Corporate Governance

Business Roundtable v. SEC: The Battle for Access (The Intensity of the Opposition) (Part 7)

By J Robert Brown Jr.

The other argument about costs concerned the underestimation that occurred when the Commission "ignored the intensity with which access nominees would be opposed by issuers."  Intensity of course is not of itself a cost.  But Petitioners assert that by underestimating the intensity, the SEC underestimated the instances in which management would expend funds to resist an access challenge. 

Much of the challenge is over a statement by the Commission that management would not always resist an access challenge.  Here is what the SEC said on that score:  

• [Costs] may be limited to the extent that the directors' fiduciary duties prevent them from using corporate funds to resist shareholder director nominations for no good-faith corporate purpose. Some commenters, in fact, characterized the costs incurred by incumbent directors to defeat shareholder director nominees as discretionary because Rule 14a-11 itself does not require such efforts. Other commenters disagreed with this characterization, asserting that the directors' fiduciary duties may compel them to expend company resources to oppose a shareholder director nominee.  We recognize that, under certain circumstances, company directors likely would oppose a particular shareholder director nominee and expend company resources in that effort, which would increase the costs to the company resulting from Rule 14a-11.

To challenge the statement, Petitioners had to argue that management would always resist, no exceptions.  One reason this would occur was that management's fiduciary duties compelled resistance.  Said another way, directors who did not resist would confront the risk of liability for breach of their fiduciary obligations. 

Fiduciary duties have a way of assuming substantive content when needed to benefit management.  See, e.g. Yucaipa Am. Alliance Fund II, L.P. v. Riggio, 1 A.3d 310, 357 (Del. Ch. 2010) (noting that management could be counted on not to abuse discretion because of the "requirement that those understandings be in the best interests of the company and its stockholders and not for the personal benefit of the board.").  But in fact, Petitioners attribute too much content to these duties.

The issue is the right to expend corporate funds.  Under the interpretation provided by the Delaware courts, management has almost unlimited discretion when it comes to expenditures (something confirmed by the Delaware Supreme Court in CA v. AFSCME).  Moreover, to the extent management's decision to oppose or not oppose a competing slate of directors is analyzed under the duty of care, it is a process standard with no real substantive content.

Nonetheless, Petitioners seem to argue that proxy contests are the one place (the only place) where management has no discretion.  The basis for this?  Apparently access candidates are always less qualified than the board's nominees.  See Brief ("Accordingly, a candidate will be an access nominee rather than a board nominee only if the board already has determined that the nominee will not serve the company as well as the candidate selected."). 

As we have already written, this does not establish an absolute duty to resist.  First, in fact, the determination by management that its candidates are better will often be subjective.  Management in fact may not know if its candidates really are superior, a circumstance particularly likely for companies without advance notice bylaws. 

Second, while management could have a duty to resist candidates who will harm shareholders (say by stripping assets) or are objectively unqualified (say a newborn child or ponzi scheme operator), that does not translate into a duty to resist all candidates simply because they will not "serve the company as well."   

Finally, objectively, management does not apply this standard to its own actions.  There are plenty of instances when management engages in a proxy fight then relents and accepts an insurgent nominee in place of its own.  This line of analysis would suggest that management violated its fiduciary obligations either by knowingly nominating a candidate less qualified than the insurgent's candidate or by dismissing a more qualified candidate to accept the insurgent's less qualified one. 

Of course, even if there could be said to be a fiduciary obligation to always ensure the defeat of access nominees, it would not be the same as saying management must always expend resources (incurring costs) to do so.  There are likely to be plenty of instances where access nominees have no realistic chance of winning.  (Petitioners concede this when they asset that the rule will be used as a "soapbox.").  Management may have strong support among shareholders and/or there may be a controlling shareholder who will decide the matter.  In those circumstances, it would be a waste of resources to combat a challenge where the outcome was preordained. 

Petitioners also seem to argue that, even absent a fiduciary obligation, management will, as a practical matter, always resist an access challenge.  To suggest otherwise will "contradict 60 years of opposition to proxy access by corporations, evidence in the rulemaking record, and the sheer intensity with which issuers and others opposed adoption of the Rules."  The statement is, as far as it goes, factually accurate.  There has been resistance to access for six decades (this is discussed in The SEC, Corporate Governance, and Shareholder Access to the Board Room). 

But the statement mixes apples and oranges.  Resistance to the imposition of a rule does not equal resistance to the practice itself.  Once the requirement is in place, companies will presumably decide whether to resist on a case by case basis.  It is not unreasonable to think that in some cases management will simply stand by their statements in the proxy, fully aware that the access candidates are not likely to be elected. 

The Brief in fact asserts that some will use access "not in an attempt to gain election, but as a 'soapbox' to address their special interests."  Where management knows that shareholders are using access as a soapbox, it has no reason to expend funds to defeat the nominees since it already knows they won't win.  Indeed, it may be a breach of the board's fiduciary obligations to unnecessarily expend resources on such a doomed access campaign.   

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 26, 2011 (boomark / email).