The SEC’s Proposed Universal Proxy Rule: Beneficial to Shareholders or Tilting the Result toward Activist Investors?
Under current law and practice, a shareholder of a public company that is asked to vote in a contested election of directors where a slate of directors had been proposed by the company and an activist investor would likely receive two competing proxy cards from the company and the activist that asks the shareholders to vote for the nominees presented:
Company Proxy Card Activist Proxy Card
Company Nominee A Activist Nominee D
Company Nominee B Activist Nominee E
Company Nominee C Activist Nominee F
It is entirely possible after reviewing the biographies of all of the director nominees that a shareholder would want to split her vote amongst the nominees from the two camps– for instance Company Nominees A and C and Activist Nominee E. However, the shareholder is not offered this choice and cannot submit both proxy cards because one or both cards would likely be invalidated since a subsequent proxy card revokes a former proxy card under state law. The shareholder could achieve her goal by attending the shareholder meeting and voting in person but in many circumstances that is not feasible.
The Securities and Exchange Commission would like to solve the shareholder’s dilemma through its proposed amendments to the proxy rules to require the use of a universal proxy card that would require all of the nominees in a contested election to be listed on a single proxy card. The proposed rules also would require disclosure about voting options and voting standards in all contested director elections – including elections involving partial and full slates of directors.
In sentiments echoed by Chairman Mary Jo White and Commission Kara Stein, representatives of the Division of Corporation Finance at the October 26th open meeting where the proposed rules were considered indicated that the proposed changes to the proxy rules are intended to address the disparity in voting experience between shareholders voting in-person at a shareholder meeting and shareholders voting by proxy.
However, as the Commission and its staff noted at the open meeting, few shareholders attend meetings in person and the primary means of voting occur through the proxy process. As such, despite the expressed goal of facilitating “shareholder democracy,” the mechanics and application of a mandatory universal proxy rule could embolden activist investors and special interest groups, encourage additional proxy contests, and alter the landscape of corporate governance in favor of shareholder activists.
The use of universal proxy card will be mandatory in all contested elections of directors. The staff of the Division of Corporate Finance indicated that the mandatory aspect of the proposed rules is intended to prevent parties to a contested election from selecting the use of a universal proxy card only where it provided a tactical advantage to the party electing that option.
Bona Fide Nominees
Under the current proxy rules, shareholders voting by proxy are generally required to vote for nominees included on either the company or dissident proxy card and do not have the opportunity to select candidates from both groups. The use of a universal ballot is permitted in a proxy contest only in the uncommon circumstance in which the opposing parties have consented to the other party’s nominees being named in the proxy statement and to serve if elected (in compliance with the “bona fide nominee” rule in Exchange Act Rule 14a-4(d)(1)). Since the required consent is rarely given, the bifurcated system is most common in proxy contests.
The proposed rules would alter the definition of a “bona fide nominee” in Rule 14a-4(d) to include a person who agrees to be named in any proxy statement relating to a company’s next meeting of shareholders at which directors are to be elected. The amendment would enable parties to include all director nominees on their universal proxy cards.
Under the proposed rules, parties to a proxy contest must notify each other of their respective director nominees. Dissidents would be required to provide such notice no later than 60 calendar days prior to the anniversary of the previous year’s annual meeting date while the company would be required to provide the dissident with the names of the nominees no later than 50 calendar days prior to the anniversary of the previous year’s annual meeting date.
In addition, under the rules, dissidents would be required to file their definitive proxy statement with the Commission by the later of 25 calendar days prior to the meeting date or five calendar days after the registrant files its definitive proxy statement.
Dissidents would be required to solicit shareholders representing at least a majority of the voting power of shares entitled to vote on the election of directors.
In voicing his opposition to a mandatory universal proxy rule at the open meeting, Commissioner Michael Piwowar noted that the rules require dissidents to only solicit a majority of shareholders entitled to vote, not all shareholders. In drawing this distinction, Commissioner Piwowar highlighted that individual retail shareholders would be the most-likely group to be exempted from the solicitation process and noted that these disenfranchised shareholders would be required to navigate the SEC’s EDGAR filing system to find information relating to a proxy contest. Both points served to underscore the proposed rule’s focus on large shareholder groups at the expense of retail investors.
Changes to Proxy Card Requirements
To address various ambiguities and errors in the descriptions of voting standards and requirements for director elections in proxy materials, the proposed rules also mandate specific changes to the voting options on the proxy card and the disclosure in the proxy statement. In particular, under the proposed amendments to Rule 14a-4(b), proxy cards would be required to include an “against” voting option for the election of directors when there is a legal effect to a vote against a nominee and to provide shareholders the ability to “abstain” in a director election governed by a majority voting standard. The proposed change would eliminate the current ability to provide a “withhold” voting option when an “against” vote has legal effect. In addition, the proposed amendments to Item 21(b) of Schedule 14A would require disclosure about the effect of a “withhold” vote in an election of directors.
It is easy to imagine a scenario in which a shareholder will mistakenly vote for more nominees then the number of directors to be elected, less than the number of nominees to be elected or merely signs the proxy card and not designate any directors. The SEC’s solution to this is to have the proxy card prominently disclose the treatment and effect of a proxy executed in the foregoing manner although it omits any specific guidance on the precise disclosure that the staff expects to see to address this potential area of confusion.
Effect of the Proposed Rules
In the Economic Analysis section of the proposed rules, the SEC offers little in the way of concrete predictions regarding the effect of the proposed rules on contested elections. The SEC notes that registrants expecting a universal proxy to result in more dissident nominees being elected may incur additional costs due to increased outreach to shareholders to in an effort to mitigate support for dissident nominees. The SEC believes the effect of the universal proxy are uncertain because it is difficult to predict the extent or direction of any changes in voting behavior as a result of the proposed amendments and to evaluate whether any resulting changes in the members of the board will lead to more or less or less effective board oversight. The SEC states any changes in voting behavior due to universal proxies are most likely to affect election outcomes that would otherwise have been very close. The SEC also believes that the election of mixed boards (those where the registrant’s and dissident nominees are elected) would be somewhat more likely under the proposed rules than current rules. We expect each of these conclusions to be hotly debated over the forthcoming comment period.
The Commission will seek public comment on the proposed rules over the next 60 days. Like similar attempts to implement a formal proxy access rulemaking, the proposed universal proxy rules are expected to generate numerous comments given the high-profile debate and possible divisive consequences of final rules. How the Commission will reflect this debate in the final version of its universal proxy rule remains to be seen.
Both opponents and supporters of universal proxy should also take note of the possibility that enactment of a final rule may be taken out of the Commission’s hands, altogether. Actions taken in July 2016 by the U.S. House of Representatives added language to a spending bill for the fiscal year beginning October 1 that would explicitly bar the SEC from implementing a finalized universal ballot rule.