The Securities and Exchange Commission has adopted final rules requiring companies to provide disclosure about their board nominating process and the means by which shareholders may communicate with directors.  The new disclosure requirements are effective for proxy or information statements that are first provided to shareholders on or after January 1, 2004 and in applicable reports for periods ending after that date.  These new rules apply to all public companies subject to the proxy rules under the Securities Exchange Act of 1934, including small business issuers and registered investment companies.  See SEC Release No. 33-8340, available at http://www.sec.gov/rules/final/33-8340.htm.

The SEC is still considering a separate proposal regarding shareholder access to company proxy statements for director nominees. 

Disclosure Regarding Nominating Committee Processes

Under the new rules, a company must disclose in its proxy statement whether it has a standing nominating committee or a committee performing similar functions.  If the company does not have such a committee, it must disclose why it believes it is appropriate not to have such a committee and identify each director that participates in the consideration of director nominees.  With respect to the nominating committee or group of directors performing the role of a nominating committee, which may be the entire board, companies are required to disclose:

  • Whether the committee has a charter.  If the nominating committee has a charter, it must make a copy of the charter available either on its website or by including a copy as an appendix to the proxy statement at least once every three years.
  • Whether the members of the committee are independent as defined in the listing standard applicable to the company.  If the company is not listed, it must select one of the definitions of independence established by a national securities exchange or quotation system and state the definition used.
  • The material elements of any policy regarding the consideration of director nominees recommended by shareholders, including whether the committee will consider such nominees.  If no such policy exists, the company must explain why not.
  • The procedures to be followed by shareholders in submitting director nominees.  Any material changes to these procedures must be disclosed in the company’s annual or quarterly reports.
  • Any minimum qualifications the committee believes a nominee must possess for a position on the board and any specific qualities or skills the committee believes are necessary for one or more of the company’s directors to possess.
  • The committee’s process for identifying and evaluating nominees and whether there are any differences in how the committee evaluates nominees recommended by shareholders.
  • For each nominee approved for inclusion on the company’s proxy card, which one or more of the following categories recommended that nominee:  shareholder, non-management director, chief executive officer, other executive officer, third-party search firm, or other specified source.
  • The functions performed by any third party engaged to assist in identifying and evaluating potential nominees.
  • If the committee received, at least 120 days before the anniversary of the prior year’s proxy statement, a nominee recommendation from a shareholder or group of shareholders owning at least 5% of the company’s voting stock for at least one year, the identity of the nominee, the shareholder or group of shareholders making the recommendation and whether the committee chose to nominate the candidate (provided that the identity of the shareholder(s) or nominee is not required without the written consent of both the nominee and such shareholder(s)). 

In addition, the SEC adopted new disclosure standards requiring companies to report any material changes to the procedures for security holder nominations in the applicable Form 10-Q or Form 10-K filed for the period in which the material change occurs.  For this purpose, a “material change” would include new adoption of procedures after a company has previously disclosed that it did not have such procedures in place. 

The new rules are intended to operate in conjunction with the revised listing standards proposed by the New York Stock Exchange and the Nasdaq Stock Market and approved by the SEC on November 4, 2003, that include new requirements relating to the nomination process.  Under the new NYSE and Nasdaq listing standards, director nominations must be made by a nominating committee comprised solely of independent directors (or, in the case of Nasdaq, by a majority of independent directors).  In addition, both require a written charter (or, in the case of Nasdaq, a board resolution) addressing the nomination process.  In its adopting release, the SEC noted that while the revised listing standards demonstrate the importance of the nomination process and represent a strengthening of the role and independence of the nominating committee, the disclosure requirements under the new rules will provide useful information to shareholders regarding the nomination process, the manner of evaluating nominees and the extent to which the boards of directors of the companies in which they invest have a process for considering shareholder recommendations. 

Disclosure Regarding Shareholder Communications with the Board

The new rules also require companies to disclose in their proxy statements whether the board provides a process for shareholders to send communications to the board.  If the company does not have such a process, it must disclose why not.  If the company does have such a process, it must disclose:

  • the manner in which 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, how the company determines which will be relayed to the board.

Companies must also disclose their policies regarding director attendance at annual meetings and state the number of board members who attended the prior year’s annual meeting.  The information regarding the manner in which shareholders can send communications to the board, how the company determines which communications will be relayed to the board and director attendance at annual meetings may be made on the company’s website rather than in its proxy statement provided that the proxy statement references the web address where such information appears.

Conclusion

While the new disclosure requirements do not mandate that companies take any additional action, we anticipate the disclosure obligations alone may drive changes in corporate policy to the extent not already mandated by the NYSE and Nasdaq listing standards or other rulemaking.  These new disclosure requirements are the first to be finalized of the reforms contemplated by the SEC Staff’s July 15 report on proxy reform.  As the comment period on the SEC’s shareholder access proposal draws to a close on December 22, 2003, we will see whether the SEC will use its jurisdiction over the proxy process to bring about more radical change in corporate governance.