The Battle for Shareholder Access: The Current State of Play - 30 May 2009

The Battle for Shareholder Access: The Current State of Play

(Editor’s Note: This post is based on a client memorandum by Charles Nathan, Alexander Cohen, Constantine Skarvelis and Raluca Papadima of Latham & Watkins LLP.)

Highlights

• Shareholder proxy access is coming, and it will be the hottest
issue of the 2010 proxy season. Public companies should expect, and be
prepared for, the strong likelihood of shareholder proxy access in the
2010 proxy season.

• The SEC is scheduled to vote on a proposed shareholder proxy
access rule tomorrow, May 20, 2009. We assume that Chairman Schapiro
intends the rule to become final around the end of October—that is, in
time for the 2010 proxy season.

• Senator Charles Schumer of New York has introduced a bill that,
among other things, would confirm the SEC’s authority to adopt a proxy
access rule and that would require the SEC to adopt rules directly
regulating proxy access, rather than deferring to state law.

• The Delaware General Corporation Law has been amended to authorize
companies expressly to adopt bylaws providing for shareholders access
to the company’s proxy statement for director nominations.

• Most observers now believe the question is not whether there will
be shareholder proxy access for 2010, but rather what it will look
like. The shape of proxy access depends principally on whether the
final version of the SEC rule:

• For those who accept that shareholder proxy access is a foregone
conclusion, the key is the details of how shareholder access will be
implemented—the so-called “workability” issues. Workability in the
context of proxy access is far more complicated than it may first
appear. However, it will be the key to whether proxy access becomes, as
many of its supporters assert, a sparingly used device that has the
effect of instilling greater accountability of directors or, as many of
its opponents fear, the progenitor of countless election contests and
divided and dysfunctional boards.

Background

What is Proxy Access?

Shareholder proxy access is a proposed regime that would allow
shareholders of a public company to include in a company’s proxy
materials (proxy statement and proxy card) candidates for director
nominated by the shareholder in opposition to the company’s candidates
for election. Under the current regime, only the company’s nominees for
election to the board of directors are included in company proxy
materials. If a shareholder wants to nominate opposition candidates, it
must prepare, pay for and distribute separate proxy materials. The
obvious point of shareholder proxy access is to change the classic
election contest paradigm and thereby facilitate shareholders’ ability
on a virtually costless basis to elect directors who are not on the
board slate.

Who are the Players?

There are six main groups of players in the proxy access struggle:

• Corporate governance activists, spearheaded by labor unions, state
and local government pension funds and the Council of Institutional
Investors, have been the main proponents pushing for proxy access.
Although not as vocal, activist investors are also supporters of proxy
access;

• The SEC, where Chairman Schapiro has announced that she views proxy access rulemaking as a key priority;

• Members of Congress, such as Senator Schumer and other prominent
Democratic lawmakers, seem committed to creating a shareholder access
regime of some type;

• The business community, led by the US Chamber of Commerce (the
Center for Capital Market Competitiveness) and The Business Roundtable,
has been strongly opposed to proxy access since the first SEC
rule-making foray in 2003;

• The legal community, through its various bar associations and a
number of law firms, will weigh-in on the latest round of the proxy
access debate once the SEC issues its proposed rule; and

• The proxy advisory firms, most notably RiskMetrics, which will
have a large say on shareholder voting on proxy access proposals and on
contested director elections resulting from proxy access, are expected
to support proxy access.

Recent History of the Proxy Access Debate

Rule 14a-8. Rule 14a-8, adopted by the SEC under the
Securities Exchange Act of 1934, provides that a public company must
include a shareholder’s proposal on its proxy card, along with a
supporting statement in its proxy statement, if certain procedural
requirements are met. Rule 14a-8 also enumerates certain circumstances
when a company is permitted to exclude a shareholder proposal (after
submitting its reasons to the SEC), including that the proposal relates
to an election for membership on the company’s board of directors or
analogous governing body. This so-called “director election” exclusion
has traditionally been interpreted by the SEC as permitting exclusion
of shareholder proposals that would lead to election contests, as well
as proposals that would directly create an election contest.

Round One: SEC’s 2003 Proposal. During the 2003 proxy
season, the American Federation of State, County & Municipal
Employees (AFSCME) submitted an access proposal to Citigroup. The SEC
staff permitted Citigroup to exclude AFSCME’s proposal under the
director election exclusion of Rule 14a-8. AFSCME appealed to the
Commission, which unanimously upheld the staff’s position. But, at the
same time, then-SEC Chairman William Donaldson ordered the SEC staff to
review the question of shareholder access under the proxy rules.

In October, 2003, the SEC issued a proposed proxy access rule, which
provided that if certain “governance failures” occurred at a public
company, holders of 5 percent or more of the stock could nominate
directors at the following annual meeting through inclusion in the
company’s proxy materials. In addition to specifying the triggering
“governance failures,” the rule proposal dealt with a number of
practical issues, including the maximum number of proxy access
directors that could be elected, that proxy access would not be
available to shareholders with a control intent and independence and
informational requirements for utilization of the proxy access process.
The proposed rule engendered significant criticism, and was ultimately
abandoned in 2004 because of a lack of consensus among the SEC
Commissioners.

Round Two: SEC’s 2007 Proposals. During the 2005 proxy
season, AFSCME again submitted a Rule 14a-8 proxy access proposal, this
time to AIG. The SEC staff permitted AIG to exclude the proposal as
relating to an election of directors. AFSCME sued AIG in a federal
district court. The district court found in favor of AIG and AFSCME
appealed.

