Executive Overview

The SEC has issued final rules that amend proxy statement and periodic report requirements to enhance disclosure regarding a company’s process for director nominations and shareholder communications with board members. 

Effective Date

Companies must comply with these disclosure requirements in their first proxy statement mailed on or after January 1, 2004, and in their Forms 10-Q and 10-K for the first reporting period ending after January 1, 2004. For a copy of the final rules, see http://www.sec.gov/rules/final/33-8340.htm. Note – these effective dates are earlier than the effective dates for similar disclosure requirements under the New York Stock Exchanges recently finalized corporate governance standards.

These rules do not address the much more controversial issue of giving shareholders direct access to a company’s proxy statement for promoting their own nominees, which is the subject of a separate rule proposal that the SEC issued in October of this year. Recent SEC staff statements have indicated that the timing for finalizing such shareholder access rules is, at the earliest, February 2004.

Disclosure Regarding Nomination Process

The final rules add new Item 7(d)(2) to Schedule 14A. A company’s proxy statement must disclose whether the company has a standing nominating committee or another committee that performs similar functions. If the company has no such committee, it must state the reasons for that decision and the names of the directors who participate in considering board nominees. The company must disclose:

  • whether the committee has a charter and, if it does, the company must either post the charter on its website (giving its website address), or attach it to its proxy statement at least once every three years;
  • whether the members of the committee are independent pursuant to the listing standards applicable to the company (if the company is not listed, it must choose one definition of independence as established by a national securities exchange or association and disclose whether the members of the committee are independent under that standard);
  • the material elements of any policy on the consideration of director candidates recommended by shareholders, including a statement as to whether the committee will consider director candidates so recommended and, if the committee does not have such a policy, a statement of that fact and the basis for the board’s view as to why it does not have such a policy;
  • any procedures governing shareholder submission of director nominees. In addition, material changes to these procedures must be disclosed in the company’s Form 10-Q or 10-K, depending on the quarter in which the changes were made, pursuant to new Item 401(j) of Regulation S-K. Adoption of such procedures, where the company previously disclosed that it had none, constitutes a material change;
  • the process for identifying and evaluating nominees and any differences in the evaluation process if the nominee is recommended by a shareholder; any specific, minimum qualifications that the committee believes must be met by a nominee and any specific qualities or skills that the committee believes are necessary for one or more of the company’s directors to possess; for each nominee approved by the committee for inclusion on the company’s proxy card (other than a nominee who is an executive officer or standing for re-election), state which one or more of the following categories of persons or entities recommended that nominee: shareholder, non-management director, chief executive officer, other executive officer, third-party search firm or another, specified source; and
  • if the company pays a fee to one or more third parties to identify, evaluate or assist in identifying or evaluating potential nominees, disclose the function performed by such third-party or parties.

One of the more significant new disclosure requirements is the requirement that if a company’s nominating committee receives, at least 120 days before the anniversary of the prior year’s release of the proxy statement, a director recommendation from a shareholder or group of shareholders who have beneficially owned more than 5% of the company’s voting common stock for at least one year as of the date of the recommendation, and if both the candidates and the recommending shareholder or shareholder group provide their consent at the time of the recommendation, the company must disclose:

  • the name of the candidate and of the shareholder or shareholder group that made the recommendation; and
  • whether the company chose to include the candidate on its proxy card.

The 5% share ownership threshold was increased from the originally proposed 3%, and the SEC elected not to require that a company disclose the reasons why it decided not to nominate any rejected candidate.

Disclosure Regarding Shareholder Communications With the Board

The final rules add new Item 7(h) of Schedule 14A, which requires a company to disclose in its proxy statement the process by which shareholders may send communications to the board. If the company does not have such a process, it must disclose the specific basis for that decision. If the company has a process for shareholder communications, it must disclose:

  • how shareholders can send communications to the board, and, if applicable, to specified individual directors; and
  • if all shareholder communications are not sent directly to board members, the company’s process for determining which communications will be relayed to directors; however, the company’s process for collecting and organizing shareholder communications need not be disclosed if it has been approved by a majority of the independent directors.

The company must also describe any policy regarding board members’ attendance at annual meetings and state the number of board members who attended the prior year’s meeting. These disclosures relating to shareholder communications with the board and annual meeting attendance, other than disclosure of whether the board provides a communication process and if not, why not, may be made on the company’s website rather than in its proxy statement. If that election is made, the proxy statement must reference the web address where shareholders may find the disclosures.

Copyright 2004 Gardner Carton & Douglas

This article is not intended as legal advice, which may often turn on specific facts. Readers should seek specific legal advice before acting with regard to the subjects mentioned here.