A tale of two countries: developments in proxy access

Canada and the US

Securities and Corporate Finance Alert

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Proxy access is the ability for a shareholder to nominate candidates for election to the board of directors. In Canada, the Canada Business Corporations Act (CBCA) and many provincial corporate statutes, including the Ontario Business Corporations Act (OBCA), have long allowed for proxy access. Nevertheless, proxy access remains a major topic in Canadian corporate governance debates. 

Proxy access by-laws have increased in popularity in the United States in recent years. Just two years ago, according to Institutional Shareholder Services (ISS), less than one percent of S&P 500 companies allowed for proxy access. Today, according to ISS, over 40% of those companies are offering some form of proxy access to their shareholders and it is expected that a majority of these companies will adopt some form of proxy access before the end of the 2017 proxy season. In the United States proxy access continues to be the go-to option for shareholders seeking to assert a greater voice in director elections.

CANADA - PROXY ACCESS: A WORK IN PROGRESS

How proxy access works in Canada

Directors of Canadian companies are typically nominated by the board or management of the corporation and presented to shareholders annually in the management proxy circular in the form of a ‘slate’. Voting for directors under Canadian law is based on a plurality system, where shareholders do not vote to elect each director, but may support or withhold support of an individual director nominee. In 2014, the Toronto Stock Exchange (TSX) made it mandatory that each TSX-listed issuer adopt a ‘majority voting’ policy. Such a policy typically requires that an elected director immediately tender his or her resignation if he or she was not elected by at least a majority of the votes cast at the meeting.

While majority voting policies are viewed by many as a step towards improving corporate governance, shareholders of Canadian companies still seek a mechanism by which to influence the composition of boards of directors and therefore the operation and affairs of the corporation. However, unlike in the United States, Canadian companies have not typically adopted proxy access by-laws, primarily because there are already statutory mechanisms that allow for shareholder nominations of directors.

Under both the CBCA and the OBCA, there are four methods by which registered shareholders can nominate individuals for election to the board of directors:

  1. requisition a meeting to elect directors;
  2. submit a shareholder proposal to nominate directors to be included in the corporation’s proxy circular; 
  3. nominate individuals from the floor of a shareholders’ meeting; and 
  4. engage in a proxy contest.

 

Limits on proxy access

Despite the statutory entitlement to proxy access, there are a number of conditions that limit the practicality of proxy access in Canada. Some of these include:

  • Eligibility Requirements for Shareholder Proposals: to submit a shareholder proposal, a shareholder must hold, for the six months prior to the proposal submission, either alone or in the aggregate, voting shares equal to at least 1% of the outstanding voting shares of the corporation or shares whose fair market value is at least $2,000. Further, a proposal that includes director nominations must be signed by one or more holders of shares representing (in the aggregate) at least 5% of the shares of the corporation entitled to vote at the meeting.
  • Strict Deadline for Proposal Submission: Typically, a shareholder proposal must be submitted four to six months prior to the meeting date. This timing can make it difficult for a shareholder to plan and maintain support for a proposal.
  • Potential Lack of a Platform for Shareholders to be Persuasive: A shareholder proposal and the supporting statement together are limited to 500 words in the corporation’s proxy circular, whereas the length of management’s response to the proposal is unrestricted. There is no requirement that the shareholder’s nominee is to be included in a management circular in the same location and with the same prominence as the issuer’s nominees.
  • Solicitation Limitations: Shareholders cannot directly solicit more than 15 other shareholders without preparing a dissident proxy circular. The requirement for a dissident proxy circular can serve as a disincentive to submit a proposal as it is often expensive and time intensive to prepare. The proponent shareholder may also need to look at the retention of a proxy advisory firm, adding expense to the process.
  • Limited Utility of Meeting Requisition Right: While shareholders holding 5% of the shares of a Canadian company can requisition a shareholders’ meeting, Canadian courts have interpreted the applicable legislation in such a way that renders this right less useful than it appears. Canadian courts have held shareholders to an extremely high standard of technical compliance in submitting requisitions and have often deferred to the business judgement of the incumbent board of directors in deciding what is a reasonable date to schedule a meeting requisitioned by shareholders.

Defence mechanisms against proxy access

To the extent proxy access does become more relevant in Canada, corporations and incumbent boards of directors will be able to defend themselves through the use of advance notice by-laws, which set a deadline by which shareholders intending to propose a director nominee must submit a notice of director nomination to the issuer’s management prior to the annual or special meeting. This prevents a shareholder from presenting a nomination from the floor of the meeting and is intended to ensure that all shareholders are able to make an informed decision when electing directors, having received adequate notice of the nomination.

