Comment Period Ends for Proxy Access; Now What?

The extended comment period for the Securities and Exchange Commission’s proposal to allow shareholder access to the proxy statement has now closed—and the controversial idea still seems as divisive and unclear as ever.

The comment period formally ended Jan. 19, after the SEC re-opened it for further input in December. The Commission ostensibly wanted to hear more input on its proposal to allow some shareholders to place nominations for corporate directors into the proxy statement, but it also was playing for time to let Congress put shareholder proxy access into law as part of its regulatory reform legislation to inoculate the Commission from the inevitable legal challenges that will follow.

That legislation, however, has bogged down in the Senate, so now the SEC seems poised to move forward on its own.

Allen

“Most companies are preparing for a proxy access world and trying to figure out what that means,” says Claudia Allen of the law firm Neal Gerber Eisenberg. “A lot of companies have majority voting, and coupled with access, that’s a major change. They’re trying to figure out what kind of world that creates for long-term stockholders.”

In a speech at a securities regulation conference last week, SEC Chairman Mary Schapiro said the Commission is “nearing a vote” on its proposed rule, and SEC observers widely believe Schapiro and the two Democratic appointees on the Commission will ultimately approve it. But given the lack of legislative ammunition from Congress, enormous opposition from Corporate America, and a huge volume of public comments to digest, that final vote could still be months away.

Overall, however, most people expect the final proxy-access rule to follow the same basic idea the SEC proposed last summer: a new Rule 14(a)-11 that would allow shareholder access on a sliding scale, where shareholders gain nomination rights if they hold anywhere from 1 to 5 percent of outstanding shares (the larger the company, the fewer shares you need to hold) for at least one year. The proposal would also amend Rule 14(a)-8 to give shareholders the right to submit proposals related to director elections or the nomination process—including proxy access—although those proposals could still be defeated. Currently, boards have the power to keep such resolutions off the proxy statement.

Somers

“There’s been no hint from the Commission I’ve seen that they’re going to back off on the basic structure of what they’ve proposed,” says Jeff Somers, a partner at the law firm Morse, Barnes-Brown & Pendleton.

The SEC plan drew more than 500 comment letters, a huge response. Commenters differed sharply over Rule 14(a)-11 to require proxy access, but there was general support for an amended Rule 14(a)-8 to let shareholders try to achieve proxy access on their own.

Originally, Corporate America’s opposition to proxy access also focused on whether a federal rule from the SEC was even a good idea, or whether the matter should remain a question for states’ corporation laws. But amid general expectation that proxy access is going to be reality sooner or later, the debate has shifted to how to craft a rule that can be applied workably to the universe of roughly 12,000 public companies. One major criticism that has emerged: that the SEC proposal only works one way, making it easier for shareholders to put nominees on corporate ballots; it does not allow issuers to make access more restrictive or to opt out of access altogether, even if shareholders would allow it.

“A lot of companies have majority voting, and coupled with access, that’s a major change. They’re trying to figure out what kind of world that creates for long-term stockholders.”

— Claudia Allen,

Chair, Corp. Governance Practice,

Neal Gerber Eisenberg

“The best way for the Commission to resolve this debate (and to assure workability can be achieved in all cases) is to allow for meaningful shareholder choice,” wrote Stanley Keller, Robert Lang, and Charles Nathan, three well-known corporate lawyers who submitted an extensive comment letter that explores alternative ways the SEC could provide shareholder choice.

Opt In vs. Opt Out

Critics of unfettered proxy access offered two alternatives. First, an “opt in” approach proposed by a group of seven law firms sketched out a default federal rule of no proxy access, but shareholders could implement access if they chose by adopting a by-law amendment, approving a by-law amendment submitted by the board, or ratifying a board-adopted by-law amendment. Or, under an “opt out” approach, Rule 14(a)-11 allowing proxy access would be the federal default rule, but shareholders could adopt more or less restrictive provisions—including no access at all—via the same by-law changes outlined above.

The seven law firms said they favored an opt-in system, but wrote in their comment letter that if the SEC is adamant in adopting Rule 14(a)-11, letting companies opt out of it is more consistent with the Commission’s stated goal of empowering shareholders and has broad support among a wide range of business constituencies.

