A Reply to Professors Macey and Grundfest

Entering the ongoing debate in this venue between Professors Macey and Grundfest—two individuals of profound intellect I greatly admire and respect—is doubtlessly foolish on my part. Nonetheless, I have been known to abandon caution frequently, and see no reason to change at this stage of my professional existence. The focal point of the debate is an important and thoughtful Paper co-authored by SEC Commissioner Dan Gallagher and Stanford Law Professor (and former SEC Commissioner) Joe Grundfest (a summary of the Paper is available here). The Paper discusses the obligation of proponents of shareholder proposals to avoid misleading shareholders when explaining the reasons those shareholders should support their proposals.

In commenting upon the Gallagher/Grundfest Paper, Professor Macey seemingly assumes the mantle of “Harvard Protector” (his original post criticizing the Paper is available here) an unusual role—to say the least—for a Yale Law Professor (and former Administrator) of distinction. Perhaps, he also disputes Professor Grundfest’s response to his initial criticism of the Paper, which exposits legal principles (the response is available here) that contest some of Professor Macey’s initial commentary. In his latest reply (available here), Professor Macey, on occasion, appears to be looking a gift horse in the mouth.

If, as Professor Macey contends, Professor Grundfest’s response to Professor Macey’s original posting contains concessions—a characterization I’m not certain Professor Grundfest would accept—or if Professor Macey is correct that Professor Grundfest has retreated from certain positions previously espoused in the Gallagher/Grundfest Paper—something I am certain Professor Grundfest would not concede—Professor Macey’s comments pointing out these concessions and retreats are superfluous. Surely those of us interested (and, dare I say, sophisticated) enough to read the Harvard Law School Forum’s postings on Corporate Governance and Financial Regulation don’t require Professor Macey (or anyone else) to tell us what concessions or retreats Professor Grundfest has embraced! Professor Macey also seems reluctant to acknowledge that there are considerable points of commonality between the two professors on many substantive issues raised and discussed in the Gallagher/Grundfest Paper.

Conversely, Professor Grundfest may be unduly eager to minimize apparent areas of conflict that clearly exist with Professor Macey, so much so that his response to Professor Macey may gloss over some of the very real differences between Professor Macey’s position and the Gallagher/Grundfest Paper’s commentary and substance. Professor Grundfest may also be understandably eager to focus attention away from the Paper’s provocative title to its real thesis, which is a substantive, scholarly, and important contribution to the law of shareholder proposals.

In what may prove to be a vain hope—that I can extract fundamental issues from the ongoing debate and offer those concerned with the proper administration of the federal securities laws important points on which to focus—I offer, in relatively abbreviated bullet form, the following propositions on which the continuing debate can focus:

