Proxy Access Bylaw Developments and Trends

The significant success of shareholder proxy access proposals this year is likely to result in even more shareholder proposals for proxy access in the 2016 proxy season. As of August 13, 2015, 82 shareholder proxy access proposals have come to a vote in 2015, and 48 have passed. In many cases, shareholder proposals were approved despite a pre-existing bylaw (most often adopted after the receipt of the shareholder proposal) or a conflicting proposal by the company with modestly more restrictive terms. The average vote in favor of all proposals was 54.4%, and ISS recommended for all shareholder proxy access proposals.

This post summarizes developments in the area of proxy access, including an analysis of the record of company responses to shareholder proxy access proposals received during 2015 (with further detail set forth in Annex A of the complete publication). Those companies that receive a proxy access shareholder proposal or that are evaluating preemptive adoption of a proxy access provision will want to consider the appropriate terms and requirements. In all cases, as a matter of preparedness, companies should be aware of options to respond to potential shareholder proxy access proposals. For more information regarding shareholder proposals generally, our 2015 Proxy Season Review (discussed on the Forum here), which we distributed on July 20, details the results of these proposals during the 2015 proxy seasons.

As a threshold matter, we emphasize that the practical consequences of adopting proxy access remain unclear. Although a small number of proxy access bylaws have been in existence for a couple of years (four provisions predated 2011), we are not aware of any proxy access nominees to date. More importantly, in the area of activist campaigns for board seats, we do not believe proxy access is likely to play a significant role. Activist investors are unlikely to use proxy access for several reasons. First, like now-vacated Rule 14a-11, proxy access bylaws require that the nominating shareholders be passive investors without the intent to influence the control of the company. Many activist investors will not meet this passivity requirement. Second, proxy access bylaws require the nominating shareholders to meet a three-year holding period. Such a holding period is inconsistent with some activist investors’ historical investment periods. Proxy access bylaws restrict the number of nominations generally to 20-25% of the board, and activist proxy contests are often for more seats. Finally, activists who threaten or wage proxy contests are unlikely to use proxy access (even if they could meet the passivity requirement) because the solicitation efforts that can be undertaken as part of a traditional proxy contest provide substantially greater flexibility and a greater likelihood of success and the cost is generally not substantial compared to the investment made in the issuer. [1] Other potential nominating shareholders may be deterred as well.

Depending on the market value of the issuer and the concentration of holdings, it may be difficult to accumulate sufficient shares in a “group” to nominate an individual without requiring compliance with the proxy rules—Rule 14a-2(b)(7), which exempts solicitations to form a nominating group, only applies to Rule 14a-11 nominations. [2] Potential nominating shareholders also may be concerned about the possible loss of 13G eligibility, or the potential formation of a 13D group. [3] Individuals may be reluctant to serve as proxy access nominees—in the typical activist situation, the nominated individual can rely on the activist undertaking substantial effort and expense to win the proxy contest, whereas efforts for a proxy access nominee would by their very nature likely be more limited. In addition, activist nominees generally receive indemnification agreements from the activist, which may or may not be provided to proxy access nominees in the future. We do expect, over time, that shareholders will make some use of proxy access, but we see no evidence that its use will become routine or widespread. It is also possible that the SEC may revise some of the ancillary rules adopted together with Rule 14a-11, to provide comparable exemptions for nominations and solicitation activities pursuant to proxy access bylaws, or consider no-action relief, eliminating some impediments to proxy access utilization.

Key Proxy Access Terms and the Emergence of Market Trends

The appropriate terms of a proxy access bylaw will differ from company to company and proxy access bylaws as a whole are still relatively new. However, trends are beginning to develop for certain key terms. To assist companies in the process of considering their own proxy access provisions, we analyze below a summary of key terms that have been adopted by public companies thus far. Attached to the complete publication as Annex B is a sample form of proxy access bylaw that companies can use as a starting point in crafting their own bylaw, whether to be adopted proactively, as a competing or substantially implementing proposal, in negotiations with a proponent, or following a successful shareholder proposal.

