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E-MailAdam Emmerich is a partner in the corporate department at Wachtell, Lipton, Rosen & Katz focusing primarily on mergers and acquisitions and securities law matters. This post is based on a Wachtell Lipton firm memorandum. Other posts about proxy access, including several papers from the Program on Corporate Governance, are available here.
In an opinion issued today in the challenge brought by the Business Roundtable and U.S. Chamber of Commerce to the SEC’s adoption of proxy access, the U.S. Court of Appeals for the D.C. Circuit vacated the entire proxy access regime as an “arbitrary and capricious” exercise of the SEC’s authority. The opinion, written by Judge Ginsburg, chides the SEC for failing “adequately to assess the economic effects” of the rules. The court levels particular criticism at the SEC’s analysis of the likely costs associated with, and the frequency of, proxy contests utilizing the access rules, reliance upon “insufficient empirical data” to support a conclusion that proxy access would improve board performance, and failure to address the possibility that unions and pension funds would use the rules as a bargaining chip in unrelated negotiations with issuers. While noting that these overall defects in the rule render it invalid with respect to all types of issuers, the opinion offers lengthy criticism in particular of the decision to subject investment companies to the proxy access rules, due to the enhanced regulation imposed by the Investment Company Act of 1940.
The court did not reach plaintiffs’ claims that proxy access rules are fundamentally unconstitutional, theoretically leaving open the possibility that an access regime could be implemented in revised form in the future if the above defects are addressed. It is unclear whether the SEC will continue to pursue proxy access in the face of this unqualified rejection of such a high-profile initiative which had been many years in the making. What is virtually certain, however, is that proxy access will not apply to the 2012 proxy season.
While shareholder activists are likely to be disappointed by this decision and seek to portray it as a setback for “shareholder democracy,” we believe this is a positive development for American corporations and their shareholders. As we have always said, proxy access is not a necessary or even beneficial element of corporate governance. Shareholders have many avenues to influence boards of directors, who are in general more independent, more engaged and more vigilant than ever before, and we do not expect this ruling to decrease the frequency of proxy contests.
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Viewed from abroad – in my own case, Japan-, one can’t escape feeling dismayed and even shocked that:
(a)the self-perceived bastion of “shareholder democracy”, my own country the U.S., can’t find a way to legislate and enforce this most fundamental of shareholder rights, “access to the proxy” (and also its correlate, shareholder proposals to convene extraordinary AGMs to put proposals for director terminations to a vote);
(b)U.S. regulators were apparently so cowed by the self-serving arguments of the business lobby that they compromised in advance in a manner that is quite similar to what takes place here in Japan with respect to corporate governance-related regulation; and
(c)specifically and with respect, the SEC shot itself in the foot by limiting the application of its own proposed proxy access rule to the point where it was wide open to the “helps narrow interests only” argument (see http://reut.rs/kPRU7y , where SEC Assistant General Counsel Randall Quinn even conceded the point). Further, the SEC undermined its own credibility by projecting that the number of contested elections would decline (see same URL), a position that was unnecessary to take. All it had to do was make a reasonable estimate that the number would not rise significantly – something for which, based on other countries’ experience, they could have made a good enough case.
For instance, here in Japan, per the Company Law virtually any shareholder (those with >1% or 300 share units, a small number) can nominate directors and statutory auditors in any number, and the issuer must include such proposals in the proxy materials. But the issuer incurs little cost, as it is entitled to state in its proxy whether it is opposed to the proposals, and its reasons why. (Note: “narrow interests” is one very good reason to oppose.) Proposals to nominate directors do occur – very rarely, that is – and most of them are indeed made by “narrow interests” -, but they are almost never approved at the AGM, for that precise reason. Since such proposals clearly represent only the opinions of a certain type of minority shareholder, management needs to expend little time responding to them.
This being the case, unless we are assuming that U.S. boards composed in the majority by independent non-executive directors are inherently and obsessively disposed to needlessly overspend money and time to protect their own positions and those of incumbent management, I do not see the “cost” argument. If on the other hand we ARE assuming such an inherent disposition, is this not all the more reason we need simple rules that: (i) “all proposals to nominate or terminate directors should be listed in the proxy materials” and (ii)”any shareholder owning more than X% of company can call an extraordinary shareholders’ meeting to propose director terminations?”
Following the recent Court decision, foreign observers will conclude that the U.S. model for independent directors continues to be inherently flawed by the chummy tendencies of boards that nominate directors without taking their own medicine: i.e., without allowing shareholders to have any meaningful alternative nomination right such as might result in more constructive discussion and consensus in advance of the AGM where something more broad-based than “narrow interests” is at stake. This is not merely a “board-centric system” that we have created; it an “board honor system” without adequate disciplinary feedback loops, one that all too often prevents the appointment of truly independent directors who will add the full value that is expected of them. (And naturally, there is a societal and economic cost associated with this.)
Moreover, arguments regarding “private ordering solutions” will be seen for what they are: reasons to provide institutional investors with an excuse to continue doing nothing. Sure, shareholders who want proxy access can put forward proposals under Rule 14a-8 to amend the issuer’s bylaws to permit shareholder nominees to be included in the proxy materials, but realistically, does any institutional holder have a positive cost-benefit incentive to spend time and money amending its proxy voting practices and related IT systems to deal with such special exceptions on a one-by-one basis?
Unless the SEC immediately renews its effort by substituting a meaningful proposal for a pre-compromised and defective one, the U.S. model for “independent directors” will now be seen by many experts in many jurisdictions to be logically bankrupt and – despite all the other rules – coopted by managers in the area where it counts the most. This would not bode well for the ongoing improvement of corporate governance on a global basis.
Nicholas Benes (personal opinion)
Mr. Benes is Representative Director at The Board Director Training Institute of Japan (BDTI), a non-profit, “public interest” organization. URL: http://bdti.or.jp/english/.
This decision provides all those who are opposed to proxy access the opportunity to reload and make the case that SEC Rule 14a-11 should be withdrawn, not rewritten. As I argue in my paper, “Why Proxy Access (SEC Rule 14a-11) is Harmful to Corporate Governance,” http://papers.ssrn.com/sol3/pa…, proxy access is really a bad idea.
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