New England Biz Law Update
Last month, new Securities and Ex-change Commission Chairwoman Mary Schapiro, speaking to the Council of Institu-tional Investors, outlined her vision for the SEC’s 2009 agenda.
Having recently set the course for instituting “tagged” data through XBRL business reporting language for financials, and having rung the future death knell of GAAP in favor of international financial reporting standards, the commission will turn its attention to more ambitious and substantive problems.
Aside from proposing substantially increased oversight and regulation of hedge funds, investment advisors, credit-rating agencies, offerings of municipal securities and the operation of credit-default-swap instruments, the commission focused on two significant areas of proxy regulation.
The first related to enhanced proxy statements and Form 10-K disclosure requirements.
These enhanced disclosures serve as an illustrative check list of current hot buttons floating around the investment marketplace; the list is the SEC’s distillate of those things it believes are of greatest interest in corporate governance currently:
• There will be a proposal for greater exploration of each director nominee’s experience, qualifications and skills.
• There will be a proposal for a required discussion of the decision whether to have an independent chair as opposed to having the CEO serve in that role (echoing active shareholder discussion in this arena, evidenced most recently by the squabble at Bank of America over this issue).
• In the wake of the recent meltdown of enterprise risk management in the marketplace, there will be a proposal requiring a company to describe how the company manages risks and, in particular, the interrelationship between the company’s executive compensation structure and the acceptability of risk undertaken by executives (who may have a different risk/reward metric than the shareholders).
• There will be a proposal for enhanced disclosures of the company’s overall compensation approach, beyond the highest-paid executive officers, and disclosure about potential conflicts of interest on the part of compensation consultants. (Recent statistical studies demonstrated that consultants providing to management a wide range of services tend to recommend higher executive compensation than those whose tasks are restricted solely to the compensation arena.)
Director elections
The most interesting and controversial proposals, however, likely will emanate from the often-visited battlefield of director elections. In this regard, a little history is in order.
Although not free from occasional interpretative confusion, the SEC’s current and generally consistent view has been that a company may exclude from its proxy solicitation materials any shareholder proposal that “relates to a nomination or an election for membership on the company’s board of directors … or a procedure for such nomination or election.” Thus, under SEC Rule 14a-8, companies routinely have excluded proposals both for nominees for office and for by-law amendments that would offer a procedure for outside shareholders to mount proxy election contests.
There is a rich administrative and litigation history surrounding the exclusion of shareholder proposals relating to elections. One of the more recent ones, noted in this column last September, involved the Delaware Supreme Court striking down the propriety of a shareholder proposal for a mandatory by-law requiring the company to pay expenses of dissident shareholders who are successful in electing a short slate of directors.
That decision, In the matter of CA, Inc., turned on the narrow technical ground that the draft by-law required a company to pay expenses, which requirement was thought by the Delaware Supreme Court to deprive the corporate board of its requisite discretion with respect to such reimbursement.
The promise of SEC action to modify the exclusion provisions of Rule 14a-8 must be understood in the context of the constant attack of minority shareholders on the perceived monopoly on board seats enjoyed by management. If management can exclude nominees from the company proxy materials, exclude the institution of by-law procedures that would open up the nominating procedure and block reimbursement of proxy expenses, even if the proxy fight has proven successful, a potentially “non-democratic” entrenchment of corporate control can result.
Delaware action
The SEC’s expected proposals are further driven by action taken last month by the Delaware Legislature, which has again assumed the lead in corporate governance matters by clarifying the state law on how to craft a Delaware by-law that will permit minority shareholders to attack proxy entrenchment by management.
These statutory changes, effective Aug. 1 and in seeming anticipation of the SEC’s alteration of its current practices, provide a framework from which a company can select and custom-craft its own proxy-access approach.
In summary, the Delaware statutory amendments provide that a company’s by-laws may require inclusion of stockholder-nominated candidate information pursuant to fixed procedures. These procedures may relate to: minimum number of shares owned by a nominator and length of time of share ownership by a nominator; submission of specific information concerning stock ownership of the nominator and of the candidate; ability to exclude nominations on the part of nominators who have recently acquired or are attempting to acquire a specific percentage of stock prior to the election; and scaling of the number of nominated directors to limit the number of such nominees.
Although shareholder activists have long agitated to obtain direct access to the company’s own proxy materials, particularly for inclusion of minority nominees within the official proxy solicitation, the statute also addresses reimbursement to shareholders effecting their own solicitation for nominees. A company’s by-laws may provide such reimbursement and, if so provided, can condition reimbursement based on number of proposed directors or number of votes garnered or related to the amount of money spent by the company itself in its own proxy solicitation process.
Anomalously, and as perceptively noted in an April 15 “Briefing” from the law firm of Weil, Gotshal & Manges, the SEC’s current interpretation of its exclusionary rules would permit a company to exclude from its proxy statement the very by-law proposals that the Delaware statute now expressly permit. You will recall that the current SEC rule not only permits exclusion of shareholder nominations but also by-law proposals that would fix election procedures.
No doubt this wave of public pressure, buttressed by the new Delaware statute, which indeed emanates from the very jurisdiction where historically the primacy of board control has been a fundamental element of corporate governance, has driven the SEC to take another look at its proxy exclusion provisions.
It appears that proxy exclusion issues will be given top priority by the SEC and indeed, by the end of this month, the SEC may well have issued proposed amendments to its rule in such regard.
Chairwoman Schapiro had specifically made reference to the impact of Delaware’s then-proposed statutory changes, and now that Delaware has acted it seems almost inevitable that the commission must follow in reasonably short order.
Prior efforts
Such prompt action would be in pleasant contrast to two prior aborted runs by the SEC at proxy reform — one in 2003 and the other, more comprehensively, during the summer of 2007, which would have prevented the exclusion of shareholder proposals so as to permit direct nominations and by-law proposals establishing shareholder nominee procedures.
At the time, the SEC had proposed that the acting shareholders would have needed to continuously hold more than 5 percent of the company’s voting shares for at least one year and would have in fact complied with the Securities Exchange Act of 1934 by filing a so-called Schedule 13G with the SEC (a reporting form for institutional or passive investors holding 5 percent or more of any class of registered securities).
It would seem that such specific triggers would not be proposed by the SEC at present; the more likely regulation would make the SEC’s practices conform to the Delaware practice of leaving to each corporation the custom-crafting of proxy access for its own governance.
Finally, it should be noted that, while Delaware is a leading corporate governance jurisdiction, the statutory change described above was enacted by the Delaware Legislature and is effective only with respect to Delaware corporations. The extent to which other state legislatures will follow (as some surely will), and the degree to which the SEC proposal will be crafted only to interface with Delaware or Delaware-type statutes, remains to be worked out by the commission staff.
There may soon be further detail available through the commission’s propounding of specific rule changes, which typically are accompanied by comprehensive releases that elucidate the theories behind the commission’s chosen approach.
Stephen M. Honig is a partner in the Boston office of Duane Morris.
