Davis Polk & Wardwell Newsflash

SEC Proposes Rule to Allow 1% Shareholders (or a Group of Shareholders holding 1%) to Nominate Directors at Large Companies

May 20, 2009

In response to a public outcry over compensation and other practices and a call for accountability in the current financial crisis, a sharply divided Commission today proposed amendments that would permit shareholders owning a specified percentage of a public company’s shares to nominate a limited number of board directors on the company’s proxy statement.  SEC Chairman Mary L. Schapiro proposed the amendments over the objection of Republican Commissioners, Kathleen L. Casey and Troy A. Paredes, in an attempt to resolve the so-called “proxy access” debate that began decades ago.

While the text of the proposed rule has not yet been released, based on the discussion at the SEC’s open meeting today, a proposed new Rule 14a-11 would permit a shareholder (or a group of shareholders) of a company that is a large accelerated filer owning an aggregate of at least 1% of the company’s stock entitled to vote in a director election, to nominate up to 25% of the company’s board or one nominee, whichever is greater.  (For example, if a board has three members, a shareholder could nominate one director.  If the board has eight members, a shareholder could nominate up to two directors.) For smaller companies, shareholders that own a higher threshold of shares (at least 3% for accelerated filers and 5% for non-accelerated filers) will also be able to nominate directors on the company’s proxy. The proposed rule would apply to all reporting companies, including investment companies.

In all cases, the nominating shareholder(s) would have to certify that it has held its shares for more than a year, declare its intent to continue to own its shares through the meeting date and certify that it is not seeking to change control of the company or gain more than minority representation.  The proposed rule would also require additional disclosure on the shareholder proponent(s) and the nominee(s), similar to the disclosure required in a proxy contest.  The proponent(s) would also be liable for any false or misleading statements in any disclosure provided to the company for inclusion in the proxy statement.

If the company receives proposals nominating more than 25% of the company’s board or one nominee, whichever is greater, the new rule would require the company to include nominees proposed by the shareholder or group that first provides timely notice, which would consequently precipitate a race to file.  The new rule would also provide an exemption for those shareholders who formed a group for purposes of meeting the 1%, 3% or 5% threshold, as applicable, to clarify that those shareholders would not lose Schedule 13G eligibility solely as a result of making the nomination.

Currently, any shareholder proposal that “relates to an election” may be excluded under Rule 14a-8.  The new rule would amend Rule 14a-8(i)(8) to require companies to include shareholder proposals in their proxy materials that would amend the company’s governing documents to address the company’s nomination procedures or other nomination disclosure provisions, provided they do not conflict with the Commission’s proposed Rule 14a-11, described above.

The SEC’s action today revives the debate regarding the appropriateness of a federally mandated shareholder access rule.  Indeed, both Commissioners Casey and Paredes raised their concerns at the meeting, questioning the SEC’s authority to adopt rules mandating a company’s corporate affairs, an area that they believe is typically within the province of states.  In its presentation today, the SEC’s staff stated that under the proposed rule, certain shareholders would be able to include their nominees for director in the company’s proxy materials “unless the shareholders are otherwise prohibited — either by applicable state law or a company’s charter/bylaws — from nominating a candidate for election as a director.”  We believe this exception would be an extremely narrow one with little applicability.  In addition, the new rule would apply even if a company already has a competing proxy access bylaw in place, according to Brian Breheny, Deputy Director in the Division of Corporation Finance.  Thus, the current proposal, if adopted, would effectively trump any shareholder access bylaw already adopted by a company (or its shareholders) pursuant to state law, since, according to Breheny, a shareholder of a company that already has a proxy access bylaw in place would be able to avail itself of the proposed rule, even if the federal rule has a lower ownership threshold than the company’s.

The proposed rule will now be open to a customary public comment period.  While it is unclear what form the final rule (if adopted) will take, in light of the momentum provided by the current market crisis and Chairman Schapiro’s mandate to “ensure that shareholders have a meaningful opportunity to . . . nominate directors,” it is becoming increasingly likely that some form of proxy access amendment will be adopted.

We based this summary on oral discussions at the SEC’s open meeting today.  The text of the proposed rule has not yet been released.

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If you have any questions regarding this newsflash, please contact any of the lawyers listed below or your regular Davis Polk contact.

George R. Bason, Jr., Partner
212-450-4340 | george.bason@dpw.com

Louis L. Goldberg, Partner
212-450-4539 | louis.goldberg@dpw.com

Mutya Fonte Harsch, Associate
212-450-4289 | mutya.harsch@dpw.com


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