Given the “diverse nature and needs” of the 12,000 public companies that would be subject to the rule, the law firms wrote that uniform proxy access “would not be effective or workable without the safety valve of a two-way opt-out.”

The Society of Corporate Secretaries & Governance Professionals also threw its weight behind an opt-out approach, citing a survey of its members that found two-thirds of respondents would want to implement an opt-out form of proxy access. Moreover, the Society wrote, such “privately ordered,” shareholder-approved plans would help deter investors from launching campaigns at many companies at once—which the SCSGP warned would be “another unintended and unwelcome consequence of Rule 14(a)-11.”

And former SEC Commissioner Joseph Grundfest, now a law professor at Stanford University and co-director of its corporate governance center, argued that without shareholder choice to opt out of proxy access, Rule 14(a)-11 would run afoul of the Administrative Procedure Act. Grundfest said an opt-in rule would be “less likely to destroy shareholder wealth” than an opt-out version.

REMOVING PROXY ACCESS BARRIERS

The following excerpt is from SEC Chairman Mary Schapiro’s speech on “Removing Barriers to Proxy Access.”

[W]e need to remove the unnecessary barriers to a shareholder’s state law right to nominate candidates to a board of directors.

Such barriers serve to weaken a board’s accountability to shareholders, which in turn may impact a board’s incentive to manage risks appropriately.

And while it is surely controversial, I believe this too must change.

So, at the Commission, we are nearing a vote on a proposed rule that requires public companies to let shareholders place their nominees on the companies’ proxy ballots.

The idea is to enable the corporate proxy process to function, as nearly as possible, as a replacement for in-person participation at a meeting of shareholders.

With the wide dispersion of stock prevalent in today’s markets, requiring actual in-person participation at a shareholder meeting is not a feasible way for most shareholders to exercise their rights.

Very briefly, under our proposals, shareholders would be able to have a limited number of nominees included in the company proxy materials if those shareholders satisfy certain requirements. Among other things, that includes meeting security ownership requirements, providing certifications about their intent, and disclosing additional information.

If adopted, this and related new rules would afford shareholders a stronger voice in determining who will oversee management of the companies that they own.

Strengthening the ability of shareholders to hold boards of directors accountable to them should further empower shareholders and help to restore investor trust in our markets.

Source

Securities and Exchange Commission (Jan. 20, 2010).

On the other side, supporters of proxy access such as the Council of Institutional Investors argue that companies shouldn’t be allowed to opt out of proxy access. CII Analyst Jonathan Urick said an opt-out clause is “fundamentally inconsistent with the notion that a minimum level of access to the proxy is needed … to give substance to investors’ fundamental right to nominate directors.”

“A rule that provides for a proxy access opt-out is hardly an ‘investor choice’ model, but rather a ‘management choice’ model that permits public companies to continue to deny their shareowners the fundamental right to nominate and elect directors,” he wrote in the CII’s comment letter.

Others say the SEC should amend Rule 14(a)-8 and then wait to see whether companies follow the lead of HealthSouth Corp., which last October took advantage of changes to Delaware corporate law and adopted a by-law requiring reimbursement of “reasonable” expenses for a successful dissident board candidate.

“If the practice at HealthSouth becomes a trend, the SEC may find proposed Rule 14(a)-11 unnecessary to accomplish the objective of investor protection,” Charles Elson and Roger Coffin, director and associate director of the University of Delaware’s Center for Corporate Governance, wrote in a joint letter. Elson is also chair of HealthSouth’s nominating and governance committee.

Elson and Coffin argued that the expense of waging a full-scale proxy contest is the real barrier to shareholder power; proxy access, “while vital, is an empty right without a corresponding right to shareholder expense reimbursement.”

Meanwhile, the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness continued its hard line of calling for the SEC to withdraw the proposal, period. It described the proposal as “unwise, unnecessary, and exceeds the SEC’s statutory authority.”

The Chamber said new reports and research on proxy access published last fall (which were the pretense the SEC used to extend its comment period until last week) provide “ample additional evidence that the proposal is unworkable, will harm investors, undermine the management of companies, and erode shareholder value.”