The upcoming Universal Proxy Card (UPC) presents activist investors with only one potentially significant new burden: solicit two-thirds of the shares in a proxy contest at a portfolio company. Everything else in the new rule, including the new proxy card format and contents and the notice schedule, is largely immaterial to investors.
A close read of the rule and the supporting economic analysis suggests activists can handle this new requirement easily. Almost all proxy contests already hit the 67% level, probably because it means soliciting a surprisingly small number of shareholders. And an activist with an appetite for pushing legal and regulatory boundaries might even get by with soliciting less than 67%, depending on how we interpret “intend” and “solicit”.
Here, we plunge into the origin and rationale for this requirement, analyze its impact on activists, and set forth some possible questions about compliance. We refer to sections, pages, and footnotes in the final rule. For the basics on UPC, please see our earlier write-up.
The 67% Solution
Where did the SEC get this idea? From companies worried that UPC “potentially expos[es] registrants to frivolous proxy contests.” (p. 37). It:
…ensure[s] that … dissidents must still engage in meaningful independent solicitation efforts in order to have their director nominees elected. Current proxy rules do not obligate a dissident to solicit any number of shareholders or percentage of voting power … The Proposed Rules were based on the premise that, while registrants would have to include dissident nominees on their universal proxy card, dissidents would be subject to a new requirement to solicit a minimum percentage of voting power. The concept of a minimum solicitation threshold for dissidents remains central to the universal proxy requirement… (p. 34)
If companies need to include activist nominees on a proxy card, then activists need to solicit a minimum number of the company’s shareholders.
Also, the original proposed rule provided for a 50% level. The final regulation increased it to 67%, “in response to comment[s] that [50%] would insufficiently deter the potential for “freeriding” of dissident nominees on the registrant’s proxy card.” (p. 37).
Some Detail on the Rule
The text of the rule requires an activist to solicit shareholders that own at least 67% of the shares and say so in its proxy materials. The activist must:
[solicit] the holders of shares representing at least 67% of the voting power of shares entitled to vote … and include a statement to that effect in the proxy statement or form of proxy. (Section 14a-19(a)(3), p. 191)
An activist must also notify the company of its intent to so solicit when it notifies the company of the activist’s nominees. The notice must:
[i]nclude a statement [the activist] intends to solicit the holders of shares representing at least 67% of the voting power of shares entitled to vote on the election of directors… (Section 14a-19(b)(3), p. 192.)
If the activist changes its mind, then it needs to tell the company that, too:
If any change occurs with respect to [an activist’s] intent to solicit the holders of shares representing at least 67% of the voting power of shares … or with respect to the names of such person’s nominees, such person shall notify the registrant promptly. (Section 14a-19(c), p. 192)
Intent seems important here.
Activists Already Solicit 67%, Because It’s Not That Many
In almost all proxy contests, activists already exceed the 67% solicitation level easily. The SEC estimates 52% of activists solicit all shareholders, based on a sample of 31 proxy contests in 2018 and 2019 (p. 85, fn 220). In the other 48%, activists solicited only 20% of the shareholders and still reached 95% of the outstanding shares (p. 86, fn 223). In a separate sample of 35 proxy contests, from an earlier version of the rule proposed in 2016, only two activists solicited less than 67% of the shares (p. 106, fn 260).
What about the 48% of activists that choose to solicit less than all shareholders? They do so effectively because in most companies, 67% is not that many. The SEC estimates at the median, 1.4% of shareholders hold 67% of the shares (p. 106, fn 260).
They convert this to number of shareholders, ranging from under 50 to over 500, depending on the company size (Table 1):
Based on SEC analysis of data from a proxy services provider (p. 112, fn 273)
|Market cap||Number of shareholders||To reach 67%|
|Percent of accounts||Number of accounts|
|under $300 million||3,900||1.0%||46|
|$300 million – $2 billion||11,000||n/a||88|
|over $10 billion||279,000||0.2%||529|
It seems relatively straightforward and easy to solicit under 50 shareholders at a small cap company. For a proxy contest at a large cap company with hundreds of thousands of shareholders, it seems similarly easy to find the 500 or so needed to comply with the rule.
The SEC also estimates the additional cost to an activist of soliciting to the 67% level at $5,400. This represents the marginal cost, using a “nominal solicitation”, to solicit the additional shareholders beyond the average level typically solicited, in those contests where an activist might not otherwise do so. See our earlier analysis for detail on nominal solicitation and this figure.
“Intend” to “Solicit”
In our previous explanation of the new rule, we noted some activists might seek to avoid the 67% requirement. We wrote:
So until now, you could begin to solicit major institutions, see how that went, and decide how much further to go. Or, you could solicit only the institutions necessary to prevail in the director election. That could amount to as low as, say, 25% of the outstanding shares, depending on the expected participation and voting standard.
Now, an activist investor must meet that 67% level…
The definition of “intend” and “solicit”, in legal and regulatory domains, is critical. Note the rule requires actual solicitation (Section 14a-19(a)(3)) and notice to the company of that intent (Section 14a-19(b)(3)) or change in that intent (Section 14a-19(c)).
Suppose an activist does not solicit 67% of the shares. It’s not quite clear what might happen, or what a company or the SEC would do about it.
It seems this becomes important only if the activist wins one or more BoD seats. If it loses, then we expect the company to declare victory and the activist to slink away defeated, with no further consequence. If they settle, then we presume they agree to no litigation over the contest, including pursuing an SEC enforcement action on this particular subject.
If the activist wins, we can imagine an aggrieved BoD challenging the result based on failure to solicit to 67%. How will the company determine whether the activist in fact solicited the minimum number of shareholders? Would they seek records of the solicitation from the activist’s proxy solicitor? How will the company even know whether there is a likely case to compel discovery of that evidence? Would the company risk litigating it after shareholders just elected new directors to the BoD?
Furthermore, what constitutes “solicitation”? As we noted in our earlier explanation, the SEC specifically does not define it in the rule. It also allows the simple “notice-and-access” method. So, if an activist notifies the shareholders needed to hit the 67% level, and does no more for most of them, it seems they will comply with at least the first part of the rule.
Finally, some companies may challenge an activist based on whether the activist intended to solicit the shareholders needed to hit the 67% level. Sure, the activist can state it so intended in the notice to the company. But how will the company verify that? Would the company seek records of the legal work to prepare proxy materials, or of the proposal from the proxy solicitor?
We see some important questions, then, about interpretation and compliance. An activist that likes legal risk might decide to solicit less than 67% and worry later about whether and how the company would challenge compliance with the rule.
Please note, of course, we are not attorneys and none of what we set forth here is legal advice. Any activist that wishes to explore these avenues should consult a securities attorney.
This post comes to us from Michael R. Levin, founder and editor of The Activist Investor.