SEC Maintains “Status Quo” On Shareholder Access... the Debate Continues
By By Jane K. Storero & Jeffrey M. Taylor

At its Open Meeting on Nov. 28, a divided Securities and Exchange Commission voted 3-1 to adopt a rule codifying the long-standing SEC Staff position that permits companies to exclude from public company proxy statements bylaw amendment proposals submitted by shareholders regarding the election of directors. The SEC determined to act at this time in an attempt to provide some certainty and clarity to the brewing shareholder access debate, and to stave off a potential split in holdings among the circuit courts, in light of the September 2006 decision of the U.S. Court of Appeals for the Second Circuit in AFSCME v. AIG.1 Essentially, this new rule will overturn, by administrative action, the effect of the Second Circuit’s ruling in AFSCME. The new rule amends Rule 14a-8(i)(8) of the Securities Exchange Act of 1934 and the rule will be effective January 10, 2008. As a result, the new rule will be in effect for the 2008 proxy season. SEC Chairman Christopher Cox, who had promised SEC action before the 2008 proxy season, stated that the SEC’s decision “maintains the status quo of the past decade, preserving every right that shareholders presently enjoy, while ensuring there is no unintended breach in the disclosure and antifraud protections applicable to proxy contests.”2 Despite Chairman Cox’s promise to revisit the issue next year, the SEC’s action was met with sharp criticism by shareholder rights activists and Democratic members of Congress who favor shareholder access. Ann Yerger, Executive Director of the Council of Institutional Investors, noted that the adoption of this rule represented a “sad day for shareowners.”3

Rule 14a-8 permits a shareholder who owns a relatively small amount of a public company’s stock to submit a proposal for inclusion in a company’s proxy materials, provided that the shareholder complies with certain procedural requirements and the proposal does not fall within one of the 13 specified exclusions. Amended Rule 14a-8(i)(8) now expressly permits a company to omit from its proxy materials any proposal that “relates to an election for membership on the company’s board of directors or analogous governing body or a procedure for such nomination or election.”4

The SEC’s Controversial Proposals and the Electronic Shareholder Forum Rule

In adopting this rule, the SEC chose between two opposing proposals related to shareholder access, which the SEC previously submitted for public comment in July in the wake of the Second Circuit’s decision in AFSCME. The two alternatives proposed by the SEC brought to the forefront the debate that has been simmering for some time between activist shareholders and companies regarding shareholder access.

TThe first proposal (which was ultimately adopted by the SEC) essentially codified the SEC Staff’s long-standing interpretation of Rule 14a-8(i)(8), as previously described.

The second proposal, often referred to as the “access” proposal, which was not adopted at this time, would have expressly permitted significant, passive investors who file reports on Schedule 13G and who hold at least 5% of a company’s stock for at least one year to put forward for inclusion in a company’s proxy statement a proposal to amend its bylaws relating to the nomination of directors. In addition, this proposed rule would have amended Schedule 13G to require expanded disclosure about the shareholder proponents.

The SEC did adopt one portion of the access proposal: it agreed to facilitate the use of electronic shareholder forums by eliminating potential legal issues with respect to the use of such forums.5 The SEC’s stated goal behind this change was to promote greater online communication among shareholders and between shareholders and management of the companies they own.6 Specifically, the SEC agreed to clarify that participation in an electronic shareholder forum, which could arguably constitute a solicitation subject to the SEC’s proxy rules, will be exempt from most of the proxy rules if the conditions established by the rule are met, including the following requirements:

• Communications by any participant in an electronic shareholder forum must occur more than 60 days prior to the date announced by the company for its annual or special meeting of shareholders.
• The communicating party must not solicit proxies related to such meeting. (A participant in an electronic shareholder forum will be eligible to solicit proxies after the date that the exemption is no longer available, provided that the solicitation is conducted in accordance with the SEC’s proxy rules.)
• The solicitation must not occur more than two days following the company’s announcement of the meeting, where the company announces a meeting of shareholders less than 60 days before the meeting date.

In his opening remarks at the July SEC Open Meeting at which the two shareholder access proposals were first submitted for public comment, Chairman Cox indicated that by advancing two different proposals, he hoped that a final rule on the subject would ultimately benefit from the “full breadth of commentary about different ways of attacking this issue.”7 Chairman Cox certainly got his wish, as the SEC received approximately 34,000 comment letters on the dueling proposals, making them the most heavily commented on proposals in recent memory, even exceeding the number of comments received by the SEC on its controversial 2006 amendments to the executive compensation rules.

