On July 22, 2011, the United States Court of Appeals for the District of Columbia Circuit granted the petition filed by the Business Roundtable and the U.S. Chamber of Commerce to vacate the SEC’s proxy access rule because, among other reasons, the SEC failed adequately to consider the rule’s effect on efficiency, competition and capital formation as required by law. See the full opinion.
Rule 14a-11, adopted by the SEC in October of 2010, would have permitted a shareholder who has continuously held at least 3% of the voting power of a company’s securities for at least three years to nominate a director and require the company to include the shareholder’s nominee in the company’s proxy statement and on the company’s proxy voting card. Absent this form of proxy access, a shareholder must incur the expense of filing its own proxy statement and engage in a proxy contest in order to have its nominee considered by shareholders.
Shortly after adoption of the rule, the Business Roundtable and the U.S. Chamber of Commerce filed a petition with the U.S. Court of Appeals for the District of Columbia Circuit seeking to have the rule set aside. In November 2010, the SEC voluntarily stayed the application of Rule 14a-11 and a related amendment to Rule 14a-8 dealing with shareholder proposals, pending resolution of the court challenge. In its decision, the Court, which has previously invalidated SEC-rulemaking on similar grounds, noted that the SEC acted arbitrarily and capriciously in issuing the rule because it failed adequately to analyze the rule’s economic costs and benefits. The Court stated:
Here the Commission inconsistently and opportunistically framed the costs and benefits of the rules; failed adequately to quantify the certain costs or to explain why these costs could not be quantified; neglected to support its predictive judgments; contradicted itself; and failed to respond to substantial problems raised by commenters.
In particular, the Court criticized the SEC’s estimates of the costs companies would likely incur in responding to shareholders utilizing Rule 14a-11, as well as the SEC’s analysis of how frequently directors would be nominated using the rule. The Court also criticized the SEC for relying on "insufficient empirical data" to conclude that proxy access would improve board performance and increase shareholder value and for failing to address the possibility that unions and pension funds would use the rules to gain advantages unrelated to shareholder value.
Although the Court struck down the entire rule, it nevertheless addressed concerns specifically applicable to investment companies that were not addressed by the SEC. The Court noted that the SEC failed adequately to address whether the requirements of the Investment Company Act of 1940 reduced the need for, and therefore any benefit from, proxy access for shareholders of investment companies and whether the rule would impose greater costs on investment companies by disrupting their governance structures.
The Court’s decision was issued on the first anniversary of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which specifically authorized the SEC to issue rules regarding proxy access. In light of the explicit Dodd-Frank mandate, we think it is likely that the SEC will either appeal the Court’s decision or re-propose proxy access rules that address the Court’s concerns. The SEC Division of Corporation Finance has announced to date that it is considering its options. In any event, it appears unlikely that there will be any form of SEC-mandated proxy access rule in effect for the 2012 proxy season.
As part of the SEC’s proxy access initiative, the SEC adopted an amendment to Rule 14a-8 at the same time it adopted Rule 14a-11. This amendment, which would prohibit companies from excluding shareholder proposals relating to proxy access, was not covered by the Court’s decision because the petition challenging Rule 14a-11 did not challenge the amendment to Rule 14a-8. However, the SEC order that stayed application of Rule 14a-11 in October of 2010 also stayed the amendment to Rule 14a-8 because, in the SEC’s words, “the amendment to Rule 14a-8 was designed to complement Rule 14a-11 and is intertwined, and there is a potential for confusion if the amendment to Rule 14a-8 were to become effective while Rule 14a-11 is stayed.” See the SEC’s Order Granting Stay, dated October 4, 2010. Therefore, in addition to deciding whether to appeal the Court’s decision or re-propose a form of proxy access that complies with the Court’s decision, the SEC must also decide how to proceed with the Rule 14a-8 amendment.