In September 2006, the Second Circuit held that AFSCME’s proposal to
include specific names of shareholder-nominated candidates did not
“relate to an election for membership on the company’s board of
directors” within the meaning of Rule 14a-8 and therefore could not be
excluded by AIG, basing its holding on what it viewed as a flawed SEC
administrative process for interpretation of the director election
exclusion. The practical result was that, under the court’s decision
(technically only binding in the Second Circuit), the SEC staff could
no longer allow companies to exclude access proposals from proxy
statements. Within days of the Second Circuit decision, SEC Chairman
Cox announced that the SEC would resolve the issue for the 2007 proxy
season. But it was not possible to reconcile fully the differing views
of Commissioners (which were split along party lines) and no resolution
was achieved.

In July 2007, after additional months of study and three roundtable
discussions, the SEC issued two different—and to some extent
conflicting—proposals.

• The “Exclusion Proposal” reiterated and justified the
SEC’s long-standing position that shareholder proxy access proposals
are excludable. It further proposed amendment of Rule 14a-8 to provide
explicitly that access proposals can be excluded from company proxy
materials, on the ground that these proposals cause contested voting.

• The “Access Proposal” permitted 5 percent shareholders
to propose access bylaws, provided that they held the stock for at
least one year and did not have a control intent. The proposed rule
imposed additional disclosures on shareholders proposing access bylaws
or nominating director candidates under access bylaws.

• The issuance of each proposal for public comment was approved by a
3-2 split along party lines, with the two Republican Commissioners
supporting the Exclusion Proposal and the two Democratic Commissioners
supporting the Access Proposal. SEC Chairman Cox supported both
proposals. In November, 2007, after the departure of one of the
Democratic Commissioners and over opposition of the remaining
Democratic Commissioner, the SEC adopted the Exclusion Proposal but
announced that it would revisit the issue in the near future.

SEC’S 2009 Proxy Access Proposal

In April 2009, SEC Chairman Mary Schapiro publicly stated that she
supported shareholder proxy access as a way to make company boards more
accountable to investors, and to ensure that a company’s owners have a
meaningful opportunity to nominate directors. Chairman Schapiro also
noted that the United States is one of the few developed countries that
does not give shareholders some access to the proxy and emphasized that
proxy access has not lead to “enormous dislocations in other countries.”

The SEC is scheduled to consider a proxy access rule proposal on May
20th. The proposed rule, of course, will be open to public comment
before being adopted by the Commission. But if, as we expect, Chairman
Schapiro intends to have the proposal finalized in time for the 2010
proxy season, the comment period could well be quite short (perhaps as
little as 30 days). It is likely that the Commission will attempt to
adopt its proxy access rule in the fall of this year in order to allow
any shareholder proposals under the new proxy access rule to comply
with the Rule 14a-8 submission deadline. Alternatively, if (as seems
increasingly likely) the SEC’s new proxy access rule bypasses Rule
14a-8 and provides a direct, federal right to proxy access, early
adoption of the rule would be just as critical to permit its
implementation for the 2010 proxy season.

Updates Regarding the Other Constituencies

State Corporation Law. In April 2009, the Delaware
legislature amended the Delaware General Corporation Law to permit a
Delaware corporation to adopt a proxy access bylaw that would allow
“private-ordering” by companies for adoption and implementation of
proxy access. As amended, the statute authorizes (but does not
requires) a Delaware corporation to adopt bylaw provisions that give
shareholders the right to include in the corporation’s proxy
solicitation materials shareholders’ nominees for the election of
directors. The bylaw may establish procedures and conditions governing
the access right, which may include:

• minimum stock ownership and duration of ownership by the nominating shareholder;

• a definition of beneficial ownership that may include options or other rights;

• a requirement of specified information about the nominating shareholder and the director nominee;

• a limit on the number or proportion of directors that may be nominated;

• preclusion of nominations by persons or of persons who have
acquired a specified percentage of the voting power of the company; and

• appropriate indemnification of the company for any false or
misleading statement made or provided by the nominating shareholder.

The Schumer Bill. Today, Senator Charles Schumer of New
York introduced a bill that, among other things, would confirm the
authority of the SEC to issue a proxy access rule. In addition to
establishing SEC authority to regulate proxy access, the proposed
legislation would require the SEC to adopt substantive regulations
governing proxy access. We assume that the Schumer bill aims to
pre-empt contrary state law in the administration of proxy access,
although the posted draft is silent on the topic.

The other main features of Senator Schumer’s “Shareholder Bill of Rights Act of 2009” are:

• SEC-reporting companies must include in their annual meeting
proxies a separate resolution for a non-binding shareholder vote on the
compensation package for executives. They must also include a
resolution in a merger proxy for a non-binding shareholder vote on
“golden parachute” arrangements;

• The SEC must establish rules requiring listed companies to meet the following corporate governance standards:

The US Chamber of Commerce. In a public letter sent to SEC
Chairman Schapiro on April 28, 2009, the US Chamber of Commerce stated
that it is “opposed to a federal shareholder access right,” and that
“there is no compelling need for a federal access right.”

• The Chamber emphasized the main reasons for its opposition, as follows:

• The Chamber then asserted the SEC lacks authority to regulate
corporate governance, which is a matter of state law. The Chamber also
stressed that “the recent actions by Delaware should give pause to any
federal action in the field of shareholder access.”

http://blogs.law.harvard.edu/corpgov/2009/05/30/the-battle-for-shareholder-access-the-current-state-of-play/