by James Hyatt
Given the green light by Congress, the Securities and Exchange Commission approved and released a long-awaited rule on proxy access — procedures under which shareholders can get their nominees for corporate directors included in proxy materials issued by public companies.
The SEC three times had made a run at proxy access rules, which include changes long sought by corporate governance activists, but hadn’t issued a final policy in the face of political and corporate resistance. This year’s Dodd-Frank Wall Street Reform and Consumer Protection Act (Section 971) authorized the SEC to write the rules.
Under the new rule approved by the Commission, shareholders seeking access to corporate proxy materials would:
—have to own at least 3% of the total voting power entitled to vote at the meeting.
—be able to aggregate holdings to meet the 3% requirement.
—be required to have held their shares for at least three years.
—not be able to use the new rule “if they are holding the securities for the purpose of changing control of the company.”
—be able to include one nominee or a number up to 25% of the board, whichever is greater. (If a board had three members, shareholders could nominate one; if a board had eight members, up to two nominees could be proposed).
The SEC said “‘smaller reporting companies” would be subject to the rule only after a three-year phase-in period. Commission staff said the three-year delay would enable smaller companies to see how the rule works at larger companies and how it would affect them. It would also let the commission determine whether changes in the rule might be required, the staffers said.
New rules generally take effect 60 days after publication in the Federal Register, SEC staff said.
The new rule — called Rule 14a-11 — requires shareholders to submit nominees no later than 120 days before the anniversary date of the mailing of the prior year proxy statement. Thus, if the rule becomes effective on Nov. 1, 2010, it would be available at companies that mailed their last annual meeting proxy statement no earlier than March 1, 2010.
Vote on Party Lines
As had been widely expected, the SEC acted on a 3-2 vote to adopt the new procedures, with Republican commissioners Troy Paredes and Kathleen Casey voting no. Commissioner Casey said the proposal represents “a series of arbitrary choices” that empower institutional shareholders “to the detriment” of individual shareholders and that the proposal is “likely to result in significant harm” to the economy.
Commissioner Parades protested that under the new rules, shareholders would be “unable to opt out” of the procedures “even if they want to,” and said it is at odds with state corporate law, particularly in Delaware.
SEC Chairman Mary Schapiro said shareholders should expect to see “dozens of instances of give and take” as the new rules take effect. She called the proposal “rational, balanced and necessary” and pledged the SEC would prepare to make “prompt changes” to the rules if they seem appropriate.
Commissioner Elisse Walter said the proposal at last gives shareholders “a genuine alternative” in voting on directors. The right to vote is meaningless, she said, if shareholders have no choice other than nominees presented by management.
Three Percent Rule
The 3% rule is a significant hurdle, making challenges at large companies such as International Business Machines or Exxon Mobil Corporation particularly difficult. But pension, union and other large funds could pool their votes with other investors to offer candidates. (Congressional conferees turned down efforts by Sen. Christopher Dodd of Connecticut to include a 5% ownership threshold in the financial reform bill.)
Reacting to the proposal, the U.S. Chamber of Commerce said the SEC “is responding to the campaign of a small group of special interest activist investors while ignoring the needs of the vast majority of investors who will never be able to use proxy access.”
Some groups had urged the SEC to permit “private ordering” of proxy access procedures — letting companies establish their own procedures to create proxy access under Delaware and other state corporate regulations. Across-the-board rules, they argued, aren’t always appropriate. And a number of companies urged the SEC to permit shareholders to opt out of proxy access procedures.
Backers have told the SEC proxy access is long overdue. In a comment letter to SEC Chairman Mary Schapiro, Jeff Mahoney, general counsel of the Council of Institutional Investors, said proxy access will “contribute to the strengthening of our capital markets by making boards more responsive to shareowners, more thoughtful about whom they nominate to serve as directors, and more vigilant in their oversight responsibilities.”
Opponents gave the SEC a number of objections to proxy access. Richard Templeton, chairman, president and chief executive of Texas Instruments, said the process “would promote a focus on short-term interests and could result in what are essentially annual proxy contests…distracting management and board attention from the creation of long-term shareholder value.”
Legal Challenges Likely
Challenges to the rules seem likely. Bloomberg recently reported that the U.S. Chamber of Commerce has retained Eugene Scalia of the law firm Gibson, Dunn & Crutcher (and son of U.S. Supreme Court Justice Antonin Scalia) to “review the forthcoming SEC rules for a potential legal challenge.” The Chamber’s Center for Capital Markets Competitiveness says “…the SEC has failed to demonstrate a compelling need for this rule-making or how capital markets will be made more efficient by its adoption.”
Some companies have found the best defense is a good offense — engaging major shareholders to see if some middle-ground resolution is possible short of a board challenge. Indeed, Weil, Gotshal & Manges LLP corporate partner Holly Gregory has advised companies to “Know who your large owners are — the top twenty or thirty shareholders — and consider whether to reach out to them in advance of the next meeting to find out what their concerns are, especially with regard to board composition and executive compensation.”
And, she adds, “Ensure that investor relations personnel are well-versed on institutional investor and proxy advisor positions on ‘hot button’ issues — as well as the company’s rationale where its approach departs from these positions.”
Proxy battles can also be expensive, notes writer Julie Connelly in Corporate Board Member magazine (Third Quarter 2010) in an article titled “Proxy Access: Worth Little More Than a Hill of Beans.”
Proxy battles entail legal fees, proxy-solicitation costs, and, in some cases, payments to prospective board candidates. Indeed, there’s general agreement that finding candidates to serve on board is getting more difficult, given increased demands on a director’s time and exposure. To help identify potential board candidates, the pension fund of the California Public Employees’ Retirement System, the nation’s largest in terms of assets, is creating a “Diverse Director Database.”
J. W. Verret, an assistant professor of law at George Mason University’s law school, has been thumbing his nose at proponents of proxy access with a series of “16 defenses” he is proposing for boards of directors to thwart the expected SEC proposal. (One example: if shareholders can nominate a quarter of the board, give decision making to an Executive Committee of the Board made up of the other 75%.)
Editor’s Note 8/25/2010: This article has been updated from an earlier version to reflect the outcome of the SEC vote and to incorporate additional comments.