ON JULY 25, the U.S. Securities and Exchange Commission published an interpretive release and two proposed rules that reflect a split among the commissioners regarding shareholder access to the director-nomination process. This development follows a problematic decision last year by the U.S. Court of Appeals for the Second Circuit in American Federation of State, County & Municipal Employees, Employees Pension Plan v. American International Group, Inc. (the AFSCME decision).

The SEC’s conflicting proposals have sent mixed signals to public companies that are considering whether to change the method for nominating directors for election to the board. Institutional shareholders, which are generally unhappy with the SEC’s proposals, will likely continue the fight for proxy access in the courts.

Many institutional investors and other commenters have blasted one or the other of the contradictory proposals, while the International Brotherhood of Teamsters (Teamsters) and other commenters oppose both proposals. Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee (HFSC) has called for the SEC to postpone further action until the two departing Democratic commissioners, who supported one of the conflicting proposals, have been replaced. In the meantime, SEC Chairman Christopher Cox , who acknowledges that the two proposals are contradictory, told reporters last month that he intends for the commission to press forward to adopt a rule on the proxy access issue in time for the 2008 proxy season.


In the AFSCME decision, the court held that AIG could not rely on Rule 14a-8(i)(8) to exclude a shareholder proposal seeking to amend a company’s bylaws to establish shareholder nominating procedures for directors in the company’s proxy materials. The court interpreted the SEC’s previous statements as limiting the election exclusion to shareholder proposals dealing with an identified board in a specific upcoming election. The SEC had urged the court to adopt a broader interpretation of the rule, which would exclude proposals by shareholders that could make future election contests more likely.

Interpretive Guidance

The SEC was concerned that the AFSCME decision has created confusion over the proper application of the Rule exclusion and could lead to contested elections for directors without adequate disclosure. It has therefore issued interpretive guidance to confirm the position it has taken since 1976. Specifically, the release reaffirms the SEC’s view that a shareholder proposal can be excluded under the Rule if the proposal could result in a director-election contest in the future.

The interpretive guidance seeks to lay to rest a concern raised by the court in the AFSCME decision that the SEC had inconsistently applied the Rule exclusion in various no-action letters. According to the SEC, allowing shareholders to include their nominees in company proxy material could, in fact, create a contested election of directors without the shareholders conducting a separate proxy solicitation. If the election exclusion were applied as contemplated by the court in the AFSCME decision, the SEC states that it would create an opportunity for a shareholder to wage an election contest without providing the required disclosures governing proxy contests. This, according to the SEC, would be inconsistent with its 1976 statement and the staff ’s application of that statement in responding to Rule 14a-8 exclusion notices from companies in the intervening years, with few exceptions.

In 1993 and again in 1995, SEC staff issued no-action letters that were inconsistent with its no-action precedent and previous SEC statements regarding similar shareholder proposals. The SEC takes the position in the interpretive release that those two letters were issued by staff in error because they were clearly at odds with the SEC’s otherwise clear position and statements with respect to the Rule exclusion. As the interpretive release adds little, if anything, to the argument presented in the SEC’s brief to the court, it will be interesting to see whether the Second Circuit in a future dispute will accept the SEC’s interpretive guidance as being dispositive of the Rule exclusion issue.

Exclusionary Proposal

The proposed Rule amendments sponsored by Mr. Cox and the two Republican commissioners are intended to clarify the scope of the Rule exclusion. If adopted in their proposed form, the Rule amendments would permit a company to exclude a shareholder proposal that related to (i) a nomination or election of a director to a company’s board or analogous governing body, or (ii) a procedure for such nomination or election. Thus, the amendments would, for example, permit a company to exclude from its proxy materials shareholder-proposed bylaws concerning director nominating procedures similar to those in the AFSCME case.

According to the SEC, the amendments would help a company determine whether the Rule would permit exclusion of a shareholder proposal relating to procedures for shareholder nominees for directors, thus promoting more efficient capital formation.

Inclusionary Proposal

In addition to the proposed exclusionary Rule amendments, Mr. Cox and the two Democratic commissioners proposed, by another 3-2 vote on the same day, diametrically opposed amendments that would permit the inclusion in a company’s proxy statement of certain shareholder-proposed bylaws providing director-nomination procedures for shareholders.

