Enbar Toledano, Section 5 of the Voting Rights Act and Its Place in ?post-racial? America Jill E. Fisch, the Destructive Ambiguity of Federal Proxy Access

• Jurisdiction: United States,Federal
• Publication year: 2012
• Citation: Vol. 61 No. 3

THE DESTRUCTIVE AMBIGUITY OF FEDERAL PROXY ACCESS

Jill E. Fisch*

ABSTRACT

After almost seventy years of debate, on August 25, 2010, the U.S. Securities and Exchange Commission adopted a federal proxy access rule. The

1. Circuit promptly invalidated the new rule before it ever went into effect.

   This Article examines the ill-fated rule and concludes that, although the D.C. Circuit did not identify its flaws, the rule was ambiguous in its application and unlikely to increase shareholder input into the composition of corporate boards. More troubling was the SEC’s ambiguous justification for its rule, which was neither grounded in state law nor premised on a normative vision of the appropriate role of shareholder nominations in corporate governance.

   
   

   Although the federal proxy access rule in its current form is now dead, had it gone into effect, its practical significance would have been minimal. The SEC’s ambiguous approach to proxy access, an approach that significantly predates its adoption of Rule 14a-11, is particularly problematic because its rules continue to burden issuer-specific innovations in nominating procedures. The SEC has acknowledged this criticism but has refused to remove existing regulatory burdens.

   
   

   The core of the problem, as illustrated by the SEC’s experience with proxy access, is that federal regulation is poorly suited for regulating corporate governance. Private ordering offers a more flexible mechanism for maintaining equilibrium in the allocation of power between shareholders and managers. Absent federal regulatory interference, existing state law permits issuer-specific innovation regarding the shareholder role in nominating director candidates. This Article concludes by outlining the federal regulatory changes necessary to enable effective private ordering.

   
   

   * Perry Golkin Professor of Law, University of Pennsylvania Law School. I presented earlier drafts of this Article to New York University’s Topics in U.S. and Global Business Regulation seminar, the Brooklyn Law School Faculty Workshop, and the Center in Law, Economics, and Organization Workshop at the University of Southern California Gould School of Law, and received many helpful suggestions.

   INTRODUCTION 436

   1. THE HISTORY OF FEDERAL PROXY ACCESS 440

   2. THE FEDERAL PROXY ACCESS RULE 447

   3. JUSTIFYING FEDERAL PROXY ACCESS 452

      1. The SEC’s Explanation 452

      2. The Terms of Federal Proxy Access 457

      3. The Exclusivity of Federal Proxy Access 474

      4. Rationalizing Proxy Access 476

   4. PROXY ACCESS AND CORPORATE GOVERNANCE 483

      1. Proxy Access and Corporate Governance 484

      2. Federalizing Proxy Access 490

   5. AN ALTERNATIVE REGULATORY APPROACH 494

CONCLUSION 499

INTRODUCTION

Under U.S. corporate law, the shareholders elect the board of directors.1 In most cases, however, those shareholders do not nominate director candidates. Instead, the nominating committee of the board chooses a slate of candidates, and those candidates are submitted to the shareholders for approval.2 Absent the infrequent phenomenon of an election contest,3 shareholders do not participate in the nomination process.4

1. See, e.g., DEL. CODE ANN. tit. 8, § 211(b) (2001) (“[A]n annual meeting of stockholders shall be held for the election of directors . . . .”).

2. See Order Approving NYSE and NASD Proposed Rule Changes and Amendments Relating to

   Corporate Governance, Exchange Act Release No. 48,745, 68 Fed. Reg. 64,154, 64,177 (Nov. 4, 2003) (approving a New York Stock Exchange rule change requiring listed issuers to have an independent nominating committee).

3. See Lee Harris, Missing in Activism: Retail Investor Absence in Corporate Elections, 2010 COLUM.

   BUS. L. REV. 104, 120–21 (summarizing several reports on the frequency of contested elections and finding that, over the time period from 1996 to 2008, the number of contested elections at public companies averaged around thirty-six per year).

4. Election contests, in which a challenger files a separate proxy card and conducts an independent

   solicitation, generally involve a substantial shareholder that is either seeking control of the company or seeking, through board representation, to effect a change in corporate strategy. See CHRIS CERNICH ET AL., IRRC INST., EFFECTIVENESS OF HYBRID BOARDS 7–11 (2009), available at http://www.irrcinstitute.org/pdf/ IRRC_05_09_EffectiveHybridBoards.pdf (describing how hedge funds use partial board representation to attempt to change corporate strategy). Few election contests are premised on differences in directors’ personalities as opposed to the policies they propose to implement. Cf. Rosenfeld v. Fairchild Engine & Airplane Corp., 128 N.E.2d 291, 293 (N.Y. 1955) (distinguishing between election contests premised on policy disagreements and those based on personal issues).

