November 13, 2014
Management groups speak with confidence. Regulators promise certainty. Shareholder activists talk of possible litigation. What does it all mean?
It seems the SEC's recent amendment to Rule 14a-8(i)(8) has brought less certainty than the Commission had hoped regarding whether bylaw amendments requiring companies to put qualifying shareholder nominations on the proxy may be excluded from that same proxy by management.
Institutional shareholders have long proposed 'proxy access' initiatives demanding the right to nominate directors for election to the board. This would usually require amendments to corporate bylaws allowing qualifying shareholders – those who hold a certain percentage of company stock – be permitted access directly to a company's proxy statements.
The issues surrounding such access have been hotly debated and contested within companies, among industry associations, with regulators, with legislators and in the courts. Lurking behind the technical issue of whether proxy access bylaw proposals may be excluded by management under SEC Rule 14a-8 is the larger question of whether or not they are a good idea.
Broadly, pro-access advocates argue that such proposals, when successful, bring full democracy to corporate elections that otherwise limit shareholders to voting on a management slate, and give shareholders leverage in their efforts to get directors to negotiate over contested election procedures and other matters.
Opponents of proxy access claim to be protecting corporate democracy from the distorting influence of certain types of institutional investors. 'If special interest groups have access to a company's proxy, that raises concerns about directors being beholden to various interest groups,' argues Thomas Lehner, director, public policy for the Business Roundtable, an industry group composed of CEOs from publicly traded companies.
Special interests cited in this regard may include unions, pension funds, environmentalists or, increasingly, hedge funds or sovereign wealth funds. The argument that proxy access is necessary to advance the interests of corporate democracy has disappeared, Lehner says, due to recent changes in corporate voting practices: 'With companies moving to majority voting, effective advise and consent mechanisms already exist.'
To Richard Ferlauto, director of pension and benefit policy at the American Federation of State, County and Municipal Employees, Employees Pension Plan (AFSCME), believes concerns about 'special interests' are 'a total red herring,' and the rise of majority voting favors, rather than moots, the case for reform. 'At least two majority votes are required, and in some companies a super-majority, to change bylaws and then you have to win a majority of votes to get on the board,' he argues. 'So it would be very difficult for a special interest group of any type to hijack the process against the interests of the shareholders. As to hedge funds and sovereign wealth funds, proxy access amendments that we support require long term holding periods, so people who are in and out of a stock would be barred from running candidates.'
The litigation and regulatory environment
The SEC recently published final changes to Rule 14a-8, effective January 10, 2008 and intended, according to the December 11 Federal Register, 'to provide certainty regarding the meaning of this provision in response to a recent court decision.'
In that decision –American Federation of State, County and Municipal Employees, Employees Pension Plan v. American International Group (AFSCME v. AIG) – the US Court of Appeals for the Second Circuit held that a proxy access proposal that met the company's qualifying standards could not be excluded under Rule 14a-8. Specifically, the Court reversed the trial court's refusal to strike a 'no action' letter that the SEC had issued. This letter sent out by the Commission had given management the assurance that if it excluded a proxy access bylaw proposal it would not be treated as a violation of the rule.
While Rule 14a-8 allowed for exclusion of a proposal that 'relates to an election,' the Court found that this language was ambiguous on the subject of whether proposals concerning future elections (such as proxy access bylaw proposals), rather than a present election, were excludable. The SEC had filed an amicus brief in favor of excludability. The Court found the rule to be ambiguous, and held that the SEC's interpretation was not entitled to the deference usually accorded agency interpretations in such circumstances because the SEC had taken a contrary position from 1976 to 1990, and inconsistent positions from 1990 to 1998, without 'so much as acknowledging a changed position, let alone offer[ing] a reasoned analysis of the change.'
The Court appeared to encourage the SEC to address Rule 14a-8's ambiguity by amending certain components of it, emphasizing that it took 'no side in the policy debate regarding shareholder access to the corporate ballot,' and that 'Congress has determined that such issues are appropriately the province of the SEC, not the judiciary.'
The SEC followed this suggestion, amending the rule to provide for exclusion of an otherwise qualifying shareholder proposal: 'if the proposal relates to a nomination or an election for membership on the company's board of directors or analogous governing body or a procedure for such nomination or election.'
Time will tell whether the Commission can achieve its stated purpose of bringing greater certainty surrounding the proxy access issue, but confusion remains for the 2008 proxy season.
Fighting a losing battle – for now
According to Ferlauto, proxy access proposals have been filed with at least six companies. Though all of these were filed well over 30 days ago, he says, to date only two companies – Bear Stearns and JP Morgan Chase – have requested 'no action' letters, and the SEC has not yet acted on these requests even though they, too, were made more than 30 days ago.
So nothing has yet percolated to the point at which litigation becomes an option. Will that happen and, if it does, how will access advocates and, if asked, the courts, react to the exclusion of proxy access proposals, in light of the new Rule 14a-8?
'I think the SEC has been very clear, there is no ambiguity,' says Lehner. 'If proxy access proposals are filed, the SEC will issue 'no action' letters, if asked to do so by the company. If the proponents turn around and litigate, I think they'll lose and be wasting their money.'
Reform advocates appear to agree about the SEC's likely response, but they part ways on the futility of litigation. 'Presumably, the SEC will grant no action letters, based on the new rule,' says Ferlauto. 'The real question is, did the SEC meet the bar created by the Second Circuit? Was their rulemaking clear, well thought out and non-ambiguous? There are a lot of ambiguities in the rule. They could have done it more effectively, and we believe litigation is definitely an option that remains open to us.'
