Shareholder activist groups won a brief victory this summer when the Securities and Exchange Commission (SEC) voted to approve new proxy access rules that make it easier for investors to elect--or remove--members of a company's board of directors. But the triumph ended up being just another chapter in the decades-long debate over proxy access.
By late September, the U.S. Chamber of Commerce and the Business Roundtable had filed suit in the D.C. Circuit, claiming the rules would give special interest groups undue power in board elections. Less than a week later, the SEC put a stay on the new rules, reasoning it didn't want to force companies into possibly costly compliance measures while the rules faced litigation.
Despite the stay, the SEC is not backing down. In its order announcing the hold, the agency promised the rules will take effect eventually, projecting the litigation will be resolved by spring.
While the SEC's decision to put a hold on the rules surprised some, most experts agree that the reprieve gives the corporate world a welcome opportunity to prepare for the change.
"Businesses that have to deal with proxy access now have plenty of time to get ready for what will inevitably be re-promulgated later," says Brian Cartwright, a partner at Latham & Watkins and former general counsel of the SEC.
Though the roots of the proxy access debate go deep, the SEC received the nudge it needed to vote on official rules this summer with the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The SEC drafted its most recent proposal in May 2009, which it largely abandoned after special interest groups bombarded it with comments. But in July, the Dodd-Frank Act gave the SEC express authority to adopt proxy access rules. Even though proxy access wasn't a direct factor in the financial crisis, DLA Piper Partner Diane Frankle says that this provision was Congress' way to address corporate governance.
"Basically it was a check in the box," she says. "Congress was telling companies, 'We want directors to know the heat is on them, because if they are not doing their jobs, they won't be elected next time.'"
On Aug. 25, the SEC passed the rules by a 3-2 vote.
The rules' most controversial feature is 14a-11, which enables shareholders to submit their nominees to corporate boards in a company's proxy statement. Previously, most companies allowed other board members to publish their nominees in the statement, while shareholders could propose nominees only at the annual meeting. The meetings happen after investors who couldn't attend the meeting have already cast their votes by proxy.
Not all shareholders are equal under the rules. In order to nominate a board member, the investor must have owned at least 3 percent of the company for at least the past three years. They can, however, join forces to create that 3 percent share.
Though the rules' purpose is to increase "fairness and accountability," according to SEC Chairman Mary Schapiro's Aug. 25 statement, there are several elements that have raised corporate ire.
Most prominently, the Chamber of Commerce and the Business Roundtable claim in their suit that special interest groups, such as labor unions, would use the rule to leverage corporate boards to their purposes. Because shares can be aggregated to meet the rules' minimum requirements, union members could pool their shares to become eligible.
That leverage could come in the form of backroom negotiations, says Chuck Nathan, co-chair of Latham & Watkins corporate governance practice.
"[Groups] can come to the board and say, 'We're going to nominate you, but we don't have to unless you talk to us,'" he says. "There's nothing to stop a group from asking a company to publicly pledge to build the next factory in the U.S. or adopt a green agenda as the price of it going away."
One of the rules' other intentions is to decrease the likelihood of costly proxy contests, which were previously the only recourse for shareholders unhappy with the slate of candidates submitted by the board.
But Frankle says the rules actually inject a tremendous amount of uncertainty into the election process, possibly increasing the likelihood of a proxy contest as investors seek additional access beyond that which is stipulated in the rules.
Laura Richman, of counsel at Mayer Brown, points out that just because shareholders can publish their nominations in the proxy materials in no way guarantees that their nominees will be elected. The greater impact may be that the rules encourage companies to pay more attention to shareholder issues.
"The board of directors may proactively go out and increase dialogue with larger shareholders to get a sense of what issues concern them," she says. She says senior staff can in some cases pre-empt the use of proxy access simply by seeing what concerns shareholders and responding to, or explaining their reasoning behind, those issues.Getting Ahead
With the stay on the rules, corporations received an eleventh hour reprieve. Originally, the proxy access rules were set to take effect at the end of October. Experts project that companies now have six to nine months to prepare.
Even though the Chamber and the Business Roundtable are challenging the rules, Nathan says it's unlikely much will change. Therefore, in-house counsel need to start preparing for the inevitable now.
"This is a wakeup call," he says. "Companies have been given a reprieve to [adhere to the rules] thoughtfully and deliberately. Let's not squander that."
Cartwright says that one of the most influential factors in guiding how in-house counsel should prepare will be their company's individual history. In particular, counsel should examine internal board politics that guided confidentiality in what may have previously been a more informal nominating process. He also advises developing rules of conduct for handling the increased likelihood of contested elections.
"You may not choose to adopt any of these measures until there is finally a proxy access rule in place," he says. "But this time can be used to work through issues in careful, thorough way rather than a hurried, stressful way."