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Proxy Access

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. In 2009, the SEC again proposed to require proxy access in a new rule 14a-11. In response, it received about 700 comments. The comments were sharply divided on the merits of the proposed rule. Major corporations and their law firms opposed it, whereas institutional investors supported it. Congress weighed in with Section 971 of the Dodd-Frank Act of 2010, which amended section 14 of the Securities Exchange Act to give the SEC explicit authority to require proxy access. The SEC ultimately adopted a modified rule 14a-11 in 2010. In Business Roundtable v. SEC (2011), however, the D.C. Circuit struck down this new rule as "arbitrary and capricious" under the Administrative Procedure Act. Judge Ginsburg's opinion is noticeable for its hostility towards the SEC and its strict demands of cost-benefit analysis. The SEC seems intent on trying it again, but has not mustered the resources to do so yet.

Why might proxy access matter?: The shareholder collective action problem

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 materialswhich 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, 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 lose $500,000 (50% × $1m – 50% × $2m = -$500,000). Thus, 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 $48m (50% × $100m - $2m = $48m).

Variations in the bylaws or the charter

As usual, these default rules can be changed in the charter (cf. DGCL 102(b)(1)) or in the bylaws (cf. DGCL 109). Details of permissible bylaws were disputed, prompting the 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 can shareholders not use charter amendments for this purpose?). And SEC rule 14a-8 allows them to collect "votes" for such amendments using the corporation's proxy. Rule 14a-8(i)(8) excludes director nominations from 14a-8, but it does not exclude bylaw proposals relating to such nominations in subsequent meetings. In 2014/15, activist shareholders — in particular, New York City's Comptroller, responsible for the City's pension funds— used this route at dozens of US corporations, and many of these proxy access proposals passed.

A skeptical note: Why are proxy campaigns so costly?

It remains to be seen if any shareholders will actually use these new proxy access rights. As explained above, the idea is that proxy access will make it much cheaper for an activist to propose a candidate, and hence alleviate the collective action problem. But let's take a closer look at the costs, and whether proxy access really reduces them.

Traditionally, an important expense in running proxy campaigns was 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 corporations’ shares. But challengers still need to buy a lot of lawyer time to comply with SEC requirements and to 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 public relations firms. After all, the insurgent must compete with the board, who buys the same services (including litigation) with the corporation’s coffers. Costs for legal and other advice are rather independent of proxy access.

The Ideology of Proxy Access

If proxy access does not indeed reduce costs for “insurgent” shareholders, why would everyone fight about it? The answer is suggested by the following comment from Ted Mirvis of Wachtell, Lipton, Rosen, & Katz in response to the 2007 proposals:

“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.”

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December 07, 2017

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Holger Spamann

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