Corporate Governance

A Legal Challenge to Proxy Access

By J Robert Brown Jr.

The fight continues.

The Chamber of Commerce and the Business Roundtable filed a Petition in the DC Circuit challenging the shareholder access rule.  Attached is a motion addressed to the SEC asking for a stay of the rule.  To the extent that the Commission denies the motion for a stay, the Chamber and Business Roundtable have indicated that they will seek a stay from the DC Circuit. 

The Motion filed with the Commission sets out the arguments for challenging access.  Largely missing is anything challenging the Commission's authority to adopt the rule (save a First/Fifth Amendment argument tossed in at the end), an issue essentially put to rest by Dodd-Frank.  Mostly, the Motion argues that the rule is arbitrary and capricious. 

This is a challenge under the administrative procedures act.  See 5 USCS § 706.  It is the residual claim that can be brought against any final action by an agency.  The standard is a high one.  In adopting a rule, the agency must maintain a record.  A rule can be arbitrary where the record does not support the agency's decision.  In effect, the agency must "examine the relevant data and articulate a satisfactory explanation for its action."  Motor Vehicle Mfrs. Ass'n v. State Farm Mut. Auto Ins. Co., 463 US 29.  

The motion contains a number of alleged "errors" by the Commission in adotping the rule.  The first, and presumably the one viewed as the strongest, concern's the Commission's treatment of the costs associated with access.  One of the costs will be the amount expended by companies trying to defeat an access challenge.  The SEC noted the costs but also had this to say: 

• the costs for companies may be less to the extent that directors determine not to expend such resources to oppose the election of the shareholder director nominees and simply include the shareholder director nominees and the related disclosure in the company's proxy materials. The requisite ownership threshold and holding period of Rule 14a-11 may also limit the number of shareholder director nominations that a board may receive, consider, and possibly contest.

The statement is accurate and, if anything, conservative.  It does not say that companies will avoid access challenges.  It merely states that if they do, costs "may be less." 

Yet this language, according to the Chamber and Business Roundtable, is what rendered the SEC's decision arbitrary and capricious.  As the Motion notes:

• But, the Commission hypothesized, such contests might not materialize because directors might "determine not to expend . . . resources to oppose" shareholder nominees, rather they might "simply include the shareholder director nominees" in the proxy materials without opposition.

According to the motion, the Commission "offered no support for this assertion" and the assertion conflicted with the board's fiduciary obligation to defeat nominees viewed by the board as "unqualified or less qualified".  In effect, the Motion argued that boards will always view access nominees as unqualified and always oppose them.  To suggest otherwise renders the rule arbitrary.

The factual basis for the assertion?

• a shareholder nominee will go forward as an "access" nominee rather than the board's nominee only if the board has reviewed the shareholder nominee's qualifications and determined they will not serve the company and shareholders as well as the nominee identified by the board.  A board making this decision will already have made a choice that election of their nominee warrants the higher costs caused by an election contest. 

To the extent suggesting that boards will always challenge access nominees, there are several problems with this statement. 

First, even if the board opposes access nominees, it does not mean that it will expend funds opposing them.  A board may size up the situation and realize that the access candidates have little or no chance of winning.  In those circumstances it would arguably violate the board's fiduciary duties to expend funds to oppose the nominees. 

Second, a board may view its candidates not as more qualified, but equally qualified.  In those circumstances, a board might decide not to campaign and simply leave the decision to shareholders.  This will be particularly true where the shareholders nominating the access candidates also do not campaign. 

Third, even if the board views its candidates as superior, it is too simple to contend that there is a fiduciary obligation to expend funds on a proxy campaign against the access nominees.  Use of funds for a proxy fight will be funds unavailable for other purposes.  A board, consistent with its fiduciary duties, may opt to spend the funds on matters deemed more important than the proxy contest.

Access nominees can only be made by 3% shareholders (or groups) and only shareholders who have held their shares for three years or more.  In other words, access nominees will be submitted by large and longstanding shareholders.  Particularly where management is certain of the outcome, it is not unreasonable to assume that the company will at least sometimes sidestep a proxy fight, both to save money and to avoid further offending long-term investors.

In short, the Commission never claimed that companies would forgo challenges to access nominees.  But even if that representation can be extracted from the language of the Release, the Motion filed by the Chamber and Business Roundtable has not disproved it.  

Full post as published by The Race to the Bottom on September 30, 2010 (boomark / email).