SEC Dramatically Changes the Rules for Proxy Contests

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Kai Liekefett, Derek Zaba, and Beth Berg are partners at Sidley Austin LLP. This post is based on their Sidley memorandum. Related research from the Program on Corporate Governance includes Universal Proxies by Scott Hirst (discussed on the Forum here).

On November 17, 2021, the U.S. Securities and Exchange Commission (SEC) adopted new Rule 14a-19 and amendments to existing rules under the Securities Exchange Act of 1934 to require the use of “universal” proxy cards in all nonexempt director election contests at publicly traded companies in the U.S. The new “Universal Proxy Rules” contain only slight modifications from rules the SEC first proposed in October 2016, for which the SEC reopened the public comment period during 2021. The rules will take effect for shareholder meetings after August 31, 2022. We expect a significant increase in proxy contest threats once the Universal Proxy Rules go in effect.

Members of Sidley’s Shareholder Activism & Corporate Defense Practice sent a formal comment letter to the SEC regarding the proposed rules — the only letter from a U.S. law firm suggesting material amendments that would protect against the potential for misuse of a mandatory universal proxy system. As we argued previously, the Universal Proxy Rules create the equivalent of “proxy access on steroids.” While comparable to the vacated Rule 14a-11, which allowed shareholders holding at least 3% of a company’s outstanding shares for three years to put dissident directors on the company’s proxy statement, the Universal Proxy Rules confer substantially more significant rights to shareholders without any minimum ownership requirements (i.e., owning only one share for one minute will be sufficient). Although this was a concern voiced by several Commissioners, the SEC proceeded with the adoption of the Universal Proxy Rules as originally proposed. The new rules will reshape the process by which hostile bidders, activist hedge funds, social and environmental activists, and other dissident shareholders may utilize director elections to influence control and policy at public companies.

As the rules will dramatically change the methods by which proxy contests at public companies have been conducted for decades, this article summarizes the principal mechanics of the Universal Proxy Rules and the implications of the rules for public companies.

Background and Existing Rules

The central feature of a contested corporate election is that shareholders are asked to vote, or give voting instructions by proxy, for two competing slates of director nominees: a company slate assembled by the board of directors and a “dissident slate” assembled by one or more dissident shareholders. [1]

Under existing SEC rules, shareholders are not able to give voting instructions picking selectively from the company and the dissident proxy cards unless they attend and vote at a shareholder meeting virtually or in person. Shareholders voting by proxy have been limited, instead, to giving voting instructions on the “company proxy card,” for or against the company’s nominees, or on the “dissident proxy card,” for or against the dissident nominees and, in the case of “short slates,” additionally for and against any company nominees supported by the dissident. [2] Under the existing system, the company and dissident shareholder disseminate to shareholders both their own separate proxy statements and their own separate proxy cards that feature their distinct slates. [3]

Overview of the Universal Proxy Rules

Under the new, mandatory universal proxy card system, a proxy card will have to include both the company nominees and the dissident nominees. Shareholders will be able to give voting instructions in favor of any combination of properly nominated candidates they choose, up to the number of authorized seats for election at the meeting. The Universal Proxy Rules will become effective for shareholder meetings after August 22, 2022.

The following discussion summarizes the principal components of the rules.

1. Required Use of Universal Proxy Cards in All Contested Elections

The Universal Proxy Rules require use of a universal proxy card by both the company and the dissident shareholder soliciting proxies in all nonexempt director election contests involving companies with a class of securities registered under Section 12 of the Exchange Act. [4]

Any proxy card used in director election contests must contain options to give voting instructions for any of the candidates nominated by the company and any dissident shareholder. If the dissident has nominated a full slate of dissident candidates, the universal proxy card may permit shareholders to grant voting authority for either all company nominees or all dissident nominees, as a group. Otherwise, the universal proxy card must give shareholders the ability to grant voting authority to any combination of nominees they select from both the company and dissident slates.

