On July 22, 2011, the U.S. Court of Appeals for the D.C. Circuit vacated Securities and Exchange Commission Rule 14a-11. Rule 14a-11 would have permitted eligible shareholders of public companies to nominate candidates for election as directors and have them included in the company's proxy statement and form of proxy along with the company's nominees. To be eligible to nominate a director under Rule 14a-11, a nominating shareholder had to own securities representing at least 3% of the voting power of a company for at least three years prior to the nomination and through the date of election. In the ruling in Business Roundtable and Chamber of Commerce of the U.S. v. Securities and Exchange Commission (D.C. Cir. July 22, 2011), the three-judge panel found that the SEC had acted in an "arbitrary and capricious" manner in adopting the proxy access rule without realistically assessing and weighing the rule's economic effects. The Court's full decision can be accessed here.
The plaintiffs contended that the proxy access rules violated the Administrative Procedure Act, that the SEC failed "adequately to consider the rule's effect upon efficiency, competition, and capital formation," as required by law, and that the rules infringed upon issuers' rights under the First and Fifth Amendments as the rule was a "taking of corporate property because it forces companies to fund and carry election-related speech that is opposed by a company's duly-elected board of directors."
Rule 14a-11 is the latest in a series of attempts by the SEC to make it easier for shareholders to effect changes in boards of directors. Without the rule, dissident, activist and other shareholders who want to change the make-up of a board will have to mount a proxy contest and incur substantial expense in the process that they will not recover unless they succeed in defeating the board's own nominees.
The D.C. Circuit Court, in an opinion by Judge Ginsburg, agreed with the plaintiffs and further stated that "the Commission 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." Since the Court based its ruling under the APA, it did not address the constitutional challenges to the rule.
At this point, the SEC has within 60 days from the decision to respond to the court's decision before it becomes effective, appeal the case directly to the Supreme Court or attempt to resolve and address the cost-benefit concerns raised by the D.C. Circuit Court. Given the basis and tone of the decision, the SEC may find it more difficult to resuscitate proxy access yet again. Regardless of the eventual reaction by the SEC, it is unlikely that a new rule could be in place in time to affect the 2012 proxy season.
In addition to Rule 14a-11, the SEC previously revised Rule 14a-8 to permit shareholder proposals that seek to establish a procedure in a company's governing documents to include one or more shareholder director nominees. This amendment was not challenged by Business Roundtable and Chamber of Commerce. The implementation of this rule was stayed while the case was decided. Irrespective of the SEC's course of action with respect to Rule 14a-11, the SEC could lift the stay on Rule 14a-8 in which event companies could receive shareholder proposals in the 2012 proxy season seeking to institute a shareholder nomination process via binding by-law amendment.