Speech by SEC Commissioner:
Statement at Open Meeting to Adopt Amendments Regarding Facilitating Shareholder Director Nominations
Commissioner Kathleen L. Casey
U.S. Securities and Exchange Commission
August 25, 2010
Thank you very much, Madame Chairman. I also want to thank the staff for their dedication and hard work on this release. While I adamantly disagree with just about everything in the adopting release, I sincerely appreciate your efforts.
Let me start with an observation and a prediction. The observation is that it appears that a primary, if unstated, objective of this rule is to put the issue of proxy access behind the Commission once and for all. My prediction is that, paradoxically, the rule that the Commission adopts today virtually guarantees that the Commission will be forced to deal with this issue for years to come. I say this for two reasons. First, I believe that the rule is so fundamentally and fatally flawed that it will have great difficulty surviving judicial scrutiny. Second, an inevitable consequence of this rule, if it survives, is that the staff will be tasked with the unenviable responsibility of brokering disputes and addressing a broad array of issues arising from the operation of this new federal right every proxy season.
This result is unfortunate, because it was so clearly avoidable — it was not a necessary consequence of adopting a rule that would truly facilitate shareholders’ state law rights to nominate directors.
Unfortunately, the adopting release goes through a jiu-jitsu exercise of purporting to give deference to state law and to increase shareholder choices under state law, when in fact the rules do exactly the opposite. As a result, the logic does violence to our historical understanding of the roles of federal securities law, state law, shareholder suffrage and private ordering, with potentially far-reaching implications. The consequences of this exercise include a series of arbitrary choices that are not tethered to empirical data and a number of internal inconsistencies that make the rules difficult to defend. Furthermore, the rules continue a disturbing trend of empowering institutional shareholders to the detriment of individual shareholders. Finally, the policy objectives underlying the rule are unsupported by serious analytical rigor, and the release fails to fairly and adequately consider the costs and impact of these rules. In this regard, I believe these rules are likely to result in significant harm to our economy and capital markets.
Although the adoption of these rules today reflects a clear choice by a majority of the Commission, this action clearly is not result of any greater consensus or mitigation of controversy in the area of proxy access.
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The rules before the Commission would mandate a federal proxy access regime that, despite purporting to be based on rights granted under state law, provides that state corporate law and the governing documents of public companies can expand upon the federal proxy access right, but cannot narrow or waive this right even if shareholders wish to do so.
In order to justify a federal rule with this odd, “asymmetrical” option, the Commission purports to elevate proxy access to a fundamental shareholder right guaranteed by the federal securities laws.
As a preliminary matter, I find it remarkable that the Commission has cynically and dramatically transformed its characterization of a federal proxy access regime since its June 2009 proposal. Prior to the passage of the Dodd-Frank bill in July 2010, our authority to promulgate a proxy access rule was subject to significant doubt. To the extent that we held such authority under existing law and court precedent, that authority depended upon any rule being characterized as procedural, rather than substantive, and the proposing release went to great lengths to characterize the proposed rules as procedural. With our authority now assured by the Dodd-Frank bill, the Commission has abandoned all pretence that the rule was ever procedural and has embraced this new notion of proxy access as a fundamental shareholder right. This transformation is extraordinary, particularly in light of Congress’s decision merely to provide the Commission with authority to adopt proxy access rules, rather than to require that we do so. It is hard to imagine how such a fundamental shift in justification for the rule can be so summarily made without seriously undermining the credibility of the rule itself and the adequacy of our process to support it.
Equally remarkable is the assertion that, while this fundamental right derives from state law, and states can abrogate the proxy access right entirely simply by eliminating the shareholder right to nominate directors, states cannot be trusted to define the contours and limits of this new fundamental right. Yet the Commission’s rules expressly preempt any state law that would in any way narrow or waive, or that would permit companies to narrow or waive, the proxy access right — even pursuant to a shareholder-adopted bylaw.
Perhaps most astonishingly, while the adopting release maintains that the proxy access rules increase shareholder choice simply by mandating that shareholder nominees appear on a company’s proxy card rather than on a nominating shareholder’s proxy card, the release refuses to concede that the rules eliminate shareholder choice by precluding them from exercising their state law rights to establish procedures by which a company conducts director elections.
So, the perverseness of this rule is to claim to empower shareholders through the adoption of a federal rule that explicitly restricts and prevents these same shareholders from exercising their state law rights. It also effectively preempts recent state legislative efforts to adopt different regimes such as those undertaken in North Dakota and Delaware.
