May 18, 2009
Proxy Wars, A Battlefield Update
Posted by J.W. Verret

Thanks Gordon for inviting me back.  As a fan of the Glom I feel like being here is like getting to open for your favorite band, so I am very excited to be back.

I think DC could be the coolest place in the world to be a lawyer.  It seems like everyone you meet around town either has a fancy title, or serves as counsel to someone who has a fancy title.  So I've been trying to insert myself into the Proxy Access Wars as much as possible, which my work at the Mercatus Center Financial Markets Working Group allows me the freedom to do, and I thought I would offer an update from the battlefield.

If you recall, the SEC proposed rules back in 2003 and 2007 that would have allowed shareholders to place nominees on the corporate ballot in elections, so that challengers to incumbent boards would not need to finance their own proxy contests.  Both attempts failed to result in a final rule.  Last time I was here I briefly discussed my own limited proxy access idea, majority voting for contested elections through preferential ranking ballots.  See Pandora's Ballot Box, or a Proxy with Moxie?  Majority Voting, Corporate Ballot Access, and the Legend of Martin Lipton Re-Examined.  Despite the SEC's indecisiveness in this area, Delaware also amended the General Corporation Law this spring to recognize the legality of proxy access bylaws.

Based on regular consultation with Commission staff, I can first report that at the SEC's open meeting Wednesday, it looks like the Chairman is poised to introduce two proxy access proposals.  The first would be similar to the Commission's proposal from 2003, and would write an access method directly into the securities laws.  The second, more flexible proposal would permit shareholders to put forward elections bylaws which, if passed, would then subsequently control how shareholders can access the corporate ballot.  The direct access proposal rides roughshod over state corporate governance, and is vulnerable to challenge under the Business Roundtable v. SEC decision.  The access via bylaw proposal is more consistent with Business Roundtable and with notions of symbiotic federalism explored by Kahan and Rock here.

At the same time, Senator Schumer is set to introduce, tentatively on Tuesday, his "Shareholder Bill of Rights."  I've been working with staffers for the Senate Banking Committee to oppose most of the substance of this bill, and recently had the chance to talk strategy with Counsel for a Senior Republican Senator who has been asked to co-sponsor the legislation.  One of the provisions in the current pre-release version of the Schumer Bill addresses Proxy Access.  Section 4 of the Schumer Bill currently reads: 

"Section 14A of the Securities Exchange Act of 1934, as added by this Act, is amended by adding at the end the following: ‘‘(d) CONFIRMATION OF COMMISSION AUTHORITY ON SHAREHOLDER ACCESS TO PROXIES FOR BOARD NOMINATIONS.— ‘‘(1) COMMISSION RULES.—The Commission shall establish rules relating to the use by shareholders of proxy solicitation materials supplied by the issuer for the purpose of nominating individuals to membership on the board of directors of an issuer."

Direct Access written into the securities laws is far more of a threat to the business community than access-via-bylaw, and as currently written the Schumer Bill grants the SEC authority to adopt both proposals.  I think this bill will have a significant impact on what the SEC decides to do, since the SEC will want to avoid challenge to its rules under the Business Roundtable v. SEC holding, and supporting legislation from Congress would allow it to do just that.

I suggested to staff for the Republican Senator that they condition co-sponsorship on altering the language of Section 4 to this instead:

"The SEC shall establish a rule by which shareholders are permitted to use Rule 14a-8 to propose bylaw amendments establishing procedures that would permit eligible shareholders to nominate candidates for the board of directors into the company’s proxy materials. Such rule shall require that the proposals comply with the procedural requirements of Rule 14a-8 and additional proposed disclosure requirements.  Such rule shall require that, to be included, the bylaw amendments are required to be submitted by a shareholder proponent that has filed a Schedule 13G including all required disclosures and has continuously held more than 3% of the company’s securities entitled to be voted on the proposal for at least one year.  The SEC shall also be required to amend Schedule 13G and any other applicable rules to require disclosure regarding the shareholder proponent’s background and relationships with the company."

Three advantages to the Access Via Bylaw method, which would be required under the draft language I provided, are:
1) under 14a-8 the bylaw would still need to be legal under state law, that means the SEC would be required to certify questions regarding bylaws to the Delaware Supreme Court, which would somewhat limit SEC interference with state corporate governance; 2) under 14a-8, Boards could adopt their own bylaws, then keep some shareholder proposed bylaws off of the ballot for being already substantially implemented under 14a-8.  This would reduce ballot access abuse by some shareholders, like Unions or other activists, who may only want to use the corporate ballot for objectives that conflict with wealth maximization; and 3) there would be an inherent two year waiting period to the access via bylaw method, limiting short term challenges.

I also suggested a 3% holding requirement rather than the 1% holding requirement included in the Schumer Bill.  I would guess the final number will depend on who is the better horse trader in the Senate cloakrooms, and your guess is as good as mine on that one.

The bylaws that Boards and shareholders could craft under an access-via-bylaw rule are limited only by the creativity of the lawyers that draft them.  I would continue to suggest a ballot that permits shareholders to rank candidates, the results of which would be determined by a majority voting standard (rather than the current plurality voting standard) in contested elections.  To measure the results of a hypothetical runoff, shareholder ranked preferences for the nominees that made it into the hypothetical runoff would be used to determine the winner.  With the preferential majority vote trigger, rather than a plurality trigger, the influence of special interests would be severely constrained.

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