• The Gallagher/Grundfest Paper raises important issues regarding the current regime by which shareholder proposals are assessed, adjudged and imposed upon corporate shareholders.
• This continues Commissioner Gallagher’s lucid and insightful comments on the existing regulatory regime governing shareholder proposals—and its administration—embodied in his speech earlier this year at Tulane Law School (available here).
• The regulatory process regarding shareholder proposals arose out of fraud concepts—if management solicits proxies that would allow it to exercise its discretion on any other, unenumerated, issues, management must disclose those issues it is aware will be raised at the annual meeting, and how it intends to vote on those issues.
• The current utilization of the shareholder proposal mechanism—as part of a campaign to further certain generic principles—is governed by the SEC’s rules, including the general antifraud provisions. Those who seek to influence shareholder views and votes—whether management or shareholder proponents—are obligated to be honest, accurate and fair in their disclosures.
• The current proxy solicitation system is broken, and is badly in need of repair, as Commissioner Gallagher discussed at Tulane, and as the SEC itself suggested when it issued its so-called “Proxy Plumbing Release” in 2010 (available here)
  • Despite the receipt of an impressive number of comments on its concept release, the SEC has been unable to devote substantial attention to the issues identified in the Proxy Plumbing release, although the SEC Staff has recently issued important guidance concerning the appropriate role of proxy advisory firms (and the institutional investors that employ them), and their legal obligation, in making recommendations about shareholder proposals, to base their recommendations on factually accurate, complete and current information, a concept applicable to the current debate (a copy of the SEC Staff Guidance can be found here).
• A fundamental flaw with the shareholder proposal rule and its administration is that its current use inundates shareholders with a plethora of issues, only some of which are actually relevant to improving shareholder values.
  • Indeed, even proposals that are rejected by 90% of a company’s shareholders can, nonetheless, be repeatedly resubmitted to shareholders under the SEC’s current rules. A current rulemaking petition filed by eight groups seeks to change that dynamic (available here), but there is little hope that immediate relief is in sight. (As a matter of prudent disclosure, I helped draft the petition that seeks to create more practical standards regarding the resubmission of rejected proposals.)
• If shareholders are to vote intelligently on the myriad proposals submitted to them, they must be given honest and accurate information that enables them to understand not only the reasons favoring adoption of the proposal, but also the reasons militating against the proposal’s adoption. That concept is inherent in the SEC’s proxy rules.
• When arguments made by proponents in support of their shareholder proposals rely upon studies and statistical analyses they claim demonstrate the positive attributes of the proposal, it is misleading not to indicate the existence of studies and statistical analyses that reach the opposite conclusion.
  • This is particularly true where claims are made about the “weight” of authority.
• If, contrary to the law, shareholders are not given accurate and materially complete information, even if only once, the resulting antifraud violation is significant, and carries with it the capacity to mislead investors into supporting the proposal.
  • While I concede there is a distinction between seven such violations and 129, it is a distinction without a difference as far as the law is concerned.
  • A single violation can seriously harm investors; seven is extreme and reflective of recidivism; and 129 is cause for alarm and effective action.
• Staggered boards provide benefits to existing corporate shareholders; among other things, they
  • Make it more likely that someone seeking to acquire control of their company will be required to negotiate with the company;
  • Make it less likely that the acquisition of the company will occur without the payment of an acquisition premium;
  • Ensure stability and governance continuity without adversely entrenching any board members;
  • Enhance the independence of outside directors;
  • Ensure that directors have a long-term perspective, not the short-termism that afflicts so many U.S. companies;
  • Potentially attract a broader network of interested and capable individuals; and
  • Emulate the structure of the United States Senate, which is, in effect, a large staggered board where only one-third of the members are up for a vote every two years!
• Staggered boards also may prove detrimental to corporate shareholders; among other things, they
  • May discourage some acquirers from expending efforts to unseat ineffective boards;
  • Deprive shareholders of the renewed focus unitary boards have vis-à-vis excessive expenses and self-serving efforts that often accompany the efforts of activist investors and/or hostile efforts to acquire corporate control;
  • Can increase the cost of hostile control efforts, potentially reducing any premium shareholders might receive if an acquisition attempt proceeds, and the acquisition is successful; and
  • May reduce board incentives to monitor more critically the performance of current management.
• The SEC Staff is overtaxed and understaffed, but that does not validate the Staff’s announced decision to limit their review to vague proposals, and not to pursue fraudulent supporting statements that accompany shareholder proposals.
  • The SEC Staff has suggested that it will review shareholder proposals (and supporting statements) it believes are vague, but will largely demur regarding fraudulent statements or other compliance issues (SEC Staff Legal Bulletin No. 14B, available here).
  • This has the effect of rendering nugatory the most effective and cost-efficient process public companies have for testing the propriety of shareholder proposals and supporting statements. If the SEC Staff encouraged companies to voice their concerns over the possible misleading nature of supporting statements, and was seen as willing to weigh in against misleading statements, the Staff would receive a great deal of assistance from companies, and could dramatically reduce its investment of time.
  • Under the current state of affairs, many companies are either acquiescing in the proposals of aggressive proponents, or going directly to court to test the compliance of a proponent’s materials. See Express Scripts Hold. Co. v. Chevedden (available here), cited in Professor Grundfest’s response to Professor Macey’s initial blog posting.
  • Litigation is decidedly the worst way to resolve these disputes, for proponents, for shareholders and even for the SEC—witness the Delaware federal court’s recent decision to eviscerate the “ordinary business” exception from the requirement that companies include shareholder proposals in their proxy materials, notwithstanding the opposite SEC Staff opinion on the application of the SEC’s own rule, Trinity Wall St. v. Walmart Stores Inc. (available here).
• What is required is what Commissioner Gallagher urged at Tulane Law School’s Governance Conference earlier this year—a more thoughtful and pragmatic set of rules, subject to revised and effective procedures by the SEC’s Staff.
• That speech, as well as the Gallagher/Grundfest Paper, are a much-needed call for renewed debate, analysis, amended regulations and revised procedures affecting shareholder proposals that achieve two objectives—protecting the interests of shareholders (both with respect to making legitimate and lawful proposals, and with respect to avoiding unnecessary burdens inflicted by proposals that are false, repetitive or fail to promote shareholder value), and creating a cost-efficient and expeditious mechanism for resolving public company concerns that shareholders may be misled.
• Commissioner Gallagher and Professors Grundfest and Macey have performed a valuable public service—they have initiated a dialogue about an important issue, and cast a spotlight on it that commands our attention. It would be a shame if that dialogue were diverted by side issues—whether Harvard violated the law, if it did how many times it violated the law, or whether arguments have been abandoned, positions conceded, or how many angels can stand on the head of a pin.
• Instead, it seems to me the outgrowth of the debate that has been started—first by Commissioner Gallagher in New Orleans and now by the Grundfest/Gallagher Paper—is whether two simple tweaks can be made expeditiously to enhance the shareholder proposal process:
  • Can the SEC Staff find the time and resources to take a vigilant approach to shareholder proposals and supporting statements that present the possibility of fraud, or misleading investors?; and, on the other side of the coin,
  • Would it be feasible for the SEC Staff to assist shareholder proponents by issuing an up-to-date guide on how shareholder proposals and supporting statements should be drafted to comply with, among other requirements, the antifraud provisions applicable to the solicitation of support for shareholder proposals?

If we can turn to the important substance introduced by the Gallagher/Grundfest Paper, and enhanced by Professor Macey’s substantive questions and issues, we may yet realize the value of stimulated discourse on a topical, yet controversial, subject.