On October 27, 2015, the SEC's Division of Corporation Finance issued two new compliance and disclosure interpretations (C&DIs) on Rule 14a-4(a)(3) under the Exchange Act, which requires that proxy statements clearly and impartially identify each "separate matter" submitted to a shareholder vote by a reporting company or any other person soliciting proxy authority (known as "unbundling"). The new C&DIs, Questions 201.01 and 201.02, mandate that when a reporting company undergoes a major change to its organizational documents, including changes to its corporate governance, in connection with its acquisition of another reporting company, the acquiror's changes must be put to separate votes using separate boxes on the proxy card. The new C&DIs replace the SEC's previous guidance contained in its September 2004 Interim Supplement to the Publicly Available Telephone Interpretations, which had allowed all matters related to the underlying merger to be subsumed within the one vote on the merger itself.

The question as formulated in C&DI 201.01 notes that in mergers, acquisitions, and similar transactions in which shareholders of the target receive equity securities of the acquiror, amendments to the organizational documents of the acquiror can often be required by the transaction agreement. The question asks under what circumstances must the target company, which seeks shareholder approval of the transaction, present separately on its form of proxy card proposal(s) relating to the amendment(s) to the organizational documents of the acquiror. Under previous guidance, these changes might have been thought to be so inextricably intertwined with the transaction as to effectively constitute a single matter, not "separate matters" for approval by the target shareholders.

The SEC's new answer notes that any time an acquiror contemplates a material amendment to its organizational documents that would require approval of its shareholders, the amendment must be presented to the acquiror's shareholders on the acquiror's form of proxy separately from other material proposals (such as approval of the issuance of shares or approval of the transaction agreement).

Examples of the kinds of amendments that are material and must be presented separately include:

By contrast, the following changes are likely in most cases to not be considered material beyond the overall context of the transaction and would not require separate approval:

The C&DI adds that in situations where the acquiror is required to present multiple amendments separately on its proxy card, or would be required to do so if it were conducting a proxy solicitation, if target shareholders are to receive equity securities of the acquiror in the transaction, then the target must present the same set of amendments separately on the target company's form of proxy and submit them to a vote of the target shareholders. This is because these amendments, which are terms of the transaction agreement that the target shareholders are being asked to approve, would effect material changes to the very equity security that they are receiving in the transaction. The C&DI notes the SEC staff position that target shareholders should have an opportunity to express their views separately on those material provisions that will establish their substantive rights as shareholders, even if they would not otherwise be entitled to vote on these matters under state corporate law.

The C&DI clarifies that if the acquiror submits an amendment to increase the number of authorized shares of its equity securities for approval of its shareholders, the target is not required to submit this proposal to target shareholders as long as the increase is limited to the number of shares reasonably expected to be issued in the transaction.

In all cases, the parties are free to condition the closing on shareholder approval of any separate proposals. Any such conditions should be clearly disclosed and indicated on the form of proxy.

C&DI 201.02 adds that the analysis does not change just because the parties form a new entity to act as an acquisition vehicle that will issue equity securities in the transaction. The C&DI notes that the party whose shareholders are expected to own the largest percentage of equity securities of the new entity following the closing would be considered the acquiror. As the deemed acquiror, this party must determine if any material provision or provisions of the new entity's organizational documents that are a term of the transaction would represent a material change from its organizational documents, and this change would ordinarily require the approval of its shareholders. If so, this party must submit each of these provisions separately on its form of proxy to a vote of its shareholders. Consequently, if the party considered to be the acquiror would be required to submit these items to separate votes of its shareholders, the other party to the transaction must also submit these items separately on its form of proxy to a vote of its shareholders.

One obvious target of the rule change is inversion transactions, which have not disappeared from the M&A landscape in spite of the Treasury Department's regulations aimed at making them less attractive for the inverting corporation (see Legal Update, IRS Issues New Anti-Inversion Rules). Under the new interpretation, any material change newly reflected in the acquiror's organizational documents resulting from the change in jurisdiction of incorporation must be separated out on the proxy card and put to a separate vote of the shareholders. As a result, the shareholders will have an opportunity to approve the transaction while rejecting the change to the organizational documents. This will allow shareholders to avoid a situation in which they approve a transaction, only to be surprised to find their powers curtailed in the combined company's new, perhaps less shareholder-friendly jurisdiction. Similarly, the new interpretation might derail the practice of adopting staggered boards simply by adding contractual commitments into the transaction agreement to adopt such a structure, without putting the matter to a vote. (Although one could wonder why a rational, informed shareholder would have ever approved a deal that was contingent on a corporate-governance change whose disadvantages outweighed the deal's economic benefits, nevertheless, the new interpretation will now put the choice to the shareholders more explicitly.)

If the shareholders reject the changes to the company's corporate governance, the parties will not be forced to proceed with the transaction, as long as they conditioned the closing on the approval of the changes and disclosed that condition to the shareholders. Left somewhat open in the SEC's new interpretation is the question of what would happen if the acquiror shareholders were to approve all of the changes, yet the target shareholders did not. As a matter of state law, the target shareholders' rejection of the changes should not preclude their adoption, since the target's shareholder vote is not binding—the target shareholders are not yet shareholders of the acquiror.

If the parties have chosen to condition the closing on the approval of all changes by both sets of stockholders, then the question is rendered moot. But if the parties condition the closing on the approval of the acquiror's changes by only the acquiror's stockholders (and explicitly disclose that distinction in the proxy materials), seemingly the parties would have the legal and contractual right to proceed with the closing and adopt all the changes to the acquiror's governing documents, in spite of the target stockholders' rejection of the corporate-governance amendments.

The C&DIs do not address this possibility. However, the fact that the target shareholder vote on the acquiror's organizational documents is essentially non-binding and advisory in nature is not unique among the votes mandated by the SEC.

Whether the new voting rules will meaningfully curtail U.S.-based companies' pursuit of inversion deals remains to be seen.