September 17, 2006
Federalism & Corporate Governance
Posted by Gordon Smith

Larry Ribstein has an interesting post on "The federal role in corporate governance," partly inspired by my debate with Steve Bainbridge. Among other things, Larry asks:

Can Delaware adopt a shareholder access rule without stepping on federal law? Does it have any incentive to do so given the federal government’s dominant role in the area?

My answers: Yes and Maybe. Vice-Chancellor Leo Strine's recent contribution to the Harvard Law Review's symposium on shareholder power offers a state-based alternative to the SEC's failed shareholder access rule:

The contours of a traditionalist-influenced statute of that kind might go like this: Suppose that every three years, all public companies without staggered boards had to

* Distribute a proxy card that includes the name of any qualified director candidate who has been timely nominated by a qualified stockholder or stockholders owning at least 5% of the company's voting stock.

* Reimburse the reasonable solicitation costs of any qualified director candidate--nominated by a qualified stockholder or stockholders owning at least 5% of the company's voting stock--who has received at least 35% of the votes cast in an election governed by the reformed process. That is, this would not be an annual requirement but a system of reimbursement that operates triennially.

State law might also limit public companies' ability to adopt nomination deadlines that exceed a certain period in advance of annual meetings so that stockholders are able to take advantage of the increased access the new reforms would permit.

To avoid the subsidizing of hostile bidders, the definition of qualified stockholder could exclude any stockholder who, individually or in concert with others, is seeking to acquire within the twelve or twenty-four months following the meeting date either more than 20% of the company's voting stock or a sizeable portion of its assets. Alternatively, use of this access could subject the users to the strictures of Delaware's antitakeover statute. To gain access to the company's proxy card, the qualified stockholders would be required to represent to the company that they qualify under this definition and agree to comply with the prohibition on takeover behavior.

Now, companies with staggered boards would have to be treated differently. For public companies with staggered boards, this system would operate annually with the same ownership thresholds and the same prohibition against access to the proxy card and reimbursement to present or potential bidders. In this way, every seat on a board, staggered or not, would periodically be subject to the competitive system outlined above.

Leo E. Strine, Jr., Toward a True Corporate Republic: A Traditionalist Response to Bebchuk's Solution for Improving Corporate America, 119 HARV. L. REV. 1759, 1778-79 (2006).

Could Delaware implement this system without stepping on the SEC's toes? The SEC might want to change some of its rules, but I don't see anything in the proposal that would be preempted by federal law.

Would Delaware ever do this? Maybe. If these rules were mandatory, corporations operating under them would be more susceptible to takeovers. I suspect that this would drive some corporations away from Delaware. As a result, it would not be attractive to the Delaware legislature.

On the other hand, if the rules were optional, some managers would be willing to subject themselves to elections as a signal of their self-confidence, and some investors might agitate for the practice. Having the option available may be value-enhancing for Delaware corporations.

Note that Leo's proposal and the proposals advanced by Lucian Bebchuk that prompted Leo's proposal go well beyond more modest changes to the SEC's shareholder proposal rule resulting from the Second Circuit's recent opinion in  AFSCME v. AIG. In that case, the Second Circuit held that the SEC had changed its interpretation of the shareholder proposal rule. The "old" interpretation would allow shareholders to have access to the corporate ballot for bylaw proposals that would "establish a process for shareholders to wage a future election contest." If you want to ignite the "dynamic process of contracts" around corporate elections, as Larry suggests, it's hard to imagine a better way to do it.

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