SEC Adopts New Rules Regarding Nominating Committee Functions and Communications Between Shareholders and Boards of Directors

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Ashley Griffith
5 years ago
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T O O U R F R I E N D S A N D C L I E N T S January 9, 2004 The SEC recently adopted new rules that require increased disclosures in proxy statements about nominating committee procedures and

1 T O O U R F R I E N D S A N D C L I E N T S January 9, 2004 The SEC recently adopted new rules that require increased disclosures in proxy statements about nominating committee procedures and communications between security holders and boards of directors. The rules became effective on January 1, 2004 and companies must comply with the new disclosure requirements in proxy or information statements that are first sent or given to security holders on or after January 1, The SEC also added a related disclosure requirement to Form 10-K and 10-Q which will require companies to describe any material changes to the procedures by which security holders recommend nominees to the company s board. The 10-K and 10-Q disclosure is applicable for the first reporting period ending after January 1, The new rules require discloses about, among other things, nominating committee charters, the independence of nominating committee members, minimum qualifications for directors, procedures for identifying directors, the source of nominations, and in some cases recommendations for directorships by 5% shareholders. The rules are part of an ongoing SEC effort to give shareholders greater understanding of and access to the nomination process. The SEC is still considering the adoption of additional, more significant rules which would require companies to include security holder nominees for election as directors in company proxy materials. Disclosures About Nominating Committees SEC rules already require proxy statements distributed in connection with the election of directors to disclose (1) whether the company has a nominating committee or other committee performing similar functions, (2) the names of the committee members, (3) the number of committee meetings held in the prior fiscal year, (4) the functions of the committee, and (5) whether the committee considers candidates recommended by security holders and the procedures to be followed in submitting nominations. Fried, Frank, Harris, Shrive & Jacobson LLP New York One New York Plaza New York, NY Washington, DC 1001 Pennsylvania Avenue, NW Washington, DC Los Angeles 350 South Grand Avenue Los Angeles, CA Paris 5,boulevard de la Tour-Maubourg Paris France Fried, Frank, Harris, Shriver & Jacobson (London) LLP 99 City Road London EC1Y 1AX United Kingdom The new rules require the following additional disclosures in proxy statements: Copyright January 9, 2004 Fried, Frank, Harris, Shriver & Jacobson LLP A Delaware Limited Liability Partnership

2 Existence of Committee. The proxy statement must disclose whether or not the company has a nominations committee. 1 If the company does not have a standing nominating committee or committee performing similar functions, the company must disclose the basis for the view of the board that it is appropriate not to have such a committee and the name of each director who participates in the consideration of director nominees. Committee Charter. If the nominating committee 2 has a charter, the proxy statement should disclose whether a current copy of the charter is available on the company s website. If the charter is on the website, the company must disclose the website address. If the charter is not on the website, the company must include a copy of the charter as an appendix to the proxy statement at least once every three fiscal years. If the charter is not on the website and is not included as an appendix to the proxy statement, the company must disclose in which of the prior fiscal years the charter was so included. If the committee does not have a charter, the company must disclose that fact. 3 Significantly, the SEC did not adopt its proposal that the proxy statement include a description of the material terms of the charter. Independence. If the company is listed on an exchange that has independence requirements for nominating committee members, the company must disclose whether the members of the nominating committee are independent (as defined by the relevant exchange). If the company is not a listed issuer, the company should disclose whether the members of the committee are independent (using any definition of independence approved by the SEC). Nonlisted issuers must use the same definition of independence for purposes of this nominating committee disclosure as they use for purposes of their disclosure about the independence of audit committee members. The SEC did not adopt its 1 The New York Stock Exchange listing standards require listed companies to have a nominating/corporate governance committee composed solely of independent directors. Nasdaq requires nominees for director to be determined, or recommended to the board for determination, either by (1) a nominations committee consisting of all independent directors or (2) a majority of the independent directors. Nasdaq would allow one member of the committee to be not independent under exceptional and limited circumstances. The NYSE and Nasdaq requirements do not apply to controlled companies. The NYSE and Nasdaq rules become effective for U.S. companies upon the first to occur of (1) the company s first annual meeting after January 15, 2004 and (2) October 15, For purposes of these disclosure requirements (other than the requirement relating to the existence of the committee itself), the term nominating committee refers not only to nominating committees and committees performing similar functions, but also to groups of directors fulfilling the role of a nominating committee, including the entire board of directors. 3 The NYSE requires the nominating/corporate governance committee to have a written charter that addresses specified topics, including an annual performance evaluation of the committee. Nasdaq requires the issuer to certify each year that it has adopted a formal written charter or board resolutions, as applicable, addressing the nominations process and such related matters as may be required under the federal securities laws. Fried, Frank, Harris, Shriver & Jacobson LLP 2 April 15, 2004

