Proxy Access: Solution for ’08 Slipping Away

The head of the Securities and Exchange Commission played for more time last week on the vexing issue of shareholder access to proxy statements, telling Washington lawmakers the SEC still wants to reach some resolution to the problem—despite calls from Congress for the Commission to do nothing for now.

Speaking before the Senate Banking Committee, SEC Chairman Christopher Cox defended plans to move ahead with controversial rulemaking that would either deny or allow shareholders the power to include director nominations in the proxy. One plan would allow shareholders to amend bylaws to establish director nomination procedures; the other would not, and essentially ratify a longstanding SEC interpretation against proxy access.

Cox

Cox has steadfastly pledged to put a final rule in place before the 2008 proxy season. But last week he dismissed what he called “a widespread assumption” that the SEC must adopt one of the two proposed rules “or do nothing,” and said the SEC could adopt something quite different from the two choices that have been proposed.

“We may also adopt a rule that is different than either of those proposed,” Cox told the committee. “The only requirement is that the proposed rule, and the questions the agency has asked, provide fair notice to the public of what the Commission is contemplating and the issues involved.” As long as the final rule or rules are “a logical outgrowth” of what was proposed, he continued, “We are free to amend the proposals and to consider improvements that the public comment process has brought to our attention.”

The SEC is reviewing more than 34,000 comment letters submitted on the dueling proxy access proposals, which were released in tandem last July. The agency’s latest attempt at revamping its proxy access rules was spurred by a September 2006 court decision that invalidated the SEC’s longstanding interpretation against proxy access. As a result, the SEC staff stopped granting relief to companies allowing them to exclude access bylaw proposals under Rule 14a-8(i)(8) of the Securities Exchange Act.

Noting that the SEC staff has no formal view on what its proxy access rule says or how the rule applies in any specific case, Cox said: “There can be absolutely no excuse for our continuing to fail to answer that basic question.”

Not everyone sees it that way. Some lawmakers, along with shareholder activists and institutional investor groups, have called on the SEC to postpone action on a final rule until all five commissioner posts are filled. Currently, one Democratic slot on the Commission is vacant, and the other Democratic commissioner, Annette Nazareth, wants to leave as soon as the Bush Administration names a replacement. That leaves Cox, who says he favors proxy access, and his two fellow Republican commissioners, who oppose it.

Atkins

Rumors abound that the SEC will hold an open meeting later this month to vote on the issue, with Cox expected to vote with Republican Commissioners Paul Atkins and Kathleen Casey in favor of the proposal that would reaffirm the SEC interpretation against proxy access. As of yesterday, the SEC has not announced any further meetings this month.

That has not stopped shareholder activists from fearing the worst. Yesterday, a group of eight large pension funds joined forces to speak out against any plan to kill shareholder access to the proxy. Organized by the California Public Employee Retirement System—a quiet but powerful force for shareholder rights—the group represents $300 billion in assets. They were joined by the Council of Institutional Investors, a trade association whose members manage $3 trillion in assets. They called for the SEC to take no action at all, rather than put proxy access on hold.

“We are at a critical point the in the history of shareholder rights,” said Jack Ehnese, CEO of the California State Teachers’ Retirement System and chairman of the CII. “Demonstrating leadership and protecting the rights of shareowners is paramount, and we are highly concerned about the direction we see this heading. We are asking the Commission to stop and listen to the boards of shareholders.”

Fred Buenrostro, CEO of CalPERS, had no comment on any potential litigation if the SEC does ban proxy access.

‘Get It Right Once and for All’

Among those calling for a delay was Sen. Jack Reed, D-R.I., who said both proposals “miss the mark.” Citing rumors that the SEC will adopt the so-called non-access proposal for the 2008 proxy season and then revisit for the following one, Reed said the Commission “should take its time and get it right once and for all, with the benefit of a full complement of commissioners to consider the issue.”

Cox countered that doing nothing would provoke “more needless litigation” about the meaning of the SEC rule and would create “a law of the jungle for any actual shareholder proposals that are advanced in the meantime.” Several shareholder activist groups already contend that last year’s court decision means they can push for proxy access, while business groups say the opposite.

COX COMMENTS

Below is an excerpt of SEC Chairman Christopher Cox’s testimony in front of the Senate Banking Committee.

I cannot predict what the Commission will do. It is widely reported that the Commissioners have irrevocably formed their views on what they will do, both now and in the future. But in fact the Commissioners, just like the staff, take this issue very seriously and with an open mind. Though some of my colleagues did not vote to approve the proposed rule to broaden proxy access that we published for comment last summer, it was not because they or any of us thinks the current system could not be improved. Rather, as one of them said, the current framework “is far from perfect,” but it has “at least created a framework for dealing with these problems.” Another of the Commissioners objected to the proposed rule because it did not consider “other potentially viable alternatives.” This bespeaks an open mind and a willingness to seek improvements in the proxy process for the benefit of all investors, which is what I believe each of the members of the Commission brings to this issue. We are still evaluating over 34,000 comments from the public on this issue, and we take that job very seriously. The testimony that you will hear today, as well as your own comment that each of you is offering during this hearing, will add very usefully to this public record, and we will be very attentive to it as well.

