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Looking Ahead to 2012: Impact of the Defeat of Rule 14a-11 on Proxy Access

Friday, September 23, 2011

Adrienne Kitchen Moeller | Bloomberg Law Shareholder access to proxies and the ability to get director nominees on company ballots became a hot-button issue after the 2008 credit crisis with the public call for corporate governance reforms. This article reviews the steps taken by the U.S. Congress and the Securities and Exchange Commission (SEC) to facilitate easier shareholder access to proxies, explores the defeat of one such proposed measure, and examines the possible effects of the remaining rules that will form the basis of shareholder access going forward—barring, of course, any additional legal challenges.

The Rise and Fall of Rule 14a-11

Rule 14a-11 was adopted by the SEC as part of its proposed overhaul of its rules concerning shareholder access to proxies. The rule arose out of the 2008 economic downturn and credit crisis, after which Congress empowered the SEC to adopt a rule requiring all publicly-traded companies to include shareholder nominees on their proxy forms. As adopted, Rule 14a-11 required a company to incorporate shareholder nominees for director in its proxy materials, provided the shareholder met certain eligibility requirements and was not prohibited by state or foreign law or a company's governing documents from proposing a candidate.

— SEC Adopts Rule 14a-11

Rule 14a-11 was to apply to all companies subject to the Securities Exchange Act of 1934 (Exchange Act) proxy rules, including registered investment companies, but it excluded companies whose only public securities were debt securities. Under the rule, a shareholder was eligible to nominate a candidate only if the shareholder held, in the aggregate, at least 3 percent of the total voting power of the company's securities that could be voted on the election of directors at the annual meeting. Rule 14a-11 further required a shareholder to meet this threshold continually for at least three years as of the date the nominating shareholder filed notice on new Schedule 14N and through the date of the annual meeting. In addition, Rule 14a-11 prohibited a shareholder from relying on its provisions if the shareholder's intent was to change control of the company or gain more seats on the board than was permitted under the rule. In the event that a shareholder satisfied the eligibility requirements, Rule 14a-11 provided that the shareholder could nominate the greater of one nominee or a number of nominees equivalent to 25 percent of the board of directors.

— Business Groups Raise Objections

Unhappy with the potential costs and other impact on companies that they saw arising out of Rule 14a-11, the Business Roundtable and the U.S. Chamber of Commerce sought legal intervention. On October 4, 2010, the SEC granted a motion filed by the Business Roundtable and the Chamber of Commerce to stay the effect of newly adopted Rule 14a-11 and its related rules and amendments after the filing of a petition for review in the U.S. Court of Appeals for the District of Columbia Circuit.1The petitioners argued that the rule was promulgated in violation of the Administrative Procedure Act. When the SEC initially adopted the new proxy access rule, it had explained that the rule would provide shareholders with a mechanism to exercise "traditional rights under state law" to nominate candidates. It further stated that the proxy voting process did not allow shareholders to provide input in nominating directors. Additionally, the SEC expected that Rule 14a-11 would amend Rule 14a-8(i)(8) to require companies to include shareholder proposals that aimed to create procedures for including shareholder director nominees in company proxy materials.

— Defeat of Rule 14a-11

The D.C. Circuit vacated Rule 14a-11 in a July 22, 2011 opinion by Judge Douglas H. Ginsburg. The court agreed with the petitioners' argument that the SEC acted arbitrarily and capriciously by failing to sufficiently evaluate the economic consequences of the rule and by failing to connect those consequences to efficiency, competition and capital formation. The court found that the SEC inappropriately discounted the rule's potential costs (e.g., management distraction) as a byproduct of shareholders' general, state-law right to elect directors, rather than considering the marginal costs of including shareholder nominees in the company's proxy materials. Regarding the rule's benefits, the court found that the SEC "relied upon insufficient empirical data when it concluded that Rule 14a-11 will improve board performance and increase shareholder value by facilitating the election of dissident shareholder nominees." Moreover, the court held that the SEC did not undertake "serious evaluation" of the use of the rule—and the resulting costs to a company—by shareholders with special interests. The SEC's adopting release, explained the court, did not address whether and to what degree the rule would supplant traditional proxy contests.2 The Business Roundtable praised the court's decision to "prevent special interest politics from being injected into the boardroom" and for recognizing what they felt would have been the rule's negative impact on "efficiency, competition and capital formation."3 Other organizations, such as the Council of Institutional Investors, were dismayed by the ruling, feeling that the court had wrongfully substituted its judgment in place of the SEC's own cost-benefit analysis.4 On September 6, the SEC announced that it would not seek a rehearing on or appeal the D.C. Circuit's decision.5

Amendments to Rule 14a-8

Shortly after it announced that it would not appeal the ruling on Rule 14a-11, the SEC advised that the amendments to Rule 14a-8 pertaining to shareholder proposals that were also adopted in 2010 would be effective upon publication of notice in the Federal Register.6 Although the amendments to Rule 14a-8 were not challenged in the Business Roundtable litigation, the SEC had voluntarily stayed the effective date of those amendments at the time it stayed the effective date of Rule 14a-11. The stay order provided that upon the finalization of the court's decision, the stay of the effective date of these amendments would expire. Where Rule 14a-11 would have required a company to include eligible shareholder nominees for director positions in its proxy materials, Rule 14a-8(i)(8), as amended, permits eligible shareholders to require companies to include shareholder proposals that seek to amend a company's governing documents (i.e., bylaws) concerning director nomination procedures, provided the proposals do not otherwise conflict with other SEC proxy rules or applicable law.7 The SEC explained that this would allow shareholders to establish proxy access standards on an individual company basis rather than via a uniform standard as Rule 14a-11 had prescribed.8 Prior to the amendment, Rule 14a-8(i)(8) allowed companies to exclude from their proxy materials shareholder proposals by qualifying shareholders relating to elections. The effectiveness of the amendments means that companies will no longer be able to rely on Rule 14a-8(i)(8) to relatively easily exclude a proposal seeking to establish a procedure in a company’s governing documents for the inclusion of one or more shareholder nominees for director in the company’s proxy materials. A shareholder is now eligible to submit such a proposal if it has continuously held, through the date of the meeting and for at least one year prior to the date the proposal is submitted, at least $2,000 in market value or 1 percent of the company's securities entitled to be voted on the proposal at the meeting. However, the amended rule also provides that companies may nevertheless exclude a shareholder proposal under Rule 14a-8(i)(8) if it (1) would disqualify a nominee who is standing for election; (2) would remove a director from office before his or her term expired; (3) questions the competence, business judgment, or character of one or more nominees or directors; (4) nominates a specific individual for election to the board of directors; or (5) otherwise could affect the outcome of the upcoming election of directors.9

Looking Ahead: Potential Challenges

Looking forward to the 2012 proxy season, it is likely that shareholders will attempt to take advantage of the relatively light eligibility requirements under the Rule 14a-8 amendments to attempt to get their director nominees on the proxy ballot vis-

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