Court, SEC Revive Proxy Access Rule

Proxy access, an idea anathema to most corporate boardrooms, has roared back to the forefront of corporate governance debates with a key court ruling in favor of shareholders and looming new regulatory hearings on the topic.

With unusual swiftness for a governmental agency, the Securities and Exchange Commission last week scheduled an open meeting for Oct. 18 to approve new rules for submitting shareholder resolutions related to nominating directors in time for the 2007 proxy season.

The SEC’s announcement came in reaction to a decision by a federal appeals court that disagreed with the SEC’s longstanding interpretation of Rule 14a-8(i)(8), which addresses when a company must include a shareholder’s proposal in its proxy statement.

The court ruling—issued by the influential 2nd Circuit Court of Appeals, which covers New York and the mid-Atlantic states—said shareholders can submit proposals for the proxy concerning director nominations. Companies have bitterly opposed proxy access, and the SEC said it is moving ahead quickly to clarify rules around the issue given the large number of public companies subject to jurisdiction in the 2nd Circuit.

Cox

“These rights are best secured under consistent national application of Rule 14a-8 to shareholder proposals,” SEC Chairman Christopher Cox said in a statement, adding that he wants to provide “certainty with regard to shareholder proposals in every judicial circuit.”

The decision, American Federation of State, County and Municipal Employees v. American International Group, does not suddenly allow shareholders to put their own slate of director nominees onto a company’s proxy statement; it only says that shareholders can submit proposals for the proxy concerning director nominations from shareholders.

Even so, many observers—including at least one SEC source—believe this series of developments is likely to lead to a wave of shareholder resolutions during the 2007 proxy season calling for companies to implement some form of proxy access. “Like the majority vote issue, there is significant support on an individual basis to include a proxy access provision in the nomination process,” AFSCME spokesman Richard Ferlauto says.

AFSCME, long an agitator for more shareholder rights, submitted a proposal to AIG in December 2004 for inclusion in its 2005 proxy statement that would have amended AIG’s bylaws to require the company, under certain circumstances, to publish the names of shareholder-nominated candidates for director together with any candidates nominated by AIG’s board of directors. AFSCME argued that its proposal was seeking to change AIG’s election procedure, not to address a specific election.

AIG refused, and sought approval from the SEC to omit the measure from its proxy altogether under the election exclusion clause of Rule 14a-8, on the basis that the proposal “relates to an election.” The SEC issued a no-action letter indicating it would not recommend an enforcement action against AIG should the company exclude the proposal from its proxy statement.

AFSCME then sued the insurance giant to force the issue. The U.S. District Court for the Southern District of New York ruled in favor of AIG and the SEC, but the appeals court ruled in AFSCME’s favor.

The appeals court pointed out that complicating this question is not only the ambiguity of Rule 14a-8 itself, but also the two different interpretations the SEC has ascribed to the rule’s language. The SEC’s first interpretation was published in 1976, the same year that it last revised the election exclusion, the court noted.

The SEC’s Division of Corporation Finance, which handles investor disclosure matters and issues no-action letters, continued to apply this interpretation consistently until 1990, when it began applying a different interpretation, the court added, “although at first in an ad hoc and inconsistent manner.”

In its opinion, the court wrote that when confronted with an ambiguous regulation, the interpretation the agency made when the rule was first implemented should be the controlling standard. “Accordingly, we hold that a shareholder proposal that seeks to amend the corporate bylaws to establish a procedure by which shareholder-nominated candidates may be included on the corporate ballot does not relate to an election within the meaning of the rule, and therefore cannot be excluded from corporate proxy materials under that regulation,” the court wrote.

From Court Decision To SEC Regulation

Not surprisingly, shareholder advocates have hailed the ruling and the SEC’s subsequent announcement. Ann Yerger, executive director of the Council of Institutional Investors, admits she was surprised the SEC acted so quickly, adding that “sooner rather than later is better. Our members are making their plans for 2007.” Yerger says she is heartened that the SEC will settle the issue “so there is no uncertainty during the [upcoming] proxy season.”

Daniel Pedrotty, general counsel for the AFL-CIO’s Office of Investment, calls the ruling “a huge and encouraging victory.”

“Proxy access is a way for institutional investors to have a voice in the boardroom,” he says. “It is something we have been working toward. We hope the decision is a springboard in that direction.

Ferlauto

Ferlauto, however, concedes that the appeals court ruling left some room for the SEC to create no formal interpretation of Rule 14a-8. In a footnote, the court stated: “If the SEC determines that the interpretation of the election exclusion embodied in its 1976 statement would result in a decrease in necessary disclosures or any other undesirable outcome, it can certainly change its interpretation of the election exclusion, provided that it explains its reasons for doing so.”

Regardless, Ferlauto doubts the court ruling and the SEC’s anticipated change to Rule 14a-8 will ultimately lead to the agency proposing new rules for unrestricted new proxy access. “I’m not sanguine of seeing a rule passed,” he says.

Rather, Ferlauto believes that if the court decision is codified by the SEC, Corporate America will see a surge in measures calling on companies to make bylaw changes that would require a proxy access mechanism—much like the calls for majority vote standards to elect board directors, which have exploded in the last two years. One SEC official says he expects a large number of resolutions since what he calls the “proponent community” is good at coordinating its efforts.

Pedrotty “absolutely” believes more resolutions for proxy access are waiting in the wings. “It will be like the majority vote trend, which we view as very compatible with proxy access,” he says. “We’ll be looking closely at which companies this proposal makes sense [to target].”

Unlike the majority vote movement, companies will be less likely to voluntarily implement a proxy access bylaw change, since they fiercely opposed that idea when the SEC offered its own proxy access proposals in 2003.

The SEC’s original Proposed Rule 14a-11 was not deemed very aggressive in the first place, even though it called for certain investors to nominate their own director after a two-step process over a two-year period. Under that plan, before certain shareholders could put up their slate of nominees, one of the two initial triggers had to be tripped.

One required that a shareholder group owning at least 1 percent of voting shares outstanding for at least a year submit a proposal for a nomination procedure, and for that proposal to receive more than 50 percent of the votes cast at the meeting. The other trigger would occur if at least one of the company’s nominees for the board of directors for whom the company solicited proxies received “withhold” votes from more than 35 percent of the votes cast at the annual meeting. If either one of those triggers happened, then the following year a shareholder owning more than 5 percent of the shares for two years could nominate a director.

Not everyone, however, believes a proxy access rule would be enough to change a boardroom significantly. Charles Penner, general counsel of the $4 billion activist hedge fund Jana Partners, calls the latest developments “interesting” and something the fund will monitor. Still, he stresses that Jana traditionally favors filing its own proxies, calling it a more effective way to communicate with shareholders. He adds: “I doubt [recent developments] change those factors.”