SEC Adopts Rules on Enhanced Disclosure of Nominating Committee Functions and Communications Between Shareholders and Boards of Directors

On November 24, 2003, the Securities and Exchange Commission adopted new rules under the Securities Exchange Act of 1934, as amended (the Exchange Act), that would require public companies to provide:

• increased disclosure regarding the operation of their board nominating committees, and
• new disclosure regarding the means by which shareholders may communicate with their boards of directors.¹ 

Companies subject to the proxy rules (including registered investment companies)² must comply with these new disclosure requirements in proxy or information statements that are first sent or given to their shareholders on or after January 1, 2004, and in their periodic reports for the first reporting period ending after January 1, 2004.

The enhanced disclosure rules were initially proposed on August 8, 2003.³ The final rules generally followed the text of the proposed rules, although certain revisions were made by the SEC in response to comments received on the proposals, the most important of which were to eliminate proposed requirements to disclose the reasons for rejecting a shareholder nominee for director and to describe actions taken by a board of directors in response to a shareholder communication, and to add a requirement to disclose a company’s policy with respect to attendance of directors at annual meetings.⁴ These disclosure rules implement a portion of the recommendations made by the Division of Corporation Finance in its July 15, 2003 staff report to the SEC on direct shareholder access to the director nomination process.⁵ On October 14, 2003, the SEC also proposed new rules under the Exchange Act that would, under certain circumstances, require public companies to include in their annual meeting proxy statements and on their proxy cards nominees for director that are submitted by shareholders meeting specified standards.⁶  Those proposed access rules are described in detail in our Client Alert No. 343, published October 29, 2003.⁷

The new proxy statement disclosure requirements are intended to provide shareholders with additional, detailed information upon which to evaluate the boards of directors and nominating committees of the companies in which they invest. For purposes of

these requirements, disclosure is required with respect to a “nominating committee" or any other committee or portion of a board of directors, including the entire board, performing a similar function. The amendments to Schedule 14A will require public companies to include the following information in their proxy statements:

• Whether the company has a standing nominating committee and, if not, provide a statement by the board of directors as to why it is appropriate that the company does not have such a committee.
• The name of each director who participates in consideration of director nominees.
• For listed companies, disclosure of whether the members of the nominating committee are independent as defined in the listing standards of the market in which the company’s securities are listed or quoted.⁸
• For non-listed companies, disclosure of whether each member of the nominating committee is independent, consistently applying to all members of the nominating committee, as well as to disclosures with respect to audit committee members under the proxy rules,⁹ any definition of independence of a registered national securities exchange or association that has been approved by the SEC (effectively, the definitions in the new rules of either the NYSE or NASDAQ) and stating which definition is being used.

• Whether or not the nominating committee has a charter, and if it does:
• Disclosure of whether a current copy of the charter is available on the company’s Web site and, if so, disclosure of the Web site address.
• If a current copy of the charter is not available on the company’s Web site, a copy of the nominating committee charter is required to be included as an appendix to the company’s proxy statement at least once every three fiscal years.

• If the nominating committee has a policy on the consideration of board nominees recommended by shareholders, a description of the material elements of that policy (including a statement as to whether the committee will consider board nominees recommended by shareholders), or, if there is no such policy, a statement by the board of directors as to why it is appropriate that the company does not have such a policy.
• If the nominating committee will consider board nominees recommended by shareholders, a description of the procedures to be followed in submitting such recommendations.
• Any material changes by a company to such procedures, or the initial adoption of such procedures by a company that previously disclosed it had none, must be disclosed in the company’s next filing on Form 10-Q or 10-K.¹⁰
• A description of any specific, minimum qualifications that the nominating committee believes must be met by any board nominee recommended by the nominating committee, as well as any specific qualities or skills that the nominating committee believes are necessary for one or more directors to possess.
• A description of the nominating committee’s process for identifying and evaluating board nominees, and any differences in the manner in which the nominating committee evaluates board nominees based on whether the nominee is recommended by a shareholder.
• Disclosure of the function performed by any third party that is paid a fee by the company and used to identify or assist in identifying or evaluating potential board nominees.

• With respect to each board nominee approved by the nominating committee for inclusion on the company’s proxy card (other than those nominees who are executive officers or directors standing for re-election), disclosure of which one or more of the following categories of persons or entities that recommended that nominee: shareholder, director, chief executive officer, other executive officer, third-party search firm, or other specified source.
• If the nominating committee (a) receives, by a date not later than the 120th calendar day before the anniversary of the date that the company’s prior year proxy statement was released to shareholders, a board nominee that is recommended by a shareholder or group of shareholders who individually, or in the aggregate, beneficially owned greater than 5 percent¹¹ of the company’s voting common stock for at least one year as of the date of the recommendation, and (b) decides not to nominate such candidate, disclosure of the candidate and those shareholders who nominated such candidate; provided, however, that no such disclosure is required without the written consent of both the shareholder or shareholders and the candidate to be so identified, which consent, together with evidence of the required share ownership by any shareholder that is not a registered holder of the shares, must be contained in the communication proposing the nomination.

As a result of these disclosure requirements, public companies will need to think very carefully about their nominating committees’ processes and procedures (and consider potentially modifying them) in preparation for these potentially burdensome new disclosures that will have to be made in this upcoming 2004 proxy season. 

As part of providing shareholders with a means by which to communicate with members of the board of directors and improve the transparency of board operations, each public company is required to disclose in its proxy materials whether the company’s board of directors provides a process by which shareholders can send communications to them and, if not, explain the basis for the view of the board of directors that it is appropriate for the company not to have such a process. In addition, each company must either include the following information in such proxy materials or place the information on its Web site and disclose the Web site address in its proxy materials:¹²

• If the company has a process by which shareholders can send communications to the board of directors:¹³
• A description of the manner by which shareholders can send communications to the board of directors and, if applicable, to specified individual directors.
• If all shareholder communications are not sent directly to board members, a description of the company’s process for determining which communications will be relayed to board members, unless the process has been approved by a majority of the company’s independent directors.
• A description of the company’s policy, if any, with regard to board members’ attendance at annual meetings and a statement telling the number of board members who attended the prior year’s annual meeting.

It is important to note that under Exchange Act Rule 10A-3(b)(3), the audit committees of listed companies must establish procedures for: (a) the receipt, retention and treatment of complaints received by the company regarding accounting, internal accounting controls or auditing matters and (b) the confidential, anonymous submission by company employees of concerns regarding questionable accounting or auditing matters.

In addition, the new NYSE corporate governance rules require NYSE-listed companies to disclose a method for parties to communicate directly with the non-management members of their boards. Therefore, public companies will need to consider all applicable requirements in order to put a comprehensive and cohesive set of communications procedures in place by their 2004 annual meeting.¹⁴