Certainly, it makes sense for the Commission to characterize this new right as fundamental. The mandatory, asymmetrical structure of the rule largely depends on this characterization.
Yet, if one accepts that the proxy access rule is a fundamental right, any limitations under the rule that deny any shareholder access to the proxy would appear to be inappropriate. Most obviously, how can the Commission justify any ownership or holding period thresholds that will deny some shareholders the right to proxy access?
I do not accept that a federal proxy access mechanism is a fundamental right, and so I readily acknowledge that restrictions on the use of proxy access are necessary to allow companies to run efficient and cost-effective director elections. The result of the Commission’s characterization of proxy access as a fundamental right, however, is an unnecessarily prescriptive rule that sets arbitrary thresholds and standards that discriminate among shareholders and companies.
The explanation in the adopting release of the choice of the 3% / 3 year thresholds dramatically illustrates this point. That discussion analyzes, among other things, aggregate statistics about shareholder ownership concentrations across over 6,000 public companies. In particular, the discussion analyzes the relative ability of shareholders — either alone or by forming a group with other shareholders — to satisfy various ownership thresholds that the Commission considered.
These statistics broadly indicate that approximately 1/3 of filers as of a recent date had at least one stockholder that alone would satisfy the 3% / 3 year thresholds. At these companies, the proxy access right would be extremely easy to use for at least one stockholder.
By contrast, slightly fewer than 2/3 of filers did not have even a single shareholder owning at least 1% of the issuer’s shares for the 3-year holding period. At these companies, the proxy access right would be comparatively difficult — perhaps in some instances virtually impossible — to use. At these companies, at least four shareholders, and perhaps many more, would need to form a nominating group in order to use the proxy access rules.
Thus, there is nothing “fundamental” — or even particularly meaningful — about a 3% ownership threshold or a 3-year holding period. These are simply lines drawn to try to come up with some rational solution to the difficult — maybe insurmountable — issues arising from attempting to establish a workable federal proxy access right that will apply to all public companies. The disparate effects of these thresholds at different companies and, as a result, on their shareholders, illustrate the folly, from a policy perspective, of attempting to promulgate a one-size-fits-all proxy access rule.
In order to appear flexible and perhaps to overcome these issues, the rule provides that companies and their stockholders may expand upon the federal proxy access right by, for example, lowering these thresholds. But if the thresholds chosen have no particular meaning, an asymmetrical amendment option cannot cure these deficiencies. Rather, the asymmetrical nature of the option to amend a federal proxy access right that is not tethered to any meaningful data renders the option itself arbitrary.
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As previously noted, the rules represent an abrupt and unjustified departure from decades of corporate law tradition, legislation, jurisprudence and practice:
- Rather than presuming, as corporate law does, that companies and their shareholders are generally capable of privately ordering their affairs based on their unique individual circumstances, the rules presume that shareholders are incapable of determining the director election procedures that are in their best interests.
- Rather than presuming, as corporate law does, that directors, who are bound by their fiduciary duties and charged with maximizing shareholder value, will in fact act in the best interests of shareholders, the rule seems to presume that the relationship between directors and shareholders is fundamentally an adversarial power struggle.
Certainly, in the past, policymakers have questioned some of these presumptions at “the margins,” especially following well-publicized examples where some of these presumptions did not hold. The Sarbanes-Oxley Act, and our rulemaking pursuant to that Act, is the most obvious example.
The reasoning justifying the proxy access rules, however, if expanded into other contexts, is potentially tectonic in terms of its impact on our longstanding understanding of the relative roles of federal securities law and state corporate law, particularly as regards private ordering at individual companies. For instance, the notion that a majority of a company’s shareholders cannot legitimately determine the processes by which an election of directors at the company will be conducted calls into question the legitimacy of any shareholder vote that affects the rights and privileges of shareholders.
The paradigm of a power struggle between directors and shareholders is one that activist, largely institutional, investors assiduously promote, and this rule illustrates a troubling trend in our recent and ongoing rulemaking in favor of empowering these shareholders through, among other things, increasingly federalized corporate governance requirements. Yet, these shareholders do not necessarily represent the interests of all shareholders, and the Commission betrays its mission when it treats these investors as a proxy for all shareholders. I believe many activists will concede that their interests in proxy access do not lie solely in the ability to successfully place a nominee on a company’s board of directors; instead, the proxy access right is also an important means of obtaining leverage to seek outcomes outside of the boardroom that may otherwise not be achievable — outcomes that are often unrelated to shareholder value maximization.
