Speech by SEC Commissioner:
Statement at Open Meeting to Propose Amendments Regarding Facilitating Shareholder Director Nominations
Commissioner Kathleen L. Casey
U.S. Securities and Exchange Commission
May 20, 2009
I would also like start this morning by thanking the Division of Corporation Finance for the dedication and professionalism that they once again have brought to bear on this issue. I would also like to thank the Office of General Counsel, Office of Economic Analysis, and the Division of Investment Management for their work on this release.
As has previously been noted, today’s proposal represents the fourth in the past six years in which the Commission has visited the issue of granting shareholders access to a company’s proxy in connection with the election of directors — or proxy access — and I am, as ever, very grateful to the Staff for all of their hard work.
Regretfully, however, I do not support the rule amendments that the Commission proposes today.
Nexus to Financial Crisis
As a preliminary matter, I must take issue with the attempt in the opening pages of the release to justify the imposition of a federal proxy access regime as a necessary response to the current financial crisis. The release claims that the financial crisis has led to concerns and questions about the accountability and responsiveness of some companies and boards of directors to the interests of shareholders, including accountability for risk management at the companies they oversee. The proposal cites these concerns as a primary impetus for the Commission to revisit proxy access.
But I believe this rationale is ill-founded for two simple reasons:
First, as I mentioned, this is the fourth proposal on proxy access in six years. And in truth, as we have all recognized, the Commission has been “revisiting” and debating the issue of proxy access for decades.
Second, even if I thought that there was a legitimate nexus to the financial crisis and that the proposal before us would be responsive to the real risk management issues at some financial institutions that have contributed to the crisis, this federal substantive proxy access regime will be imposed not only the country’s largest banks and Wall Street firms, but also on thousands of other large and small public companies across the country.
And I have yet to understand how toy manufacturers, grocery stores, beer and candy companies, educational systems, retail clothiers, fast food chains, weight loss companies and health food chains had anything to do with the excessive risk-taking and compensation structures that the Commission cites today as the rationale to propose a federal proxy access rule.
These firms differ from each other in countless ways, including their states of incorporation, businesses, and other characteristics, but they have one thing in common: they are large and small public companies that had little to do with the financial crisis.
Intrusion into State Law Prerogative
More fundamentally, this release places the Commission squarely into the territory of creating a federal corporate governance regime, as it affects two matters at the heart of corporate governance — director elections and shareholder rights. As the release acknowledges, however, corporate governance has historically been a matter of state law. This model reflects our federal system of government, which grants the federal government certain enumerated powers and reserves all other powers to the states.
The advantages of reserving authority to the states — including matters of corporate law and corporate governance — are well-chronicled. Primary among these are the ability of states to respond to the needs of the constituents affected by their laws — including the companies organized under their laws and the investors in those companies — as well as the ability of states to function as “laboratories” for innovation and experimentation.
The states are best situated to understand and respond to the needs of companies organized under their laws and shareholders of those companies. In the proxy access context, and in the absence of an overriding federal mandate, many states would likely opt to permit “private ordering,” whereby a company and its shareholders could decide for themselves whether the company’s shareholders should be given access to the company’s proxy materials; other states might preclude or, alternatively, affirmatively mandate proxy access.
Where a state chooses private ordering, different companies and their shareholders will likely arrive at different conclusions as to the advisability of granting proxy access, based on differences in their size, capital structure, investor composition, existing corporate governance policies, experiences, and a nearly endless array of other circumstances unique to those companies.
Because these companies are public, the empirical results of the decisions made by the companies and the states in which they are organized could then inform the future decisions of state legislatures, other companies and their boards of directors, and perhaps most importantly, investors.
As Yale University Professor Roberta Romano pointed out in one of our roundtable discussions in 2007, the reason for implementing an SEC regulation or a national law is because “we think there is a need for uniformity, and we really don’t want variation across the states or the firms within our jurisdiction.” In the context of corporate law, however, this is exactly the wrong prescription — particularly when states are being innovative and responsive.
In fact, this very state laboratory process is proceeding apace as we speak:
- Only a month ago, Delaware amended its General Corporation Law to explicitly permit companies to adopt a bylaw that would require the company to grant proxy access. Delaware is the preeminent actor in corporate law in the United States, and it is likely that other states will adopt similar provisions.
- Just two days ago, the Corporate Laws Committee of the ABA approved the first reading of amendments to the Model Business Corporation Act that include changes very similar to Delaware’s amendments. The MBCA has been adopted in whole or in part by over 30 states, so this change, if adopted, will likely have broad application.