1. Ownership threshold and holding period for making a nomination. All shareholder proposals in 2015 have proposed a 3% ownership threshold, which was the threshold in Rule 14a-11. [4] Of the 35 proxy access bylaws adopted after 2010, 25 have had a 3% ownership threshold, and ten have had a 5% ownership threshold. Of the 15 most recent adoptions (only one of which was in response to a successful shareholder proposal), 14 have been at the 3% threshold. The only exception is SBA Communications Corporation, which adopted a 5% bylaw after its non-binding management proposal at that level defeated a 3% shareholder proposal. All proxy access proposals and almost all bylaws have a continuous three-year holding period requirement, which was also the holding requirement in Rule 14a-11 (a limited number of earlier bylaws contain a shorter period).
2. Formation of shareholder groups. Only four bylaws (three of which were adopted before 2014) do not address the use of shareholder groups to reach the ownership threshold. Of the remaining 35, 21 permit a group of 20 holders, one permits a group of 15, seven permit a group of 10, one permits a group of five and five have no limit on the number of group participants. Of the 15 most recent adoptions, eleven were at 20, one each at 15 and 10, one did not permit groups, and one had no limit. A subset of bylaws provides that funds or companies under common management constitute one person. In its policy survey disseminated August 4, 2015, ISS asked whether a group limit of less than 20 adopted after a successful shareholder proposal should be considered non-responsive and potentially warrant withheld or against votes for directors. [5] In its Proxy Access: Best Practices publication (discussed on the Forum here), the Council of Institutional Investors (“CII”) noted it does not endorse a limit on the number of shareholders in the nominating group. Generally, proxy access bylaws provide that shareholders cannot be in more than one nominating group.
3. Maximum number of nominees. Companies should consider the maximum number of access nominees eligible for nomination to the board. Ignoring pre-2011 bylaws, 25 issuers have a 20% maximum, nine have a 25% maximum, and one bylaw provides for only one proxy access director. Of the most recent 15 adoptions, eleven were at 20% and four at 25%. CII opposes a limitation that would prevent shareholders from nominating at least two candidates. Most shareholder proposals provide for a 25% maximum.
4. Definition of owners. All post-2010 bylaws require that the ownership position has full economic and voting rights, as did Rule 14a-11, and excludes borrowed shares and shares subject to options, derivative or similar agreements. Although the instructions to Rule 14a-11 specifically provided that loaned stock would be considered continuously owned if the nominating stockholder had the right to recall the loaned stock and did so upon notification that its nominees would be included in the proxy statement, most bylaws do not address loaned stock. Ten issuers, including GE, Microsoft, Prudential, Bank of America, Broadridge and Merck, however, do provide that loaned stock is considered owned as long as it is recallable, and, in some cases, recalled. If stock loans are not addressed, the lending of stock may cause a break in “ownership” because in a typical stock loan both voting and dispositive rights pass to the borrower. CII has publicly stated that loaned securities should be counted towards the ownership threshold if the participant has the right to recall those securities for voting purposes and will vote the securities at the meeting, as well as representing it will hold those securities through the date of the annual meeting.
5. Deadline for notice. Proxy access bylaws vary widely on this point. Most advance notice (as opposed to proxy access) bylaws require notice to be delivered 90-120 days prior to the anniversary of the prior year’s annual meeting date. The deadline for shareholder proposals under Rule 14a-8 is 120 days prior to the anniversary of the date of the issuer’s proxy statement for the prior year, and the window provided in vacated Rule 14a-11 was 120-150 days prior to the anniversary of the date the registrant mailed its proxy statement in the prior year. Rule 14a-18 provides that a shareholder nominating a proxy access nominee under the issuer’s governing documents must provide notice on a Schedule 14N by the date specified in the registrant’s advance notice provision, or if no such date is in place, no later than 120 days before the anniversary of the mailing of the issuer’s proxy materials in the prior year.
   • Of the 35 bylaws adopted after 2010, 17 have the same window provided by Rule 14a-11—120-150 days prior to the anniversary of the mailing of the prior year’s proxy statement. Five issuers have the 14a-8 deadline, which is effectively the same deadline as the prior 17, but with no window. Another seven issuers have a window of 120-150 days prior to the anniversary of the prior year’s annual meeting. Only ten issuers have the same deadline for proxy access as they do for nominations under their advance notice bylaw.
   • In considering a required notice period, there are at least four issues that should be considered. First, issuers typically need more time than the advance notice deadline of 90-120 days prior to mailing because of the time required for reviewing and confirming the information provided (because material inaccuracies are generally a ground for exclusion in proxy access bylaws) and potentially engaging in discussions with the nominating stockholder or nominee. Second, a window ensures that the issuer is not receiving proposals throughout the year. Third, extending the general advance notice deadline to the proxy access deadline or window could result in a determination by ISS that this is a unilateral bylaw amendment resulting in a negative board recommendation—ISS specifically referred to increasing advance notice requirements in its 2016 policy survey. Fourth, if the general advance notice deadline is different from the proxy access deadline, it may be desirable to avoid any ambiguity of what constitutes an “advance notice provision” under Rule 14a-18 and to amend the advance notice bylaw to reflect the separate deadline (or window) applicable to proxy access nominations. [6]
6. Treatment of incumbent access directors. Companies should consider whether incumbent directors who were access nominees should count against the maximum number of nominees for a number of years after their election, to prevent the board from having an incentive not to renominate them. This type of provision has been adopted by about slightly more than one-third of public companies who provide for proxy access. Similarly, five companies have restricted shareholders from nominating further nominees for a period of two years if that shareholder has a prior successful access nominee currently serving on the board
7. Nominee eligibility. Proxy access bylaws include a number of eligibility standards for access nominees, including independence under relevant stock exchange standards, lack of affiliation with competitors, no criminal convictions, no violation of law or stock exchange requirements caused by the nomination and not providing materially inaccurate information. Fourteen companies permit the exclusion of nominees who have compensation arrangements with third parties for serving as a director of the issuer—although ISS has specifically questioned in its 2016 policy survey whether this provision should be considered nonresponsive. CII believes “limiting the pool of eligible board candidates by excluding those who receive candidacy fees would be an unduly onerous requirement”—it is unclear whether a “candidacy fee” would include all forms of third party director compensation.
8. Required information with respect to nominating shareholders and nominee. A company’s bylaws may require submission of reasonable information about the candidate and the nominating party, similar to what is called for by typical advance notice provisions. In this regard, it should be noted that the SEC’s Schedule 14N, which was adopted in conjunction with Rule 14a-11, remains in effect and would apply in the case of a nomination under a company proxy access bylaw. The company bylaw should be drafted to work in conjunction with Schedule 14N. Careful attention should be given to what information, in addition to existing advance notice provisions and Schedule 14N is really necessary, given ISS’s question in its current policy survey as to whether such additional disclosure requirements may be “nonresponsive.”
9. Repeat nominee eligibility restrictions. Although the exclusion of candidates who received below a specified threshold of support (usually 25%) of votes cast in a previous annual meeting appears to be a universal provision, ISS has queried in its policy survey if this should be considered “nonresponsive” and CII opposes restrictions on renominations as a result of receiving a prior low vote.
10. Other limitations. A company may determine to place reasonable limitations on the use of proxy access, including making it unavailable where a shareholder has provided a notice of a nomination under the advance notice bylaw—28 bylaws have such a provision (although in six instances proxy access is disallowed only if the number of non-proxy access candidates exceeds a certain number). Most companies have explicitly prevented a nominating shareholder from distributing a separate proxy card or from participating in solicitations for other candidates.

