Sunday, December 05, 2010

Business Groups’ Brief Attacks SEC’s Adoption of Proxy Access Rule as Fundamentally Flawed and Unconstitutional

The SEC’s adoption of a proxy access rule was based on a fundamentally flawed assessment of the rule’s costs, benefits, and effects on competition and capital formation and effected an arbitrary nullification of state law rights for director elections, said a brief filed jointly by the Business Roundtable and US Chamber of Commerce in their federal appeals court action seeing vacatur of the rule. Filed in the DC Circuit Court of Appeals, the brief also argued that it was arbitrary for the Commission to adopt the rule rather than let shareholders decide for themselves whether to adopt an access mechanism, given the SEC’s stated purpose of empowering shareholders in connection with director elections and its admission that the rules could harm corporate performance. The brief also argued that the proxy access rule violates the First Amendment. On a subsidiary point, the brief contended that the rule arbitrarily and capriciously includes investment companies within its embrace. Business Roundtable and US Chamber of Commerce v. SEC, US Court of Appeals for the District of Columbia Circuit, No. 10-1305, Nov. 30, 2010.

Armed with specific congressional authorization, the SEC adopted shareholder proxy access, Rule 14a-11, which is shorthand for a regulatory framework under which a shareholder may require the company to include in its proxy statement and proxy card a person nominated by the shareholder, and not by the board, for election to the board. The Dodd-Frank Wall Street Reform and Consumer Protection Act authorized the SEC to implement shareholder access to management’s proxy card to nominate directors for election to the board. The proxy access rule would apply to all Exchange Act reporting companies, including investment companies, other than companies whose only public securities are debt securities. The SEC also amended Rule 14a-8, which is not being challenged here, requiring companies to include in their proxy materials shareholder proposals seeking to establish a procedure in the company’s governing documents for the inclusion of shareholder director nominees in company proxy materials.

In challenging the proxy access rule, the business groups said that, had the Commission adopted only the amendments to Rule 14a-8; allowed shareholders to opt out of the rule; or deferred to state procedures such as those adopted in Delaware, shareholders could have adopted the proxy access regime they judged best even if it was more restrictive than Rule 14a-11.

The brief contended that allowing shareholders to decide whether to adopt an access mechanism would have effectuated the Commission’s stated goal of empowering shareholders in connection with director elections Shareholders could have assessed those incentives and actions at the company when deciding whether to adopt an access
mechanism and whether to repeal or revise it based on experience. The Commission arbitrarily rejected all of these alternatives, argued the business groups, and then compounded its error by permitting shareholders to use Rule 14a-8 to adopt less restrictive proxy access regimes than imposed by Rule 14a-11, while barring access mechanisms that are more restrictive than Rule 14a-11. The fact that the SEC has not typically permitted corporations to adopt alternatives under the federal securities laws, noted the brief, is no reason to reject out of hand an alternative that furthers one of the principal stated purposes of a rule, namely shareholder empowerment.

The business groups also argued that the SEC’s adoption of the proxy access rule was based on an analysis that was arbitrary and capricious because it mistakenly attributed some of the rule’s costs to state law, failed to realistically appraise the frequency and cost of access election campaigns, and displayed ``willful ignorance’’ toward the ways union and government pension funds will use the rule and the costs that companies will incur to defeat access candidates.

In addition, he proxy access rule should not enfold investment companies within its scope, said the business groups, since they are materially different than other public companies and are subject to different regulatory requirements. The only example the SEC gave of an investment company decision that warrants the protection of the proxy access rule is the approval of advisory contracts and fees, noted the brief, and the Investment Company Act already has special requirements for advisory contracts’ terms and approval, which include shareholder approval for new contracts.

Finally, the business groups contended that the proxy access rule violates the First Amendment by forcing companies to fund and carry campaign speech by third parties that is opposed by the company’s duly elected board of directors. Companies must do so even if such access is opposed by a majority of the company’s shareholders, and the speech is false and misleading. The freedom of speech protected by the First Amendment includes a right not to be compelled to speak, or to carry the speech of a third party. According to the brief, the Commission dismissed the First Amendment concerns in a single paragraph without ever considering whether the rule should be narrowed to avoid constitutional concerns.

Regulations compelling the content of speech must be narrowly tailored to serve a compelling governmental interest, said the brief, and the proxy access rule does not serve a compelling interest, but rather conflicts with the basic principle that citizens should be not be an instrument for fostering an ideological point of view that they find unacceptable. Also, the rule is not a narrowly tailored, least-restrictive alternative for achieving the government’s purpose. Relying solely on the amendment to Rule 14a-8(i)(8) would serve the Commission’s goals in a less restrictive manner, argued the business groups, as would deferring to the opportunities to establish proxy access under state law.

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