SEC Rule 14a-11 allowed a shareholder (or group of shareholders) to include a shareholder nominee, in certain limited circumstances, in a public company’s proxy statement. The Business Roundtable and the US Chamber of Commerce challenged the rule before the Court of Appeals for the District of Columbia.  The Court issued a decision which vacated Rule 14a-11.

The Court held the SEC acted arbitrarily and capriciously for having failed to assess the economic effects of the new rule.  The Court found the SEC:

  • inconsistently and opportunistically framed the costs and benefits of the rule;
  • failed adequately to quantify 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.

Costs versus Benefits

The Court looked closely at what costs and expenses a company might incur to oppose shareholder nominees.  The SEC believed that significant funds may not be expended because a board’s fiduciary duties may prevent the company from opposing a nominee or that public companies may simply chose to include the shareholder nominee in the proxy statement. The Court found that the SEC’s prediction that public companies may not choose to oppose shareholder nominees had no basis beyond mere speculation.  The SEC did nothing to estimate and quantify the costs it expected companies to incur; nor did it claim estimating those costs was not possible.  The Court noted empirical evidence about expenditures in traditional proxy contests was readily available.

Shareholders with Special Interests

The Court found that the SEC failed to consider the impact of special interest groups from utilizing Rule 14a-11.  Commenters expressed concern that employee benefit funds would impose costs upon companies by using Rule 14a-11 as leverage to gain concessions, such as additional benefits for unionized employees, unrelated to shareholder value. The Court seemed to agree that public and union pension funds were institutional investors most likely to utilize proxy access.  The Court found that by ducking serious evaluation of the costs that could be imposed upon companies from use of the rule by shareholders representing special interests, particularly union and government pension funds, the SEC acted arbitrarily.

Frequency of Election Contests

In weighing the rule’s costs and benefits, the Court found the SEC arbitrarily ignored the effect of the final rule upon the total number of election contests.   To do so, the Court believed the SEC needed to address whether and to what extent Rule 14a-11 will take the place of traditional proxy contests.  The beneficial effects of Rule 14a-11 may include making election contests more plausible for shareholders to participate in the governance of their company.  However, without knowing how often Rule 14a-11 will take the place of traditional proxy contests, the SEC has no way of knowing whether the Rule will facilitate enough election contests to be of net benefit.

The Court also found the SEC’s discussion of the estimated frequency of nominations under Rule 14a-11 to be internally inconsistent and therefore arbitrary. Simply put, the SEC anticipated frequent use of Rule 14a-11 when estimating benefits, but assumed infrequent use when estimating costs.

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