Defending Against Shareholder Proxy Access

In my paper Defending Against Shareholder Proxy Access: Delaware’s Future Reviewing Company Defenses in the Era of Dodd-Frank, I propose a variety of new defenses boards can implement to subvert and limit the reach of proxy access under the new federal proxy access regime to be implemented under Dodd-Frank.  I also consider the legality of those defenses under Delaware law and the prospect of federal pre-emption.

The debate over shareholder access to the corporate proxy has been a vibrant one, culminating recently in a provision in the Dodd-Frank Wall Street Reform Act authorizing the SEC to adopt a proxy access rule.   Recent reports indicate that the SEC is scheduled to adopt a final rule August 25.  This blog has featured commentary almost since its inception on the issue, particularly Professor Bebchuk’s work advocating for shareholder empowerment.

Advocates of proxy access urge that it will help hold Boards of Directors accountable to their owners.  Critics argue that it will give conflicted shareholders, like unions and state pensions, power they will use to facilitate their political objectives at the expense of ordinary shareholders.  The shareholder primacy and director primacy theories of corporate law have framed an extensive debate in the literature.  Regardless of which theory holds force, we can expect Boards to implement defensive strategies in the wake of proxy access to limit shareholder power, in the same way that Boards implemented defensive tactics in response to the hostile takeovers of the mid-1980s.  Delaware’s review of Board proxy access defenses will shape its role in the foreseeable future in much the same way review of Board takeover defenses shaped its role over the last 20 years.

This article in part considers what strategies may be useful for boards defending against proxy access and designs novel methods boards might consider.  This article designs a variety of novel defenses for that purpose.  Included among the roughly 16 defenses included in the paper are the novel ideas that: i) boards can limit the right of shareholder nominated board members to obtain indemnification, advancement, and insurance for legal claims by shareholders against those insurgent board members ii) boards can adopt bylaws setting forth qualification requirements for board membership to be interpreted by the board iii) poison pill triggers can be lowered such that shareholders cannot obtain the likely requisite 3% holding threshold to use the federal nomination right iv) boards can delegate more decision-making to subcommittees of the Board from which insurgents are excluded and v) new voting procedures (“Chinese Menu Ballots”) can be designed to limit special interest groups from gaining advantage under the plurality voting default.

The article examines how Delaware judges are likely to review those defenses under a vast body of jurisprudence protecting the shareholder franchise, also known as the Blasius line of cases. Though the Blasius cases protect the shareholder franchise, they do not necessarily prohibit board policies, bylaws, or charter amendments with an incidental effect on the shareholder’s federal nomination right.  The article argues that Delaware courts will need to move away from using Blasius as an outcome-determinative test in favor of providing more depth of analysis to the rule.  In order to be useful for minority slate contested elections, Blasius review will also need to develop a new life separate and apart from the takeover defense Unocal cases with which it has been paired.  The article concluded that the Blasius line of cases will permit most of the proxy access defenses presented.

Finally, this article considers whether the defenses considered are likely to be struck down as pre-empted by federal law or prohibited by the federal securities laws or stock exchange listing requirements.  The existing exchange listing standards and SEC rules would permit the defenses proposed in the article.  Further, the article argues that since most of the defenses do not actually depend on a law specifically authorizing the board to act, but instead flow from the board’s plenary authority under DGCL 141, federal pre-emption does not present a serious threat unless Congress passes new laws in this area.

The article offers a roadmap for how boards are likely to respond to proxy access and how Delaware’s role as arbiter of the shareholder/manager relationship is likely to evolve in the new environment.  Many of the commentators on this issue have argued that shareholder and boards should be able to opt-out of the federal rule in favor of an alternative approach to proxy access, but the SEC did not authorize boards and shareholders to opt-out in its most recent rule proposal.  The defenses presented in this article provide boards and shareholders a way to effectively opt-out of the federal rule by limiting its effect, and thereby give boards and shareholders the freedom to negotiate an alternative proxy access arrangement.

The full paper is available for download here.