Chapter 7
| Jurisdiction | United States |
Proxy Solicitation
Prior to the enactment of the Exchange Act in 1934, state corporate laws authorized open-ended proxy solicitations of shareholders by corporate management in order to obtain nearly limitless authority to manage the corporations without the shareholders even knowing what they were voting for or against. In effect, this practice gave management a "rubber stamp" over any matters on which the shareholders might be asked to vote.
To rectify this problem, Section 14(a) of the Exchange Act prohibits solicitation of any proxy, consent, or authorization in respect of any security registered with the SEC in violation of any rules or regulations promulgated by the SEC. In addition, Section 14 prohibits any bank or other fiduciary from giving or refraining from giving, in violation of rules and regulations promulgated by the SEC, a proxy or consent in respect of any registered security and "carried for the account of a customer." That section also requires the promulgation of certain required information to holders of record of registered securities in connection with proxy solicitations.
The SEC's Proxy Regulation Regime
Under the authority granted under Section 14(a), the SEC has created an elaborate regime to regulate proxy solicitations by registered companies. The goal was to improve what is sometimes referred to as "corporate democracy," a struggle that still continues today. Rule 14a-3(a), perhaps the most important part of the SEC's regime, requires any person who solicits a proxy from public shareholders to file with the SEC and to distribute to shareholders specified information in a document known as a "proxy statement." Rule 14a-9 prohibits any false or misleading proxy statements. It is not clear whether this is a strict liability statute (most courts have said no), whether there is a scienter requirement for liability, or whether negligence is sufficient. There is also no express private right of action, although the Borak1 case found that federal courts have the power to grant all necessary remedial relief, without deciding what should be done in that particular case.
Proxy Statements
Required proxy statements must contain information about the corporation, the background of all director nominees (if election of directors is an object of the proxy solicitation), management's compensation and conflicts of interest, and any other matter being voted on. If the vote is for directors, every shareholder must receive a copy of the corporation's most recent annual report containing information about the company's direction, operations, and current financial information. Interestingly, this may be the only federal or state law that explicitly requires such periodic communications with shareholders. Under Rule 14a-12, participants may make both written and oral communications to shareholders prior to the filing of a proxy statement, provided that all such written communications are filed with the SEC on the date of their first use, that no proxy card is furnished to the shareholders, that the shareholders are advised of the identity of the participants and their interests, and that they are advised to read the proxy statement when it is filed. However, no proxies may be sought before a proxy statement is filed.
Rule 14a-9 also provides that no solicitation may be made by means of a proxy statement that, at the time and under the circumstances under which it is made, is false or misleading with respect to any material fact or which omits to state any material fact necessary in order to make the statements contained therein not false or misleading or necessary to correct any statement in any earlier communication with respect to the solicitation of a proxy for the same meeting or subject matter that has become false or misleading.
Proxy Cards
Under Rule 14a-4, proxy cards sent to shareholders must specify who is making the solicitation, may relate to only one specific meeting, and must specify the matters and directors on which the shareholders are expected to vote. It must give the shareholders a chance to vote for or against (or abstain from) each matter, and it must give the shareholders the right to withhold their vote for any and all directors. The proxy holder must follow the shareholder's instructions.
On April 16, 2021, the SEC reopened the comment period for its proposal to require universal proxy cards in all non-exempt solicitations in connection with contested elections of directors.2 The proposed rules would establish new procedures for the solicitation of proxies, the preparation and use of proxy cards, and the dissemination of information about all director nominees in contested elections. The principal change would require the use of universal proxy cards that include the names of all duly nominated director candidates for whom proxies are solicited and it would require dissidents in a contested election to solicit the holders of shares representing at least a majority of the voting power of shares entitled to vote on the election of directors.
On November 17, 2021, a divided SEC agreed to require universal proxy cards in contested board elections, permitting shareholders to vote for any combination of nominees they wished, as they could if they were voting in person. SEC Chair Gary Gensler called this "an important aspect of shareholder democracy" that would put "investors voting in person and by proxy on equal footing." There will be a period of public comment for thirty days after the proposal is published in the Federal Register, followed by a Commission vote on a final version.
Soliciting Shareholders
Under Rule 14a-7, shareholders who themselves seek to solicit proxies from other shareholders may call upon management to mail their own shareholder solicitation materials, either separately or together with the company's own proxy materials, provided that the soliciting shareholder or shareholders pay the cost. This is sometimes known as the "common carrier" requirement. But management has an option: it can avoid the "common carrier" obligation by giving the soliciting shareholders the current list of names and addresses of shareholders or nominees who hold shares on behalf of the beneficial owners.
There is another limitation on the company's obligation to mail shareholder solicitations. Rule 14a-8 requires management to send, at corporate expense, "proper" shareholder proposals with the corporation's own proxy materials. The rule specifies which shareholders may make proposals, the procedures for their submission, management's obligations, and the procedures for the SEC to review any management decision to exclude a shareholder solicitation. There are three permissible reasons for a management decision to exclude a shareholder's solicitation: to preserve management's decision-making prerogatives; to protect management's usual proxy solicitations from interference; and to filter out illegal, deceptive, or crackpot proposals.3
It should be noted that with respect to the nomination of directors, Rule 14a-11 (authorized by Dodd-Frank) required public companies to give shareholders access to the company-funded proxy materials for director nominations. If the nominating shareholder (or group of shareholders) held at least 3 percent of the company's voting shares, and held them for at least three years, the shareholder or group could nominate up to one-fourth of the company's board. The soliciting shareholder or group was required to give the company 150 days notice and to provide full information about its nominees.4Unfortunately, the rule never took effect.
Under Rule 14a-8(i)(7), management may refuse to allow a shareholder proposal to be submitted to other shareholders if it related to the "company's ordinary business operations." On November 3, 2021, the SEC Division of Corporate Finance issued a Staff Legal Bulletin that permits shareholder proposals that raise significant social or environmental issues that would have been excluded under previous staff bulletins. We can therefore confidently expect to see many more such shareholder proposals in the future.
Liability for Fraud
Under Section 10(b) and Rule 10b-5 of the 1934 Act, there is civil (and potential criminal) liability for any false or misleading statement or omission in any required proxy statement. The standard rules for Rule 10b-5 liability apply. First, the plaintiff may either be the SEC or any shareholder.5 Second, the misrepresentation or omission must be material. Here, that would mean that there was a substantial likelihood that a "reasonable shareholder" would consider the false or misleading statement or omission to be important in deciding how to vote. Third, there must be a causal link, that is, that the proxy solicitation must be an essential link to the accomplishment of the transaction, but there is no requirement to prove reliance since it is presumed. (See Mills v. Electric Auto-Lite Co., 396 U.S. 375 (1970)).
Proxy Solicitation Examples
During the past ten years, the SEC has significantly changed the form and content of how companies disclose executive compensation. The new rules are found primarily in Item 402 of Regulation S-K (which is nearly forty pages long) and require disclosure of all compensation and highlighting performance-based versus non-performance-based compensation. Dodd-Frank introduced additional corporate governance requirements and "say on pay" and "say on golden parachutes" votes. Rule 402 disclosures are also required by Item 11 of Forms 10-K and S-1, and Item 6 of Form 10 (for spin-offs).
Not all executive officers are included. Item 402 of Regulation S-K applies to only Named Executive Officers (NEOs) who are the chief executive officer, the chief financial officer, and the three other most highly compensated individuals who were serving as executive officers as of the end of the last fiscal year.
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