The bizarre law and economics of Business Roundtable v. SEC.

Author:Hayden, Grant M.

    Corporate shareholders elect their boards of directors. (1) They do not, however, use anything like a conventional ballot. Instead, shareholders fill out a "proxy ballot" delivered to them by the incumbent board. This proxy ballot lists only the incumbent board's chosen nominees, which are very often the same board members themselves. If a shareholder wants to run for director or propose another nominee for the board, she needs to provide all other shareholders with a separate proxy ballot. (2)

    Throughout the last decade, the Securities and Exchange Commission (SEC) has been at work developing a rule for allowing shareholders to have access to the corporate proxy ballot. (3) In 2010, the agency finally passed Rule 14a-11, which would have required corporations to put shareholder-nominated candidates on the company's own proxy ballot (as long as certain conditions were met). (4) The (2010) rule was the culmination of a process that included two previous incarnations, as well as legislation that specifically paved the way for the rule's creation. (5) Less than a year after its passage, however, the U.S. Court of Appeals for the D.C. Circuit struck down the law, holding that the SEC violated the Administrative Procedure Act (APA) by failing to consider the rule's costs and benefits adequately. (6) According to the court, the SEC's failure was so egregious that the Commission's decision to promulgate Rule 14a-11 was "arbitrary and capricious." (7)

    Other commentators have noted that the D.C. Circuit's opinion rests on an extremely muscular version of judicial review--one that contravenes the traditional deference to administrative authority. (8) Our concern, however, is with the court's misapplication of law and economics principles. The court's reasoning in Business Roundtable rests on flawed empirical and theoretical conclusions about proxy access and corporate governance. It ignores the benefits of facilitating shareholder democracy and focuses instead on costs that are routine for any functioning electoral system. As a result, its decision to strike down the regulation rests on a version of law and economics that contravenes the discipline's traditional principles and exacerbates agency costs.

    Rule 14a-11 is open to debate on grounds of policy. (9) But the Business Roundtable decision improperly sides with management by casting one side of the shareholder democracy debate as "arbitrary and capricious." It is, in fact, the court's opinion that uses economic and voting-rights principles in a capricious manner. Part II provides a brief overview of Rule 14a-11 and the Business Roundtable decision. Part III discusses the basic theory of voting rights and applies them to the shareholder franchise. Part IV explains how the D.C. Circuit misconstrued the dynamics of shareholder voting and the role of Rule 14a-11 in the process. Finally, Part V discusses the larger problem exemplified by the Business Roundtable decision--namely, the growing preference amongst some law and economics commentators for a Potemkin-Village version of shareholder democracy, one that undermines the very market principles that they purport to advance.


    The SEC's proxy access rule was not a lark; it was not a quick-draw policy change that came out of the darkness. Allowing shareholders direct access to the board's proxy ballot is, in many ways, an intuitive step. The proxy ballot is designed to look like an actual ballot--an instrument for casting one's vote in the election of directors. However, the proxy ballot is in fact simply an instruction to the board as to how one's shares should be voted at the annual meeting.

    The board decides the nominees to be placed on its own ballot and oversees its distribution. It is much more akin to a letter or request to the board, made on a form that the board has provided for that purpose, as to how the shareholder's shares should be voted at the meeting. (10) It is not a ballot. The actual election is conducted at the shareholders' meeting, and the proxy ballots are used to give the board that shareholder's proxy votes. If the shareholder was personally appearing at the meeting, she could vote her shares in person and would have no need for a proxy. For those who are absent, the company's proxy ballot is a way for the incumbent board to facilitate votes--but on the board's own terms. Thus, in order to run against the incumbent board and/or the board's designated replacements, an "insurgent" candidate must provide her own proxy ballots for distribution. If the shareholder is voting with the board, she turns in the board's proxy; if voting for the opposition, either the shareholder must show up and vote directly or she must provide her proxy to the opposition's designee.

    Because we are used to voting using a designated ballot, it is natural to confuse the proxy ballot with an actual one. This confusion is perhaps at the heart of the proxy access debates. Over time, the proxy ballot has been coopted by the government for various purposes. The proxy is generally accompanied by massive disclosures required by federal law; it includes votes over compensation packages and audit providers, and it provides shareholder access for independent referenda on questions relating to a variety of potential subjects. (11) The ballots are generally sent (via mail or the web) to an accounting or proxy firm, which collects and counts the proxies, much like an independent election. Because of these accoutrements, the proxy ballot looks a lot more like a part of an independent electoral process rather than a request to the board to vote for the board's nominees as provided on a board form.

    Less than a decade after the passage of the Securities Act of 1933, the SEC first considered proxy access for shareholders. (12) The proposal--debated internally--provided that "stockholders be permitted to use the management's proxy statement to canvass stockholders generally for the election of their own nominees for directorships, as well as for the nominees of the management." (13) Shareholders would have only been permitted to add an additional nominee for each seat; thus, the company could stop adding nominees once they were twice the number of positions. (14) The Commission did not formally act upon the idea. (15)

    Proxy access came up for consideration again in 1977 and 1992. In 1977, the SEC deferred on access in favor of supporting the work of board nominating committees; the Commission intended for these committees to consider shareholder candidates as well. (16) In 1992, the Commission opted to expand Rule 14a-4 (17) to allow shareholders to include board nominees on their "short-slate" proxy ballots. (18) This reform made it easier for shareholders to seek minority representation on the board by targeting certain board nominees out of management's entire slate. (19)

    Over the past decade, however, the SEC has pursued proxy access in earnest. The Commission proposed proxy access rules in 2003 as part of a broader suite of pro-shareholder reforms. Under the 2003 proposal, proxy access hinged on a triggering event: either a vote on a special Rule 14a-8 proposal subjecting the company to proxy access, or a 35% or more "withhold" vote for one of the company's directors. (20) Once triggered, shareholders with at least five percent of the voting securities, held for at least two years, would be entitled to nominate between one and three director candidates. (21) The proposal received numerous comments but, in the end, was never acted upon. (22)

    Three years later, the U.S. Court of Appeals for the Second Circuit held that a shareholder proposal under Rule (14) a-(8), to create proxy access for shareholder director candidates, was improperly excluded from a company's proxy materials. (23) The SEC had sided with the company, arguing that the proposal related to an election and was therefore excludable under Rule 14a-8(i)(8). (24) However, the court held that the exclusion only referred to proposals concerning a particular election, not those concerning procedural rules that apply to elections in general. (25) The AFSCME decision led to a period of some confusion in the proxy world, as the court had rejected the SEC's interpretation of its own rule. (26) Thus, the SEC either would be stuck with the Second Circuit's decision or would have to change the rule.

    The Commission, confronted with this legal fork in the road, essentially chose to explore both directions at once. In 2007, it released for comment two alternative proposals: a shareholder access proposal and a status quo proposal. Under the access proposal, the SEC would change Rule 14a-8(i)(8) to allow shareholders to submit proposals amending corporation bylaws that would give proxy access to shareholder nominees. (27) Only shareholders owning greater than five percent of a company's voting securities would be permitted to make proposals in the proxy materials affecting director nomination and election procedures. (28) The access proposal would allow such shareholders to offer whatever shareholder nomination procedures they desired in the proxy materials. (29) The only substantive limitations on such procedures would be those imposed by state law or the company's charter and bylaws. (30) The status quo proposal was a codification of the SEC's interpretation prior to the Second Circuit's overturning. (31) The effect of the status quo proposal would be to reverse the Second Circuit's decision in AFSCME and continue to permit corporations to exclude from proxy...

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