Academic

Last Thursday Judge Alvin Hellerstein of the Southern District of New York dismissed Lucian Bebchuk's compaint against Electronic Arts, which we discussed here. The case involves a precatory shareholder proposal asking the board of directors of EA to propose an amendment to EA's charter or bylaws requiring EA to include in its proxy materials shareholder proposals that would otherwise be excludable under Rule 14a-8.

Judge Hellerstein's order does not explain his decision to dismiss Lucian's complaint beyond referring to the "record." Thanks to Neil McCarthy, Editor-in-chief of LawyerLinks and Steve Davidoff, I just read the transcript of the oral argument, which revolved around the issue of whether such a proposal would unduly constrain the discretion of the board.

Lucian's lawyer (Michael Barry, who shared a panel with me at ACS this summer) argued that "Section 14a-8 provides the minimum of what has to go in a proxy statement, not the maximum. There is nothing that ... says ... even if any of these proposals might be permitted to be excluded, the company has to exclude that." Barry argued that Lucian's proposal would not change Rule 14a-8, but if a charter or bylaw amendment were adopted by EA, that amended provision would affect the ability of EA's board of directors to exclude future proposals.

Judge Hellerstein was troubled by the fact that such a charter or bylaw amendment would limit the discretion of EA's board of directors to exclude proposals. The judge suggested that such a change would create a "conflict between the proxy rules and fiduciary responsibilities under state law." You can see how someone might come to this conclusion: the proxy rules grant the directors a certain amount of discretion, but the governing documents of the company purport to limit that discretion. That seems like a conflict ... unless the governing documents of the corporation are allowed to provide for limited board discretion. And why couldn't the governing documents contain such a limitation?

Jonathan Rosenberg, counsel for EA, tried to answer this question, though he seemed quite confused. His initial argument was that Bebchuk's proposal "attempts to use the [Rule] 14a-8 right of access process to effectuate an opt-out of the 14a-8 regime." According to Rosenberg, the SEC has carefully calibrated Rule 14a-8 with "checks and balances" that give exactly the right amount of discretion to the board of directors, and Bebchuk is attempting to "distort" that framework. The concern, according to Rosenberg, arises because the charter or bylaw amendment proposed by Bebchuk would allow a shareholder "without any disclosure obligations, except for the 500 words that are required in the supporting statement, or no more than 500 words, [to co-opt] the company's proxy and have the company change how it operates."

That argument actually seems fairly coherent, though I did a lot of reconstructive surgery to get it to that point. The confusing part of Rosenberg's argument comes in the middle of his "opt-out" charge when he seems to concede the viability of the bylaw (or charter) amendment proposed by Bebchuk:

If the board, in the exercise of its fiduciary duties, voluntarily decides that it wants to opt out, or not enforce any of these enumerated provisions under [Rule 14a-8,] it can do that....

And if the shareholders decide, through a proxy solicitation, that ... they want to amend the bylaws to opt out of the 14a-8 process, they could do that as well. [I]n other words, they could adopt this proposal.

So what is the problem? The problem is that Bebchuk is trying to use Rule 14a-8 to put the proposal in front of the shareholders, rather than subjecting himself to all of the disclosure requirements that accompany an independent proxy solicitation. The odd thing about this argument is that Rosenberg does not seem troubled by the proposed bylaw, but rather by the method used to propose it!

Barry picks up on Rosenberg's concession:

[Y]ou have just conceded that the -- that shareholders can go up and run their own proxy solicitation, and adopt this very bylaw that Professor Bebchuk is advocating. And, they have conceded, that the board, if they wanted to, could adopt the bylaw that says exact same thing.

Well, what does that tell you?  That tells you that they concede that, under state law, they can be restricted on how they -- how the board exercises its judgment and its discretion, its business judgement, in making this precise decision, this discretionary decision as to what to exclude under 14a-8 or not.

Now, let's think about what that means to the rest of their argument.

If they say that it's perfectly legal to adopt this bylaw, we'll talk about how you do it -- but it's perfectly legal to adopt this bylaw, what does that mean?

That means that entire discussion that the supposedly sacrosanct careful balancing that you can't touch that the SEC has done, and you can't do this through this bylaw is irrelevant.  They have just admitted that you can do it.  They just caution how you do it.

Exactly right! And, yet, Barry still loses on the motion to dismiss. What happened?

Judge Hellerstein asks Rosenberg to focus on the specific bases for exclusion under Rule 14a-8. In particular, Judge Hellerstein wants to consider the election exclusion under Rule 14a-8(i)(8), which holds that a company may exclude a proposal "[i]f the proposal relates to a nomination or an election for membership on the company's board of directors or analogous governing body or a procedure for such nomination or election."

According to Rosenberg, Bebchuk conceded in his filings with the Court that "the company [could] be forced to include shareholder nominations for directors in the company's proxy" if the proposed bylaw or charter amendment were adopted. In other words, the proposed bylaw or charter amendment would require EA to include in its proxy materials shareholder proposals that would otherwise be excludable under Rule 14a-8. Judge Hellerstein cannot abide this result, reasoning as follows:

I can't foresee the propriety in a company of stripping the directors of discretion to conduct the business of a company.  And part of that business is the decision of what to submit and what not to submit to the stockholders and voting.

Now the SEC has parsed that, to a degree, after a long period of time of pulling and tugging with different interests that surround the corporate governance issue.  And it has effected a compromise.... If it's wrong to ... strip the directors of a discretion that is found to be necessary, [it] doesn't seem to me it makes any difference whether it is the company that initiated the proposal or the stockholder that initiated the proposal.

...

[Rule 14a-8(i)(8)] says that [if] the proposal relates to a nomination, or an election from membership on the company's board of directors or analogous governing body, or a procedure for such nomination, or election, [t]he company can decide whether to submit it or not.

I would submit, that in this situation, the decision has to be made at such time as such a proposal is put to the company, and only the board can do it.  There can't be a stripping away of a company of discretion in some governing body to make that decision.

If you followed that, you saw a classic case of federalism confusion, the very problem Barry was trying to explain. Here is another paragraph from the transcript in case the prior discussion is not clear:

I would hold that the SEC has been very careful not to trammel on the -- except to the extent that it thinks it appropriate -- on the normal discretion of the board of directors..., and the proxy rules honor that.  And these 13 provisions for the exclusion, express the different views of different instances.  And this particular instance requiring the company to put a proposal that could eliminate the discretion of directors would be wrong.  And it would violate the, be contradictory, to what the SEC has done -- the SEC has said.

Judge Hellerstein believes that Rule 14a-8 -- and only Rule 14a-8 -- defines the scope of director discretion with respect to a company's proxy ballot. This is the essence of the argument, referenced in my previous post on this case, that Rule 14a-8 preempts state law on the issue of access to the issuer???s proxy statement. In that post, I wrote, "Preemption doesn't seem like a serious argument to me, so I won't write any more about that here."

Hmm.

Even Judge Hellerstein knows that his decision is headed for the Court of Appeals:

The district judge has an option to consider the issue in chambers and to write a learned, so-called, and sometimes extensive opinion about a matter of this nature.  But my judgement is that whatever I do will not be dispositive, because the losing party is going to take this up to the Court of Appeals.  And it will be the decision of the Court of Appeals that will be informative and dispositive.

Let's hope he is right about that.