Desperate Shareholders

By Thomas Brom

Remember proxy access? Way back in November 2007, Securities and Exchange Commission Chairman Christopher Cox let the air out of a promising campaign to provide dissident shareholders the limited ability to nominate board candidates on a company's proxy. After appearing to support the reform, Cox voted instead with his fellow Republican commissioners to reinstate a rule permitting companies to omit proposals that "relate to elections."

That vote was a big deal. A year before, a federal appellate court had held that companies could not omit bylaw proposals to establish an election procedure that included shareholder-nominated candidates (AFSCME v. Am. Int'l Group, 462 F.3d 121 (2nd Cir. 2006)). In the aftermath of the SEC's vote, Cox promised to seek congressional action on a new rule, but nothing came of it. So shareholder activists pursued a number of workarounds, focusing on the 2009 proxy season this spring. As a rallying cry, proxy access is back.

The heart of the conflict is rule 14a-8 of the Securities Exchange Act of 1934 - an exception to the general principle that to raise a matter at a company's annual meeting shareholders must prepare their own proxy materials (17 C.F.R. § 240.14a-8). The rule lists 13 substantive categories of shareholder proposals that a company may exclude from its proxy materials, provided the SEC issues a "no action" letter. The Big Daddy of the exclusions is rule 14a-8(i)(8), which allows companies to drop proposals to nominate director candidates.

Some of the workarounds shareholders have come up with are quixotic, and even a bit wacky. For example, in July 2007 a group of activist investors, assisted by corporate raider Carl Icahn, convinced the North Dakota Legislature to revise the state's corporation code. The group hired William H. Clark Jr., a partner at Philadelphia's Drinker Biddle & Reath, to draft the North Dakota Publicly Traded Corporations Act. Among other provisions, the new law provides a right of proxy access to shareholders who have owned 5 percent or more of a company's shares for at least two years. The idea is to encourage more companies to reincorporate in North Dakota, which currently is home to only two publicly traded corporations.

"Until North Dakota passed the statute, all corporate laws shared a basic bias toward management and the people in control," Clark says. "We still want directors to govern, but we want them working harder because they know they will face a meaningful election each year."

The American Federation of State, County and Municipal Employees (AFSCME), which had won its 2006 case challenging rule 14a-8(i)(8) only to have the SEC reinstate it, chose to pursue more litigation. The union's pension fund proposed a bylaw requiring CA Inc., a computer software company, to reimburse reasonable fees of any shareholder that seeks to elect less than a majority of the board if at least one shareholder nominee is elected. CA Inc. requested a no-action letter from the SEC, which then asked the Delaware Supreme Court to clarify two "certified" questions of law: Is the proposal a proper subject for shareholder action under Delaware law? And, if adopted, would the proposal cause the board to violate any state law to which it is subject?

Last July the Delaware court answered "yes" to both questions, holding that the reimbursement proposal was a proper subject for a proposed bylaw, but also that the bylaw was invalid because it could require the board to violate its fiduciary duties under the business judgment rule (CA, Inc. v. AFSCME Employees Pension Plan, 953 A.2d 227 (Del. 2008)).

"The SEC asked the Delaware Supreme Court to review a state law question, which allowed the question to be reviewed by the proper court rather than by the SEC or through filing an action in a federal court," says Marty Dunn, a partner in the Washington, D.C., office of O'Melveny & Myers. "The court held that a reimbursement proposal is a proper matter for shareholder action if it's about board process, but not if it compels an answer by the board."

AFSCME was pleased by the opinion. "We got 90 percent of what we wanted," says Richard C. Ferlauto, AFSCME's director of corporate governance and pension investment. "Our focus is on clarifying the procedural rights of shareholders within the context of Delaware law."

The third attempt at a workaround to proxy access came from academia. In a 2007 article, Harvard Law School professor Lucian A. Bebchuk proposed that shareholders be permitted to place on the corporate ballot any bylaw concerning elections that would be valid under state law if adopted (Lucian A. Bebchuk, "THE MYTH OF THE SHAREHOLDER FRANCHISE," 93 Va. L. Rev. 675 (2007)). Bebchuk's idea was to achieve under state bylaw what could not be achieved under the SEC rule. During the 2008 proxy season, Bebchuk submitted his proposal to various companies and then, when Electronic Arts requested a no-action letter from the SEC permitting it to drop the proposal, he filed suit (Bebchuk v. Electronic Arts, Inc., No. 08-3716 (S.D.N.Y. filed Apr. 18, 2008)).

After hearing oral arguments in November, Judge Alvin Hellerstein of the Southern District of New York dismissed the suit. Bebchuk appealed to the Second Circuit, which has granted expedited review.

Charles M. Nathan, a partner in the New York office of Latham & Watkins, calls the professor's plan "proxy access heavy," because it would have far-reaching effects. "Bebchuk's access proposal would effectively do away with rule 14a-8," says Nathan. "If shareholders can pass bylaws to circumvent the provisions of [rule 14a-8], it opens up all governance issues, not just the nomination of directors. You're talking about a different level of access."

Charles M. Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, is one of 46 law professors who signed an amicus brief supporting the plaintiff in Bebchuk. He believes shareholders should have the opportunity to vote on the bylaw, but doesn't support Bebchuk's goals. "His proposal would substitute the judgment of shareholders for that of directors," Elson says. "The shareholder proxy-reimbursement scheme in the CA, Inc. decision is a much more effective way to open the director election process."

AFSCME's Ferlauto says this year's proxy proposals are worded vaguely enough to permit corporate directors to exercise their business judgment. But Nathan doubts that union-sponsored proposals will make much of a difference. "Without substantial financial resources, most unions won't roll the dice on whether they will be reimbursed for a contested election," he says.

As for the future of rule 14a-8, Dunn of O'Melveny says, "It's the one place where multiple factors collide: shareholder interests, social interests, Sarbanes-Oxley, and disclosure requirements. Unfortunately, 14a-8 decisions come to a binary conclusion - either the proposal is in the proxy materials or it's out. The SEC needs to reexamine the rule, because of the pressures it has come under. But it's going to be a tough call."

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