On July 22, 2011, the United States Court of Appeals for the District of Columbia Circuit vacated the SEC's proxy access rule, Rule 14a-11.1 As adopted by the SEC, Rule 14a-11 would have provided shareholders with an alternative means to nominate and elect directors as it would have required companies to include shareholder director nominees in company proxy materials in certain circumstances. In vacating Rule 14a-11, the Court held that the SEC acted "arbitrary and capricious" in promulgating Rule 14a-11 and that it failed to adequately assess the economic effects of the new rule. As the Court noted:
"We agree with the petitioners and hold the Commission acted arbitrarily and capriciously for having failed once again . . . adequately to assess the economic effects of a new rule. Here 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. For these and other reasons, its decision to apply the rule to investment companies was also arbitrary. Because we conclude the Commission failed to justify Rule 14a-11, we need not address the petitioners' additional argument the Commission arbitrarily rejected proposed alternatives that would have allowed shareholders of each company to decide for that company whether to adopt a mechanism for shareholders' nominees to get access to proxy materials."2
Issues Left Unresolved by the Court's Decision Vacating the Proxy Access Rule
A number of issues were left unresolved by the Court's decision vacating Rule 14a-11 and, over the past month a half, those issues have been the frequent source of commentary and speculation by practitioners. Among those issues were the following:
- Would the SEC seek a rehearing of the Court's decision vacating Rule 14a-11?
- Would the SEC petition the U.S. Supreme Court to review the Court's decision vacating Rule 14a-11?
- Would the SEC "return to the drawing board" and, taking the Court's objections and the comments received from interested parties into effect, propose a modified form of Rule 14a-11?
- Would a modified form of Rule 14a-11 be adopted in time for the 2012 proxy season?
- Would the SEC allow the amendments to Rule 14a-8 that were adopted concurrently with Rule 14a-11 (which, while not challenged by the litigation that challenged Rule 14a-11, were also the subject of the SEC's order staying the effectiveness of Rule 14a-11) to become effective?
Statement by SEC Chairman Mary L. Schapiro on Proxy Access Litigation
On September 6, 2011, SEC Chairman Mary Schapiro issued a public statement which answers all of the above questions. According to the SEC Chairman's statement
- The SEC will not seek a rehearing of the Court's decision vacating Rule 14a-11.
- The SEC will not petition the U.S. Supreme Court to review the Court's decision vacating Rule 14a-11.
- While somewhat noncommittal with respect to whether and when a modified form of Rule 14a-11 would be proposed and what the best path forward would be, the SEC Chairman left no doubt in her statement that she is committed to finding an easier path for shareholders to follow in nominating candidates to corporate boards. She indicated that she had requested the SEC's staff to continue their review of the Court's decision as well as the comments that the SEC received from interested parties. While the SEC Chairman's statement leaves the door open for a modified form of Rule 14a-11, it seems clear that such a modified rule will not be adopted in time for the 2012 proxy season.
- The SEC's stay order staying the amendments to Rule 14a-8 and related rules will expire when the Court's decision is finalized, which is expected to be September 13, 2011. Accordingly, absent further SEC action, the amendments to Rule 14a-8 are expected to go into effect on September 13, 2011.
The Amendments to Rule 14a-8 Narrowing the "Election Exclusion" under Rule 14a-8(i)(8)
Currently, Rule 14a-8(i)(8) allows a company to exclude from its proxy statement a shareholder proposal that relates to a nomination or an election for membership on the company's board of directors or a procedure for such nomination or election. This provision currently permits the exclusion of a proposal that would result in an immediate election contest or would set up a process for shareholders to conduct an election contest in the future by requiring the company to include shareholders' director nominees in the company's proxy materials for subsequent meetings. Furthermore, a shareholder proposal is required to meet the existing procedural requirements of Rule 14a-8, including the requirement that such shareholder have continuously held for at least one year at least $2,000 in market value, or 1%, of the company's voting securities entitled to vote on such proposal, and not be subject to one of the other substantive exclusions under Rule 14a-8.
Amended Rule 14a-8 substantially narrows the scope of the election exclusion under Rule 14a-8(i)(8). As adopted, companies will no longer be able to rely on Rule 14a-8(i)(8) to exclude a proposal seeking to establish a procedure in a company's governing documents for the inclusion of one or more shareholder nominees for director in the company's proxy materials.
In addition, the amendments to Rule 14a-8 codify various prior interpretations of the SEC staff. As adopted, companies will be permitted to exclude a shareholder proposal pursuant to Rule 14a-8(i)(8) if such proposal:
- would disqualify a nominee who is standing for election;
- would remove a director from office before the expiration of such director's term;
- questions the competence, business judgment or character of a nominee for director;
- seeks to include a specific individual in the company's proxy materials for election to the board; or
- otherwise could affect the outcome of the upcoming election of directors.
As noted in the SEC's adopting release, a shareholder proposal would also continue to be subject to exclusion under other provisions of Rule 14a-8. For example, a proposal would be excludable under Rule 14a-8(i)(2) if its implementation would cause the company to violate any state, federal, or foreign law to which it is subject, or under Rule 14a-8(i)(3), if the proposal or supporting statement was contrary to any of the SEC's proxy rules.
Planning for the 2012 Proxy Season
With the amendments to Rule 14a-8 becoming effective in less than a week without the juxtaposition of Rule 14a-11 as originally intended, "private ordering" can be expected for the 2012 proxy season as shareholders can now propose amendments to a company's governing documents that would establish procedures under a company's governing documents for the inclusion of one or more shareholder nominees for director in company proxy materials. These proposals could seek to include a number of provisions relating to the nomination of directors for inclusion in company proxy materials, and disclosures related to such nominations, that require a different ownership threshold, holding period, or other qualifications or representations than those that were contemplated by the now-vacated Rule 14a-11.
In 2011, there was a decline in shareholder proposals overall, including a 16% drop among the Fortune 100 companies.3 The three most popular shareholder proposals were the authorization of shareholder action by written consent, shareholder power to call special meetings and requiring an independent board chairman separate from the CEO. Given the novelty of proxy access proposals, it is still too early to predict how these trends will affect the popularity of proxy access proposals made pursuant to amended Rule 14a-8 and whether proxy access proposals will become popular tools of a wide array of activist and/or institutional shareholders or, like we saw this past proxy season with respect to the numerous proposals empowering shareholders to take action by written consent, will be presented by a small number of individual shareholders.
Conclusion—Activists Will Have a New and Useful Quiver in Their Arsenal For the 2012 Proxy Season
Notwithstanding that Rule 14a-11 will not be a factor in the 2012 proxy season, with the soon to be effective amendments to Rule 14a-8 permitting the submission of proxy access proposals during the 2012 proxy season, activist shareholders will have yet another useful quiver in their arsenal that companies will need to prepare for.