Proxy access has been the most contested corporate governance regulation for over a decade. Proxy access means the ability of shareholders to have one or more shareholder nominees included on the corporation's proxy card. In this millennium, the SEC first proposed formal rules dealing with proxy access in 2003 and 2007.
On the occasion of the 2007 discussions, Ted Mirvis of Wachtell, Lipton, Rosen, & Katz commented:
Wars have many fronts. The battle lines in the fight between the director-centric and the shareholder-centric models of the world now once again include the SEC, as it considers whether to allow shareholders to use a company’s proxy statement for director nominations.
Section 971 of the Dodd-Frank Act amended section 14 of the Securities Exchange Act to give the SEC explicit authority to require proxy access. In the 2009 release linked below, the SEC proposed to do so in a new rule 14a-11. In response, it received about 700 comments. The comments were sharply divided on the merits of the proposed rules. I here link two that are quite representative of institutional investors on the one hand (CalPERS), and major corporations and their law firms on the other (Wachtell).
The SEC ultimately adopted a modified rule 14a-11 in 2010. The Business Roundtable challenged the rule in federal court, leading to Business Roundtable v. SEC.
As you know, shareholders have the right to nominate director candidates and to solicit proxies to vote for them. But under the default rules, shareholders do not have the right to have these candidates included in the corporation's proxy materials, which are mailed and paid for by the corporation. (What about rule 14a-8?) Nor do shareholders have the right to be reimbursed for their costs of running their own proxy campaign (hundreds of thousands or even millions of dollars*). The board may reimburse a challenger's cost if the contest was about corporate policy rather than mere personnel issues. But realistically, no incumbent board will do so. The only practical way for a challenger to be reimbursed is to win control of the board.
Given these costs, shareholder opposition faces a considerable collective action problem. An activist shareholder would need to spend a lot of money to run a proxy fight, yet reap only a fraction of the returns.
Let’s look at the incentives in a simple numerical example. Imagine better management could increase the value of a corporation’s shares by $100m (say, from $1 billion to $1.1 billion). You own 1% of those shares. Your individual benefit from better management would hence be $1m. Let’s say a proxy contest would cost $2m.
If you win and replace the board, your candidates will vote to reimburse you. You will hence make a $1m gain because your shares are worth more with better management. But if you lose, you won’t be reimbursed and your shares’ value does not appreciate, and you are stuck with the $2m costs.
Imagine the chances of winning the proxy contest are 50-50 (in practice, that’s high – people tend to be suspicious of insurgents). In expectation, you would get 50% x $1m – 50% x $2m = -$500,000. You won’t do it. And this happens even though in this example (1) you own $10m worth of shares of this one corporation – a big stake for most investors, and (2) the expected collective benefit to all shareholders combined is 50% x $100m – $2m = $48m.
As usual, these default rules could be changed in the charter (cf. DGCL 102(b)(1)) or the bylaws (cf. DGCL 109). Details of permissible bylaws were disputed, prompting adoption of DGCL 112 and 113 in 2009 (read!).
Shareholders can use bylaw amendments to obtain the right to proxy access and/or to proxy expense reimbursement even against the opposition of the board (why don't charter amendments work without board approval?). And SEC rule 14a-8 allows them to do using the corporation's proxy. Rule 14a-8(i)(8) excludes director nominations from 14a-8, but it does not exclude bylaws relating to such nominations. In 2014/15, activist shareholders used this route at dozens of US corporations, and many of these proxy access proposals passed. It remains to be seen if any shareholders will actually use these new proxy access rights.
Traditionally, an important expense in running proxy campaigns were mailing costs. These seem relatively minor now that challengers can make their materials available electronically (cf. rule 14a-16(l)) or solicit only a small number of large institutional investors, who now hold a large fraction of most shares. But challengers still need to buy a lot of lawyer time to comply with SEC requirements and avoid fraud lawsuits under rule 14a-9. A successful campaign also tends to require lots of canvassing by proxy solicitors and campaigning with the help of PR firms. After all, the insurgent must compete with the board, who spends on the same services (including litigation) from the corporation’s coffers. These costs are rather independent of proxy access …EDIT PLAYLIST INFORMATION DELETE PLAYLIST
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|1||Show/Hide More||SEC, Proposed Rule: Facilitating Shareholder Director Nominations (2009)|
|2||Show/Hide More||Wachtell, Lipton, Rosen & Katz, Proxy Access Comment Letter (2009)|
Read only section I (pp. 1-7).
Here are brief explanations of some terms in section I.A. you may not be familiar with:
(1) rights plan: An anti-takeover device we'll study in the M&A part of the course.
(2) classified board: Here, this means what is also known as a staggered board: only a subset of directors is up for election in any given year. Cf. DGCL 141(d). Again, we'll study this more in the M&A part of the course.
(3) discretionary voting by brokers: Many shares are not held directly by the ultimate beneficiaries, but by intermediaries “in street name.” In “routine” matters, these intermediaries may vote the shares in their discretion if the ultimate beneficiary does not provide voting instructions. The memo refers to a recent change in the stock exchange rules removing director elections from the list of such “routine” matters.
(4) leverage: the ratio of debt to equity in a firm's capital structure.
(4) short slate: A list of director candidates with fewer candidates than open board seats.
|4||Show/Hide More||Business Roundtable v. SEC (DC Circuit 2011)|
Please do not read the court decision before we have covered the SEC release and the comment letters in class.
This decision vacated rule 14a-11. Pay close attention to the standard of review. How could you write 14a-11 or any other rule to pass this standard? Is it realistic to expect that?
January 28, 2016
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