3 proposal that the company disclose whether at any time in the last fiscal year any member of the nominating committee was not independent. Policy Regarding Consideration Given to Security Holder Nominees for Director. If the nominating committee has a policy with regard to the consideration of any director candidates recommended by security holders, the company must describe the material elements of that policy, which must include at least a statement as to whether the committee will consider director candidates recommended by security holders. If the committee does not have such a policy, the company must disclose that fact and the basis for the view of the board that it is appropriate not to have such a policy. Procedures for Submitting Recommendations. If the committee will consider candidates recommended by security holders, the company must describe the procedures to be followed in submitting such recommendations. Minimum Qualifications for Directors. The company must describe any specific, minimum qualifications that the nominating committee believes must be met by a nominating committee-recommended nominee for director, and describe any specific qualities or skills that the nominating committee believes are necessary for one or more directors to possess. The SEC did not adopt its proposal that companies describe any specific standards for the overall structure and composition of their board of directors. In addition, despite suggestions from commenters, the SEC did not add a requirement that companies disclose the extent to which they take into consideration diversity, particularly race and gender, in nominating candidates. Process for Identifying Directors. The company must describe the nominating committee s process for identifying and evaluating nominees for director, including nominees recommended by security holders, and any differences in the manner in which the nominating committee evaluates nominees for director based on whether the nominee is recommended by a security holder. Source of Nominations. With respect to each nominee approved by the nominating committee (other than nominees who are executive officers or who are directors standing for re-election), the company must state which one or more of the following categories of persons or entities recommended that nominee: security holder, non-management director, CEO, other executive officer, third-party search firm or other specified source. The SEC did not adopt its proposal that the company disclose the name of each specific source of a nomination. Commenters objected that Fried, Frank, Harris, Shriver & Jacobson LLP 3 April 15, 2004

4 disclosure of specific sources could chill the search process and would be immaterial. 4 Fees Paid to Third Parties. If the company pays a fee to any third party or parties to identify or evaluate or assist in identifying or evaluating potential nominees, the company must disclose the function performed by such parties. Nominees of 5% Holders. The company must identify a director candidate and the security holder that recommended the candidate and disclose whether the nominating committee chose to nominate the candidate. This disclosure obligation is triggered only if the nominating committee received the recommendation by a date not later than the 120 th calendar day before the date of the company s proxy statement released to shareholders in connection with the prior year s annual meeting. 5 The disclosure obligation is triggered only by recommendations from a security holder that owned more than 5% of the company s voting common stock for at least one year as of the date the recommendation was made (or from a group of security holders that beneficially owned in the aggregate more than 5% of the company s voting common stock, with each of the securities used to calculate that ownership held for at least one year as of the date the recommendation was made). 6 The SEC s adopting release indicates that as of December 31, 2002, of companies listed on the NYSE, Nasdaq or Amex, 57% of the companies had at least one institutional security holder that owned 5% or more of the common equity securities and 1.4% had five or more such security holders. 4 The SEC stated in its adopting release that, in disclosing the category of persons that initially recommended a candidate, companies should ensure that they identify also any person or entity that caused a particular candidate to be recommended. For example, the SEC release stated, if the CEO asks a third party to evaluate a candidate, and the third party ultimately recommends the candidate, both the CEO and the third party should be identified as recommending parties in the company s disclosure. 5 If the date of the annual meeting has been changed by more than 30 days from the date of the previous year s meeting, the disclosure obligation will arise where the company receives the shareholder recommendation a reasonable time before the company begins to print and mail its proxy materials. 6 The percentage of securities held by a recommending shareholder, and the related holding period, may be determined by the company if the shareholder is the registered holder. If the shareholder is not the registered owner, he or she can submit to the company to evidence the required ownership percentage and holding period either (1) a written statement from the record holder verifying that, at the time the shareholder made the recommendation, he had held the required securities for at least one year, or (2) if the shareholder has filed a Schedule 13D or 13G or a Form 3, 4 or 5, reflecting ownership of the securities as of or before the date of the recommendation, a copy of the schedule and/or form, and any subsequent amendments reflecting a change in ownership, as well as a written statement that the shareholder continuously held the securities for the oneyear period. Fried, Frank, Harris, Shriver & Jacobson LLP 4 April 15, 2004

