Upon a finding that the Securities and Exchange Commission acted “arbitrarily and capriciously,” a panel of the U.S. Court of Appeals for the District of Columbia invalidated a new SEC rule that would have permitted an eligible shareholder or shareholder group to include its director nominees in a company’s proxy materials. (See our Client Advisory, New SEC Rules Provide Shareholders with the Right to Include Director Nominees in Company Proxy Materials, for a full description of the rules.)
The so-called “proxy access” rule was to have become effective November 15, 2010, but was stayed by the SEC after the Business Roundtable and U.S. Chamber of Commerce petitioned for Court review in September 2010. In its decision, the Court agreed with the petitioners that the SEC had failed to adequately assess the economic effects of the new rule, stating unequivocally:
“Here the Commission inconsistently and opportunistically framed the costs and benefits of the rule; failed adequately to quantify the 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.”
The Court found that three of the key assumptions made by the SEC - that company directors may choose not to oppose shareholder nominees, that contested elections would be limited and that board performance would improve overall and shareholder value would increase - “had no basis beyond mere speculation” and were made in reliance upon “insufficient empirical data.” The Court further noted that the SEC had not seriously considered the cost to companies of the consequences from special interest shareholders such as public and union pension funds using the rule to pursue self-interested objectives rather than the goal of maximizing shareholder value. The Court also found that the SEC had failed to address to what extent the proxy access rule would reduce the number of traditional proxy contests, and therefore the SEC did not have the “crucial datum” to be able to determine whether the rule would be of “net benefit.”
Similarly, the Court held the proxy access rule to be invalid as applied specifically to investment companies, finding that the SEC did not adequately address whether the regulatory requirements of the Investment Company Act of 1940 reduced the need for and the benefit from proxy access for investment company shareholders and whether the proxy access rule would impose greater costs upon such companies by disrupting their governance structure.
The Court’s decision did not, however, address new amendments to existing Rule 14a-8 that were adopted by the SEC together with the proxy access rule, the effectiveness of which had also been stayed by the SEC pending resolution of the proxy access rule dispute. The amendments to Rule 14a- 8 would allow shareholders to submit for inclusion in company proxy materials proposals regarding amendments to a company’s governing documents (charter or bylaws) seeking to establish less restrictive proxy access procedures for the inclusion of shareholder director nominees in company proxy materials (such as reduced ownership thresholds or holding periods). Previously, the SEC allowed companies to exclude such shareholder proposals. Absent a specific challenge to the Rule 14a-8 amendments, the SEC may decide to lift the stay of these amendments in the near future. This would give eligible shareholders at least some increased “proxy access” if proposed amendments to a company’s governing document were approved at a shareholders meeting.
With an overloaded plate of Dodd-Frank Act and other rulemaking priorities, it remains to be seen how the SEC will respond to the Court’s decision and whether the SEC will continue to pursue its proxy access initiatives. Because the Court’s decision rested on administrative grounds, rather than addressing the underlying Constitutional challenge, the SEC could choose to revise the proxy access rule and gather more economic evidence to support its findings.