Corporate Governance

Business Roundtable v. SEC: The Battle for Access (Assessing the Costs of Distraction) (Part 5B)

By J Robert Brown Jr.

In addition to erroneously computing the total number of access challenges, Petitioners assert that the Commission understated the costs associated with the actual use of access.  

The paperwork reduction, cost benefit, competition analysis goes on for page after page in the release.  It spans perhaps a third of the release and involves something like 300 footnotes.  There are computations and discussion of almost every cost.  Trying to find omissions in the approach is not an easy task.  

Petitioners, however, make the effort.  The SEC, according to the Brief, did not take into account the distraction of management caused by access challenges or the creation of "divisive, dysfunctional" boards.  The SEC did not attempt to quantify these costs, noting instead that they "are associated with the traditional State law right to nominate and elect directors, and are not costs incurred for including shareholder nominees for director in the company's proxy materials".  See Brief, at p. 32.

If the DC Circuit reverses, this is the most likely place that it will find error.  The Commission made no determination of costs.  But victory is still unlikely.  To reverse on this ground, the court would have to open up a vista of cost analysis that is traditionally not undertaken as part of rulemaking process.    

The problem is that the "cost" is really an opportunity cost.  Officers and directors are already paid.  Consideration of access challenges will not, presumably, result in any increase in salary, since it is merely another item to be addressed within the employment relationship.  Instead, the argument seems to be that by focusing on an access challenge, management will be distracted from other matters and the company will suffer.  The Commission in fact noted this possibility.  

• we received significant comment stating that election contests are distracting and time-consuming for companies, boards, and management.  Further, to the extent that a more competitive nomination and election process motivates incumbent directors to be more responsive to shareholders' concerns, the board may incur costs in attempting to institute policies and procedures it believes will address shareholder concerns.

In doing so, "[i]t is possible that the time a board spends on shareholder relations could reduce the time that it otherwise would spend on strategic and long-term thinking and overseeing management, which, in turn, may negatively affect  shareholder value."  Thus, in effect, Petitioners want the Commission to compute the costs associated with the decline in shareholder value that could result from the distraction resulting from an access challenge. 

The cause and effect of such "distraction" is speculative.  It has not been established that the need to devote time to access would result in sufficient inattention to other matters that shareholder values would decline (the SEC only noted that there "may" be a negative impact on shareholder value).  Nor is the connection self evident.  Time spent on access challenges does not have to be taken from other, more important matters.   

The harm to shareholders presumably presupposes that management will devote considerable time to an access challenge.  This is also unproven.  Indeed, as Petitioners acknowledge, some access challenges will likely occur even though the nominating shareholders know that they will lose.  Management will have little need in those circumstances to devote much time to the challenge.  And while Petitioners have shown that the corporate community has strongly opposed access, opposition to a rule does not tell anything about the amount of time that will be spent on a particular access challenge. 

Finally, the time devoted to an access challenge is inextricably tied to the board's fiduciary obligations.  Access challenges will, in most instances, be another method used by shareholders to get the attention of management.  In responding, the company may seek to educate shareholders on management's corporate strategy or try to address the concerns that gave rise to the access challenge.  These are traditional functions of a board that occur in the absence of an access challenge.  In effect, therefore, Petitioners are asking the court to add to the cost analysis the traditional exercise of fiduciary obligations.       

The approach is also unbounded.  If required in these circumstances, the SEC will be forced in the future to asses similar costs anytime it adopts a rule that could result in manageiral involvement.  All such rules will be a distraction and all distractions, apparently, can result in harm to shareholders. 

Assorted briefs and motions in this case, including the brief filed by the Business Roundtable, can be found at the DU Corporate Governance web site.?

Full post as published by The Race to the Bottom on January 20, 2011 (boomark / email).