- Finally, illustrating the principle that different states may arrive at different conclusions relating to the corporate governance of the companies organized under their laws, in 2007, North Dakota adopted its Publicly Traded Corporations Act that mandated for public companies, among other things, proxy access for qualified shareholders.
If the Commission adopts this one-size-fits-all substantive proxy access right, it will substitute its judgment for the judgment of those parties and bodies having the greatest knowledge of, and responsibility for, public companies — including state legislatures, the duly-elected directors of public companies, and even the shareholders themselves. It is noteworthy that the Commission would substitute its judgment for that of corporate directors, who are bound by their fiduciary duties to make decisions — including the decision whether to adopt or propose a proxy access bylaw — they believe are in the best interests of the company and its shareholders. It is antithetical to the notion of shareholder democracy that animates these rules, and is an example of paternalism, in my view, that the Commission would substitute its judgment for that of the shareholders themselves by denying them the right to consider and reject proxy access for the companies that they own.
Lest there be any doubt that the proposed rules would regulate corporate governance matters that are traditionally the province of the states, it is notable that the detailed parameters of the proposed substantive proxy access rule, including:
- the conditions under which a company will be obligated to provide proxy access;
- the eligibility requirements for nominees and proponents of nominees, such as minimum share ownership and holding period requirements; and
- the required procedures for proponents seeking proxy access,
are the exact same matters included in a non-exclusive list, under the Delaware amendments, that may be addressed in a proxy access bylaw, and the exact same matters that are specifically addressed in the North Dakota public company statute. This strongly suggests that the rule is not merely “procedural,” but rather goes to the heart of the policy considerations properly left to state legislatures or, where legislatures so provide, to the companies and their shareholders.
Threat to Predictability
A historical strength of our capital markets that is derived from placing responsibility for corporate governance with the states — particularly states with a highly developed set of corporate law principles such as Delaware — is the corporate law expertise, developed over decades, among the state legislatures, bars and courts, and the resulting predictability for companies organized in these states. Intermittent, but growing, federal intrusions significantly diminish this predictability. In an already highly uncertain business environment and market, such intrusions add to the risk calculus for companies considering going public in the United States.
Policymakers have expressed concern about the effect of increasing policy and political risk on U.S. IPOs, and the potential suffocation of innovation and growth in our economy. I fear that today’s proposed rules — with their implications for predictability for public companies — provide further reason for significant concern.
Potential Conflicts With State Law
In addition, Rule 14a-11’s substantive proxy access requirements may conflict with substantive and fundamental corporate law principles in some states, such as the principle that the board of directors is charged with the management and affairs of the corporation, and principles relating to the appropriateness of using corporate resources — in the form of the corporate proxy card and solicitation materials — to solicit proxies for candidates that were not nominated by the company.
Although these issues may now be largely settled in Delaware, other states may reach different substantive conclusions. Moreover, the rule will enjoy the presumption of validity until it is overturned. As a result, companies that take decisions following the adoption — should it be adopted — of the proposed rules would face significant uncertainty if the rules are later overturned under state law. This uncertainty is in the interests of neither companies nor their investors.
Not only should the Commission refrain, for prudential reasons, from acting in an area that is properly the province of the states, but the Commission’s authority to enact these rules is subject to significant doubt. The Supreme Court has made clear that, in the absence of an explicit federal law, state law governs the internal affairs of the corporation, and the D.C. Circuit has held that proxy rules that are substantive, rather than procedural or related to disclosure, are not valid. As I have discussed, the rules that the Commission proposes today regulate matters at the heart of corporate law, and thus our authority to adopt them is questionable.
Finally, opinions diverge widely on the impact on companies, and the benefits to investors, of providing shareholders proxy access. Different viewpoints reflect the relative priorities of the wide range of parties that are interested in the debate. It is a healthy debate to have, and developments in state law have created an environment in which proxy access policies, if deemed meritorious, can be implemented by legislatures or companies.
The ongoing and unsettled debate on the merits of granting proxy access, in my view, is the strongest possible reason to leave policy-making to state legislatures, boards of directors and shareholders.
In light of the rapid recent and ongoing developments in state law relating to proxy access, some modernization of our proxy rules is clearly necessary — in particular, the disclosure and liability regime. Consistent with the principles I have discussed today, and as I discussed in my statements in connection with the dual proxy access proposals that the Commission considered in 2007, I would gladly consider a narrowly-tailored proposal that would truly do no more than facilitate these state law developments. But such a targeted proposal is clearly not before us today. Accordingly, I cannot support the proposed rules.