SEC Sends Proxy Question to Delaware

All eyes in the governance community are on Delaware this week, as the state’s Supreme Court breaks new ground in how to resolve complicated questions of securities law—and the question itself could have huge implications for Corporate America.

At issue is a shareholder resolution from the American Federation of State County and Municipal Employees to force software maker CA to reimburse the union for the cost of proxy fights, should the union’s director candidates win at least one spot on the board. CA balked at that idea and asked the Securities and Exchange Commission to issue a no-action letter giving CA permission to ignore the request.

Rather than wade into that controversy itself, however, the SEC has handed off the question to the Delaware Supreme Court. Delaware amended its constitution last year to allow its courts to answer certified questions from the SEC, essentially cutting the Gordian knot of hearings and appeals to get legal opinions straight from the top court in the state. Delaware’s legal decisions are highly influential, since most corporations (including CA) are incorporated there.

Elson

Charles Elson, director of the corporate governance center at the University of Delaware, calls the CA question “the most significant corporate law case in probably 10 years … It goes to the question of who controls the election process, the board or investors?”

J. W. Verret, an assistant law professor at George Mason University, echoed Elson’s strong words, saying: “This has the potential to change corporate securities law in a way we haven’t seen since 1933.”

The Delaware Supreme Court heard oral arguments July 9 and is expected to rule shortly. CA plans to file its proxy materials with the SEC by July 24 for its Sept. 9 annual meeting.

The dispute started in April, when CA asked the SEC to issue a no-action letter under Rule 14a-8, arguing that under Delaware state law AFSCME’s resolution wasn’t a proper question for shareholders to decide. AFSCME, meanwhile, submitted its own argument that the proposed by-law is consistent with state law and a perfectly permissible question for shareholders.

If the proposal is allowed on the ballot, “It solves the shareholder access and say-on-pay debate. Those issues fizzle.”

— Charles Elson,

Director, Corp. Governance Center,

University of Delaware

On June 27, the SEC staff told CA that it was “unable to concur” with CA’s belief that the resolution should be excluded from the proxy statement. But at the same time, the Commission certified two questions of state law for the Delaware Supreme Court. In other words, the court will now decide whether the shareholder resolution violates Delaware corporation law; if it doesn’t, the proposal goes into CA’s proxy statement for shareholders to vote on.

Keller

Stanley Keller, a partner at the law firm Edwards Angell Palmer & Dodge, says the SEC’s referral is “a milestone event, because it establishes a basis for federal-state coordination in an area, namely corporate governance, where there has been overlapping roles.”

Keller says that because the certification question essentially lets Delaware legal experts handle questions of Delaware state law—rather than have parties argue state matters in front of the SEC or federal courts—the result is a “much better, reliable process.” State corporate law issues are “decided by a sophisticated, experienced, and responsive court, rather than leaving it to the chance of the parties’ selection of a forum,” he says.

Similarly, Lisa Fairfax, a professor and director of the business law program at the University of Maryland, says, “This allows the process to play out in a more appropriate fashion.”

Same Battles, Different Forums

AFSCME’s resolution specifically asks CA to reimburse the reasonable expenses of stockholders running a short slate of director nominees for election, provided at least one nominee is elected to the board. Various groups have pushed that cause at various companies for years, without much success.

SEC DENIES CA

The following excerpts are from CA’s Letter to the SEC and the Commission’s response.

… CA believes the Proposal may be excluded under Sections (i)(8), (i)(1), (i)(2) and (i)(3) of Ru1e 14a-8 because it relates to an election of directors, conflicts with Delaware law, and is inconsistent with the Commission's proxy rules. On behalf of CA, I ask the staff to

please confirm that it will not recommend any enforcement action to the Commission if CA excludes the Proposal from its proxy

statement and proxy card for the 2008 annual meeting.

If adopted, the Proposal would require CA to amend its by-laws to include a provision that wou1d require the Company to reimburse any stockholder who wages a “short-slate” proxy contest for related expenses if the contest is at least partially successful. Specifically, the proposed by-law would require that any stockholder or group of stockholders be reimbursed by the Company for reasonable expenses included in nominating one or more candidates in a contested election of directors at any time in the future, as long as fewer than 50 percent of the directors to be elected are contested and at least one of the stockholder nominees is elected. Reimbursable expenses would include all those reasonably incurred in connection with the contest, including those relating to printing, mailing, legal services, solicitation, travel, advertising, and public relations, up to the amount expended by the Company in connection with the contest.

