The United States District Court for the Southern District of New York recently issued a decision in an important case related to shareholder access to public company proxy statements. The case was brought by prominent corporate law professor Lucian Bebchuk, against Electronic Arts, Inc. (“EA”), a video game company incorporated in Delaware.1 Bebchuk had submitted a shareholder proposal to amend EA’s bylaws so as to give shareholders direct proxy access for further bylaw amendments. On November 13, 2008, the District Court, in a one-page decision rejected Bebchuk’s claim and affirmed EA’s decision to exclude his proposal.
Bebchuk has appealed the decision to the Court of Appeals for the Second Circuit. Nevertheless, the District Court’s decision will almost certainly stand for the 2009 proxy season since the Court of Appeals is unlikely to rule on the case until at least the second half of 2009.
This memorandum summarizes the background to, and decision in, the Bebchuk case, and describes its implications for public companies and their shareholders.
Access to company proxy statements is a hot topic for activist shareholders. There have been a number of developments in recent years leading up to the current state of affairs:
- Matters regarding shareholder voting are generally governed by state law. However, Rule 14a-8 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), permits shareholders that meet specified ownership standards to submit to a public company limited types of proposals for inclusion in the company’s proxy statement. Rule 14a-8(i) contains 13 bases upon which a company may exclude such proposals, which the company does by means of submitting a no-action letter to the SEC. These bases permit exclusion of proposals, for example, that violate state law, that the company lacks power to implement, or that relate to election of the company’s board of directors.
- Because Rule 14a-8 does not allow shareholders to include nominees for a company’s board of directors in the company’s proxy statement, dissident shareholders must bear the cost of printing and mailing their own proxy statement if they wish to solicit votes for an alternate slate of directors. The SEC’s recently adopted e-proxy rules may help such shareholders somewhat by lowering the costs to mount a proxy battle, but the e-proxy rules still do not remove the need to mail a proxy notice to some or all shareholders. Therefore, there will still be some costs associated with a proxy battle even if solely conducted by e-proxy. Furthermore, initial indications are that retail shareholders are less likely to vote after receiving an e-proxy notice than if they receive a traditional proxy statement and proxy card.2 Therefore, e-proxy may not garner the incremental votes necessary to mount a serious challenge to an incumbent board.
- The SEC first raised the possibility of granting shareholders access to a company’s proxy statement in 2003.3 Its proposals were not adopted at that time. In June 2007, the SEC took the unusual step of publishing two separate rule proposals because of a split in approach among SEC Commissioners. One proposal, which was subsequently adopted in December 2007, proposed amendments to Rule 14a-8(a)(i) to clarify that such rule not only permitted the exclusion of a proposal related to a nomination or election to a company’s board of directors, but also permitted exclusion of a proposal related to a procedure for such nomination or election.4 The second proposal contemplated significant changes to Rule 14a-8 that, among other things, would have permitted shareholders to include in company proxy materials proposals for bylaw amendments regarding procedures for nominating candidates to a company’s board of directors. The first proposal and the second proposal effectively advocated opposing positions and were therefore mutually exclusive. Notwithstanding the SEC’s decision not to adopt the second proposal, the SEC stated that it would reconsider the issue of proxy access in 2008;5 however, the financial crisis has overshadowed this intention. Finally, there have been periodic indications that Congress might address shareholder access through legislation. (The first draft of the Emergency Economic Stabilization Act included a provision that would have permitted a five percent shareholder of a company receiving rescue funds to include its board nominees in the company’s proxy statement. However, that provision was deleted in subsequent versions.)
- In July 2008, shareholders won a significant victory when the Delaware Supreme Court in CA Inc. v. AFSCME Employees Pension Plan 6 ruled that a company could be required to adopt a bylaw requiring the board to reimburse the reasonable costs of shareholders who seek to elect directors. The Court ruled that the bylaw must be drafted to permit the board to exercise its fiduciary duties in deciding whether reimbursement is appropriate under the circumstances. Such a bylaw, if adopted, would address the costs incurred by dissident shareholders in launching their own proxy battle and thereby goes a significant way towards mitigating the inability of shareholders to include their own slate of directors in the company’s proxy statement.
