Reaction mixed on SEC’s new proxy access rule

A controversial decision by the U.S. Securities and Exchange Commission requiring companies to give their shareholders a greater voice in the boardroom is drawing mixed reviews from corporate lawyers who say it is unclear whether the move will deliver on a promised corporate power shift or level the playing field, which some hope and others fear.

Bolstered by what some say is newly refined authority in the Dodd-Frank economic reform legislation, the SEC voted Aug. 25 to adopt new measures under the Securities Exchange Act of 1934 that address the long-debated issue of expanding “proxy access.”

The 3-2 vote grants shareholders with at least 3 percent voting stock in publicly traded U.S. companies that report to the SEC and who have held that stock for three years continuously the right to nominate candidates for the board of directors at annual shareholders’ meetings.
The new measure also requires companies to include shareholder proposals in their proxy materials and to pay for them to be mailed out, an often prohibitive cost that shareholders previously were required to bear.

“Fundamentally, this is about power,” said Stephen M. Honig, a corporate attorney at Duane
Morris in Boston.

Spurred on by activists, there has been “a huge perceptual shift between the absolute primacy of management” and the rights of shareholders in recent years to cede more power to investors so that they have more say in who and how their companies are run, Honig said.

“This is a major step in implementing this shift in power.”

William E. Kelly, a corporate finance and securities attorney at Nixon Peabody in Boston, agreed that the rule does “open the door” to greater participation by shareholders, but he is skeptical that it will result in sweeping changes to the way companies are run.

“I do think it’s a huge step to corporate democracy, but because of the limits, it won’t be a dramatic power shift,” Kelly said.

Given a requirement that qualified shareholders must certify that they will not take advantage of the new rule in order to wrest control of the company, Kelly said, the extreme characterizations of the rule’s impact across the political spectrum, which range from mob rule on the right to a union slam dunk on the left, are off the mark.

“Unions buying Wal-Mart, for example, is very unlikely,” he said.

‘Unjustified impediments’

Some attorneys say the new proxy access rule is a significant victory for proponents of the “shareholders’ rights” movement, while others caution the high threshold for participation means primarily hedge funds and unions will reap the benefits.

Harvard Law School Professor Lucian A. Bebchuk, widely considered one of the founders of the movement, said while the rule does remove “existing and wholly unjustified impediments” to shareholder access, the 3 percent share and three-year holding threshold are still too restrictive and do not benefit the vast majority of shareholders.

“The substantial eligibility and procedural requirements make it unlikely that the provided access will be used in a significant number of cases,” Bebchuk said in an e-mail.

“Nonetheless, the adoption of any proxy access rule, which has been for long strongly resisted by corporate management, is an important recognition of the need to end incumbents’ monopoly over placing director nominees on the corporate ballot.”

Bebchuk said the SEC “hopefully” will relax the requirements over time.
Bebchuk has argued that reducing incumbent directors’ insulation from removal by increasing shareholder influence is associated with improved value for shareholders.

Calls to attorney David P. Bergers, district administrator for the SEC’s Boston office, were not returned.

Kevin Callahan, a Washington, D.C.-based spokesman for the SEC, declined to comment on the rule or its impact.

“The pretext under which it was sold — that it will prevent future economic meltdowns — sounds nice, but it isn’t true,” said Neil H. Aronson, former chairman of the national business practice at Mintz, Levin, Cohn, Ferris, Glovsky & Popeo, now of Gennari Aronson in Needham, Mass.

Aronson said while the rule moves things “a little bit closer to the European model” where unions are automatically given seats on company boards, most boards are already conscientious about their fiduciary duty and do not need to be forced to address shareholder concerns or to keep a watchful eye on the performance of top executives.

Because the rule limits shareholders to nominate a maximum of 25 percent of a board’s composition, Aronson said, the risk that special interest groups or “renters” will suddenly be able to commandeer boards to advance their own short-term agendas or to take control of a board is minimal.

“I’m not terribly worried it’ll have that impact,” he said.

And because the rule has such narrow application, it will not make “a lot of dramatic changes,” Kelly said. “The corporate governance rules in Dodd-Frank are going to be much deeper and broader than this.”

Kelly said “activist investors,” a subgroup of hedge funds that buy into underperforming companies they feel are mismanaged — not unions — are the most probable beneficiaries of the new rule.

“They’re the ones most likely to jump on this sooner rather than later,” he said.

Anticipated fallout

Exactly when fallout from the rule will begin to emerge is a point of conflicting
estimates.

The SEC has stated the new rule will go into effect 60 days after it appears in the Federal Register and will apply at companies’ 2011 annual meetings if the one-year anniversary of their 2010 proxy statement mailing occurs within 120 days of the rule’s effective date.

Companies with a “public float” less than $75 million will not be bound by the rule for another three years.

Honig expects a surge of activity around board elections in the coming year.

“We’re going to see a plethora of candidates going forward in the next proxy season to get a voice on the board,” he said.

Kelly said one of the first aspects of the rule likely to be tested by management in the courts will be certifications of shareholder eligibility. But with preliminary talk at the SEC on the matter beginning in 2009, as well as the three-year holding requirement for shareholders, it will probably take until the 2012 or 2013 proxy season to see the full ramifications of the new rule, he said.

Aronson predicted that, during the rule’s first year of implementation, there will be some additional work for lawyers as challenges are mounted and better clarity is sought from the SEC, but the rule will not have the kind of big footprint impact of previous regulations.
“Nothing like Sarbanes-Oxley in 2002,” he said.

Future challenges

With a contentious vote split along strict party lines and Republican Commissioner Kathleen Casey publicly criticizing the vote as “fundamentally and fatally flawed,” speculation has ramped up in recent days that a lawsuit challenging the rule may be on the horizon.
Attorneys say such a suit is unlikely to succeed.

“In my view, the recent affirmation by Congress of the SEC’s authority to adopt such a rule leaves little basis for a legal challenge,” Bebchuk said.

“I think it would be remarkable if a court found the SEC didn’t properly adopt this rule,” said Honig, who noted that the SEC held two public comment periods — one more than is required — on the proposed changes beginning last year in preparation for the recent vote.
“Certainly by process, the SEC seems to have been very careful,” he said.

Similar to Goldstein v. SEC, a 2006 suit in which the U.S. Court of Appeals for the District of Columbia vacated an SEC rule on hedge fund registrations, a trade group representing corporate management interests, such as the U.S. Chamber of Commerce, likely will mount a jurisdictional challenge to the rule, Kelly said.

“Clearly, that’s going to be the first attack,” he said, noting Goldstein was widely perceived at the time as a sharp rebuke of the SEC’s rulemaking power.

“It would be shameful if they did that again,” he added.