Originally appeared in Kaye Scholer's Spring 2016 M&A and Corporate Governance Newsletter.
—by Nicholas O'Keefe and Michael Isaacs
The SEC publicly released 18 no-action letters on February 12, 2016, relating to proxy access proposals under Rule 14a-8. The SEC granted no-action relief for 15 of the proposals on the basis that the companies had substantially implemented the proposals pursuant to Rule 14a-8(i)(10). These no-action letters provide a blueprint for getting no-action relief on proxy access proposals during the 2016 proxy season.
» Click here to read more articles from our latest M&A and Corporate Governance Newsletter.Proxy access refers to the right of shareholders to put forward directors for election at an annual shareholders’ meeting using management’s proxy statement and proxy card. The SEC attempted to mandate proxy access for public companies in an amendment to the proxy rules that was adopted in 2010. The SEC’s proxy access rules were challenged by the Business Roundtable and Chamber of Commerce of the United States of America (Business Roundtable), and struck down by the US Court of Appeals for the District of Columbia
Circuit in 2011. As a result, the market has fallen back to a system of “private ordering,” in which shareholders have pressured companies to adopt bylaw amendments that provide for proxy access.
Proxy Access Broke Through in 2015
Proxy access became the big story during the 2015 proxy season, in part due to two developments. The first was a campaign launched by New York City Comptroller Scott Stringer (Comptroller’s Office) on behalf of the New York City pension funds (NYC Funds). In November 2014, Mr. Stringer and the NYC Funds started the “Boardroom Accountability Project” as a way of promoting proxy access. In collaboration with a number of other city, state and union pension funds, the Comptroller’s Office filed proxy access proposals with 75 companies. According to the ISS Preliminary 2015 U.S. Postseason Review, as of the date of the review, this represented about 65 percent of the proxy access proposal submissions for 2015.
A second development was the SEC’s reversal on exclusion of proxy access proposals on the basis of a direct conflict with a management proposal under Rule 14a-8(i)(9). In December 2014, the SEC granted Whole Foods’ no-action request to exclude a proxy access proposal submitted by James McRitchie. On a petition for a rehearing from McRitchie and under pressure from the institutional investor community, the SEC issued a statement about six weeks later announcing that it would suspend no-action decisions under Rule 14a-8(i)(9) during the 2015 proxy season pending a review of that rule. On October 22, 2015, the SEC issued Staff Legal Bulletin No. 14H (SLB 14H), which sets forth a very narrow basis for exclusion under Rule 14a-8(i)(9). According to SLB 14H, a shareholder proposal can only be excluded under Rule 14a-8(i)(9) “if a reasonable shareholder could not logically vote in favor of both proposals, i.e., a vote for one proposal is tantamount to a vote against the other proposal.” The SEC explained, by way of illustration, that a shareholder proposal that provided for proxy access for shareholders holding at least three percent of the outstanding shares for at least three years would not be excludable due to a conflict with a management proposal that provided for proxy access for shareholders holding at least five percent of the outstanding shares for at least five years because a reasonable investor could still logically vote in favor of both proposals. As a result of SLB 14H, it became significantly more difficult to exclude proxy access proposals under Rule 14a-8(i)(9).
Proxy Access Is Big in 2016
Initial indications are that there are even more proxy access proposals in 2016 than there were in 2015. In January 2016, the Comptroller’s Office announced that the number of companies that had adopted proxy access bylaws had increased from six, in November 2014, to 115. Touting the success of the Boardroom Accountability Project, the Comptroller’s Office announced that the Comptroller’s Office had filed 72 new proxy access proposals.
Individual investors (notably John Chevedden, James McRitchie, and William and Kenneth Steiner) appear to have been prolific in filing proxy access proposals during the 2016 proxy season. For example, of the 18 proxy access no-action letters published by the SEC on February 12, 16 related to proposals filed by these individuals. Moreover, the individuals appear to be more rigid than the NYC Funds in their views of what constitutes an acceptable proxy access bylaw, and appear not to be satisfied with bylaws that do not precisely conform to the criteria deemed by the Council of Institutional Investors (CII) to constitute best practices. Thus, the individual investors appear more likely than the Comptroller’s Office to file proxy access proposals at companies that have already implemented proxy access (as was the case with McRitchie’s proposal at Apple’s 2016 annual meeting).
