With the United States Court of Appeals for the District of Columbia Circuit having struck down Rule 14a-11 in Business Roundtable et al v. Securities and Exchange Commission (No. 10-1305, July 22, 2011), the question is where does proxy access now stand and what can now be expected? The Court overturned the SEC’s attempt to give shareholders the right under the federal proxy rules to have their director nominees included in management’s proxy materials because of the SEC’s failure to adequately justify Rule 14a-11 on a cost-benefit basis. The SEC has several alternatives which undoubtedly are being considered. It could seek rehearing either by the panel or en banc or appeal the decision to the U.S. Supreme Court, it could amplify its analysis of the economic justification for Rule 14a-11 and readopt the rule, it could modify Rule 14a-11 and seek to justify the modification in a way that it believes will pass judicial scrutiny, or it could do nothing on Rule 14a-11 and let it disappear. Under any of these alternatives, the question is what will the SEC do about the amendment of Rule 14a-8, which offers another route to proxy access through shareholder proposals. The amendment has been stayed pending resolution of the court action challenging Rule 14a-11 and further notice from the SEC. Again, the SEC has several alternatives – it could lift the stay and let the amendment take effect as adopted or it could revisit the Rule 14a-8 amendment. I will not presume to predict what the SEC will do, or worse, tell it what it should do regarding Rule 14a-11. However, I have some observations regarding a path forward.
The DC Circuit Court of Appeals has set a high bar for the SEC to clear in justifying a mandatory access rule. For example, in addition to finding the Commission’s cost-benefit analysis to be flawed, the Court criticized the SEC for failing to establish that proxy access would result in improved board and company performance and shareholder value. There are many (and I am one) who, although believing the SEC acted unwisely in adopting proxy access, at least in the form of Rule 14a-11, are concerned about the high, nigh impossible, bar the Court set that could put in jeopardy most SEC rulemaking of any complexity or controversy. It remains to be seen whether the high bar established by the Court in this case will be limited in subsequent cases on the basis that, because the SEC was encroaching on areas traditionally left to the states, its burden to justify its proxy access rule, notwithstanding the Congressional grant of authority, was greater.
In discussing proxy access, it is important to remember what it is, and more importantly what it is not. Proxy access is not a right to elect directors – that is left to the shareholder election process. Also, it is not a right to nominate directors – that is a matter of state law and the corporation’s governing documents. Rather, it is a right to have a proponent’s nominees who qualify included in the corporation’s proxy material. Stripped to its essentials, aside from cost savings, proxy access is the ability to have a universal proxy card.
In the absence of Rule 14a-11 or a substitute mandatory access rule, the focus shifts to Rule 14a-8, which would permit access proposals by shareholders. Although it might be tempting for the SEC to simply lift the stay and get on with it, particularly given all the demands on its resources as a consequence of Dodd-Frank rulemaking, I do not believe it is that easy because of the requirements of the Administrative Procedure Act and policy considerations.
Even if lifting the stay itself did not require a full blown cost-benefit analysis, I believe that the circumstances under which the SEC did its analysis at the time of adoption of the Rule 14a-8 amendment have changed so significantly as a result of the invalidating of Rule 14a-11 that it is questionable whether the SEC can, and indeed whether it should, make the amendment effective without a new cost-benefit analysis, preferably with the opportunity for a new comment period. As the Commission said in its Order granting a stay, “the amendment to Rule 14a-8 was designed to complement Rule 14a-11 and is intertwined.” In fact, the playing field for shareholder-initiated proposals for proxy access is different without Rule 14a-11 because the leavening effect of the proxy access rule is no longer there. As a result, the number of access proposals under Rule 14a-8 can be expected to increase and the absence of the discipline created by Rule 14a-11, with which a Rule 14a-8 proposal could not be inconsistent, disappears. Thus, significantly more and potentially unworkable proposals are likely to be made. These considerations also suggests that the SEC should go back to the drawing board with the Rule 14a-8 amendment in the absence of Rule 14a-11. A failure to do so is likely to leave the SEC vulnerable to another court challenge similar to the one that was successful on Rule 14a-11.
Many responsible opponents of Rule 14a-11, including the American Bar Association’s Committee on Federal Regulation of Securities, indicated that they would support a private ordering proxy access proposal that included appropriate safeguards to protect against misuse and unworkable arrangements. As a matter of sound policy, in the absence of a mandatory Rule 14a-11 regime, the SEC should revisit the Rule 14a-8 amendment and consider a new approach that provides for proxy access as a matter of private ordering with appropriate safeguards. Such an approach is likely to gain widespread support and finally to put to rest the long and tortured battle over proxy access, and to do so in a way that strikes the right corporate governance balance and enhances the shareholder voting franchise.