Yet the adopting release not only does not seek to address these concerns with short-term or unrelated special interest objectives, in several instances, it actually seeks to ensure that the access right is as unconstrained as possible — even when the would result in less disclosure or protection to other investors.1
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The rule is also problematic in that it is founded on presumptions about the operation and integrity of our proxy system that the Commission knows to be in question or of concern. We recently issued our “proxy plumbing” concept release that launched a fundamental reexamination of the operation of this system. That release acknowledges foundational weaknesses in the proxy process relating to, among other things, the inability of companies to communicate with shareholders, the outsized influence of potentially-conflicted proxy advisory firms, the decoupling of voting from economic interests, and questions regarding the extent to which proxy voting accurately reflects the preferences of all shareholders — especially individual shareholders — in the wake of the amendment of NYSE Rule 452. I believe the Commission blithely disregards these considerations by adopting an asymmetrical, federally-mandated proxy access rule.
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I also have significant concerns about the impact of these rules on issuers and the U.S. capital markets. In particular, the Dodd-Frank bill explicitly called for the Commission to consider the impact of any proxy access rules we might adopt on small businesses and whether any exemptions from the rules are necessary. While the three-year delay in the application of these rules to smaller reporting companies is undoubtedly very welcome to these companies, the Commission’s general assurances that this delay will “provide us with the additional opportunity to consider whether adjustments to the rule would be appropriate for smaller reporting companies before the rule becomes applicable to them” cannot satisfy the Commission’s duty to conduct this analysis.
In addition, I am concerned that the Commission and other policy makers have given too little consideration to the impact of these rules, particularly when taken together with other existing and imminent requirements pursuant to the Sarbanes-Oxley Act and the Dodd-Frank bill, on the U.S. IPO market and the U.S. capital markets generally.
Notwithstanding the analysis presented in the Cost-Benefit Analysis section of the adopting release, I am not satisfied that the Commission has seriously considered the true costs to issuers and our capital markets of imposing a new federal proxy access right, nor weighed these costs against the anticipated benefits, which appear to be speculative at best and to depend largely on the inestimable benefits of improved “investor confidence.”
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As I previously stated, the adoption of these rules, and the troubling analysis underlying them, are all the more disturbing because they are so unnecessary. The Commission has debated proxy access for many decades. Perhaps the closest the Commission has ever come to adopting a proxy access rule was in 2007, when we considered amending Rule 14a-8(i)(8) to permit shareholders to propose binding shareholder resolutions to amend a company’s bylaws to require the company to grant proxy access. Since 2007, the Delaware General Corporation Law and the ABA’s Model Business Code have been amended to include provisions that explicitly permit proxy access bylaws and proxy reimbursement bylaws. As a result, an enabling approach to proxy access has never been so ripe.
Nor would such an enabling approach to proxy access suffer from such crippling deficiencies of rationale and foundation, require that the Commission stray from its core competencies, grapple with impossible choices or wrestle with logistical complexities and the danger of unintended consequences, in the same way as the mandatory federal rules adopted today. Unlike today’s rules, an enabling proxy access rule would avoid discriminatory distinctions among shareholders in favor of true shareholder suffrage. Such an approach would facilitate companies’ and shareholders’ state rights to determine the processes that govern the nomination and election of directors, based on their unique circumstances. This approach would also, of course, facilitate shareholders’ ability to avail themselves of the rights afforded by those processes.
In conclusion, I believe this rule will find itself in the pantheon of ill-conceived Commission actions — firmly nestled beside the Commission’s recent rulemaking relating to short selling and its interpretive guidance relating to climate risk disclosure. In each case, I believe we have abdicated our responsibility to act on the basis of empirical data and sound analysis and instead have simply reacted to overwhelming political pressure. For all of these reasons, I cannot support this rule.
1 See, e.g., Rules 13d-1(b)(1) and 13d-1(c), (permitting nominating shareholders to file on Schedule 13G rather than on Schedule 13D despite the potential ability for such a nominee to influence control over an issuer); See also, e.g., Rule 14a-11(g) (declining to permit issuers to exclude shareholder nominees from the issuer’s proxy materials where the shareholder nominee makes a materially false or misleading representation or certification).