A matter of interpretation
Ferlauto notes what he describes as an 'inconsistency in the SEC's rulemaking in that a company can create a proxy access bylaw, or can put one on the ballot as a management proposal, and there's not a problem – [but an investor can not.]' The question is, can this, or other asserted substantive deficiencies in the new rule, be grounds for a court to again put aside traditional judicial concepts of deference, after the SEC amended Rule14a-8 for the express purpose of responding to the Second Circuit's concerns in AFSCME v. AIG?
The Court in AFSCME v. AIG reviewed the SEC's interpretation of prior Rule 14a-8 only because it found it to be ambiguous as to whether a ballot initiative that concerned future elections, but did not concern the election to which the proxy at issue applied, was excludable by management as a proposal that 'relates to an election.' Since the rule could be read either way (that is, in the Court's view), it was appropriate to review the agency's interpretation. Even that review would have been done deferentially, had the court not determined that the SEC's prior interpretations were inconsistent.
From one perspective, the new rule seems reasonably calculated to eliminate the prior version's ambiguity concerning application to future elections (as it would appear to be impossible to both amend the procedures for a vote and conduct that vote under the amended procedures through the same proxy). If accepted, this argument – along with the argument that prior inconsistencies of interpretation may no longer be relevant, since the new rule has not yet been interpreted by the SEC – should reduce the chances that a court would again disturb the agency's application of its rules. But even as it arguably cures one problem, the new rule may create others.
John Wilcox, new chairman of London-based consultancy Sodali and an advisor on corporate governance to (and formerly head of corporate governance for) major institutional investor TIAA-CREF, declined to comment on the new rule's direct impact on litigation, but says: 'On the substance of the issues raised by the Second Circuit, I don't think that even in the revised rule the SEC explained why it changed its position, or why the new position is the right thing for shareholders. I don't think the SEC has adequately explained why proxy access is excludable when other shareholder proposals relating to the election process are not.' (Wilcox identified this, and all his quoted opinions, as solely his own.)
'Will they interpret the new rule to exclude ballot access for bylaw amendments requiring cumulative voting, or majority voting?', Wilcox asks. The question appears largely rhetorical, but illustrates how the SEC may have to choose between inconsistent interpretation of its rules, or more radical change to established practices than it is traditionally comfortable with. Other rule changes may bridge this gap, or they might only serve to multiply the complexities.
While the prospect of litigation remains very much in the air, the suggestion that negotiation may be the better course of action is also detectable. Ferlauto says: 'You could see companies putting proxy access initiatives on their proxy ballots to accommodate shareholders.'
Beyond the 2008 proxy season
SEC chairman Christopher Cox has stated that he believes shareholders should have greater say in the nomination of directors, and that he is committed to revisiting the issue of proxy access proposals in 2008. However, the recent change to Rule 14a-8 passed 3-1 on party lines. With the sole Democratic commissioner who voted in opposition now resigned, few observers on either side of the question expect that Cox will be able to effectively revisit the issue in a reformist direction anytime soon.
'We've never had any expectation that the SEC would move forward with a real proxy access proposal under the current administration, whether those positions are filled or not,' says Ferlauto. Lehner agrees that, while Cox 'will go back and consider the subject, he won't do that until he has a full set of commissioners. With the election year, it may take a lot of time to get them confirmed.'
'By suggesting the issue would be revisited, the Commission may have been trying to reduce the impact of the decision, or the criticism of it,' says Wilcox. 'But I don't know, we should wait to see whether they follow up on it.'
With a diminished prospect of litigation and no regulatory relief in sight, access advocates might well be discouraged. But don't expect them to go away. Whether alongside litigation or without it, the everyday tools of corporate democracy and business negotiation remain available.
'Many people feel there should be a way for access to be advanced without going through all the complexities of legislation or regulation,' says Wilcox. 'Maybe it's a problem that regulation can't address sufficiently. I think it involves more state law issues. Maybe we could look for a solution there.'
Like Lehner, Wilcox points to majority voting as relevant to the solution. But unlike Lehner, he cites it as an example of how consensual reform can be accomplished, rather than as a reason why further reforms are unnecessary.
'People assume that what's good for shareholders is bad for management,' says Wilcox, adding, 'That assumption needs to be questioned.' But progress is being made, he says, 'Majority voting started as an us and them issue. It took three or four years but, working with the American Bar Association committee on corporate laws, we got to the point where it worked very smoothly, in a way that was acceptable to both shareholders and management.'
Wilcox rejects the argument that state law solutions are too complex, or encourage companies to flee the states that embrace reform. 'Very minor tweaks in Delaware law made majority voting work more efficiently,' he says. 'We haven't seen a rush of companies away from Delaware.'
The prospects of consensual reform are probably reduced by any diminishment in the threat of credible shareholder litigation. 'It would have been much better if the SEC had allowed the process to move forward on the path it had been following,' says Wilcox.
If the SEC had allowed shareholder proposals to go forward, 'companies and shareholders would have sat down and gone through the process of considering how access might work.'
To the extent their prospects of ultimate success depend upon a credible litigation threat, mid-to-far-term negotiations must await near-term developments. The very fact of litigation is as yet uncertain, and it would be imprudent to suppose that any result could be predicted with certainty. As Ferlauto ultimately concluded, 'it may be premature to talk about litigation until we hear from the SEC.' Stay tuned.