Push for reform

The Canadian Coalition for Good Governance (CCGG) released a policy statement on proxy access in May 2015, advocating for increased shareholder participation in the nomination process as a principle of good corporate governance. In the policy statement, the CCGG stated that while shareholders elect directors, “shareholders have no input in the normal course in choosing any director nominees” and that the CCGG believes “it is time for Canadian public companies to focus on enhancing 'proxy access' … and the ability of shareholders to have meaningful input into the director nomination process”. The CCGG has made a number of recommendations to improve proxy access, including:

  • Developing on-going dialogue between shareholders and directors to get shareholder input on board composition.
  • Allowing shareholders holding a meaningful percentage of a corporation’s outstanding voting shares to present director nominees to shareholders on proxy materials. The recommended threshold is 5% for a corporation with a market capitalization of at least $1 billion and 3% for a corporation with a market capitalization of less than $1 billion. Further, to determine the 3% and 5% ownership thresholds, the CCGG indicated only voting interests tied to economic interests should count.
  • Capping the number of shareholder nominees permitted under proxy access to distinguish this mechanism from a change of control.
  • Implementing a fair form of universal proxy to ensure that information about shareholder nominees is placed in the same location as the information about the corporation’s nominees in the proxy circular and that shareholders have the same opportunity as the corporation to present information regarding the nominee’s background and qualifications.
  • Removing the requirement that a nominating shareholder hold its shares for any specified period of time prior to nomination.
  • Allowing the nominating shareholder to use the issuer’s proxy circular to solicit support and allow reasonable solicitation costs of the nominating shareholder to be paid by the issuer.

The CCGG recommends that companies voluntarily adopt these policies until legislative amendments in line with these policies are enacted; however,  it appears that no company has done so to date.

UNITED STATES - THE RISE OF PROXY ACCESS

What has spurred the desire for proxy access?

While shareholders in the United States maintain the right to vote for directors, subject to state law provisions, practically speaking they are generally not involved in the process of deciding who is to be nominated to the board. Typically, individuals are nominated to boards of directors by a nominating committee of the board of directors largely controlled by the board itself. Each of the two major U.S. stock markets has requirements regarding the “independence” of the members of this committee.  The nominating committee puts forward a slate of candidates for shareholder approval. Some shareholders have lamented that this selection process diminishes shareholder influence, and have sought to gain a greater foothold in director nominations.. Proxy access is seen by certain institutional investors and shareholder proponents as a means of bolstering shareholder influence over director nominations, while avoiding the expense of a proxy solicitation.

What has paved the way for an increase in proxy access?

The 2010 Dodd–Frank Wall Street Reform and Consumer Protection Act authorized the U.S. Securities Exchange Commission (SEC) to adopt a rule requiring corporations to provide for proxy access in their by-laws. In 2010, the SEC proposed a rule that would have allowed shareholders owning at least 3 percent of a company’s shares for at least three years to include in the company’s proxy materials director nominees for up to 25 percent of the board (the so-called 3 percent/3-year/25 percent formulation).  The SEC rule was struck down by the United States Court of Appeals for the District of Columbia circuit in 2011. 

Beginning in late 2014, New York City’s pension funds submitted a proxy access proposal to 75 large companies, which were targeted based on purported concerns over the companies’ governance or other features.  In terms of volume, proxy access was the highest-profile shareholder proposal topic during the 2015 proxy season, with close to 100 shareholder proposals on the ballot, or more than four times the number of such proposals that appeared on ballots in the prior year.  Nearly all of the proxy access shareholder proposals were modeled on the 3 percent/3-year/25 percent formulation.  The 2015 proxy season is generally considered as the tipping point for proxy access shareholder proposals.

Who is pushing for proxy access?

Many asset managers have adopted policies on proxy access proposals, with some examining such proposals on a case-by-case basis.  On the public pension fund side, the California Public Employees’ Retirement System, the California State Teachers’ Retirement System (CalSTRS) and the Florida State Board of Administration each support proxy access proposals.  In January 2016, CalSTRS announced that it had contacted 30 US public companies asking them to adopt the so-called proxy access by-law and noting that it was ready to submit shareholder proposals on the topic if companies failed to heed its request.  Additionally, in January 2016, the New York City Comptroller issued a press release announcing that it had filed 72 proxy access shareholder proposals for the 2016 proxy season.  Proxy advisors Institutional Shareholder Services (ISS) and Glass Lewis each published proxy access policies, with ISS generally supporting management and shareholder proposals for proxy access that comport with the 3 percent/3-year/25 percent formulation and Glass Lewis evaluating such proposals on a case-by-case basis.