These and other considerations are addressed in the form of proxy access bylaw attached as Annex B to the complete publication.

Company Responses To Proxy Access Proposals

During the 2015 proxy season, companies employed a variety of strategies in response to shareholder proxy access proposals. To assist companies in evaluating the appropriate strategy, we have outlined below the most frequent forms of response and included as Annex A to the complete publication a more detailed summary of the results for companies which have adopted each respective response.

• No Company Action. For companies that allowed the shareholder proposal to come to a vote, but simply suggested shareholders vote against it, the shareholder proposal passed (> 50% support) 57% of the time.

• Company Offered Competing Proposal. Some companies have allowed the shareholder proposal (typically a 3% ownership threshold) to come to a vote while also offering their own company proposal (typically a 5% ownership threshold). These proposals often varied in other key terms as well. This response had mixed results and the company proposals passed approximately half of the time (in one instance, both the company and the shareholder proposal failed). In most instances, these company proposals were non-binding and covered the same provisions as the competing shareholder proposal did. This appears to be a superior approach to putting the full bylaw up for a vote. Presenting a detailed bylaw could engender a negative reaction from some shareholders in contrast to the simpler shareholder proposal and, should the company proposal lose, it would be very difficult for the company to determine exactly which provisions shareholders were voting against.

• Preemptive Adoption. Nine companies chose to adopt their own proxy access bylaw prior to the annual meeting and saw mixed results. At these companies, four shareholder proposals were passed and five failed.

• Intent Announcement. Four companies announced an intent to adopt their own proxy access proposal. In three of these cases, the shareholder proposal passed despite the intent announcement from the company, and in the fourth case the vote in favor was 49.4%.

• Management Supported Shareholder Proposal. At two companies, the company supported the shareholder proposal and in a third instance, the board took no position (although it detailed a number of governance factors for shareholders to consider), and in those three cases, the shareholder proposal passed with overwhelming support.

• No Action Sought for Substantial Implementation. General Electric was able to exclude a proxy access proposal on the basis of substantial implementation. [7]

Next Steps

The advisability of proactively adopting a proxy access provision will vary from company to company. Relatively few companies have done so to date, and trends are still evolving. In addition, as of today, most of the issuers who saw successful shareholder proposals have not yet implemented a proxy access bylaw. Accordingly, as of today there seems to be no compelling reason to adopt a proxy access bylaw proactively, although that could change, depending on a number of factors, including market practice, the development of more detailed, and restrictive, shareholder proposals, or the adoption of a particularly narrow view by ISS of which provisions would be considered “responsive.” There are, however, a number of concrete steps that are advisable to take now.