The rules also include presentation, formatting, and disclosure requirements for universal proxy cards. Universal proxy cards must

• clearly distinguish between the company’s director nominees, the dissident’s nominees (and among the nominees of multiple dissidents, if any), and nominees pursuant to proxy access;
• list nominees in alphabetical order by last name within each group (i.e., the company slate and the dissident slate);
• present all nominees in the same font type, style, and size;
• prominently disclose the maximum number of nominees for which authority to vote can be granted; and
• prominently disclose the treatment and effect of a proxy executed in a manner that grants authority to vote for more nominees than the number of directors being elected (either granting authority to vote for fewer nominees than the number of directors being elected or not granting authority to vote with respect to any nominees).

The Universal Proxy Rules do not require the company and dissident to use identical cards but only that their respective universal proxy cards adhere to the same ground rules summarized above. Notably, the company and dissident are each permitted to provide their distinct proxy voting recommendations on their proxy cards; they can list the company nominees before the dissident nominees and vice versa; and can they can choose different colors for their proxy cards.

2. Nomination Notices and Filing Deadline for Proxy Statements

Rule 14a-19 includes new and specific requirements for companies and other persons soliciting proxies for director nominees. Dissidents who fail to comply with these requirements are prohibited from using the universal proxy card and continuing with their solicitation of proxies.

Notice of Nominees: The company and the dissident must provide timely notices to each other in connection with proxy contests:

• The dissident must provide notice to the company of the names of all dissident nominees for whom it intends to solicit proxies at least 60 calendar days prior to the anniversary of the prior year’s annual meeting, unless this information has previously been provided in a preliminary or definitive proxy statement filed by the dissident.
• The company must provide notice to the same dissident shareholder furnishing the names of all nominees for whom the company intends to solicit proxies at least 50 calendar days prior to the anniversary of the prior year’s annual meeting.

If no annual meeting was held in the prior year or the date of the annual meeting has been changed by more than 30 calendar days from the prior year, the notice deadline is changed to (i) for the company, 50 calendar days prior to the date of the annual meeting and (ii) for the dissident, the later of 60 calendar days prior to the date of the annual meeting or the 10 th calendar day following the first public announcement of the date of the annual meeting. Under a new Rule 14a-5(e)(4), a company must disclose in its annual proxy statement the deadline for shareholders to give timely notice to the company of dissident nominations for inclusion on a universal proxy card in connection with the next annual meeting.

The dissident must also provide prompt notice to the company of any change in the names of its director nominees. If there is a change in the dissident’s nominees after the registrant has disseminated a universal proxy card, the registrant could elect, but would not be required, to disseminate a new universal proxy card reflecting the change in dissident nominees.

A dissident shareholder’s obligation to comply with the notice requirement under Rule 14a-19 is in addition to its obligation to comply with any advance notice provisions in a company’s governing documents that provide more specific requirements regarding the timing and content of a dissident shareholder’s notice of director nominations.

Filing Deadline: The dissident must file a definitive proxy statement by the later of (i) 25 calendar days prior to the date of the election meeting and (ii) five calendar days after the date that the company files its definitive proxy statement.

Scope of Solicitation: The dissident must solicit the holders of shares representing at least 67% [5] of the voting power of shares entitled to vote on the election of directors and include a statement to that effect in its proxy statement. However, as the SEC made clear, a dissident may choose to use the less costly e-proxy delivery method (i.e., the “notice and access” method of mailing a notice of internet availability and posting the proxy materials on a website) should it desire.

3. Revision of Bona Fide Nominee Rule and Elimination of the Short Slate Rule

Under existing Rule 14a-4(d)(1) under the Exchange Act, shareholders voting by proxy in contested elections have been limited in their choice of nominees by the “bona fide nominee” rule, which provides that no proxy card can confer authority to vote for any director nominee who has not “consented to being named” in the applicable proxy statement and to serve if elected. In practice, company candidates have rarely consented to being named in the dissident proxy statement, and dissident candidates have rarely consented to being named in the company proxy statement. As the existing bona fide nominee rule was incompatible with the adoption of a mandatory universal proxy card system, the Universal Proxy Rules amend the rule to permit proxy cards to confer voting authority for nominees who consent to be named in any proxy statement relating to the election meeting.

