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August 18‚ 2011
Federal Appeals Court Vacates SEC’s Proxy Access
Rule
By Megan N. Gates and Asya S. Alexandrovich
The US Court of Appeals for the District of Columbia Circuit
(the Court) has vacated Rule 14a-11 under the Securities Exchange Act of
1934, as amended (the Exchange Act), which was adopted by the Securities
and Exchange Commission (the SEC) in August 2010. Rule 14a-11 was designed
to facilitate access by shareholders to public companies’ proxy statements
in order to propose nominees for election to boards of directors.
On September 29, 2010, the Business Roundtable and the
Chamber of Commerce of the United States of America filed a petition with
the Court seeking review of Rule 14a-11. The petitioners also filed with
the SEC a motion to stay the effectiveness of Rule 14a-11 pending review by
the Court. The SEC granted the motion to stay the effectiveness of Rule
14a-11 and further stayed the effectiveness of the amendments to Rule 14a-8
under the Exchange Act adopted contemporaneously with Rule 14a-11. The
rules were to take effect on November 15, 2010.
In the adopting release for Rule 14a-11, the SEC noted that it
had adopted the rule based on its belief that it would lead to cost savings
for shareholders seeking to nominate directors, in part due to reduced
printing and postage costs and reduced expenditures for advertising
compared to those associated with a traditional proxy contest.1 In addition, the SEC stated
that the rule “has the potential of creating the benefit of improved board
performance and enhanced shareholder value.” The SEC also noted that it had
considered both the anticipated costs to be imposed upon public companies
by the rule related to the preparation of required disclosure, and
potential adverse effects on board performance resulting from the rule, and
had concluded that the benefits of the rule would justify its costs.
In a unanimous opinion written by Judge Douglas Ginsburg on
behalf of the three-judge panel, the Court found that the SEC
“inconsistently and opportunistically framed the costs and benefits of the
rule; failed adequately to quantify the certain costs or to explain why
those costs could not be quantified; neglected to support its predictive
judgments; contradicted itself; and failed to respond to substantial
problems raised by commenters.” The Court,
therefore, vacated Rule 14a-11 for being in violation of the federal
Administrative Procedure Act. The Court did not address the petitioners’
additional arguments that the SEC had arbitrarily rejected proposed
alternatives to the proxy access rule or that the rule violates the First
Amendment of the US Constitution.
In particular, the Court found that the SEC, among other
things:
·
Neglected both to quantify the costs that companies would incur in
opposing shareholder nominees and to substantiate the rule’s predicted
benefits;
·
Relied upon insufficient empirical data when it concluded that the
rule would improve board performance and increase shareholder value;
·
Failed to adequately consider that institutional investors with
special interests, such as unions and state pension funds, may use the rule
as leverage to gain concessions from companies unrelated to shareholder
value;
·
Arbitrarily ignored the effect of the rule upon the total number of
election contests; and
·
Failed to adequately address the benefit from proxy access for
shareholders of investment companies and costs that the rule would impose
upon investment companies by disrupting the structure of their governance.
In responding to this decision, the SEC could ask for a
rehearing before the Court, appeal the Court’s decision to the US Supreme
Court, or refine its economic analysis as directed by the Court and
re-propose a different proxy access rule. In each case, it is virtually
certain that any new proxy access rule would not be effective in time for
the 2012 proxy season.
Shareholder
Proposals to Modify Company Nomination Procedures
The Court’s ruling does not affect the validity of the
amendments to Rule 14a-8 under the Exchange Act that were adopted by the
SEC contemporaneously with Rule 14a-11. Those amendments provide that
shareholders can require companies, under certain circumstances, to include
proposals in their proxy materials that would require or request amendments
to company charters and bylaws addressing nomination procedures for members
of boards of directors. This would mean, for example, that shareholders
could propose resolutions to require a company to amend its bylaws in order
to specify particular procedures by which shareholders can propose director
nominees. In order to submit a proposal under this amended rule, a
shareholder proponent would be required to have continuously held at least
$2,000 in market value (or 1%, whichever is less) of the company’s
securities entitled to be voted on the proposal at the meeting, for a
period of one year prior to submitting the proposal.
The SEC has not yet announced whether and when it plans to
lift its stay on the effectiveness of amendments to Rule 14a-8. If the stay
is lifted, the amended rule may take effect prior to the 2012 proxy season.
* * *
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1 “Facilitating
Shareholder Director Nominations,” Release Nos. 33-9136; 34-62764;
IC-29384; File No. S7-10-09, August 25, 2010, available at http://www.sec.gov/rules/final/2010/33-9136.pdf.
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