Corporate Governance

The SEC, Rule 14a-8, and Shareholder Approval of the Auditor: Time for a Change in Policy (The Longstanding Position) (Part 3)

By J Robert Brown Jr.

We are discussing the application of the "ordinary business" exclusion to proposals seeking to encourage management to submit the outside auditor to shareholders for approval.  

Likewise the Commission took a dim view toward attempts to apply the exclusions in Rule 14a-8 to proposals calling for auditor approval by shareholders and in at least one case sought to enjoin a company from doing so.  In SEC v. Transamerica Corp., 163 F.2d 511, 513 (3d Cir. 1947), Transamerica opted, over the objection of the Commission, to exclude a number of shareholder proposals, including one calling for shareholder ratification of the auditor.  The proxy statement did reveal that a stockholder would 'present for action' a proposal at the meeting 'to require that independent public auditors should be elected by the stockholders' but did not otherwise include the text of the proposal or provide space to vote on the proxy card. 

The Commission sought to enjoin Transamerica's actions.  In determining whether the proposal amounted to a 'proper subject for action' by shareholders, the district court described the right of shareholders to ratify the independent auditor as 'proper and common' and could find no basis for excluding the proposal.   

• No cogent reason has been advanced why the proposal to have independent public auditors of the books of the corporation elected by stockholders (beginning with the annual meeting of 1947, and a representative of the auditing firm so chosen attend the annual meeting each year) is not a proper subject matter to come before the annual meeting, . . . With respect to the annual meeting of defendant Transamerica, management by the exercise of procedural limitations had no right to omit this particular Gilbert proposal from the notice of the annual meeting to be sent to all stockholders.

SEC v. Transamerica Corp., 67 F.Supp. 326 (D. Del. 1946).  Characterizing the auditors as holding a position of trust, the court mused that 'it would be an odd legal relationship whereby trustee has conclusive discretion over the method and person who shall review the trustee's accounts.'  Id.    

The Third Circuit affirmed on that issue in a somewhat exasperated tone.  "Surely the audit of a corporation's books may not be considered to be peculiarly within the discretion of the directors. A corporation is run for the benefit of its stockholders and not for that of its managers.'  Appointment of an auditor by shareholders was 'beyond any question' a 'proper action by the stockholders.'  Id.   

Although not addressing the 'ordinary business' exclusion (it had not yet been adopted), the reasoning of both courts precluded application of the provision.  The analysis reflected the view that ratification was not a matter within the exclusive purview of the board but, given the gatekeeper role of auditors, an appropriate subject for shareholders.   

In the aftermath of the decision, shareholder proposals seeking approval of auditors were common and routinely included in the proxy materials.  Shareholders often supported them and some received majority support.  In 1960, the Chairman of the Commission described them as 'popular proposals.'  Likewise, the Commission occasionally reiterated the inapplicability of exclusions to shareholder ratification proposals.

To the extent the proposals were excluded, the grounds were narrow or procedural.  The only common basis was mootness and only when the board agreed to adopt a policy effectively implementing the proposal.  Indeed, shareholder ratification emerged as a basis for excluding other proposals, particularly those seeking to impose qualitative standards on the selection of the auditor.

The topic is developed more fully in Essay: The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors.

Full post as published by The Race to the Bottom on March 24, 2011 (boomark / email).