The Destructive Ambiguity of Federal Proxy Access

Jill Fisch is a Professor of Law at the University of Pennsylvania. The Program on Corporate Governance has issued several papers concerning proxy access, including Private Ordering and the Proxy Access Debate and The Harvard Law School Proxy Access Roundtable.

The paper, The Destructive Ambiguity of Federal Proxy Access, forthcoming in the Emory Law Journal, demonstrates the tension between the federal requirements for the exercise of shareholder nominating rights and the state law principles upon which the SEC purports to ground those rights. The paper unpacks the ambiguities in the SEC’s conception of which shareholders should nominate director candidates. And it highlights the ambiguity resulting from the SEC’s failure to confront, in adopting its rule, the appropriate allocation of power between shareholders and management and the effects of proxy access on that balance.

Under U.S. corporate law, the shareholders elect the board of directors. In most cases, however, those shareholders do not nominate director candidates. Instead, the nominating committee of the board chooses a slate of candidates, and those candidates are submitted to the shareholders for approval. Absent the infrequent phenomenon of an election contest, shareholders do not participate in the nomination process.

The Securities and Exchange Commission (SEC) has struggled for years with the regulation of the shareholders’ role in nominating directors. As early as 1942, the SEC proposed a rule that would have required issuers to include shareholder-nominated candidates in their proxy statements. Ultimately, the SEC abandoned the proposal. In the ensuing almost seventy years, the SEC revisited the issue at least five times but failed to adopt a rule allowing proxy access.

Adoption of a shareholder nomination rule faced several obstacles. First, from the outset, the rule faced strong opposition from business interests. Indeed, measured by comment letters, proxy access is, by far, the SEC’s most controversial rule-making initiative. Second, as the SEC refined the federal proxy rules in response to ongoing marketplace developments, the details of a proxy access rule became both increasingly important and impossible to perfect. Fundamentally, the SEC was unable to draft a proxy access rule that would satisfy everyone. Third, the DC Circuit declared, in the Business Roundtable decision, that the SEC lacked the authority to regulate corporate governance through the proxy rules. A shareholder nomination rule was likely to raise a potential conflict with this holding and to trigger litigation seeking to invalidate the rule.

When Congress authorized the SEC to adopt a federal proxy access rule as part of the Dodd-Frank financial regulatory reforms, it removed the last of these hurdles, clearing the way both for the SEC to adopt proxy access and, more importantly, to consider explicitly the corporate governance implications of increasing shareholder access to the proxy. Yet Rule 14a-11, the SEC’s proxy access rule, adopted on August 25, 2010 when the ink on Dodd-Frank had barely dried, is limited in scope and ambiguous in both its application and its justification. Indeed, once Congress authorized the SEC’s adoption of proxy access, the SEC’s most significant change to its prior proposals was to tighten the qualification requirements, sharply limiting the number of shareholders who would be able to use the rule.

Although the SEC describes the proxy access rule as “facilitat[ing] the rights of shareholders to nominate directors to a company’s board,” the rule is highly unlikely to do so. The restrictive limitations on which shareholders qualify to use the rule, coupled with new and existing burdens on shareholder collective action, suggest that the rule will be a non-starter, ineffective in enabling shareholders even to exercise their nominating power much less to affect board composition or increase director accountability. In addition, the SEC has buttoned down the hatches with respect to state law or private ordering efforts to facilitate shareholder nominating power. Although purporting to leave issuers the option of extending shareholder rights beyond the scope of Rule 14a-11, the SEC has maintained substantial obstacles to any such extension.

Whether or not one supports shareholder nomination of directors, Rule 14a-11 raises a puzzle. If the SEC intended to facilitate shareholder nomination of directors, why did it adopt a rule that largely insulates issuers from shareholder input into the selection of director candidates? If instead, the SEC determined that increasing shareholder nominating power was a bad idea, why go through the pretense of adopting a proxy access rule at all? More broadly, the SEC’s rule-making releases offer no insight into the SEC’s normative position as to whether proxy access will improve the corporate governance of public companies. Absent such justification, the exercise of rule-making authority appears disturbingly arbitrary.

Importantly, the SEC’s rule-making does not alleviate the historical restrictions imposed by federal proxy regulation on shareholder attempts to tailor director nomination procedures through private ordering. In 2009, Delaware amended its corporate law to provide explicit authorization for proxy access bylaws, yet investor efforts to exercise this statutory authority have been stymied by federal law.
The paper argues that the SEC should retreat from its efforts to regulate the role of shareholders in nominating director candidates and modify the proxy rules to enable private ordering.

The full paper is available for download here.

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