SECURITIES REGULATION AND IR

Most corporate governance practices adopted in the United States eventually make their way into Canada. Proxy access, which is a mechanism that allows shareholders who meet certain ownership requirements to present their own nominees for election as directors, is the latest practice to begin to make inroads into Canada. Due to differences in Canadian law and the Canadian marketplace, it is likely that the U.S. approach will need to be tailored somewhat to fit Canadian companies.

In the United States, rules of the Securities and Exchange Commission (“SEC”) prohibit shareholders from nominating directors by means of a shareholder’s proposal.  Proponents of increased shareholder democracy requested that companies provide shareholders with an ability to nominate directors by means of the adoption of proxy access bylaws. While a 2010 initiative by the SEC to mandate proxy access failed, proxy access began to gain significant traction in the United States in 2015, following an initiative launched by certain U.S. pension funds coupled with support from a number of proxy advisory services. By the end of 2016, a majority of S&P 500 companies had adopted proxy access[1] and in 2017 were joined by, among others, IBM and Nike. While the specifics of these bylaws vary somewhat, the most common approach is to provide that a shareholder (or group) owning at least 3% of a company’s stock for at least three years may nominate up to 25% of the members of that company’s board of directors (the so-called “3-3-25” approach).

In Canada, the Canadian Coalition for Good Governance (“CCGG”) proposed in 2015 that U.S. style proxy access be introduced by Canadian companies but with some adjustments to reflect differences in the Canadian market. Under the CCGG proposal, nominations could be made for up to three nominees (but not to exceed 20% of the board’s membership) by a shareholder (or group) owning at least 3% of the shares (or 5% if the company’s market capitalization was less than $1 billion). Unlike the U.S. bylaws (and Canadian statutory rights), CCGG rejected the imposition of a minimum ownership period, taking the view that length of ownership does not necessarily identify shareholders with a longer term perspective.

Given the popularity of proxy access initiatives in the United States and CCGG’s support, why has proxy access remained a largely theoretical discussion in Canada?  One explanation is that Canadian law currently provides shareholders with multiple methods to nominate directors. Under the Canada Business Corporations Act (“CBCA”), holders of 5% of the outstanding shares may requisition a meeting of shareholders. In recent years, activist investors have frequently used this right to seek to replace some or all of management’s nominees to the board. However, use of this method can be expensive since Canadian law requires the preparation and mailing of a dissident proxy circular if the proxies of more than 15 shareholders are to be solicited. Additionally, shareholders of Canadian companies may make nominations from the floor of a shareholders’ meeting, but there is little likelihood of success using this method since in the absence of a dissident’s circular, solicitation of proxies is limited to a mere 15 shareholders. In addition, to prevent these unwelcome (from management’s perspective) surprises from occurring at the meeting, many Canadian companies have followed the U.S. lead in adopting advance notice bylaws, which require that notice of any proposed nominees to the board be provided to the company well in advance of the shareholders’ meeting. More significantly, and closer to the proxy access methodology being adopted in the U.S., the CBCA permits a shareholder (or group) who has held at least 5% of the company’s shares for a minimum of six months[2] to submit a proposal to nominate an unlimited number of directors, and subject to limited exceptions, the proposal must be included in the management proxy circular. However, while U.S. style proxy access bylaws generally require that equal prominence be given to shareholders’ and management’s nominees, the CBCA limits statements in support of a proposal to a maximum of 500 words, which can be placed anywhere in the management proxy circular selected by management.

Another possible explanation for the lack of support in Canada for U.S. style proxy access arises from differences inherent to the Canadian marketplace. As compared to U.S. companies, Canadian companies tend to have smaller market capitalization, their shares tend to be less liquid and Canadian companies are more frequently controlled by a significant investor, thereby heightening the influence maintained by a limited number of institutional investors on the existing boards of directors of Canadian companies.

Notwithstanding the differences in laws and marketplace, U.S.-style 3-3-25 proxy access proposals found their way into Canada in 2017 and were presented to shareholders of The Toronto-Dominion Bank and the Royal Bank of Canada. The Toronto-Dominion Bank proposal was narrowly adopted (obtaining 52.2% support) while the Royal Bank proposal was narrowly defeated (obtaining 46.8% support). Management of both banks had recommended rejection of the proposals, noting that the existing statutory rights of shareholders to nominate directors conflicted with the terms of the proposals. Specifically, the Bank Act’s[3] 5% and six-month ownership requirements conflicted with the 3% and three-year ownership requirements of the proposals, as did the Bank Act’s right to nominate an unlimited number of directors with the proposals’ 25% limit on the number of nominees. The Royal Bank also argued that acceptance of the proposal could negatively impact its Board’s range of experience, skills and perspectives, create factions within the board, increase the influence of special interest groups and result in more contested elections. 

What was not addressed by either the banks or by the proponents of enhanced proxy access was how to deal with the uniquely Canadian requirement that a minimum percentage of the board be comprised of Canadian residents. Under the CBCA, a minimum of 25% of the members of the board must be Canadian residents.[4] In the absence of a mechanism to disallow one or more nominations (even after voted proxies have been received) or otherwise prevent certain voting outcomes, circumstances could arise that result in the failure to elect the requisite number of Canadian residents. Were this to occur, the newly elected board would not be properly constituted and would be unable to act, resulting in the need to call and hold further shareholder meetings until a board satisfying the residency requirements could be elected. Clearly, the time lost and the costs incurred in holding multiple shareholders’ meetings are not in a company’s or its shareholders’ best interests. But providing a company with the ability to alter the nominations or otherwise ‘fix’ the vote so as to ensure an outcome that is compliant with the corporate statute will undoubtedly give proponents of shareholder democracy significant pause for thought.

Paul Collins is a Partner at McMillan LLP