The SEC has defended its proxy access rule, Rule 14a-11, as squarely falling within the traditional realm of federal proxy regulation by enabling proxy voters to exercise their ownership rights through the proxy process as effectively as they might have by attending a shareholder meeting. Moreover, the SEC’s adoption of a proxy access rule was specifically authorized by Section 971 of the Dodd-Frank Act, which provides that the SEC may adopt a proxy access rule “under such terms and conditions as the Commission determines are in the interests of shareholders and for the protection of investors.” In so doing, emphasized the SEC’s brief in the DC Circuit Court of Appeals, Congress removed any legal uncertainty about the Commission’s authority to regulate the use of company proxies by shareholders to nominate director candidates. The rule is being challenged by business groups. Oral argument is set for April 7, 2011. (Business Roundtable and Chamber of Commerce v. SEC, DC Circuit Court of Appeals, No. 10-1305).
Responding to the argument 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, the SEC said that Rule 14a-11 does not violate the First Amendment because the rule governs only internal communications and neither requires companies to disseminate or subsidize the speech of third parties nor speaks to the public at large. In any event, strict scrutiny does not apply to disclosures under the securities laws, reasoned the Commission, and Rule 14a-11 withstands scrutiny under any lower standard.
The SEC brief also notes that the Rule 14a-11 Adopting Release comprehensively addressed potential costs and benefits of the rule and its likely effect on efficiency, competition, and capital formation. The Commission made predictive judgments about Rule 14a-11’s economic consequences based on the available evidence and its expertise, and concluded that, on balance, it was in the interests of shareholders and for the protection of investors to adopt the rule.
In adopting Rule 14a-11, the SEC recognized that state laws create shareholders’ rights to nominate and elect directors at an in-person shareholder meeting. While leaving the nature and scope of these rights to state law, the Commission acted to ensure that proxies are used in a way that furthers, rather than frustrates, the rights to nominate and elect directors. The Commission stated that the rule would facilitate these rights because most shareholders vote by means of a proxy submitted prior to the meeting.
The Commission addressed arguments that, as a policy matter, it should allow a company’s board of directors, or a majority of shareholders, to opt into, or out of, Rule 14a-11's requirements. The SEC concluded that exclusive reliance on such private ordering would not be as effective in facilitating the exercise of the rights to nominate and elect. A shareholder’s ability to access the proxy should not be determined by private ordering, said the SEC, because it would not be appropriate to permit either a company’s board or a majority of its shareholders to deprive other shareholders of an effective means to freely exercise their franchise rights as owners of public companies. Also, the SEC noted that companies and their shareholders do not have the option to opt out of other federal proxy rules.
There was no disregard for state law, noted the SEC. Rule 14a-11 sets a fixed minimum level of proxy access that companies and shareholders may not eliminate or reduce, but permits companies and shareholders to expand that level of proxy access by private choice. Rule 14a-11 does not preclude the adoption of access bylaws under state law provisions dealing with proxy access, such as Delaware’s newly revised corporation law. The only constraint on the adoption of such bylaws is that they cannot prevent Rule 14a-11 from applying by its own terms
Noting that the State of Delaware filed an amicus brief asserting that the Commission ignores its choice to create an enabling regime as to proxy access that embodies Delaware’s tradition of private ordering, the SEC said that rejecting a policy choice is not ignoring it. Rather, the Commission did consider Delaware’s regime but rationally determined not to rely on private ordering as the exclusive means for establishing proxy access. On the other hand, the rule does facilitate the specific state law right to nominate and elect directors traditionally provided under Delaware law.
At bottom, petitioners’ argument amounts to a disagreement with the Commission’s policy choice not to rely exclusively on private ordering, said the SEC, and this
disagreement provides no basis to overturn the rule.
The Commission adopted the rule to ensure that, to the extent practicable, shareholders can use the federal proxy process to meaningfully exercise the rights they have under state law to nominate and elect directors at an in-person shareholders’ meeting. The SEC said that there was nothing inconsistent or arbitrary in its decision to allow shareholders to submit proposals to expand the proxy access provided by the rule but to preclude companies and shareholders from opting out of Rule 14a-11 in favor of a more restrictive access regime.
Despite the urging of amici Investment Company Institute and Independent
Directors Council that Rule 14a-11 should not cover investment companies, the Commission concluded that investment companies should be covered by Rule 14a-11 since the shareholders of investment companies have the right under state law to nominate candidates for the board of directors. Based on the available evidence and its expert judgment, the Commission decided that neither the potential costs to investment companies nor the separate regulatory regime to which investment companies are subject obviates the need for Rule 14a-11 or justifies depriving investment company shareholders of its potential benefits.
The fact that state law does not require investment companies to have annual meetings did not alter this conclusion. In the SEC’s view, the application of Rule 14a-11 to investment companies represents a reasonable determination that, when investment companies do have meetings at which shareholders could exercise their state-law nomination and election rights, they should be equally able to do so through the proxy process.
The Commission said that it carefully considered the potential economic consequences of Rule 14a-11, alternatives to adopting the rule, and the extent of competition, efficiency, and capital formation under existing regulatory regimes. The Commission reasonably concluded, based on this analysis, that the potential benefits of Rule 14a-11 justified the potential costs.
Any assessment of the economic effects of Rule 14a-11, which creates for the first time a mechanism for shareholders to use company proxy materials to nominate director candidates, is necessarily predictive and hence uncertain, said the SEC. Citing relevant case law, the Commission pointed out that it must only acknowledge factual uncertainties and identify the considerations it found persuasive. This is precisely what it did in adopting Rule 14a-11, maintained the Commission, in that it reasonably assessed potential costs and benefits and, recognizing the uncertainties in its analysis, concluded that the collective benefits of adopting Rule 14a-11 justify the costs.
Moreover, the Commission considered the views of commenters who believed that directors’ fiduciary duties may compel them to expend company resources to oppose a shareholder director nominee. While recognizing that some companies likely would oppose a particular shareholder nominee and incur the consequent expenses, the
Commission reasoned that these costs may be limited to the extent that the directors’ fiduciary duties prevent them from using corporate funds to resist shareholder director nominations for no good-faith corporate purpose.
The SEC rejected the contention that it acted arbitrarily and capriciously in estimating the frequency with which the proxy access rule would be used as representing, at bottom, nothing more than a disagreement with the Commission’s predictive judgment on a subject the Commission recognized is inherently uncertain
The Commission recognized that companies could be negatively affected if shareholders use the new rules to promote their narrow interests at the expense of other shareholders. The Commission noted, however, that these potential costs may be limited to the extent that the ownership threshold and holding requirement allow the use of the rule by only holders who demonstrated a significant, long-term commitment to the company and thus would be less likely to act in a way that would harm shareholder value.