The Shareholder Access Debate

The SEC proposals not only opened the flood gates of comments from hedge funds, unions and pension funds, as well as other institutional investors, academics and lawmakers, but they also provided insights into the significant differences of opinion regarding shareholder access. One view, expressed largely by corporate America and business groups, strongly advocated for maintaining the pre-AFSCME “status quo” in accordance with the SEC’s previous long-standing interpretation of Rule 14a-8.8 These groups argue that access would enable special interest groups to further their own agendas, which may not be in the best interests of all shareholders. Other commentators have suggested that the SEC does not possess the legal authority to promulgate rules governing director elections.9 Some commentators have gone so far as to call shareholder access a “threat to capitalism.”10

The diametrically opposite view, taken by members of the investment community, as well as some academics and lawmakers, favored the regime created by the Second Circuit’s opinion in AFSCME and the corresponding right of shareholders to propose bylaw amendments on director elections without restriction or condition.11 A somewhat novel view, espoused by noted Stanford University professor and corporate governance expert Joseph Grundfest,12 supports utilizing an “advice and consent” regime.13 This “advice and consent” concept is grounded in the idea that the shareholder franchise provides the ultimate weapon of shareholder democracy.14 Prof. Grundfest’s view is that a system of checks and balances, similar to the U.S. Senate’s “advice and consent” role with respect to presidential appointees, constitutes sufficient legal and practical power to shareholders over directors in the context of a majority voting structure. According to Prof. Grundfest, under majority voting, the shareholder franchise requires corporate directors to be sensitive to the concerns of the shareholder electorate or face the risk of being voted out of office.15 Further, Prof. Grundfest argues that this “advice and consent” power promotes more civil, effective, constructive, and economically efficient control over corporate America than is offered under a shareholder access system. Prof. Grundfest attacks the concept of a shareholder access rule as an overly complicated and confrontational procedure that may not necessarily serve the long-term best interests of either shareholders or companies.16

The Impact of the Second Circuit’s Opinion in AFSCME

It should be noted that, following the Second Circuit’s decision in AFSCME, very few shareholder access proposals were put forth by shareholders. During the 2007 proxy season, there were only four such shareholder access proposals. Of the four proposals, only one was approved, one was withdrawn and the other two failed to pass. However, this may not be the case for 2008. Three large institutional investors, led by AFSCME, have already submitted proxy access proposals to J.P. Morgan, Chase & Co. and Bear Stearns Cos. and have announced that other similar proposals will follow.

The New E-Proxy Rules

In an attempt to diffuse some of the pressure related to the shareholder access issue, in July, the SEC also adopted new electronic proxy, or “eproxy” rules, which require public companies and other soliciting persons to post their proxy materials on a publicly-available Internet Web site and provide shareholders with a notice regarding the availability of proxy materials on the Internet.17 It was intended that these proxy changes would provide increased shareholder access to the proxy process by arguably making it less expensive for third parties to solicit proxies and wage a proxy contest as the costs of printing and mailing would be substantially reduced. It remains to be seen whether these rule changes will have this intended effect.

The Majority Voting Alternative

In light of the rise in shareholder access proposals and concerns over the Second Circuit’s decision in AFSCME, over 100 public companies, including Intel, General Electric and Pfizer, adopted bylaw amendments or corporate governance policies requiring that a director who receives more “withhold” votes than “for” votes in an uncontested election immediately submit his or her resignation as a director. Under the Pfizer corporate governance policy, the board of directors has 90 days to determine whether to accept or reject the director’s resignation. This approach was popular with public companies as it provides the board of directors with flexibility in addressing a “withhold vote” campaign. However, this approach was found to be distasteful by institutional investors, who viewed it as a means to entrench current management. Critics of these majority voting policies suggest that they will permit hedge funds to disrupt the corporate electoral process. Some commentators have also suggested that majority voting policies or bylaws are poised to create a shift in the balance of power between existing management and shareholders, the magnitude of which is unknown at this time.18 Whether these majority voting mechanisms will satisfy even the activist shareholders may not be known until the 2008 proxy season gets underway.

Incrementalism

One criticism to shareholder access is that it represents an “all or nothing” response that, once implemented, cannot easily be rescinded or removed. And even if it imposes burdensome costs to companies, shareholder activists will not easily give up any powers that may be ultimately bestowed on them. Prof. Grundfest supports his “advice and consent” approach over a shareholder access rule, in part on incrementalist grounds. He theorizes that a shareholder access regime is problematic because it is, among other things, complicated, expensive, arbitrary, prone to litigation and difficult to undo.19 Given the potentially negative known and unknown consequences of any shareholder access rule,20 an incrementalist approach in reforming this area sounds appealing.

Where Do We Go From Here?

Although Chairman Cox has promised that the SEC will revisit the shareholder access issue next year, this may be easier said than done given the partisan division of the SEC regarding this issue and the anticipated changes to the composition of the SEC to occur in 2008. (Because of recent resignations, the Commission is soon to be two commissioners short, and without any Democratic Party representation.) Although the SEC’s adoption of changes to Rule 14a-8 may have provided some certainty as to the applicable rule of law in the wake of the AFSCME decision, it did not serve to lessen the intensity of the shareholder access debate. The SEC’s action regarding shareholder access will likely be put to the test in 2008 as AFSCME has promised to litigate if companies exclude their access proposals.

