incumbents, who received “nay” votes from one-quarter of the shares cast. At last year’s election, almost half of the votes cast were against the incumbent directors. Nevertheless, the Texas Industries board didn’t seem to “get” these messages. Indeed, when a director resigned last year, he was replaced by a former board member from a few years earlier.

After analyzing the company, Shamrock concluded that it was an undervalued asset whose prospects were stymied by arrogant and unaccountable management. The investment firm started buying the stock in the second half of 2008.

Initially, when Shamrock wrote letters to the Texas Industries directors suggesting how to change the company’s governance practices, it received no response from them. “We had a real tough time getting management to sit down and talk to us,” Mr. Gold said. “The chief financial officer finally did, and late in the game, the C.E.O. and ultimately the chairman came by. But fair to say, while the conversations were polite, they just stonewalled us.”

A spokeswoman for Texas Industries didn’t respond to two requests for an interview.

Shamrock decided to take its case to the company’s owners. In late June, the three directors it was proposing for board seats fanned out across the country, meeting with big investors and making their arguments for change. They were Marjorie L. Bowen, a former managing director of Houlihan Lokey Howard & Zukin, an investment firm; Gary L. Pechota, a former chief executive of Giant Cement Holding; and Dennis A. Johnson, a managing director at Shamrock.

Mr. Johnson said he met with two dozen investors in person and spoke by phone with others. It helped that Texas Industries shares were largely in the hands of institutional investors rather than individuals.

“Within the first three weeks I met with investors representing probably 60 percent of the shares outstanding,” Mr. Johnson said. “We pursued the proxy contest conveying our message that this is an undervalued company with a lot of potential and our assessment of what some of the solutions to this problem could be. We wound up by asking the shareholders to get on board and help effect this change with us.”

The meetings went on until the day before the Texas Industries annual meeting on Oct. 22, Mr. Johnson said. “We didn’t run across anyone who said they opposed what we were doing,” he added.

At the annual meeting, Mr. Johnson said the company let him make an eight-minute speech outlining Shamrock’s reasons for taking up the proxy fight. Nevertheless, when shareholders at the meeting asked questions of Mr. Johnson, the board didn’t allow him to answer, he said.

Once the vote was tallied, it showed that Shamrock’s message had come through loud and clear to shareholders, including public pension investors and private mutual funds. While public funds have been more willing to take up such fights, Mr. Johnson says he’s now seeing an interest among mutual funds that previously shunned the activist route.

“In the past, you had a lot of skepticism about activist investors that prevented large institutional investors from wanting to talk to you,” Mr. Johnson said. “Secondly, there was this natural conflict where a lot of institutional investors wanted to make sure they would continue to have access to management of the companies they own. But that is less the case today, and that’s why it’s very good for shareholders going forward.”

To be sure, a proxy battle like Shamrock’s is expensive and out of the reach of many investors. Mr. Gold estimated that his campaign cost roughly $1 million, adding approximately $1 a share to his firm’s cost basis in the stock.

Such costly battles illustrate why it’s crucial that shareholders be allowed to put up alternate slates of directors without having to spend millions of dollars, Mr. Gold said.

“There needs to be democratization of the boardroom,” he said. “Boardrooms will say it will be like Congress and everyone will be arguing. But capitalism is based on democracy: it is a bit messy, but it’s the best system we’ve come up with.”

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