Corporate Governance

Regime Change and the SEC's Corporate Governance Agenda: #1 Access

By J. Robert Brown

We have been setting out a top ten list of items that should be considered by the new Commission in the realm of corporate governance.

The single most important issue that requires immediate SEC attention is access.  On this issue, it is almost hard to know where to begin.  The Commission's actions in this area was hard to defend and, while those who opposed access won the battle, they have almost certainly lost the war.

Directors are elected by shareholders but they are nominated by management.  Proxy contests involving competing slates of directors nominated by both shareholders and management occur around 25 times a year, an anemic number given that there are more than 10,000 public companies.  When the company is large (over $200 million in market capitalization), the average number of proxy contests is three. As a result, directors know that they will lose their comfortable sinecure on the board only if they are not renominated.  This in turn will most often occur when they have an unsuccessful relationship with the CEO.  In other words, directors who want to be reeelcted have an incentive to act in the best interests of the CEO, not shareholders. 

There are many explanations for the state of affairs but the most significant is the cost involved in nominating a competing slate of directors. Shareholders cannot, under Rule 14a-8, include their nominees in the company's proxy statement but must pay the cost of writing and distributing their own proxy statement.

Shareholders tried to circumvent the limitation by submitting under Rule 14a-8 bylaws that, if adopted, would require the company to include shareholder nominees in the proxy statement.  In other words, access was provided not by Rule 14a-8 but by the bylaw.  The bylaws invariably provided that nominees could only be submitted by large shareholders (or groups of shareholders) and only for short slates.   It was a cumbersome and slow process.  Shareholders wanting to submit nominees would need to wait two years, the first to pass the bylaw and the second to submit the nominees.  The cumbersome process made it less likely shareholders would get the authority to include nominees in the company's proxy statement and made it less likely that it would be a vehicle used by short term investors to pressure management. 

This type of access existed for one proxy season.  During the one proxy season, there was no abuse and limited interest in the bylaws.  In at least one case, shareholders passed an access bylaw while in two others (HP and UnitedHealth) they failed.  One company (Comverse) voluntarily put one in place.  Nonetheless, the Chairman of the SEC voted to reverse this shareholder right, justifying the position by taking a number of outrageous positions, including that the proxy antifraud provisions would not apply to shareholder nominees and a "law of the jungle" would reign, with the worst coming from off shore hedge funds.

As a result, shareholders could not include in the company's proxy statement a bylaw that would provide access if it passed.  By eliminating access bylaws, the Commission did not reform the proxy rules and add prophylactic disclosure requirements applicable to shareholders who included their nominees in the company's proxy statement.  This could occur in connection with the two companies that have access bylaws and any other company that voluntarily includes the nominee in the proxy statement.  Thus, the Commission left in place, by its own admission, a gaping hole in the proxy disclosure regime. 

Had the Commission left matters alone, and allowed access bylaws to be included in the company's proxy statement, it would have eliminated most of the pressure from shareholder groups for access.  At the same time, by requiring shareholders to first adopt a bylaw, it would have meant that shareholders would rarely get the authority to include their nominees in the company's proxy statement. 

But the Commission lacked the foresight to take that approach.  As a result, pressure for access will build, only now shareholders will insist not on the two step process requiring a bylaw but on more direct access to the proxy statement for nominees.  In other words, when the Commission amends Rule 14a-8 and authorizes access, it will be much broader than the proposal rejected by the Commission.

The time has come to amend Rule 14a-8 to allow shareholders to include nominees in the company's proxy statement.  The rule should track the proposals submitted by shareholders to HP and UnitedHealth, with an ownership threshold (1-3%, individually or as a group) and applicable only to short slates.  For at least the last two decades, shareholders have sought the right to include nominees in the company's proxy statement.

A history of access and a discussion of the inevitability of the Commission's steps are contained in The SEC, Corporate Governance, and Shareholder Access to the Board Room.

Full post as published by The Race to the Bottom on January 12, 2009 (boomark / email).