SEC Approves Proxy Access

On August 25, 2010, the SEC voted to approve rules to allow shareholders access to a company's proxy, so-called "proxy access." For many years, proxy access was debated but no action was taken. Only until the recent enactment of the Dodd-Frank Act could the SEC take final action on the subject. By a 3-2 vote, the Commission passed the new rule which will go into effect in 2011 for most companies. The following highlights are from the new rule:

• Proxy access will be available to a shareholder or group of shareholders who own, and have continually owned at least three percent of the company's voting stock for three continual years or more. If a shareholder owns more than three percent of the company's stock, the shareholder need not hold the additional shares for that same period to qualify for access to the proxy.
• Shareholders may combine their shares to form a group to achieve the threshold.  However, shareholders cannot borrow stock to achieve these thresholds.  Shareholders who have lent stock may count it toward the threshold as long as the lending shareholder has the right to recall the stock and will do so if the company includes the shareholders' nominee in the proxy.
• A nominating shareholder or group of shareholders must provide a statement as to the intent to hold the qualifying minimum amount of shares through the date of the annual meeting. The nominating shareholder or shareholders will also be required to disclose their intent to continue ownership of the shares after the director elections. The shareholder should not be holding the company's securities with the purpose, or with the effect, of changing control of the company.
• A company is required to include no more than one shareholder nominee or the number of nominees that represents 25 percent of the company's board, whichever is greater.
• The nominating shareholder or each member of the nominating shareholder group are required to provide a representation that the shareholder nominee meets the objective criteria for "independence" of the national securities exchange or national securities association rules applicable to the company.
• If the board determines that a nominee is not qualified, it can ask the SEC to issue a "no action letter" to permit the company to exclude the nominee.
• Smaller reporting companies will be subject to the new proxy rule but implementation will be deferred for three years. The delay is intended to allow smaller companies to evaluate the rule in larger companies and provide additional time for the SEC to make adjustments. A smaller reporting company is an issuer that is not an investment company, an asset-backed issuer, or a majority-owned subsidiary of a parent that is not a smaller reporting company and that had a public float of less than $75 million.
• The rule amends Rule 14a-8 permitting shareholders to establish proxy access on their own by voting on resolutions to amend bylaws, as long as those conditions do not contradict the federal rule.
• Importantly, a nominating shareholder or group must disclose under a separate disclosure (Schedule 14N) whether, to the best of their knowledge, the nominating shareholder's or group's nominee meets the company's director qualifications, if any, as set forth in the company's governing documents.

The Future of the U.S. Proxy Voting System

On July 14, the SEC announced its decision to review the proxy voting system. This system, which the SEC refers to as "proxy plumbing," addresses current concerns in a "concept release." The SEC's concept release is intended to generate solutions with regards to three areas of concern in the U.S. proxy voting system: enhancing the accuracy, transparency, and efficiency of the voting process; improving shareholder communications and increasing shareholder participation; and determining whether voting power is aligned with economic interest.

The concept release provides an overview of the proxy voting process, and what the SEC and others see as current flaws in the system. The release does not offer specific rule proposals; rather, it lists possible regulatory solutions and asks interested parties to comment on the feasibility of the suggestions.

In the first section of the release, the SEC notes several impediments to the accuracy, transparency, and efficiency of the voting process. These problems include over-voting and under-voting, the inability of investors to confirm the accuracy and receipt of votes, the lack of information regarding shareholder meeting agendas and topics, and concerns over the fee structure for delivering proxy materials. Generally, the SEC's proposed solutions rely on increased disclosures to improve the voting system. For example, granting shareholder and security intermediaries access to issuer voting records could help solve the inability to confirm vote receipts. In a second possible solution, securities exchange rules would be revised to require dissemination of shareholder meeting agendas and topics in advance of the meeting date.

The SEC also attempts to tackle the lack of communication and participation of retail shareholders. Retail investor participation in proxy voting has historically been low.¹ The SEC highlights three areas in need of possible improvement: issuer communication with shareholders, lack of investor participation, and an inability to collect data from proxy statements and other documents. There are a variety of proposed remedies to these problems, including eliminating the OBO/NOBO distinction, improving investor education websites, and/or requiring data in proxy statements to be "tagged" using XBRL.