In its supporting statement, AFSCME notes that the Proposal focuses on successful “short-slate” contests—those involving a competing slate of candidates that, if elected, would not comprise a majority of the board—with success defined as the election of at least one candidate. A successful “long-slate” contest would result in a change of control and the new board would have the authority to approve reimbursement for contest expenses if it decided to do so. Thus, as a practical matter, there is no need for a mandatory reimbursement by-law in those situations, according to AFSCME. Rather, the Proposal seeks to mandate reimbursement when contest proponents do not gain control of the board, so that they can by-pass the board and obtain reimbursement without board approval.

—David Harms

Sullivan & Cromwell (representing CA)

Source:

CA Letter to the SEC (April 18, 2008).

We are unable to concur in your view that CA may exclude the proposal under rule 14a-8(i)(3). Accordingly, we do not believe that CA may omit the proposal from its proxy materials in reliance on rule 14a-8(i)(3).

We are unable to concur in your view that CA may exclude the proposal under rule 14a-8(i)(8). Accordingly, we do not believe that CA may omit the proposal from its proxy materials in reliance on rule 14a-8(i)(8).

Under Section 11(8) of Article IV of the Delaware Constitution, the Delaware Supreme Court may hear and determine questions of law certified to it by the Commission. To help us determine whether you have satisfied your burden of demonstrating that CA may exclude the proposal under rule 14a-8(i)(1) or under rule 14a-8(i)(2), at our request, the Commission has certified the state law questions raised by your letter under rule 14a-8(i)(1) and rule 14a-8(i)(2) to the Delaware Supreme Court, specifically, (1) whether the proposal is a proper subject for action by shareholders as a matter of Delaware law, and (2) whether the proposal, if adopted, would cause CA to violate any Delaware law to which it is subject.

—Thomas J. Kim

Chief Counsel & Associate Director

Source:

SEC No-Action Letter (June 27, 2008).

A CA spokesman and outside lawyer for the company both declined to comment on the resolution. Richard Ferlauto, AFSCME’s director of pension and benefit policy, says the pension fund wants “to clarify that under Delaware law, shareholders have the right to amend bylaws to change election procedures.”

Ferlauto says the certification process is significant because it “changes the relationship between the SEC and the Delaware courts.” Had the SEC not referred the question to the Delaware courts and simply declined to issue a no-action letter, the union probably would have taken CA to court over the dispute, he says.

AFSCME is one of the most outspoken shareholder activists out there, and its litigation habits have already caused numerous headaches at the SEC. Earlier this decade the union sued American International Group over a proposal to amend AIG’s by-laws so that shareholders could place director nominations in the proxy statement.

That fight culminated in the 2006 decision by a federal appeals court in favor of AFSCME’s proxy access proposal. The SEC subsequently voted last November to amend the federal proxy rules to codify a long-standing Commission policy against shareholders’ proxy access at least for 2008, a move that sent shareholder activists into fits.

In theory, the Commission will try to approve a final rule clarifying proxy access later this year, although no shortage of skeptics wonder whether that will really happen. But many also say that if the Delaware Supreme Court certifies this shareholder resolution—which essentially would force companies to help defray the cost of dissident shareholders’ campaigns—that may quiet the calls for full proxy access.

Ferlauto

A victory on the CA resolution “would improve the issue of access, but it doesn’t solve it,” Ferlauto says. Dissidents would still have to foot the cost of proxy contests upfront, which is the major hurdle to running dissident campaigns, he says. And if the dissidents fail to win any seats, they would get no money at all.

“If it goes on the ballot, we’ll have gotten what we wanted,” Ferlauto says. “This provides another tool in our arsenal, particularly if proxy access continues to be stalled.”

Fairfax shares Ferlauto’s view. “Is it a substitute for proxy access? No,” she says. “But it’s helpful for those who would like to have movement on the question of proxy access.”

Elson, who describes the CA resolution as “proportional reimbursement” and calls it “the most effective way to create greater director accountability,” takes a somewhat different view. He believes that if the proposal is allowed on the ballot, “It solves the shareholder access and say-on-pay debate. Those issues fizzle.”

Conversely, if the Delaware Supreme Court sides with CA and says the resolution isn’t permissible under state law, “access is back on the table at the SEC,” he says.

With an agenda already bursting at the seams and only six months until SEC Chairman Christopher Cox’s tenure expires, that is probably the last thing the Commission wants to happen. Verret, however, says the Delaware court could try a third option: ruling the resolution as legal, but also ruling that companies have a fiduciary duty not to reimburse shareholders in certain cases.

Verret

Even Verret admits, “That’s a wishy-washy middle ground and would be likely to lead to further litigation.”

Ferlauto says AFSCME is waiting for a new administration, and a new SEC chairman, to arrive in January and reopen the debate on proxy access.

“There’s not enough time in this calendar year to go through the process of creating a new regulation with the required public hearings.” he says. “We’re waiting for a new chairman appointed by the next president, and that’s when it will get resolved.”