As the debate continues and we await possible further action by the SEC in 2008, one cannot help but ask, given the divergence of views, whether it is even possible to reach a consensus on this issue.

NOTES:

1. Am. Fed. of State, Cty. & Mun. Empls., Empls. Pension Plan v. Am. Int’l Group, 463 F.3d 121 (2d Cir. 2006). In AFSCME, the court refused to apply a long-standing SEC Staff interpretation of the proxy rules permitting public companies to exclude from their proxy statements bylaw amendment proposals regarding the nomination of directors.
2. Press Release, Securities & Exch. Comm’n, SEC Votes to Codify Longstanding Policy on Shareholder Proposals on Election Procedures, SEC Press Release No. 2007-246 (Nov. 28, 2007), available at http://www.sec.gov/news/press/2007/2007-246.htm [hereinafter SEC Press Release].
3. Press Release, Council of Institutional Investors, Council of Institutional Investors Deplores SEC Move to Curb Investor Rights (Nov. 28, 2007), available at http://www.cii.org/press/cii_releases/sec%20proxy%20access%2011-28-07.pdf (internal quotations omitted).
4. SEC Press Release, supra note 2, (emphasis added).
5. Press Release, Securities & Exch. Comm’n, SEC Adopts Proxy Rule Amendments Encouraging Electronic Shareholder Forums, SEC Press Release No. 2007-247 (Nov. 28, 2007), available at http://www.sec.gov/news/press/2007/2007-247.htm.
6. Id.
7. Chairman Christopher Cox, Opening Remarks at the SEC Open Meeting (July 25, 2007), available at http://www.sec.gov/news/speech/2007/spch072507cc.htm.
8. A number of comment letters submitted to the SEC on the two access proposals have espoused positions supporting the SEC’s previous interpretations of Rule 14a-8. See, e.g., comment letters from Abbott Laboratories (Oct. 19, 2007); Burlington Northern Santa Fe Corp. (Oct. 10, 2007); Society of Corporate Secretaries & Governance Professionals (Oct. 5, 2007); Chevron Corp. (Oct. 2, 2007); The Business Roundtable (Oct. 1, 2007).
9. Cf. Rose A. Zukin, We Talk, You Listen: Should Shareholders’ Voices Be Heard or Stifled When Nominating Directors?, 33 Pepp. L. Rev. 937, 981 (2006) (discussing various objections to the SEC’s 2003 proposed shareholder access rule).
10. See Phil Kerpen, An Under-the-Radar Threat to Capitalism, Nat’l Review Online, Jan. 16, 2007, available at http://article.nationalreview.com/print/?q=NDNlMGQ2YjIzMDVhMTNjOTE3NmYxZTk1ZmY0NjVmOWY=.
11. See, e.g., comment letters from Council of Institutional Investors (Nov. 19, 2007); Christopher C. Dodd et al. (Nov. 1, 2007); Prof. Lucian Bebchuk et al. (Oct. 2, 2007); Boston Common Asset Management (Oct. 2, 2007); Cal. State Teachers’ Ret. Sys. (Oct. 2, 2007).
12. Disclosure: Prof. Grundfest is a member of the Editorial Advisory Board of Wall Street Lawyer. – ed.
13. Joseph A. Grundfest, The Wizard of Oz, the United States Constitution, and Corporate Governance--Address to the Thirty-Ninth Annual Institute on Securities Regulation (PLI) (Nov. 9, 2007), available at http://ssrn.com/abstract=1028424.
14. See Unocal v. Mesa Petroleum Co., 493 A.2d 946, 959 (Del. 1985) (“If the stockholders are displeased with the action of their elected representatives, the powers of corporate democracy are at their disposal to turn the board out.”).
15. Grundfest, supra note 12, at 5.
16. Id. at 7-9.
17. SEC Release No. 34 -56 135 , Shareholder Choice Regarding Proxy Materials (July 26 , 2007), available at http://www.sec.gov/rules/final/2007/34 -56 135 .pdf.
18. See J.W. Verret, Pandora’s Ballot Box, Or a Proxy with Moxie? Majority Voting, Corporate Ballot Access, and the Legend of Martin Lipton Re-Examined, 62 Bus. Law. 1007, 1051 (May 2007).
19. Grundfest, supra note 12, at 9.
20. Commissioner Paul S. Atkins, Remarks at the Corporate Directors Forum 2007 (Jan. 22, 2007), available at http://www.sec.gov/news/speech/2007/spch012207psa.htm.

About the Author

Jane K. Storero (storero@blankrome.com) is a Partner, and Jeffrey M. Taylor (taylor-j@blankrome.com) is an Associate, in the Philadelphia office of Blank Rome LLP. Ms. Storero advises companies on securities offerings, mergers and acquisitions and compensation disclosure, and boards of directors on corporate and securities law issues including executive compensation and corporate governance matters. Mr. Taylor works with public companies operating in a wide range of industries on public and private securities offerings and other corporate transactions, public disclosure and periodic reporting obligations, and executive compensation and corporate governance issues.