A parting shot

While some passed Paul Atkins’ comments off as ‘sour grapes’ – he has been a vocal opponent of proxy access – the SEC commissioner raised several important points during his address this summer to the US Chamber of Commerce. Any attempt to revisit the shareholder access proposal and implement the ‘long release’ would be fraught with danger, Atkins said.

There is a widely held belief in some segments of the market that with a change of personnel at the top of the SEC, proxy access will be a foregone conclusion. Atkins suggested it would be illegal without putting the proposal out for further comment. ‘To the extent that some of you might have thought that consideration of the long release was finished, I’m afraid you may be mistaken,’ he told his audience.

Atkins pointed out that adoption of the long release could violate the Administrative Procedure Act and therefore be open to legal challenge. He specifically highlighted recent situations in which SEC rules have failed to stand up to legal scrutiny. ‘We’ve seen how SEC rules have crashed and burned over not comporting with [the procedural] statute,’ he said, noting previous ‘dubious assertions of authority’ by the agency.

States of awareness

Examples of recent rulemaking attempts that have since been overturned by state courts are a proposal to register hedge fund advisers and mandate independence of mutual fund boards. Business Roundtable also led action against the SEC regarding rule 19c-4.

‘The Business Roundtable case (AKA ‘one share, one vote’) should serve as a warning to the SEC about what it needs to do to ensure its rules are upheld by the courts,’ explains Patrick Daugherty, a corporate partner at Foley & Lardner. ‘Business Roundtable tried to warn the SEC that it did not have the authority to pass rule 19c-4.’ That 1988 rule against restricting shareholder voting rights was struck down in 1990 after Business Roundtable launched a suit against it.

‘What I find most interesting about the Atkins speech,’ says Richard Slavin, a partner at Cohen and Wolf, ‘is that he cited what has been happening in the development of state-level governance lawmaking, for example in North Dakota.’ The state implemented stricter shareholder protection laws during 2007 in an attempt to ingratiate itself with investors and possibly attract new corporate listings. ‘If states start passing their own rules on these matters then what weight will that carry in respect to the SEC and other federal rulemakers?’ asks Slavin, suggesting it could become a classic case of state law versus federal law.

Another wrinkle in the situation may be a state’s desire for increased revenue. If an instrument such as proxy access is seen as something ‘that allows hedge funds to become more active, then it could start to gain traction because states will be competing for hedge fund business,’ explains Slavin.

States’ displeasure with federal rules is nothing new. Take the example of the National Securities Market Improvement Act of 1996 (NSMIA), which is very unpopular with the states. ‘In some cases,’ explains Slavin, ‘[the states] have been looking for ways to undermine or circumvent it.

‘The biggest issue here is the [possible] preemption of state law. If states keep trying to undercut rules like 14a-8 [including shareholder proposals in the proxy] then Congress might be forced to act. This is something that happened in the 1990s with NSMIA.’

James Doty, a partner at Baker Botts, frames the turbulent discussions, ‘The Administrative Procedure Act is all about whether there was a fair opportunity for the rules to be influenced. Proposal 14a-8 is not new and has been well considered.

‘From a practical standpoint, it is likely the SEC will revisit proxy access soon. Both commissioners [Elisse] Walter and [Luis] Aguilar have expressed an interest in re-examining the issue. The problem is that chairman [Christopher] Cox has publicly stated that he wants unanimity among the commissioners before this proposal is adopted. That is not likely to happen but recent events may have softened his stand. And it may not matter anyway because Cox does not have a lot of time left at the Commission.’

So it is clear that the Commission is keen on revisiting the issue but adopting the proposal without further comment would lead to significant problems. Some experts believe that even with further comment the rule could still be vulnerable.

Daugherty states: ‘In my view, if the SEC were to adopt the ‘long version’ of the rule, with or without further comment, the courts would not credit its authority. It is important to remember that the SEC does not make laws. The SEC’s function is to set disclosure rules and they are significantly overstepping the mark by trying to go further than that.’

The right consistency

The courts uphold the rules and will occasionally look to the opinion of the SEC on matters of clarity or interpretation but they need to see some consistency in approach and interpretation or they will not credit the SEC’s interpretation. The rule would still be vulnerable even after further public comment because of the flip-flop, but it would be a little less vulnerable.

Many supporters hope the change in commissioners will lead to a rapid adoption of the rule, but Daugherty does not credit this argument: ‘Ours is a government of laws, not of men, so the fact that the government is going to change should not make a difference.’

Beyond the legal discussion there is a more basic, ideological argument: What level of control should shareholders have over corporate management?

Doty explains, ‘A number of Commissions have struggled with how the interests of shareholders can best be protected and what role, if any, they should have in the company.

‘You simply cannot have a corporate enterprise run under a situation where everything is put to the shareholders for a vote. It is just not practical and business has never been run that way in the past. Nothing would ever get done.’

Proxy access, if it ends up being adopted, would significantly change the balance of power that currently exists at companies between shareholders and board/management. Many individuals, especially within companies, feel that allowing too much influence by investors over the day-to-day operations of a company is a dangerous thing. Former SEC commissioner Philip Lochner recently warned that that the agenda of money managers, people who run public pension funds and other institutional investors may have political themes and are often not interested in the maximization of shareholder returns.

Daugherty concurs: ‘This will be yet another weapon for activists with personal or political agendas to highjack the director nomination process.’

It is impossible to fully resolve the competing interests of shareholders, the board and management. Someone will always be unhappy with the outcome. All that can be done is to find a workable balance between all interests.

Yet Daugherty believes that the attitude that presently prevails at the SEC has served to destabilize US companies. ‘Are we really protecting the rights of shareholders if we are undermining the operation of public companies? Institutional shareholders don’t need more help. In fact it could easily be argued that they should be constrained.’