Rule 14a-4(d)(4), the “short slate rule,” permits a dissident shareholder seeking to elect a minority of dissident candidates to the board to “round out” its slate by soliciting from shareholders their proxy authority to vote for some of the company’s nominees through the dissident card. As the short slate rule is unnecessary in a mandatory universal proxy card system, the Universal Proxy Rules eliminate the rule altogether.

4. Other Amendments Relating to Universal Proxy Cards

The Universal Proxy Rules are designed to allow that universal proxy cards can be used while still permitting the company and dissident to create and disseminate their own individualized proxy statements. To this end, the new rules contain the following features:

• The company and the dissident will each be required to include a statement in its respective proxy statement referring shareholders to the other party’s proxy statement for information about such other party’s director nominees. This rule is a new Item 7(h) of Schedule 14A.
• Under the amended Rule 14a-5(c), the company and dissident will be able to satisfy certain disclosure obligations by referring information that is already, or will be, furnished by another party in its proxy statement. Currently, as written, Rule 14a-5(c) permits parties to refer to information that has been previously furnished, but in a universal proxy system this could prevent a company from relying on Rule 14a-5(c) to omit required information by referencing the dissident proxy statement where the dissident proxy statement is still to be filed. The new rules therefore amend Rule 14a-5(c) to clarify that a party can rely on the rule to reference information that is reasonably expected to be filed in an upcoming proxy statement of the other party. [6]
• The new rules also require a company to disclose in its annual proxy statement the deadline for shareholders to give timely notice to the company of dissident nominations for inclusion on a universal proxy card in connection with the next annual meeting. This change is being made through a new Rule 14a-5(e)(4).

5. Miscellaneous Amendments Relating to Director Elections

The SEC has also used this rulemaking opportunity to adopt amendments to existing proxy rules with respect to voting options for director elections, unrelated to the universal proxy card regime.

Voting options for director elections and the effects of these options differ based on the applicable voting standards established under state law and a company’s governing documents. As a result, director elections may be subject to one of many different voting standards, including, primarily, the plurality, majority of votes cast, and “majority of shares present and entitled to vote” standards. The plurality standard allows shareholders to give voting instructions “for” and to “withhold” votes from candidates, but it generally does not allow shareholders to “abstain”; the majority standards allow shareholders to giving voting instructions “for” and “against” candidates or to “abstain” but typically do not allow shareholders to “withhold” votes. The effect of “against,” “withhold,” and “abstain” options vary depending on the voting standard, applicable law, and the company’s organizational documents.

While the federal proxy rules do not govern the voting standards used in director elections, the new rules amend Rule 14a-4 and Item 21(b) of Schedule 14A to reduce ambiguities and inaccuracies in companies’ disclosure by requiring

• inclusion of an “against” voting option for director elections where there is a legal effect to such vote;
• inclusion of an “abstain” option for director elections where a majority voting standard applies; and
• disclosure regarding the effect of a “withhold” vote on director elections in the proxy statement.

Conclusions and Guidance for Public Companies

We provide the following practical guidance for consideration:

• Boards of directors may expect dissident shareholders to use the availability of the universal proxy card — and the uncertainty it creates — as an additional source of leverage when they make demands to, and negotiate with, boards. It is currently unknown whether the new regime will give dissidents new advantages at the ballot box. Public advocates of shareholder activism have, however, championed the adoption of the new rules. Their enthusiasm may reflect a premonition that the universal proxy card will afford dissidents with additional leverage when negotiating with boards and ultimately allow them to place more dissident candidates on boards through negotiations and proxy contests.
• The Universal Proxy Rules constitute a seismic shift in the regulatory regime governing proxy contests at public companies, but the new rules contain few guardrails to protect against misuse. Unlike comparable rules previously adopted by the SEC, the new rules provide no barrier to entry in the way of fixing a minimum amount or duration for stock ownership. They provide no meaningful consequences for shareholders that initiate a proxy contest insincerely, causing a company to expend resources but without the intent follow through. To the extent a company has not been thoroughly evaluating its shareholder activism preparedness and defenses outside of the proxy season, the coming year is a good time to start.
• Advance notice bylaws — which impose requirements on dissident shareholders to provide information about themselves and their candidates in advance of the dissemination of proxy statements — have become all the more important as a means of obtaining information regarding dissidents and their nominees, including the intentions of dissidents. To help ensure the quality of dissident director candidates and to protect a company and its shareholders from misuse of annual elections and proxy machinery, a company’s advance notice bylaws should be thorough and designed in the interest of obtaining information a company needs to vet director candidates before they are nominated and elected to a board of directors. Advance notice bylaws have long been enforced by state courts. The Delaware Court of Chancery in Rosenbaum v. CytoDyn recently validated their function and importance, a case argued and won by Sidley attorneys. [7]
• Public companies should review the applicability of the Universal Proxy Rules to their peacetime disclosure requirements. The new rules require, among other things, that a company disclose in its annual proxy statement the deadline for shareholders to give timely notice to the company of dissident nominations for the next annual meeting and that a company include specific disclosures concerning its voting standards. For most companies with a fiscal year ending December 31, 2021, this new required disclosure must be included in the proxy statement for their 2023 annual meeting (i.e., the first shareholder meeting held after August 31, 2022).
• If faced with dissident nominations in the coming year, it will be especially important for companies to comply with the Universal Proxy Rules applicable to their disclosures and solicitation process. The SEC is likely to be vigilant with respect to proxy materials in contested elections in the upcoming proxy seasons because of the new rules. Consulting with counsel experienced in proxy contests will smooth the path to clearing SEC review and other regulatory barriers and soliciting proxies quickly and efficiently.

Endnotes

1 In the current (and outgoing) system, while the company always nominates a number of director candidates equal to the number of available seats for election, a dissident shareholder may nominate either the same number of “dissident candidates” (a “full slate”) or fewer dissident candidates (a “short slate”) and then “round out” its slate, up to the number of available seats, by indicating which of the company’s nominees the dissident shareholder will additionally support at the election upon receipt of proxies from shareholders. Pursuant to technicalities under the federal proxy rules, a dissident proxy card offering a short slate states which company nominees the dissident will not vote for upon receipt of shareholder proxies, thereby indirectly indicating which of the company’s nominees the dissident will vote for upon receipt of shareholder proxies.(go back)

2 Depending on applicable voting standards, shareholders may be given the option to “withhold” votes on the director candidates as opposed to the option to vote “against” director candidates. See below under “Miscellaneous Amendments Relating to Director Elections.”(go back)

3 Under the current proxy rules, companies and dissident shareholders are permitted to instead use universal proxy cards, as are further described below, on their own volition. In practice, such use has only occurred in two recent proxy contests (Sandridge Energy Inc. in 2018 and EQT Corporation in 2019).(go back)

4 The universal proxy system is not mandatory for a dissident’s consent solicitation to remove existing company directors and does not apply to director elections at registered investment companies or business development companies. In its proposing release, the SEC opined that consent solicitations, although related to the election of directors, do not raise the same concerns that mandatory universal proxy cards are intended to address because shareholders would have access to a consent card that reflects all of their voting options for the removal and appointment of directors to fill the vacancies, if any, created by the removal of directors. Funds and business development companies will remain subject to the federal proxy rules currently in effect.(go back)

5 The SEC originally contemplated a mere majority threshold, but the threshold was increased to 67% in the final rulemaking.(go back)

6 This change in effect codifies how Rule 14a-5(c) has been applied in recent years, as dissident preliminary proxy statements periodically clear SEC review while relying on Rule 14a-5(c) to incorporate information from a forthcoming proxy statement of a company.(go back)