Proxy access has been the dominant theme during the 2016 proxy season.  It has been reported that over 200 proxy access proposals were filed.  In fact, it is reported that about 259 U.S. companies have adopted some form of proxy access, including 185 S&P 500 firms – of which 94% were implemented since January 1, 2015.

What are the contents of proxy access by-laws and what are the latest developments?

Most proxy access by-laws address, in some form, the following issues:  (a) ownership threshold, (b) length of ownership, (c) maximum number of stockholder nominated candidates, (d) calculation of qualifying ownership, including treatment of “loaned” shares, (e) stockholder group limit, (f) maximum number of access nominees, (g) notice deadlines, (h) future disqualification of stockholder nominees, (i) voting commitments, and (j) third-party compensation arrangements. As a result of the previously proposed SEC rule and the developments of the 2016 proxy season, the primary features of a proxy access by-law have largely been settled with allowing a single shareholder or group of up to 20 shareholders who own at least 3 percent of the company’s stock for at least three years to include in the company’s proxy materials director nominees for up to 20 percent of the board (the so-called 3/3/20/20 formulation).  In fact, approximately 40 companies were able to exclude proxy access by-law shareholder proposals during the 2016 proxy season pursuant to SEC rule 14a-8(i)(10), since they had “substantially implemented” the shareholder proposal.

For the upcoming U.S. proxy season, we are seeing a new emerging trend where proponents are asking companies that have previously adopted a proxy access by-law to amend certain provisions (Fix-It Proposals).  Not surprisingly, companies have sought relief from the SEC staff on Fix-It Proposals, asserting that they can be excluded under Rule 14a-8(i)(10) since the company has “substantially implemented” the proposal.  The results of such a request have not been generally favorable to companies.  In fact, in seven of the nine instances we are aware of, the company has not been successful in excluding the Fix-It Proposal.  The take-away from this experience is that the SEC staff appears to have two standards – one for initial adoption of a by-law provision and a second for the amendment of a previously adopted proxy access by-law provision.  This line of demarcation between these two camps is not very clear and we continue to advise companies to consider how they would respond to a proposal to adopt a proxy access by-law.  In addition, we are seeing other trends in the content of the proxy access by-laws being submitted for the 2017 proxy season including, among other matters: (a) allowing shareholders to nominate up to one-quarter (25%) of the board of directors and (b) redacting the limitation on the number of shareholders who can aggregate their shares to achieve the 3 percent holding requirement.

Adoption of proxy access doesn’t translate into application

While the number of U.S. corporations that have adopted proxy access by-laws has dramatically increased, so far, we have not seen any parallel rise in the number of shareholder-appointed directors. This result has led some practitioners to ponder whether the proxy access phenomenon would be similar to instances involving majority voting. Interestingly, in November 2016, GAMCO Asset Management Inc. (GAMCO) (an entity affiliated with activist investor Mario Gabelli) filed a Schedule 14N and a Schedule 13D/A (this was the ninth amendment to the Schedule 13D) submitted a proxy access director nomination to National Fuel Gas (National Fuel), which had previously adopted a proxy access by-law. This proxy access test drive was rather short-lived since National Fuel rejected the director nomination on the basis that GAMCO was not able to comply with certain provisions of National Fuel’s existing by-laws.  GAMCO withdrew its director nomination shortly thereafter.  It remains to be seen how proxy access will impact the board nomination/election process in actual terms. We recommend that boards consider whether to adopt proxy access even in the absence of a shareholder proposal and prepare in the event a proposal is received.  While there is sufficient precedent for some of the primary terms of a proxy access by-law, it is very likely that increasing attention will be given to the secondary provisions in a proxy access by-law.

Conclusion

In summary, proxy access is a potentially useful tool for shareholders that is growing in popularity. While no director has apparently been elected through proxy access in Canada or the United States to date, boards of directors should consider all available strategies to be prepared for this form of shareholder activism.

This update is intended as a summary only and should not be regarded or relied upon as advice to any specific client or regarding any specific situation.

If you have any questions about this bulletin or if you would like further information about these topics, please contact the authors.