By James Hamilton, J.D., LL.M.
A consortium of the largest institutional pension funds in the world have weighed in on the current debate on the role of shareholders in the corporate director election process. In a recent letter to SEC Chairman Christopher Cox, the funds expressed concern about the implications of the SEC’s original announcement that clarification of the Exchange Act’s shareholder proposal rule is necessary in light of a recent Second Circuit panel opinion. The funds believe that the court’s decision breaks a significant logjam in the evolution of procedures to encourage more responsive boards.
Calling the panel’s opinion a critical juncture in US business history, the funds urged the SEC to seize this historic opportunity and allow shareholders access to the proxy for resolutions relating to the director electoral process. In both principle and practice, emphasized the funds, US board electoral processes are outdated and detrimental to maximizing shareholder value. The signatories to the letter included, among others, the California State Teachers Retirement System, the London Pensions Fund Authority, PGGM in the Netherlands, and the Ontario Teachers Pension Fund. There is power behind the letter since the funds aggregately represent $3.4 trillion in invested assets. The SEC intends to consider the issue at a Dec. 13 open meeting.
The appeals court panel ruled that a shareholder proposal seeking to amend a company's by-laws to establish a procedure by which shareholder-nominated candidates may be included on the corporate ballot did not relate to an election within the meaning of the SEC's proxy rules and could not be excluded from proxy materials. An SEC no-action letter and a federal district court ruling allowed the company to exclude the proposal based on rule 14a-8(i)(8), which allows the exclusion of a proposal relating to an election for membership on a company's board of directors. However, the appeals court found that a shareholder proposal does not relate to an election under the exclusion if it simply seeks to amend the by-laws to establish a procedure by which shareholders are entitled to include in the proxy materials their nominees for the board of directors. AFSCME v. American International Group, Inc., CA-2, September 5, 2006, CCH Fed. Sec. L. Reps. ¶93,942. Reacting to the court's ruling, the SEC announced that the Division of Corporation Finance would recommend an amendment to rule 14a-8 regarding director nominations by shareholders.
It is very difficult for investors outside the US to understand the fact that shareholders of US companies lack basic shareholder rights taken for granted in other developed markets, said the funds, who added that experience in the UK, Australia and the Netherlands has shown that boards whose members may be removed by shareholders are more sensitive to shareholder opinion and more likely to engage in meaningful dialogue with the institutions that hold their shares. Moreover, the right of shareholders to reject nominees, to propose a nominee, and to call an extraordinary general meeting to vote on changes to board composition neither destabilizes companies nor leads to contested elections.
In the view if these institutional investors, the recent practice of the SEC staff has made it more difficult for a better method to evolve in the US. Under Rule 14a-8(i)(8), shareholders have been denied the right to vote on efforts to address the situation. The funds find it remarkable that this use of the rule granting companies no-action letters in the face of evolving shareholder democracy standards in other countries has been used more consistently since 1990 than it had before.