Blueprint for Substantial Implementation
Proxy access bylaws typically contain minimum share ownership and holding periods for nominating shareholders, and other qualifying and process-related provisions. For example, Chevedden’s form proxy access proposal, which conforms to the CII criteria, includes the following:
- The nominating shareholder must have owned three percent or more of the company’s outstanding shares of common stock, including recallable loaned stock, continuously for at least three years; and
- The number of shareholder-nominated candidates should not exceed one quarter of the directors then serving or two, whichever is greater.
Consistent with the CII criteria, Chevedden opposes provisions in proxy access bylaws such as limits on the number of shareholders that can be aggregated in order to satisfy the three percent limit, and restrictions on re-nominations when a nominee fails to receive a specific percentage of votes.
In the three letters of February 12 for which the SEC denied no-action relief, the companies had implemented a five percent ownership threshold. In the 15 letters for which the SEC granted no-action relief, the companies had implemented a three percent ownership threshold. In all cases, the requisite holding period was three years. A three percent ownership threshold and a three-year holding period appear to be the most important requirements for getting no-action relief on the basis of substantial implementation. (This ownership threshold and reporting period are also consistent with those contained in the SEC’s vacated proxy access rule.) Minor deviations from other CII criteria did not preclude no-action relief in several situations. For example, companies were granted no-action relief notwithstanding having shareholder aggregation limits of 20, or candidate limits equal to the greater of two candidates and 20 percent of the directors then serving (instead of CII’s limit of 25 percent).
Considerations for Unilaterally Implementing Proxy Access
The 18 no-action letters provide clear guidance on what companies need to do in order to get no-action relief to exclude proxy access proposals. But what are some of the considerations for companies that follow that guidance by unilaterally implementing proxy access bylaws?
Proxy access now has significant support among the institutional shareholder community. Many of the large institutional shareholders have publicly issued policies regarding proxy access. The proxy solicitation firms have a lot of data regarding the institutions’ voting records. ISS and Glass Lewis (which many of the smaller institutional shareholders defer to) generally support proxy access proposals that conform to the CII criteria. For companies without significant institutional ownership, this may not be a concern. For others, depending on the shareholder base, trying to defeat a proxy access proposal may elicit an investor backlash.
Even if successful in defeating a proxy access proposal, some companies may find the success to be short-lived. The Comptroller’s Office and the individual investors have shown a willingness to engage in repeat campaigns at companies that have defeated their proposals.
Resisting a proxy access proposal may also be viewed negatively by institutional investors that support it.
Losing a proxy access vote may be worse than unilaterally implementing a proxy access bylaw in order to get no-action relief. There is the time, effort and expense spent on a losing endeavor, and the lost ability of the company to position itself as being proactively responsive to shareholder concerns. In addition, companies may lose flexibility when implementing a proxy access proposal after losing the vote compared to substantially implementing a proxy access proposal in order to avoid a vote. ISS will evaluate a board’s response to a majority-supported shareholder proposal for proxy access, and may recommend against individual directors, members of the nominating/governance committee or the entire board, if the implemented bylaw amendment deviates from the shareholder proposal in ways that ISS considers significant. Similarly, Glass Lewis will consider recommending a vote against a member of the governance committee following a board failure to sufficiently implement a shareholder proposal that was supported by a majority of votes cast.
Will Proxy Access Bylaws Lead to a Surge of Nominees?
Proxy access bylaws are typically drafted to preclude nominations by shareholders who have the intent to change or influence control, or otherwise engage in proxy solicitations other than the solicitation of proxies in support of their nominees. So they are unlikely to be used by hedge fund activists. Large institutional investors, like State Street, Blackrock, Vanguard and Fidelity, do not have a history of proposing candidates for boards, and so are unlikely to become active users of
proxy access bylaws. Many smaller institutional investors will simply not have the resources or systems in place to start nominating directors. The concern expressed most often in the issuer community, and raised by the Business Roundtable in its litigation with the SEC, is that proxy access may be misused by union pension funds, government pension funds and other institutional investors with special interests. Presumably these institutions will exercise self-restraint in the immediate future, because widespread tales of misuse would be likely to harm their agenda of having proxy access broadly implemented. When they do start nominating candidates, it will create a new type of proxy contest. Time will tell how adept the government and union pension funds and other special interest groups will become at nominating director candidates and generating sufficient support among the broader shareholder base to prevail in these contests.
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