   The Securities and Exchange Commission (SEC) has struggled for years to regulate the shareholders’ role in nominating directors.5 As early as 1942, the SEC proposed a rule that would have required issuers to include shareholder- nominated candidates in their proxy statements.6 Ultimately, the SEC abandoned the proposal. In the ensuing almost-seventy years, the SEC revisited the issue at least five times but failed to adopt a rule allowing proxy access.7

   
   

   Adoption of a shareholder nomination rule faced several obstacles. First, from the outset, the rule faced strong opposition from business interests. Indeed, measured by the number of comment letters, proxy access is, by far, the SEC’s most controversial rule-making initiative.8 Second, as the SEC

   refined the federal proxy rules in response to ongoing marketplace developments, the details of a proxy access rule became both increasingly important and impossible to perfect. Fundamentally, the SEC was unable to draft a proxy access rule that would satisfy everyone. Third, the D.C. Circuit

   
   

5. State corporation law, rather than federal securities regulation, is the source of any shareholder power to nominate director candidates. Since the 1930s, however, the federal proxy rules have regulated the procedures and disclosures associated with shareholder voting and the solicitation of proxies. See Jill E. Fisch, From Legitimacy to Logic: Reconstructing Proxy Regulation, 46 VAND. L. REV. 1129, 1130–31 (1993). Although the federal rules ostensibly do not modify shareholders’ substantive voting rights, as a practical matter, federal regulation has substantially limited the exercise of those rights. Id. at 1134 (“[T]he SEC has affirmatively impeded the effectiveness of the shareholder voting process . . . .”); Leo E. Strine, Jr., Breaking the Corporate Governance Logjam in Washington: Some Constructive Thoughts on a Responsible Path Forward, 63 BUS. LAW. 1079, 1087 (2008) (“[T]he use by stockholders of their state law rights had been stymied by the SEC itself . . . .”).

6. Securities Act Release No. 2887, Exchange Act Release No. 3347, Holding Company Act Release No.

   3988, Investment Company Act Release No. 417, 1942 WL 34864 (Dec. 18, 1942).

7. See DIV. OF CORP. FIN., SEC, 96TH CONG., STAFF REP. ON CORPORATE ACCOUNTABILITY 29–32

   (Comm. Print 1980) (describing task-force and public hearings on proxy access in the late 1970s); Facilitating Shareholder Director Nominations, Securities Act Release No. 9046, Exchange Act Release No. 60,089, Investment Company Act Release No. 28,765, 74 Fed. Reg. 29,024 (proposed June 18, 2009) (to be codified at 17 C.F.R. pts. 200, 232, 240, 249, 274) [hereinafter Proposing Release] (proposing a proxy access rule); Shareholder Proposals, Exchange Act Release No. 56,160, Investment Company Act Release No. 27,913, 72 Fed. Reg. 43,466, 43,472 (proposed Aug. 3, 2007) (to be codified at 17 C.F.R. pt. 240) (proposing a rule that would allow 5% shareholders to propose proxy access bylaw amendments); Security Holder Director Nominations, Exchange Act Release No. 48,626, Investment Company Act Release No. 26,206, 68 Fed. Reg. 60,784 (proposed Oct. 23, 2003) (to be codified at 17 C.F.R. pts. 240, 249, 274) (proposing a proxy access rule); Regulation of Communications Among Shareholders, Exchange Act Release No. 31,326, Investment Company Act Release No. 19,031, 57 Fed. Reg. 48,276, 48,288 (Oct. 22, 1992) (to be codified at 17 C.F.R. pts. 240, 249) (considering a universal ballot as part of proposed amendments to the bona fide nominee rule).

8. See Broc Romanek, Doing the Math: How Many Proxy Access Comment Letters This Decade?,

THECORPORATECOUNSEL.NET BLOG (Feb. 12, 2010, 7:50 AM), http://www.thecorporatecounsel.net/Blog/ 2010/02/math-of-comment-letters.html (stating that the SEC had received almost 52,000 comment letters on proxy access as of February 2010). It should be noted that many of these were duplicate or form letters. Id.

declared in its 1990 decision in Business Roundtable v. SEC that the SEC lacked the authority to regulate corporate governance through the proxy rules.9 A shareholder nomination rule was likely to raise a potential conflict with this holding and to trigger litigation seeking to invalidate the rule.10

When Congress authorized the SEC to adopt a federal proxy access rule as part of the Dodd–Frank financial regulatory reforms,11 it removed the last of these hurdles, clearing the way for the SEC both to adopt proxy access and, more importantly, to consider explicitly the corporate governance implications of increasing shareholder access to the proxy. Yet Rule 14a-11,12 the SEC’s proxy access rule, adopted on August 25, 2010, when the ink on Dodd–Frank was barely dry,13 was limited in scope and ambiguous in both its application and its justification. Indeed, once Congress authorized the SEC’s adoption of proxy access, the SEC’s most significant change to its prior proposals was to tighten the qualification requirements, sharply limiting the number of

shareholders that would be able to use the rule.

Although the SEC described the proxy access rule as “facilitat[ing] the rights of shareholders to nominate directors to a company’s board,”14 it failed to do so. The restrictive limitations on which shareholders qualify to use the rule...