Under this conflicting set of amendments, the Rule would expressly permit the inclusion in a company’s proxy materials of shareholderproposed bylaws providing for directornomination procedures for shareholders. Under the amended Rule, the shareholder or group of shareholders proposing director-nomination procedures would have to own more than 5 percent of a company’s securities and would have to be passive investors eligible to file a Schedule 13G.

The SEC asserts in this fundamentally different proposal that new proxy access procedures would reinforce shareholders’ state law rights to nominate directors while ensuring full disclosure in election contests. Specifically, the Rule would permit a shareholder to have included in a company’s proxy a bylaw proposal for director-nomination procedures, including a proposal like the one in the AFSCME case, subject to filing a Schedule 13G that would include specified public disclosures regarding the proponent’s background and interactions with the company.

The Rule amendments would permit qualified shareholders to propose any shareholder nomination procedures at their discretion, subject only to limitations imposed by applicable state law or the company’s charter and bylaws. For example, a proposal could specify the number of directorships subject to the procedure and the allocation of costs associated with the procedure, as well as the level of share ownership for those making director nominations. The voting threshold required to adopt the bylaw would be that prescribed by state law or a company’s charter and bylaws.

Mixed Reactions

Reaction to the two SEC proposals has, as expected, been strong on all sides and, to some degree, reflects the lack of consensus among the commissioners. The U.S. Chamber of Commerce, for example, has said that greater proxy access for shareholders would not advance shareholder financial interests but, rather, would allow special interest groups to push their agendas at the expense of the other shareholders.

Business Roundtable President John Castellini obviously agrees, stating in published reports that the “Democratic proposal” would, if adopted, politicize the director election process and discourage qualified, independent directors from serving. The Social Investment Forum (SIF) has expressed concern that the Democratic proposal permitting access actually takes away shareholder rights and may open the door for additional curbs on so-called advisory shareholder resolutions. The SIF and a number of institutional investors have issued warnings to the SEC that they will fight any effort to limit their rights to participate in the shareholder resolution process.

Executive Director Ann Yerger of the Council of Institutional Investors testified at a recent hearing of the HFSC against both proposals in favor of the “status quo.” In other words, let the courts decide. The Teamsters also oppose both SEC proposals in favor of operating under the AFSCME decision. This approach would leave open the door to shareholders seeking to establish shareholder nominating procedures through bylaw amendments without meeting any additional ownership or disclosure requirements.

The widespread institutional opposition to one or both of the shareholder access proposals and the HFSC’s call to postpone final action until the departing commissioners are replaced may have a chilling effect on the SEC’s willingness to adopt either proposal in time for the upcoming proxy season. The recently reported departures of the two commissioners have provided the SEC with sufficient cover to postpone a final decision.

As this article was going to press, Mr. Cox told reporters that the SEC should go back to the drawing board on the controversial proxy access issue but would likely finalize a rule soon as a short-term solution. Given the widespread criticism of, and the apparent confusion surrounding, the two proposals, a timeout may be optimal, except of course for the companies that receive shareholder access proposals during the 2008 proxy season. On the other hand, it is difficult to reconcile Mr. Cox’s plan to adopt a “temporary fix” with the notion that the commission will be rethinking the issue again next year.


The SEC’s interpretive guidance reaffirms its position in the wake of the AFSCME decision by the Second Circuit. Some say the SEC should have stopped there because that was all the AFSCME court required. Instead, the SEC also proposed two conflicting proxy access proposals that have been widely criticized and that, absent final action, will further confuse the proxy access landscape for companies that receive shareholder proposals in the upcoming proxy season.

At least for the moment, the SEC has left open the issue whether shareholders should have the choice to create their own proxy access procedures. However, recently SEC Chairman Cox has said again that he wants to push through a short-term solution in time for the 2008 proxy season. Based upon the reaction to the two current proposals, whatever the SEC ultimately decides to do in the near term, institutional shareholders will likely continue the battle for unfettered proxy access in the courts.