The Bebchuk Case
In February 2008, Harvard Law Professor Lucian Bebchuk submitted a shareholder proposal and supporting statement for inclusion in EA’s proxy statement. The proposal sought an amendment to EA’s bylaws which, if adopted, would have permitted any shareholder who continuously held stock with value of at least $2,000 for one year before submitting its proposal, or any shareholder who held at least five percent of EA’s outstanding shares at the time of submission, to submit a proposal to amend EA’s bylaws if the amendment was permitted pursuant to Delaware law. If adopted, the effect of Bebchuk’s bylaw amendment would have been to permit shareholders to submit a proposal in a subsequent year to further amend EA’s bylaws to permit shareholder access to the company’s proxy statement. Bebchuk’s bylaw amendment would not have been subject to exclusion pursuant to Exchange Act Rule 14a-8, because the amendment would have expressly required the company to permit a shareholder vote on the proposal.
In March 2008, EA submitted a no-action letter to the SEC seeking to exclude the proposal in accordance with Rule 14a-8.7 EA enumerated numerous reasons for opposing the proposal.
In April 2008, Bebchuk filed a complaint against EA in the United States District Court for the Southern District of New York seeking a declaratory judgment and requesting injunctive relief requiring EA to include the proposal in its 2008 proxy statement. Bebchuk claimed that EA had violated Rule 14a-8 by excluding the proposal. EA responded with a motion to dismiss that included three principal arguments:
- EA argued that Bebchuk’s proposal was a direct attempt by shareholders to bypass the SEC’s existing regulatory framework that governs the content of proxy statements.
- The SEC specifically grants thirteen exceptions that allow companies to exclude proposals. The “relates to election” exception in Rule 14a-8(i)(8) would be circumvented by Bebchuk’s proposal, because shareholders would be able to submit any proposal, including a proposal related to nominating board members. Bebchuk’s proposal could therefore remove from the board the discretion that was specifically granted by the SEC’s rules (the so-called “indirect consequences argument”).
- Companies are allowed by Rule 14a-8(i)(3) to exclude proposals “contrary to any of the Commission’s proxy rules,” which would include proposals from shareholders that are inherently vague or indefinite. EA alleges that the proposal is disqualified here, because EA and its shareholders would not know what specific action Bebchuk’s proposal would require.
On November 13, 2008, Judge Hellerstein issued a one-page decision granting the motion to dismiss with no further explanation. The transcript from the oral argument, however, shows that Judge Hellerstein’s primary concern was that Bebchuk’s proposal would usurp the standardized and SEC-guided rights of directors to control the company, specifically through proxy statements. “I can’t foresee the propriety in a company of stripping the directors of discretion to conduct the business of a company,” he said. “And part of that business is the decision of what to submit and what not to submit to the stockholders and voting.”
Judge Hellerstein noted that he did not write an extensive opinion because the case would likely be taken up to the Court of Appeals for the Second Circuit. Bebchuk has already appealed the decision.
Implications and Analysis
The Bebchuk case has already generated significant interest beyond its immediate parties. An amicus curiae brief was submitted in support of EA’s position by the US Chamber of Commerce. A further amicus curiae brief was submitted in support of Bebchuk’s position on behalf of 46 professors from 28 law schools around the United States. The professors based their support on two grounds. First, in contrast to EA and the Chamber of Commerce, the professors believe that Rule 14a-8 does not preempt state law since that would have the consequence of invalidating any state corporate law providing shareholders with access to a company’s proxy statement. They believe that Rule 14a-8 merely sets a minimum requirement and that it is permitted to include a bylaw expanding shareholder access beyond Rule 14a-8. Second, the professors contended that the “indirect consequences argument,” if accepted, would significantly expand the exclusion under Rule 14a-8(i)(8) from excluding proposals that relate to director election and nomination procedures to excluding proposals that relate to bylaw amendment procedures. As the case proceeds to the Court of Appeals, it seems likely that interested parties will file further amicus curiae briefs.
It will take a number of months for the parties to fully brief the appeal and for the Court of Appeals to hold oral arguments. It will then likely take several months for the Court to issue its decision. As a result, a decision from the Court of Appeals is unlikely to be issued until at least the second half of 2009, and the decision of the District Court in favor of EA will therefore stand for the 2009 proxy season. Other companies that receive shareholder proposals modeled on the Bebchuk proposal, assuming that they wish to exclude them, will still be required to submit a no-action letter request to the SEC. However, consistent with the position in Staff Legal Bulletin No. 14 and the SEC Staff’s response to EA’s no-action letter, the Staff may choose to express no view on such a no-action request because the issue is the subject matter of pending litigation.8 Therefore, companies can rely on the standing decision of the District Court in this matter to exclude such a proposal unless and until the decision is overturned by the Court of Appeals.
We will provide a further update when the Court of Appeals issues its decision.