The American Federation of State, County and Municipal Employees (AFSCME) pension fund on Nov. 30 threatened to sue several corporations unless they amended their shareholder proxy rules.
AFSCME’s threat responded to a Nov. 28 Securities and Exchange Commission (SEC) ruling that restricted the “proxy access” of shareholders — particularly the right to place director nominees on corporate ballots. The decision was a major setback for shareholder rights advocates, who wish to hold management to account for poor earnings performance.
The SEC has recently devoted considerable attention to the issue of proxy access — allowing shareholders to place alternative independent nominees for director on a company’s proxy statement:
Institutional investors and legal experts believe that allowing for independent director nominations, as is the case with the proxy rules that apply in nearly all other industrialized countries, significantly improves a company’s corporate governance practices.
Having some influence over director selection is necessary for shareholders to be able to exercise meaningful oversight over corporate decision-making, and to hold directors and management accountable for corporate performance.
The passage last month of the “no access” measure by a 3-1 vote of the five-member Commission (one Democratic seat is unfilled) belied SEC Chairman Christopher Cox’s oft-expressed commitment to consensus rule-making. It has sparked a major backlash from many pension and hedge fund managers, shareholder rights advocates and labor groups.
Business seeks restrictions
Cox’s predecessor as SEC chairman, William Donaldson, attempted to reform the proxy process but saw those efforts blocked. Corporations, along with business groups such as the U.S. Chamber of Commerce that represent corporate interests, have argued that changing proxy rules to allow shareholders greater access would allow “special interests” such as pension funds and environmental advocacy groups to clutter up proxy statements and disrupt annual meetings with non-germane proxy proposals:
• Business-friendly shift. Cox endorses the concept of consensual rule-making that balances the interests of various parties. Yet the SEC has clearly shifted in a business-friendly direction during his tenure as chairman, and away from an investor-driven focus — whether of the individual or institutional variety.
• Congressional ire. Democratic politicians such as Rep. Barney Frank (Mass.), the chairman of the House Financial Services Committee, state pension fund spokesmen and shareholder rights advocates have all criticized the SEC’s move and called for new policies to improve proxy access and strengthen shareholder rights.
Crucial corporate governance rule
The new rule nominally clarifies the SEC’s long-standing interpretation of Rule 14(a) under the Securities Exchange Act of 1934. This rule allows a company to exclude from its proxy materials shareholder proposals relating to an election for membership on the company’s board of directors:
•Appeals court ruling. This interpretation had previously been thrown into doubt by a 2006 decision by the U.S. Court of Appeals for the Second Circuit in a lawsuit filed by AFSCME against AIG. The court held that AIG should not have excluded the AFSCME shareholder proposal under this rule because it did not relate to a specific election, but to “procedures for elections” generally. The court also found that if the SEC disagreed with this interpretation of its rule, the Commission needed to circulate a notice of proposed rule-making that set forth its alternative interpretation, and to take public comments and follow standard rule-making procedures.
• SEC response. The latest SEC action resurrects the rule’s status quo prior to the 2006 decision; that approach had been in place for 30 years. Cox maintains that SEC action was necessary before the 2008 proxy season begins, to promote clarity and reduce the potential for further litigation; he claims that more comprehensive attempts at proxy reform are still in progress. The rule will take effect 30 days after its publication in the Federal Register.
Further SEC action?
Cox has promised to revisit proxy rules in 2008, but to shareholder rights advocates, these pledges are wearing thin. The SEC has considered proxy rule changes for several years. The Commission appears to have been prodded by the Second Circuit’s decision to refine its interpretation of the rule in question (rather than by any greater concern to reform the proxy process).
Proliferating legal challenges
Cox’s rationale for the ruling, to restrict the scope of potential lawsuits during the 2008 proxy season, may have backfired:
• Shareholder lawsuits. AFSCME and two other plaintiffs have filed legal motions to compel Bear Stearns and JPMorgan Chase to amend their corporate bylaws so as to allow shareholders access to company proxy statements. These financial services defendants may try to block the motion by citing the SEC’s recent reiteration of its proxy disclosure rule; AFSCME now says that it is willing to litigate if it does not secure proxy access. Bear Stearns and JPMorgan Chase have reportedly been targeted by these significant shareholders because of concerns over whether they have appropriately disclosed and accounted for their sub-prime exposure.
• Supportive state authorities. Thus far, the New Jersey Division of Investments and the Office of the North Carolina State Treasurer have joined in the filing for proxy access with Bear Stearns, while the North Carolina treasurer has also filed for proxy access at JPMorgan Chase.
Cox’s SEC leadership
The circumstances under which the SEC adopted the rule, with one Democratic seat on the Commission vacant, leaving only four commissioners to consider the issue, raised questions about the agency’s even-handedness. These criticisms are somewhat misplaced, since even if another Democratic commissioner had been present and voted to reject the rule, a 3-2 majority would still have prevailed. However, Cox emphasizes a “consensus-based” approach to SEC decisions, which appears to have collapsed in the face of the proxy controversy.
Early last year, congressional Democrats raised the issue of whether measures to enhance shareholder rights might also promote the relative competitiveness of U.S. capital markets by reducing the demand for litigation by disaffected shareholders. Cox’s SEC failed to endorse this agenda, which has been swept aside by the more pressing concerns over the sub-prime mortgage crisis. Dissatisfaction over the latest proxy decision — and especially the manner in which it was undertaken — may reignite the debate over widening shareholder rights.
International competitiveness concerns
The inconsistency between the U.S. proxy approach, and the system in place in other industrialized countries, may no longer be sustainable given concerns that it may reduce the relative attractiveness of U.S. investments:
U.S. policymakers may need to go beyond last year’s overstated concerns that excess regulation was reducing the relative attractiveness of U.S. capital markets, and launch a more comprehensive re-examination of how to make U.S. investment policies welcoming to foreign investors.
“No-access” proxy rules that make it more difficult for shareholders to influence the governance of their own corporate holdings may make U.S. capital markets less attractive to international investors — particularly hedge funds and private equity groups.
Oxford Analytica is an international consulting firm providing strategic analysis on world events for business and government leaders. See www.oxan.com.