Activists Vow Litigation Over Proxy Access

Shareholder activists are threatening to drag companies into court this proxy season over their right to place director nominations into the proxy statement.

Just hours after a Securities and Exchange Commission meeting last week that confirmed companies do not have to allow such proposals, pension funds and other outspoken advocates of proxy access vowed to file numerous resolutions proposing exactly that. If companies don’t let the resolutions proceed, the activists will sue in the New York-based 2nd Circuit federal court—which instigated the current turmoil over proxy access with a ruling last year that companies cannot ban such resolutions.

Already in the crosshairs are Bear Stearns and JP MorganChase. The American Federation of State, County, and Municipal Employees union has filed binding resolutions at both companies to establish proxy access procedures, ostensibly because senior management at the two investment banks bungled their way into the sub-prime mortgage crisis so badly. Richard Ferlauto, AFSCME’s director of corporate governance and pension investment, says Bear Stearns and Morgan Chase are only the first of several financial services companies the union will target.

Ferlauto

If the banks ask the SEC for permission to exclude the proposals, Ferlauto says the union will litigate in hopes of overturning last week’s SEC move. “We believe we would prevail in the Second Circuit, and that’s what we intend to do,” he tells Compliance Week.

As expected, SEC Chairman Christopher Cox last week reversed his stated position supporting proxy access and voted with fellow Republican Commissioners Paul Atkins and Kathleen Casey to amend the federal proxy rules to codify a long-standing SEC policy that companies can exclude proxy access proposals related to director elections. The vote amends the language of Rule 14a-8(i)(8) to read: “If the proposal relates to a nomination or an election for membership on the company’s board of directors or analogous governing body or a procedure for such nomination or election,” then the company can exclude it.

Annette Nazareth, the SEC’s lone Democrat, voted against the rule proposal.

Cox has maintained that a final rule was needed now to clarify uncertainty in shareholders’ ability to propose bylaw changes before the 2008 proxy season gets underway. He has promised to revisit the issue again next spring, in hopes of finding a permanent solution that would satisfy shareholder activists as well.

Mittelman

Legal experts are uncertain just how far AFSCME and other shareholder activists can go with their efforts to circumvent the amended rule. David Mittelman, of the law firm Reed Smith and a former SEC lawyer, says the 2nd Circuit is likely to be much more open to the SEC’s position on proxy access now that the Commission has written it into the rules. A recent U.S. Supreme Court decision favoring more power for government agencies to interpret rules as they deem appropriate is also likely to dampen the lower court’s appetite for siding with shareholder activists, he says.

“I expect the SEC to vigorously defend its reaffirmed position in court. And I expect the SEC to win,” Mittelman says.

Protracted Fighting Likely …

Critics say last week’s vote was unnecessary and dismiss Cox’s rationale that the market needed certainty about proxy access for the upcoming annual meeting season. Nazareth, for example, noted that the SEC had no clear policy for the 2007 proxy season, and Corporate America still saw only three proposals calling for proxy access, with only of them passing.

Nazareth

“If certainty were so important, it could have been provided after the AFSCME decision and before the 2007 proxy season, when any uncertainty surely was greater than it is now,” Nazareth commented during the meeting. “Any fear about a flood of such proposals did not materialize.”

Cox has pledged to revisit the issue next year as part of a broader effort to overhaul federal proxy rules and make them a better fit with states’ corporation laws. “We can adopt a rule that makes the federally regulated proxy system fit better with the state authorized rights of shareholders to determine the directors of the companies that they own,” he said.

The SEC did propose an alternate idea this summer, allowing proxy access for investors who hold at least 5 percent of company stock for one year or longer. That won no plaudits from shareholder activists either, who said that the threshold would be impossible to achieve for most large companies today. That proposal went into the deep freeze with last week’s vote against proxy access.

What’s more, Ferlauto says, the AFSCME has “no confidence that Cox will be able to move a proxy access proposal forward within the current administration.”

“If he had the capacity to create a real access rule within the Commission, he would’ve done it already. He had a year to work on it,” Ferlauto says.

McGurn

Other institutional investors have equally harsh words for the SEC. Robert Feckner, president of the powerful California Public Employee Retirement System, called the vote “a serious wrong turn from the Commission’s duty to adopt regulations that ‘do no harm’ to investors.” Patrick McGurn, special counsel for RiskMetrics Group, said the SEC decision “leaves investors’ efforts to enhance boardroom accountability in limbo.” The Council of Institutional Investors and the AFL-CIO also denounced the vote.

Democratic lawmakers aren’t happy either. Both Barney Frank, chairman of the House Financial Services Committee, and Christopher Dodd, chairman of the Senate Banking Committee, had urged the Commission not to vote on proxy access until its fifth seat—a Democratic one now vacant—was filled. In theory, with two Democrats, Cox could have pushed through a policy in favor of proxy access.

Frank said the amendments leave shareholders “with inadequate recourse to influence insular boards” that are unresponsive to their concerns. Dodd said he will hold Cox to his promise to revisit the issue next year. “Proxy access needs to be thoroughly reviewed and other options explored” to ensure that the SEC isn’t undermining investors’ rights and to promote the competitiveness of U.S. financial markets, he said.

Loftus

But Geoff Loftus, vice president of the Society of Corporate Secretaries and Governance Professionals, says proxy access “isn’t the issue.”

“What we really need is broad director elections where directors are held accountable—majority voting that has teeth in it,” he tells Compliance Week. “We think that’s a workable solution.”

Loftus cited models adopted by Intel and Pfizer as good examples of majority voting policies that hold directors accountable.

Electronic Forums Approved

The SEC also voted unanimously to facilitate the use of electronic shareholder forums. The amendments aim to alleviate fears that discussion in an online forum might be viewed as a proxy solicitation, by clarifying that participation in an electronic shareholder forum will be exempt from most of the proxy rules if some conditions are satisfied.

To qualify, participant communications must occur more than 60 days prior to the shareholder meeting date and participants can’t solicit proxy authority while relying on the exemption. Participants will be eligible to solicit proxy authority after the exemption is no longer available, as long as the solicitation is conducted in accordance with Regulation 14A. If a company announces a shareholder meeting less than 60 days in advance, the solicitation couldn’t occur more than two days after the company’s announcement.

The amendments also provide that a shareholder, company, or others acting on their behalf to maintain such a forum will not be liable under federal securities law for statements posted by another participant.

While Mittelman says the SEC’s liability shield rule will encourage more experimentation, he does not expect public companies to adopt electronic forums widely, at least not in the initial year.

“Public companies in 2008 will have many items on their plate, ranging from executive compensation to e-proxy to lingering 404 issues,” he says. “How actively shareholder advocates and third parties pursue e-forums is the true wildcard.”

Mittelman says the SEC has “injected a significant degree of uncertainty” through shareholder e-forums. “Public companies anxiously will seek counsel on a vast number of legal and strategic issues arising from shareholder e-forums,” he says.

Both rules take effect 30 days after their publication in the Federal Register. The adopting releases are expected to be posted to the SEC Web site shortly.