Proxy Access Bylaw Developments And Trends by Sullivan & Cromwell
Introduction
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 memorandum 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). 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, 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 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.
- 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).
- 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, 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.
- 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.
- Definition of ownership. 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.
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