Finally, the SEC addresses issues where voting power may not align with the economic interests of the company. As an example, the SEC specifically highlights the role of proxy advisory firms in the proxy voting process. Concerns are raised due to possible conflicts of interest, lack of competition, lack of accuracy in voting recommendations, and lack of regulatory oversight. The SEC seeks to improve these issues, with solutions focused on clarifying or revising current regulations and increasing the transparency of the formulation of their voting recommendations.

The SEC's concept release offers both a laundry list of problems as well as many broad solutions. Essentially, this encourages an open discussion on the future of the proxy voting system. Investors, corporations, and others are encouraged to participate and offer their best advice. Changes to the voting system will not occur until some time next year and there will be further opportunities to comment. NACD will keep the director community informed as changes occur.

See "Briefing Paper: Roundtable on Proxy Voting Mechanics," (May 24, 2007).

New Developments at the SEC

At a meeting of the Society of Corporate Secretaries and Governance Professionals, SEC Chairman Mary Schapiro spoke about the agency’s role in the new economic environment. She stressed the need for greater transparency in company filings and explained that her staff is working on updating disclosure requirements, and acknowledged that one possible revision may address risk disclosure requirements.

Chairman Schapiro also commented on corporate governance saying, “the SEC’s job is not to define for the market what constitutes “good” or “bad” governance, in a one-size-fits-all approach.” She emphasized the SEC’s role in promoting effective communication and accountability among shareholders, owners, directors, and executives. With this in mind, she cited the recent proxy enhancement provisions related to director qualifications and oversight of risk.

The SEC is also prepared to release a new proposal related to another proxy initiative – the voting infrastructure (referred to as “proxy plumbing” within the SEC). The proposal, or “concept release,” is scheduled to be released on July 14. This concept release has been hinted at by SEC commissioners over the past few months but very few details have been released.

For more from SEC Chairman Schapiro’s speech please click here.

The Dodd-Frank Wall Street Reform and Consumer Protection Act

The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law on July 21, 2010. The Act includes major reforms to consumer protections, trading restrictions for big banks, and the regulation of financial products. The Act also contains significant new provisions in corporate governance. These governance provisions are listed below.

Summary of Corporate Governance and Executive Compensation Provisions

Say-on-Pay: Shareholders must have a nonbinding advisory vote on executive compensation (say-on-pay) every one, two, or three years. At least once every six years, effective at the first annual shareholder meeting after enactment of this bill, shareholders must vote to hold this advisory proxy vote every one, two, or three years.

Shareholder Approval of Golden Parachutes: In any proxy or consent solicitation material in which the shareholders are asked to approve M&A activity, the company must disclose any and all compensation (including the total value) expected to be paid to executive officers based on the proposed M&A activity. This proxy must also include a non-binding shareholder vote to approve the compensation agreements. The SEC may exempt small companies from these provisions if it finds these provisions to be disproportionately burdensome.

Independent Compensation Committees: All companies listed on a national securities exchange must have a fully independent compensation committee in which all members of the committee are considered independent. The securities exchanges will set the guidelines for determining independence. The consultants selected by the compensation committees must be independent as well. The exchanges may choose to exempt companies from this requirement based on size and other factors.

Increased Compensation Disclosures: Disclosure of executive compensation must be accompanied in the proxy by a discussion of the relationship between compensation already paid and the financial performance of the company. Companies must also disclose the median annual compensation of all employees of a company, excluding the CEO, the total annual compensation of the CEO, and the ratio between the two.

Clawbacks: If a company is required to file an accounting restatement due to the material noncompliance with a financial reporting requirement, the company must recover all incentive-based compensation related to the incorrect statement paid to current or former executives within the three-year period before the restatement.

Employee or Director Hedging: Proxy materials must disclose whether any employee or board member of the company holds or was granted, any financial instrument to hedge against a decrease in the value of the company.

Increased Compensation Oversight for the Financial Industry: Financial institutions must disclose all incentive-based compensation of their employees. Federal regulators can enact regulations or guidelines to prohibit any types of such incentives that they consider excessive, or that could lead to financial loss to the institution.

Elimination of Broker Voting: A broker is prohibited from voting a proxy for director elections, executive compensation, or any other significant matter without instructions from the beneficial owner.

Proxy Access: The SEC is given the authority to create rules determining procedures pertaining to proxy access. The SEC may exempt small issuers from proxy access.

Board Leadership Structure Disclosures: Companies must disclose and explain their choice of board leadership structure, and whether the CEO/chair position is combined or separated.