Corporate Governance

The SEC's Access Proposal: Some Observations (Preempting Director Qualification Requirements)

By J. Robert Brown

The access proposal does more than provide for access.  It overturns an untransparent system of rendering nominees ineligible through board imposed qualifications.  Delaware permits the setting of qualifications for the board of directors.  See 8 Del. C. § 141(b)("The certificate of incorporation or bylaws may prescribe other qualifications for directors.").  In the area of shareholder nominations, however, this authority presents plenty of opportunity to put in place vague standards that can be used to exclude shareholder nominees.  See Stroud v. Grace, 606 A.2d 75 (Del. 1992)(court upheld article bylaw against challenge that it was excessively vague; article provided that one category of directors must have "substantial experience in line . . . positions" in "substantial business enterprises" or "substantial private institutions."). 

The SEC has, in the past, tried to regulate these standards by requiring disclosure. Companies must set out any qualifications for board membership.  As Item 407(a) of Regulation S-K provides:

• Describe any specific minimum qualifications that the nominating committee believes must be met by a nominating committee-recommended nominee for a position on the registrant's board of directors, and describe any specific qualities or skills that the nominating committee believes are necessary for one or more of the registrant's directors to possess;

The disclosure requirement at least prevented "secret" qualifications that could be used when it was too late for shareholders to change the nominee. Moreover, nothing under Delaware law required any kind of detailed explanation for the disqualification of a director.

Access will alter this approach. First, the proposing release indicated that shareholder nominees are "not the company's nominee."  As a result, "we do not believe it is appropriate that shareholder nominees be required to meet the nominating commitee's or board's criteria."  Apparently, this means that board imposed qualifications will not be valid. 

Moreover, the the extent that nominees are excluded from the proxy statement, Proposed Rule 14a-11(f)(7) provides that that company must provide to the SEC "notice of the basis for its determination".  Moreover, to the extent based upon state law principles, the notice must include a "supporting opinion of counsel."  Proposed Rule 14a-11(f)(8).  The shareholder will have the right to submit a response.

Thus, the system will become more transparent.  Moreover, the basis for excluding the nominee will be at issue.  It will be the staff that determines whether the exclusion was proper, with the staff having the authority to provide "an informal statement of its views".  Finally, the exclusion of a director otherwise not permitted "shall be a violation" of the Rule.  Proposed Rule 14a-11(f)(14).

This approach sets up a tension with director qualification requirements.  It does not overturn them but does eliminate them as a basis for excluding a nominee from the proxy statement. To the extent that a company uses qualifications to exclude a nominee from the proxy statement, it will be in violation of the proxy rules and risk a federal law suit.  If the nominee is allowed, the company may nonetheless refuse to seat anyone elected if they violated the board imposed qualification requirements.  This in turn may precipitate a law suit in state court over the validity of the qualification requirement.  Of course, if the nominee loses, the law suit will become unnecessary.

Thus, the approach by the Commission guarantees inclusion in the proxy statement but does not and cannot guarantee the nominee will take office if elected.

In any event, Proposed Rule 14a-11 will put the Commission staff in the business of determining when a director can and cannot be excluded from the proxy statement.  This will be an improvement over reliance on the anemic fiduciary obligations imposed on boards.

Full post as published by The Race to the Bottom on July 06, 2009 (boomark / email).