On Nov. 28, the U.S. Securities and Exchange Commission adopted an amendment to Rule 14a-8(i)(8) that effectively denies shareholders access to the director-nomination process. This amendment allows a company to omit from its proxy material any proposal that relates to a nomination or an election for membership on a company’s board of directors or a procedure for such nominations or elections.
According to Chairman Christopher Cox, the SEC’s action, taken by a vote of 3-1, maintains the status quo of the past decade and is necessary to provide clear guidelines to companies before the upcoming proxy season.
In July of this year, the SEC proposed diametrically opposed proxy-access rule amendments that reflected a split among SEC members and added further confusion to the proxy-access issue following the American Federation of State, County and Municipal Employees Pension Plan v. American International Group Inc. decision ( AFSCME decision) by the 2nd U.S. Circuit Court of Appeals. Institutional shareholders, which are almost uniformly opposed to the non-access proposal adopted by the SEC, have already signaled their willingness to continue the fight in the courts.
The SEC’s action to adopt the exclusionary proxy-access rule amendment is surprising because many institutional investors and other commentators had blasted the proposal as being anti-shareholder and “undemocratic.” Chairman Barney Frank of the House Financial Services Committee (HFSC) and other members of Congress had also called for the SEC to postpone further action until the two departing Democratic commissioners, who supported the conflicting proposal, have been replaced.
In the meantime, Cox, who acknowledged that the two proposals were contradictory, insisted that the SEC needed to press forward to adopt a rule on the proxy-access issue in time for the 2008 proxy season. In light of these pressures from institutional shareholders and Congress, and especially Cox’s undertaking to re-open the discussion on shareholder proxy access in 2008, this latest action by the SEC is puzzling and seems precipitous.
In the AFSCME decision, the 2nd Circuit held that AIG could not rely on Rule 14a-8(i)(8) to exclude a shareholder proposal seeking to amend a company’s bylaws to establish shareholder-nominating procedures for directors in the company’s proxy materials. The court interpreted certain of the SEC’s previous no-action letters as limiting the election exclusion to shareholder proposals dealing with an identified board in a specific upcoming election. The SEC had urged the court to adopt a broader interpretation of the rule, which would exclude any proposals by shareholders that could make future election proxy contests even more likely.
The SEC, concerned that the AFSCME decision had created confusion over the proper application of the rule exclusion and might lead to contested elections for directors without adequate disclosure, issued interpretive guidance in July to confirm the position that it has taken fairly consistently since 1976. Specifically, the release reaffirmed the SEC’s view that a shareholder proposal can be excluded under the rule if the proposal could result in a director-election contest in the future.
The interpretive guidance attempted to lay to rest a concern raised by the 2nd Circuit in the AFSCME decision that the SEC had inconsistently applied the rule exclusion in various no-action letters. According to the SEC, allowing shareholders to include their nominees in company proxy material would, in effect, create a contested election of directors without the shareholders conducting a separate proxy solicitation. This would create an opportunity for a shareholder to wage an election contest without providing the required disclosures governing proxy contests.
The rule amendments, which were sponsored by Cox and the two Republican commissioners last July and adopted recently, are intended to clarify the scope of the rule exclusion. As adopted, the rule amendments permit a company to exclude a shareholder proposal that relates to:
A nomination or election of a director to a company’s board or analogous governing body; or
A procedure for such nomination or election.
Thus the amendments would, for example, permit a company to exclude from its proxy materials shareholder-proposed bylaws concerning director-nominating procedures that could affect future elections similar to those in the AFSCME case. According to Cox, the amendment could not await further consideration by the SEC next year after replacements for the two Democratic commissioners have joined the SEC.
Reaction to the SEC’s no-access proxy proposal was, as expected, bitterly opposed by embattled shareholder groups, who were perplexed that the SEC would favor management over the shareowners. The Social Investment Forum and a number of institutional investors issued warnings to the SEC that they would continue to fight any effort to limit their rights to participate in the director-nomination process.
Executive Director Ann Yerger of the Council of Institutional Investors, for example, testified at a recent hearing of the HFSC against the no-access proposals in favor of the status quo. In other words, let the courts decide. The Teamsters also opposed the SEC proposal in favor of operating under the AFSCME decision. This approach would have left open the door to shareholders seeking to establish shareholder-nominating procedures through bylaw amendments without meeting any additional ownership or disclosure requirements.
The substantial institutional shareholder opposition to the SEC’s no-access proposal and the HFSC’s call to postpone final action until replacements for the departing commissioners have been seated apparently did not dampen the SEC’s determination to adopt the no-access proposal in time for the upcoming proxy season. The recently reported departures of the two Democratic commissioners provided the SEC with ample cover to postpone a final decision, especially since they and Cox had sponsored the alternative “pro-access” proxy proposal.
Given the widespread criticism of, and the apparent confusion surrounding, the two contradictory proposals, a time-out by the SEC would seem to have been optimal – except perhaps for the companies that receive shareholder access proposals during the 2008 proxy season. It is difficult to reconcile Cox’s plan to adopt a “temporary fix” in the form of the no-access amendments with the notion that the SEC will be rethinking the issue again next year.
The SEC’s action to adopt a no-access proxy rule amendment is not surprising because it is consistent with the SEC’s interpretive guidance in July and reaffirms its position before the 2nd Circuit in the AFSCME case.
Some commentators have pointed out, however, that the SEC could have taken a time-out after issuing the interpretative guidance because that was all the 2nd Circuit required. Instead, after proposing two conflicting proxy-access proposals this past summer that were widely criticized and further confused the proxy-access landscape, the SEC has adopted a controversial no-access rule amendment that likely will spur institutional shareholders to continue the battle for unfettered proxy access in the courts.
Already, three institutional shareholders, including AFSCME, reportedly have announced that they have sent proxy-access proposals to financial institutions, including Bear Stearns and J.P. Morgan Chase. The director of AFSCME reportedly said that this action by the SEC “will tar [Cox's] legacy as an anti-shareholder chairman.”
These developments would seem to be a harbinger of what to expect in the 2008 proxy season: a record number of such proxy-access proposals by activist shareholders followed by further court battles.
JORIS M. HOGAN is a partner of Torys LLPand specializes in mergers and acquisitions, corporate finance and corporate governance in the corporate and capital markets group, which he co-heads.