5 The company is not required to include disclosure unless it has received the written consent of both the nominator and the nominee. The shareholder or group must provide to the company, at the time of the recommendation, the written consent of all parties to be identified and, where the shareholder or group members are not registered holders, proof that the shareholder or group satisfied the required ownership percentage and holding period as of the date of the recommendation. The SEC increased its proposed threshold from 3% to 5% in response to comments. The SEC also eliminated its proposed requirement that the company disclose the specific reasons for not nominating a particular candidate (although the company would still have to identify the candidate). The SEC also added a related disclosure requirement to Form 10-Q and Form 10- K. Companies are required to describe in those forms any material changes to the procedures by which security holders may recommend nominees to the company s board, where those changes were implemented after the company last provided disclosure about the procedures for recommending nominees (which typically would be in the prior year s proxy statement). An instruction to the new rule states that adoption of procedures under which security holders may recommend nominees to the board, where the company s most recent disclosure indicated that the company did not have in place such procedures, will constitute a material change. This disclosure requirement is applicable for the first reporting period ending after January 1, Disclosures About Communications Between Security Holders and Boards of Directors The SEC s new rules also require disclosure in the proxy statement about the following items related to communications between security holders and boards of directors (the disclosure in the latter three bullet points may be provided only on a corporate website rather than the proxy statement if the proxy statement indicates a website address where the information appears): 7 Existence of Process for Communications. The company must state whether or not its board of directors provides a process for security holders to send communications to the board. If it does not, the company must state the basis for the board s view that it is appropriate not to have such a process. 8 7 The term security holder communication (1) does not include communications from an officer or director of the company, (2) includes communications from an employee or agent of the company only if they are made solely in the employee s or agent s capacity as a security holder and (3) does not include shareholder proposals submitted pursuant to Rule 14a-8 under the Securities Exchange Act of The New York Stock Exchange listing standards provide that, in order that interested parties may be able to make their concerns known to non-management directors, a company must disclose a method for such parties to communicate directly with the Fried, Frank, Harris, Shriver & Jacobson LLP 5 April 15, 2004

6 Manner of Communications. If the company has a process for security holders to send communications to the board, the company must describe the process by which security holders can send communications to the board and, if applicable, to specified individual directors. The SEC did not adopt its proposal to require companies to name those board members to whom security holders can send communications. Method of Sifting Communications. If all security holder communications are not sent directly to board members, the company must describe how it determines which communications will be relayed to the board. However, a company s process for collecting and organizing security holder communications need not be disclosed if the company s process is approved by a majority of the independent directors. Attendance at Annual Meetings. The company must describe its policy, if any, regarding board members attendance at annual meetings. The company must state the number of directors who attended the prior year s annual meeting. 9 The amendments to the proxy rules apply only to domestic companies with equity securities registered under Section 12 of the Securities Exchange Act of 1934 and to investment companies registered under the Investment Company Act. Companies which are subject to periodic reporting only by virtue of Section 15(d) such as private issuers of high yield debt are not subject to the proxy rules and, as a result, are not subject to virtually all of the new rules regarding nominating committees and shareholder communications. If you have any questions concerning this matter please do not hesitate to call your regular Fried Frank contact or any of the undersigned. New York Valerie Ford Jacob Stuart Gelfond Michael Levitt presiding director or with non-management directors as a group. The NYSE provides that this method may be analogous to the procedures used by the audit committee, pursuant to SEC and NYSE rules, to receive, retain and treat complaints regarding accounting, internal accounting controls or auditing matters. 9 The SEC did not adopt its proposal to require disclosure of any material action taken by the board during the preceding fiscal year as a result of communications from shareholders. Fried, Frank, Harris, Shriver & Jacobson LLP 6 April 15, 2004

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