SEC Staff Issues Further Guidance on the Proxy “Unbundling” Rule

The following post comes to us from Phillip R. Mills, partner in the Mergers and Acquisitions Group at Davis Polk & Wardwell LLP, and is based on a Davis Polk client memorandum. Work from the Program on Corporate Governance about bundling includes Bundling and Entrenchment by Lucian Bebchuk and Ehud Kamar, discussed on the Forum here.

The SEC’s Division of Corporation Finance recently released three Compliance and Disclosure Interpretations concerning the SEC’s so-called unbundling rule (Exchange Act Rule 14a-4(a)(3)), which requires proxies to identify clearly and impartially each “separate matter” intended to be acted upon.

Nearly a year ago, in Greenlight Capital, L.P. v. Apple, Inc., a federal court enjoined Apple from bundling four charter amendments into a single proposal. The Apple decision highlighted the lack of clarity in the unbundling rules and the risk that the SEC or an activist shareholder could challenge a company’s presentation of proposals. The new C&DIs provide bright-line guidance for amendments to equity incentive plans but leave other situations to be considered on a facts-and-circumstances basis and, implicitly, to be discussed with the SEC Staff in cases of uncertainty.

Two new concepts will need to be addressed going forward:

  • Matters that are “inextricably intertwined,” such as the basic financial terms of a series of preferred stock, may be bundled, even if they are “material.” How to interpret this phrase outside of the context of the terms of a single security is not clear.
  • Consistent with past practice, a single, material matter may be presented with a number of immaterial matters. However, a new C&DI qualifies this with the concept that companies should unbundle any immaterial matter that management “knows or has reason to believe” is “one on which shareholders could reasonably be expected to wish to express” a separate view on, even though it “does not substantively affect shareholder rights.” This guidance may have been issued in response to the situation in Apple in which the proposed elimination of blank check preferred stock, which would have had the effect of limiting board discretion rather than having any impact on shareholder rights, was nonetheless required by the court to be unbundled because it was known that an activist shareholder was publicly proposing the issuance of a dividend in the form of preferred stock. Companies will thus have to consider not just whether a matter is material in the ordinary sense of the term, but also whether there are circumstances known to it suggesting that a particular shareholder or shareholders may want to express a view on the matter.

Specifically, the new C&DIs provide that:

  • Multiple amendments to an equity incentive plan may be presented as one matter and do not need to be unbundled. This is the case even if each of the changes are “material” and the rules of a national securities exchange would require shareholder approval of each of the changes if presented on a standalone basis. See Question 101.03.
  • Multiple, material matters that are so “inextricably intertwined” that they effectively constitute a single matter may be presented as one matter and do not need to be unbundled. The Staff does not define “inextricably intertwined” but provides, by way of example, that charter amendments regarding a series of preferred stock that (i) reduces the dividend rate and (ii) extends the maturity date may be presented in a single charter amendment because each of the proposed changes “relates to a basic financial term” for the preferred stock and was “the sole consideration” for the other. However, the C&DI provides that multiple matters will not be viewed as being “inextricably intertwined” merely because they were negotiated as part of the same transaction or because they were viewed as “essential to the overall bargain.” See Question 101.01.
  • A single, “material” matter may be presented with a number of “immaterial matters.” The Staff notes that while there is no bright-line definition for materiality, one consideration will be whether a given matter “substantively affects shareholder rights.” By way of example, the Staff would not ordinarily object to the bundling of a proposal to declassify the board (which it considers material) with amendments to change the par value of the common stock and eliminate provisions relating to a series of preferred stock that is no longer outstanding and is not subject to further issuance (both of which it considers immaterial). On the other hand, the declassification proposal could not be bundled with a proposal to permit shareholders representing 40% of the company’s outstanding stock to call special meetings since the Staff would view both matters as material. Also, if management “knows or has reason to believe” that a particular amendment is one on which shareholders “could reasonably be expected” to express a separate view from one of the other amendments (even if it does not substantively affect shareholder rights), the proposal should be unbundled. See Question 101.02.

The Staff also reiterated that state law rules will not govern whether a proposal must be unbundled under Rule 14a-4(a)(3) and referred to its prior guidance in the September 2004 Interim Supplement to the publicly available telephone interpretations for the application of the unbundling rules in the M&A context. Also, as before, even if proposals are unbundled, the rules do not prohibit companies from conditioning the approval of matters on one another.

For more information, see the full text of the Exchange Act Rule 14a-4(a)(3): Division of Corporation Finance Compliance and Disclosure Interpretations.

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