Our rulemaking is, as I’m sure you know, a work in progress. Even the Commissioners who voted for the broader proposal raised questions about it that were put to the public for comment, and each of us who voted for it explicitly acknowledged the trade-offs that exist. In the words of one of my colleagues, our challenge is to “balance the rights of shareholders, with the legitimate goal of leaving the management of companies largely to the board and the managers, whose primary focus should be on profit generation.”

There is a widespread assumption that having published the two proposals, the Commission has only a binary choice—that we must adopt one of them, or do nothing. But in fact we may also adopt a rule that is different than either of those proposed. The only requirement is that the proposed rule, and the questions the agency has asked, provide fair notice to the public of what the Commission is contemplating and the issues involved. So long as the final rule or rules are a logical outgrowth of what was proposed, we are free to amend the proposals and to consider improvements that the public comment process has brought to our attention.

The “do nothing” alternative is doubly dangerous. Not only will it provoke more needless litigation about the meaning of our rule, which in light of the recent Supreme Court decision might well be resolved in favor of the agency’s longstanding interpretation in any event, but it will create a law of the jungle for any actual shareholder proposals that are advanced in the meantime. That’s because unless we accept the Second Circuit’s invitation to clarify the current rule, all of the protections of the proxy contest rules are out the window—including requirements for disclosure of conflicts of interest, and possibly even the antifraud rules that prevent deliberate lying to investors. It is obvious that many shareholders support the main effect of the Second Circuit decision, which is that the Commission’s existing rule concerning proxy access is called into question, because they want to have access to the proxy. You will hear from them on the next panel, and I personally am very attentive to their concerns. But it should be possible to gain the more effective use of the proxy that they seek without abandoning other important shareholder protections, such as our disclosure and antifraud rules.

Source

Senate Banking Committee (Nov. 14, 2007).

“Whatever the Commission decides to do, we will restore certainty about the application of our rules,” Cox told lawmakers.

The SEC chairman said he agrees with commenters who say the agency should “go back to the drawing board” and take a fresh look at this issue. “We will do that,” he told the committee.

According to published reports, Senate Democrats have recommended two names as possible nominees to fill the vacancies at the SEC: Luis Aguilar, a partner at the law firm McKenna, Long & Aldridge, and Elisse Walter, head of regulatory policy and programs at the Financial Industry Regulatory Authority. But the full Senate must confirm any person the White House nominates, which could take weeks or even months.

Castellani

Also testifying before the committee were John Castellani, president of the Business Roundtable; Dennis Johnson, senior manager for corporate governance at pension fund CalPERS; Anne Simpson, executive director of the International Corporate Governance Network; and Jeff Mahoney, general counsel to the Council of Institutional Investors.

Castellani said proxy access will distract boards and potentially lead to the election of “special interest” directors. It might also convince some U.S. companies to go private, he said. “Rules allowing virtually anyone to force bylaw amendments regarding director elections would provide another reason for companies to go private or list elsewhere,” he said.

Meanwhile, Mahoney called Cox’s argument for fast action on the final rule as “less than convincing.”

“We’ve already gone through one proxy season with the [September 2006] decision in place and the great legal uncertainty that Chairman Cox apparently fears never materialized,” Mahoney said, noting that there were only three proxy access resolutions during the 2007 proxy season.

Simpson called both proposals “unnecessary and confusing.” She suggested that they “both be left quietly on a shelf somewhere.” Shareholder advocacy groups such as the ICGN say even the proposal favoring proxy access is no good, because it requires shareholders to own 5 percent of outstanding stock before they can make proposals to allow director nominations—a threshold the activists say is too high.

Simpson

In markets where shareholders do have the right to propose director candidates, Simpson said, it’s viewed as “a reserve power” that is rarely used. She said that of the roughly 500 proposals in the last six or seven years in Britain, they’re “almost exclusively targeted at companies where the board is doing a bad job.”

In the United Kingdom, a proposal to nominate a director can be made by a shareholder who holds 5 percent of the company’s shares or by a group of 100 shareholders. In much larger markets like the United States, however, the 5 percent threshold is “an impossible hurdle to reach,” Simpson said.

Johnson at CalPERS said the uncertainty Cox raised concerns about is a “red herring.”

“When a court of appeals gives an opinion, there is absolute certainty,” he said. “The Second Circuit clarified that the current SEC regulation doesn’t exclude proxy access.” Johnson said the SEC should “reconsider its timing and start anew at the right time, when it has a full commission.”

“The SEC failed to act on the proxy access issue for years when there was a full commission,” Johnson said. “Why rush to judgment now?”