Wednesday, July 1, 2009

SEC Proposes Shareholder Access to Director Nominations

Earlier this month, the SEC published for comment the text of the proxy access rules the Commission proposed at its May 20, 2009 open meeting, "Facilitating Shareholder Director Nominations" (the Release). This proposal would require companies, in certain conditions, to include shareholder nominees for directors in their proxy materials, and is somewhat controversial, only garnering three votes in favor of proposing it out of the five member Commission.

The Release proposes a new rule, Rule 14a-11, that if adopted would require companies to include shareholder nominees for directors in company proxy materials under a set of prescribed circumstances. The Release also proposes to amend the existing Rule 14a-8(i)(8) to allow shareholders to propose amendments to the company's governing documents to put into effect the shareholder nomination of directors contemplated in the newly proposed Rule 14a-11.

The new rule would apply to all companies filing reports with the SEC under the Securities Exchange Act of 1934 (with a few exceptions) regardless of size, and notably including investment companies.

Tiered Eligibility

In order for shareholders to seek to nominate directors, the Release proposes a minimum ownership requirement tiered according to company size:
  • 1 percent of the shares of a large accelerated filer (net assets of $700 million or more),

  • 3 percent of the shares of an accelerated filer (net assets of $75 million or more, but less than $700 million), and

  • 5 percent of the shares of a non-accelerated filer (net assets less than $75 million).
According to the Release, "the tiered beneficial ownership thresholds that [the Commission is] proposing represent an effort to balance the varying considerations and address the possibility that certain companies could be impacted disproportionately based on their size."

For investment companies, the tiered structure would be applied based on investment companies' net assets as of a specified measurement date:
Because registered investment companies are not classified as large accelerated filers, accelerated filers, and non-accelerated filers, we propose to base the tiers on the net assets of the companies.[citation omitted] In particular, we are proposing tiers for registered investment companies that are based on the worldwide market value levels used by reporting companies (other than registered investment companies) to determine filing status.[citation omitted]

Under the proposal, the amount of net assets of a registered investment company for these purposes would be the amount of net assets of the company as of the end of the company’s second fiscal quarter in the fiscal year immediately preceding the fiscal year of the meeting, as disclosed in the company’s Form N-CSR filed with the Commission, except that, for a series investment company the amount of net assets would be the company’s net assets as of June 30 of the calendar year immediately preceding the calendar year of the meeting, as disclosed in a Form 8-K filed in connection with the meeting where directors are to be elected. [citation omitted]
Though investment companies do not typically file a Form 8-K, the Commission believes it to be necessary because Form N-CSR, the fund's annual report, discloses assets by series, rather than in aggregate.

Holding Period and Aggregation of Ownership

In addition to the minimum ownership requirement, the proposed rule would require Each nominating shareholder to have held the requisite number of shares continuously for at least one year prior to the date it notifies the company of its intent to nominate a director, and must intend to hold the shares at least through the date of the annual or special meeting.

Under the proposal, shareholders who are otherwise unaffiliated would be permitted to aggregate their holdings to meet the minimum ownership threshold described above. The rule would impose no limit on the size of a nominating group, and would allow communications, filed with the SEC, for the purpose of forming a nominating group, provided they are limited in scope to the nomination of directors and do not request or solicit actual proxies. These nominating groups would still be required to report under Regulation 13D if they reach the point where they have beneficial ownership of in excess of 5% of the company's securities, however.

Limit on Number of Directors Nominated

Shareholders using the the proposed method of nominating directors could nominate the greater of:
  1. one director (for a board of seven or fewer) or

  2. up to 25 percent of the board (rounded down to the closest whole number under 25 percent).
Any additional shareholder-nominated directors may be elected through a conventional proxy contest for the same meeting.

Timing of Proposals

Shareholder nominations of directors would still be subject to the timing restrictions applicable to other proxy proposals under Rule 14a-8.

Filings and Required Disclosures

In order to use the proposed Rule 14a-11 nominating process, each nominating shareholder, including each shareholder comprising a nominating group, would be required to make a number of affirmative representations about their intentions, including:
  • the shareholder intends to hold its shares through the date of the annual meeting, as well as its intent with respect to continued ownership following the meeting (although the proposed rule is silent as to whether and how the shareholder’s lending of its shares during this period would affect either of these statements);

  • the shareholder’s nominees are in compliance with applicable objective stock exchange independence requirements;

  • neither the nominee nor the nominating shareholder has an agreement with the company regarding the nomination;

  • the shareholder is not attempting to effect a change of control (or to gain more than a minority of directors);

  • the candidate’s nomination to or initial service on the board, if elected, would not violate controlling state or federal law or applicable listing standards;and

  • the shareholder or shareholder nominating group is eligible to use Rule 14a-11 in terms of the minimum share ownership requirements.
Given the controversial nature of this wide ranging proposal, even amongst the SEC's commissioners, there will very likely be a great many comments submitted by an enormous diversity of constituencies. Because the fund industry is included in this proposal, it bears special attention from fund directors as well as management and industry service providers.

The full text of the proposing release is available at: