Bloomberg reports:
More than two-thirds of companies that received proxy access proposals this year from the New York City pension funds have agreed to implement the director-nomination mechanism without holding a shareholder vote. ...
For the 2016 proxy season, the New York City pension funds filed proxy access proposals to allow a group of shareholders that collectively own at least 3 percent of the company for three years to nominate up to 25 percent of the board in any given year.
By adopting bylaws with these parameters, some companies have been able to fend off shareholder resolutions that attempt to obtain other concessions, such as allowing loaned shares to be counted toward eligibility (31 CCW 84, 3/16/16). Staff of the Securities and Exchange Commission have concluded that these companies substantially implemented proxy access, giving them a basis to exclude shareholder resolutions that touch on the matter from their proxy materials.
I get that adopting a less intrusive bylaw can stave off more intrusive ones, but I'm disappointed in corporate managers for not trying harder to stop this nonsense in its tracks.
As I explained in my book Corporate Governance after the Financial Crisis
The SEC offers two explanations for adopting proxy access. First, because shareholders who appear in person at an annual stockholders’ meeting would have the power to nominate a director, the rule simply ensures that shareholders can exercise that right via the proxy system. In other words, the SEC claims, the rule simply effectuates existing state law rights. In fact, however, the SEC’s argument is false. On the one hand, in some respects the rule is more restrictive of shareholder rights than is the state law it supposedly effectuates. On the other hand, however, the rule creates new federal entitlements that do not exist under state law.
As to the former, the proxy system as a whole was already more restrictive than what may be done by a shareholder in person. Rule 14a-11 simply continues that pattern. Under state law, for example, any shareholder could make a nomination at the annual meeting, not just those meeting Rule 14a-11’s criteria on issues like the ownership threshold.[1]
As to the latter, Rule 14a-11 disallows restrictions on the shareholder nominating power that are likely permissible under state law.[2] In Harrah’s Entertainment, Inc. v. JCC Holding Co.,[3] Vice Chancellor Leo Strine addressed the extent to which Delaware law permits restrictions on that power:
Because of the obvious importance of the nomination right in our system of corporate governance, Delaware courts have been reluctant to approve measures that impede the ability of stockholders to nominate candidates. Put simply, Delaware law recognizes that the “right of shareholders to participate in the voting process includes the right to nominate an opposing slate.” And, “the unadorned right to cast a ballot in a contest for [corporate] office... is meaningless without the right to participate in selecting the contestants. As the nominating process circumscribes the range of choice to be made, it is a fundamental and outcome-determinative step in the election of officeholders. To allow for voting while maintaining a closed selection process thus renders the former an empty exercise.”[4]
Vice Chancellor Strine went on to explain, however, that a corporation may in fact opt out of the default voting—and nominating—rules of state law, provided it does so clearly and unambiguously:
When a corporate charter is alleged to contain a restriction on the fundamental electoral rights of stockholders under default provisions of law——such as the right of a majority of the shares to elect new directors or enact a charter amendment—it has been said that the restriction must be “clear and unambiguous” to be enforceable.[5]
Consequently, the SEC’s claim that the shareholder power to nominate and elect directors is imposed by state law and “cannot be bargained away” is likely erroneous.
The extent to which Rule 14a-11 thereby displaces state corporate law with new federal entitlements was a key point in SEC Commissioner Troy Paredes’ dissent from adoption of the rule. He explained that “Rule 14a-11’s immutability conflicts with state law. Rule 14a-11 is not limited to facilitating the ability of shareholders to exercise their state law rights, but instead confers upon shareholders a new substantive federal right that in many respects runs counter to what state corporate law otherwise provides.”[6] On both sides of the equation, Rule 14a-11 thus is hardly a means of facilitating shareholders’ state law rights.
The SEC’s second justification is that proxy access will promote director accountability.[7] In fact, however, because proxy access’ effect will be to increase the number of short slates, albeit to an uncertain extent, its impact on corporate governance likely will be analogous to that of cumulative voting. Both result in divided boards representing differing constituencies. Experience with cumulative voting suggests that adversarial relations between the majority block and the minority of shareholder nominees commonly dominate such divided boards.
The likely effects of proxy access therefore will not be better governance. It is more likely to be an increase in interpersonal conflict (as opposed to the more useful cognitive conflict). There probably will be a reduction in the trust-based relationships that are the foundation of effective board decision making.[8] There may also be an increase in the use by the majority of pre-meeting caucuses and a reduction in information flows to the board as a whole. Not surprisingly, early research suggests that proxy access reduces shareholder wealth.[9]
In his dissent, Commissioner Paredes pointed to additional pre-Rule 14a-11 studies undercutting the SEC’s position:
The mixed empirical results do not support the Commission’s decision to impose a one-size-fits-all minimum right of access. Some studies have shown that certain means of enhancing corporate accountability, such as de-staggering boards, may increase firm value, but these studies do not test the impact of proxy access specifically. Accordingly, what the Commission properly can infer from these data is limited and, in any event, other studies show competing results. Recent economic work examining proxy access specifically is of particular interest in that the findings suggest that the costs of proxy access may outweigh the potential benefits, although the results are not uniform. The net effect of proxy access — be it for better or for worse — would seem to vary based on a company’s particular characteristics and circumstances.
To my mind, the adopting release’s treatment of the economic studies is not evenhanded. The release goes to some length in questioning studies that call the benefits of proxy access into doubt — critiquing the authors’ methodologies, noting that the studies’ results are open to interpretation, and cautioning against drawing “sharp inferences” from the data. By way of contrast, the release too readily embraces and extrapolates from the studies it characterizes as supporting the rulemaking, as if these studies were on point and above critique when in fact they are not.[10]
In sum, proxy access is bad public policy, unsupported by the empirical evidence, and the pet project of a powerful interest group. In other words, quack corporate governance.
[1] Fisch, supra note 603, at 19.
[2] Id.
[3] 802 A.2d 294 (Del.Ch. 2002).
[4] Id. at 310-11 (citations omitted).
[5] Id. at 310.
[6] Troy Paredes, Comm’r, Sec. & Exch. Comm’n, Statement at Open Meeting to Adopt the Final Rule Regarding Facilitating Shareholder Director Nominations (“Proxy Access”) (Aug. 25, 2010), http://www.sec.gov/news/speech/2010/spch082510tap.htm.
[7] Fisch, supra note 603, at 18.
[8] Cf. Stephen M. Bainbridge, Why a Board? Group Decision Making in Corporate Governance, 55 Vand. L. Rev. 1, 35-38 (2002) (discussing how trust and cooperation norms affect horizontal monitoring within the board).
[9] Ali C. Akyol et al., Shareholders in the Boardroom: Wealth Effects of the SEC’s Rule to Facilitate Director Nominations (Dec. 2009).
[10] Id.
