The SEC, Corporate Governance, and the Non-Access Proposal

Editor’s Note: This post is from J. Robert Brown, Jr. of the University of Denver .

The October 2nd deadline is quickly approaching for comments on the SEC’s two proposals on proxy access for bylaw proposals related to shareholder nominations to the board.  One proposal would deny shareholder access to the proxy altogether; the other would permit access on a limited basis, extending it only to those shareholders holding more than 5% of the company’s voting shares. 

Both proposals were approved by a 3-2 vote, with Chairman Cox the deciding vote in each case.  Those votes was taken before Commissioner Campos resigned.  In my view, his resignation increases the likelihood that the non-access proposal will be adopted.  As I explain below, this would be an unfortunate development both for the SEC and for shareholders.

The non-access proposal would amend Rule 14a-8(i)(8), which currently allows for the exclusion of proposals that “relate[] to an election” to the board.  The amended Rule would permit issuers to exclude any proposal that relates “to a nomination or an election for membership on the company’s board of directors.”  In other words, issuers could exclude not only proposals that affect the election process, but also proposals that relate to director nominations and the procedures used to nominate or elect directors.  This proposal is a bad idea for a number of reasons.

First, the proposal will effectively result a federal regulation that denies shareholders their rights under state law.  As the Commission has noted, the proxy process is meant to operate as a substitute for the shareholder meeting.  Rule 14a-8 is not, therefore, an example of bureaucratic largesse–it is an imperative designed to facilitate a process that now serves the function the shareholder meeting once did.  By excluding access proposals under Rule 14a-8, the Commission would make it virtually impossible for shareholders to raise such proposals–because, to raise them, shareholders would have to endure the cost and delay associated with providing their own proxy.   

Second, the proposed language is imprecise, and will thus encourage issuers to exclude an increased number of shareholder proposals.  The Second Circuit has already described the language in Rule 14a-8(i)(8) as “not particularly helpful.”  The non-access proposal not only retains the imprecise language described by the Second Circuit–the new Rule would also add additional unhelpful changes. 

For example, the proposed Rule would include any proposal that “relates” to a nomination or to “procedures” for any election.  That language is far broader than the existing Rule and would allow for the exclusion of, for example, proposals related to director qualifications, cumulative voting, or majority-vote requirements.  In sum: the language is much broader than necessary simply to deny access on director-nomination bylaws.  It will instead encourage firms to exclude broad categories of proposals–some of which, the SEC staff have held, are not subject to exclusion under the current Rule. 

The Commission has acknowledged the breadth of the proposed language, but has promised only that the staff will “not adopt an inappropriately broad reading” that would permit exclusion of “all proposals regarding the qualifications of directors, the composition of the board, shareholder voting procedures, and board nomination procedures.”  That commitment, however, is no real limitation: because it offers no objective basis for cabining the staff’s interpretive authority, it does not ensure that proposals previously required to be included in corporate proxies will survive the new language.  Third, the language of the proposed rule will result in unintended consequences.  It will, among other things, encourage shareholders to offer proposals that cannot be excluded under the Rule–and that, if adopted, will result in even more election contests.  For example, the staff has, in the past, declined to allow issuers to exclude proposals that call for the “reimbursement of shareholder expenses in contested elections.”  Shareholders unable to include an access proposal in the company’s proxy may simply propose a bylaw that would require reimbursement of proxy expenses.  This type of proposal would, if adopted, likely result in far more contests than an access proposal under the current Rule.This example is not hypothetical.  In Citigroup Inc., AFSCME submitted a proposal that “urge[d]” the board to amend the bylaws to “provide procedures for the reimbursement of the reasonable expenses . . . in a contested election of directors.”  Citigroup sought to omit the proposal, arguing that it “would directly encourage parties to engage in proxy contests.”  The Commission, however, declined to allow Citigroup to omit the proposal.  Fourth, the reasons the Commission has given for adopting such broad and confused language are inadequate.  The Commission has mostly argued that proxy access for bylaw proposals for shareholder nominations to the board would result in inadequate disclosure to shareholders.  At best, this reasoning would support amendments to the Rules that would ensure adequate disclosure for shareholder nominees in the company’s proxy statement. 

The proposed Rule is needlessly broad, imprecise, and unlikely to accomplish its intended purpose.  It will also unnecessarily tax Commission resources, requiring the staff to make fine distinctions in ruling on no-action requests from issuers.  Moreover, shareholders are likely to seek ways to circumvent the restrictions of the new Rule–and to do so in ways that will result in even more election contests.

Finally, it sets an awful precedent, aligning the Commission with those in the corporate-governance debate who would deny shareholders rights they would otherwise have under state law.  As I argued in Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure, the Commission has become increasingly involved in the corporate-governance process.  A hallmark of that involvement should, at a minimum, be to do no harm–that is, to avoid using federal regulation to reduce existing governance rights.  That is exactly what this proposal would do.

The Race to the Bottom Blog has submitted a comment letter to the SEC describing these concerns in greater detail.

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