• Review Shareholder Profile. Issuers should review their shareholder profile with their proxy solicitor to determine the likelihood of success if a shareholder proxy access proposal is made. It should be assumed, however, consistent with most governance trends, that the support of institutional shareholders for proxy access will grow over time.
• Consideration of Potential Terms. Consideration of what terms would be appropriate, and preparing potential bylaws, is advisable at this stage. Proxy access bylaws are complicated and should be tailored to fit with existing bylaw provisions as well as a company’s particular situation. Becoming familiar with the mechanics and evaluating terms will allow companies to respond quickly as trends become clearer or if a proposal is received. Although shareholder proposals were not excluded on the basis of conflicting with management proposals this year, [8] GE was able to exclude a proposal on the basis of substantial implementation. Depending, in particular, on what limitations ISS determines to impose on “responsiveness” following its policy survey, which should be announced in November, it may be preferable to adopt a proxy access provision and seek to exclude the shareholder proposal as substantially implemented, or to structure a competing non-binding proposal, in order to have greater flexibility in crafting the other provisions in the proxy access bylaw. Depending on who proposes proxy access provisions next year, it may also be possible to successfully negotiate an acceptable outcome as well. All these actions are more easily undertaken with a bylaw considered in advance.
• Board Preparation. As a part of an issuer’s general review with its Board of proxy season developments, the Board should be informed about developing proxy access trends, and the potential advantages and disadvantages of the various strategies relating to proxy access. Again, a prepared Board will allow companies to respond quickly.

The complete publication, including Annexes, is available here.

Endnotes:

[1] Most proxy access bylaws do not prohibit additional solicitation efforts for that nominee, other than requiring the use of the issuer’s proxy card and in some cases the filing of all soliciting material with the SEC, whether or not required by the proxy rules. However, there are a number of restrictions that limit shareholder solicitation efforts in connection with using proxy access. First, virtually all proxy access bylaws have a 500-word limitation on proponent statements to be included in the proxy statement, as did Rule 14a-11 (which provided for 500 words for each nominee). Second, the exemption for solicitation efforts by a nominating stockholder or group for its nominee contained in Rule 14a-2(b)(8) is limited to nominations under now-vacated Rule 14a-11 (and in response to comments the SEC declined to expand it to nominations pursuant to a corporation’s governing documents). Third, many proxy access bylaws prohibit proceeding under both proxy access and the advance notice provisions in the bylaws. Finally, the exemption under Rule 14a-2(b)(1) (where no authorization or revocation is furnished or requested) is unavailable unless the nominating stockholder takes the improbable position that it is not acting on behalf of its nominee.
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[2] The SEC rejected comments that the exemption under Rule 14a-2(b)(7) also cover formation of a group under a company’s governing documents, because “[g]iven the range of possible criteria companies and/or shareholders could establish for nominations, we continue to believe it would not be appropriate to extend the exemption to those circumstances.” The adopting release noted that in forming a nominating group, shareholders would also have the option to structure their solicitations under the exemptions for solicitations of no more than 10 shareholders (Rule 14a-2(b)(2)) and for certain communications that take place in an electronic shareholder forum (Rule 14a-2(b)(6)).
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[3] The exception for director nominations to the passive investor requirements of Rule 13d-1(b)(1)(i) applies only to nominations under Rule 14a-11. Here again the SEC declined to extend the exception to nominations under a company’s governing documents because of the differing criteria that could be adopted, noting instead that Schedule 13G eligibility would be a fact-specific inquiry. In the adopting release, the SEC noted “nominating shareholders will need to consider whether they have formed a group under Exchange Act Section 13(d)(3) and Rule 13d-5(b)(1)….”
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[4] Data throughout this post is based on information from ISS and FactSet Shark Repellent, as well as our own selective review of public filings.
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[5] The 2016 ISS policy survey can be accessed at: http://www.issgovernance.com/iss-releases-annual-policy-survey.
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[6] Because Rule 14a-18 provides that Schedule 14N is to be provided to the registrant by the date specified in the registrant’s advance notice provision, absent including a proxy access deadline in the advance notice provision, there could be an ambiguity as to which deadline prevails for purposes of filing Schedule 14N. Existing advance notice provisions should generally be carefully reviewed to ensure there are not inconsistencies with proxy access bylaws.
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[7] The General Electric no-action letter and related correspondence is available at: http://www.sec.gov/divisions/corpfin/cf-noaction/14a-8/2015/kevinmaharrecon030315-14a8.pdf.
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[8] For a discussion of the SEC staff’s decision, and the announcement by SEC Chair White that spurred it, see our publication, dated January 16, 2015, entitled “SEC Staff Suspends No-Action Relief on Conflicting Shareholder Proposals.” Chair White has indicated that the goal with respect to this issue “is to provid[e] clarity for next year’s proxy season.” See SEC Chair White Speech, available at: http://www.sec.gov/news/speech/building-meaningful-communication-and-engagement-with-shareholde.html (and discussed on the Forum here).
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