Corporate Governance

The SEC's Access Proposal: Some Observations (The Relationship to State Law)

By J. Robert Brown

The most interesting issue concerns the SEC's efforts to preempt state law in the area of access.  It is a partial but likely effective approach.

Delaware recently amended its state statute to permit access bylaws.  Many have represented that this is a positive step whereby Delaware will permit companies to voluntarily allow access.  Commissioner Paredes did so in explaining his decision to vote against the SEC's access proposal.

In fact, the provision was more likely designed to impede rather than encourage access.  The evidence?  Isn't it coincidental that Delaware adopts an access statute at the very time that it has become inevitable that the SEC would impose access at the federal level?  Moreover, Delaware did so even though there was little uncertainty that access bylaws were already permitted.

What wasn't clear, however, were the limits that could be imposed on access under state law.  Thus, for example, it was likely unclear under state law whether access could be conditioned upon the length of time shareholders owned their shares.  The state law amendment makes it clear that companies may restrict the right of access based on the length of time shares are owned.  See Section 112(1)("A provision requiring a minimum record or beneficial ownership, or duration of ownership, of shares of the corporation's capital stock, by the nominating stockholder, and defining beneficial ownership to take into account options or other rights in respect of or related to such stock").  In other words, the provision more than anything else clarifies the restrictions that can be imposed on access.

As a result, corporations now have the right to limit access in ways that are more restrictive than anything the SEC might require.  Where the SEC requires a 1% ownership threshold for some companies, these same companies could impose a 5% or even 10% ownership threshold.  Where the SEC requires a one year holding period (really 16 months since its one year from the date the shareholder notifies management of an intent to submit nominees), companies could impose a two, five or ten year holding period.  These restrictions would effectively eliminate access.

The SEC has opted to handle this in the proposal by providing that access applies unless "state law or a company's governing documents prohibits shareholders from nominating directors."  Governing documents include the articles and bylaws.  See Exchange Act Release No. 60089 n. 98 (June 10, 2009).  Thus, access bylaws that impose more severe restrictions would be ineffective. 

Did that mean that Section 112 was a dead letter?  Not entirely.  The release noted that the governing documents could still provide rights "in addition" to those contained in Rule 14a-11.  In other words, companies could adopt a bylaw that reduced the ownership thresholds or the holding period for shares.  This, of course, is highly unlikely to happen, at least on any regular basis.  The promise of Section 112 was to limit, not augment access. 

In short, the SEC has proposed a rule that preempts the Delaware efforts to restrict access.  It was the right result.  It will, however, be an issue that comes up in the inevitable litigation that challenged the Commission's authority to adopt an access proposal.

Full post as published by The Race to the Bottom on June 30, 2009 (boomark / email).