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Court Gives SEC an F for Proxy-Access Job Not So Well Done

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A nice thing about being a director of a U.S. public company is that, if you're nominated for re-election, you can't lose. Not, like, "incumbents have an advantage": you actually can't lose, and as long as one share votes for you you'll be re-elected even if everyone else votes against you. (That's been changing a bit but still largely true.) You might not get re-nominated, say if you insider trade or just piss off Ken Griffin, but once the board nominates you you're pretty much set.

The only way to get actually voted out is if a shareholder mounts a proxy contest, mailing proxy cards to all other shareholders to try to get their own nominees elected. That's expensive enough that it normally only happens in hostile M&A situations, or when boards are really exceptionally screwing up.

The SEC has been trying for some time to put in place a "proxy access" rule, which would allow shareholders to nominate director candidates on the company's proxy card, without going to the expense of a proxy fight. Companies are less jazzed about this. So they've sued, again and again, to stop the SEC, and so far they've succeeded.

Today they won again, as the D.C. Circuit today struck down the latest SEC proxy access rule, saying:

We agree with the petitioners and hold the Commission acted arbitrarily and capriciously for having failed once again — as it did [twice before] — adequately to assess the economic effects of a new rule. Here the Commission inconsistently and opportunistically framed the costs and benefits of the rule; failed adequately to quantify the certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments; contradicted itself; and failed to respond to substantial problems raised by commenters.

We're pretty sympathetic to proxy access and find it odd that the securities laws make it impossible for anyone to run for the board of directors of a company without an expensive proxy fight. But the SEC's Rule 14a-11 wouldn't have done much for what we typically think of as "activist investors," institutions who want to trigger a sale or a major change in corporate strategy. Investors nominating directors under the rule must have held their stakes for at least 3 years, can't be seeking a sale of the company or control over the board, and can only nominate up to one quarter of directors. So the rule is basically intended to let you nominate one annoying guy to come to board meetings and say "what about the shareholders? won't anyone think of the shareholders?"

Actually that guy probably won't be thinking mainly about the shareholders. Instead, as the court explains:

The petitioners next argue the Commission acted arbitrarily and capriciously by “entirely fail[ing] to consider an important aspect of the problem,” to wit, how union and state pension funds might use Rule 14a-11. Commenters expressed concern that these employee benefit funds would impose costs upon companies by using Rule 14a-11 as leverage to gain concessions, such as additional benefits for unionized employees, unrelated to shareholder value.

In practice, it seems unlikely that shareholders would vote for the pension plan nominees, because they're heartless bastards, but the court apparently worried that just the expense and stress of telling shareholders to vote against the nominees would be too much for public companies to bear.

The SEC is kind of boxed in here because the court held them to a high standard of finding empirical evidence that the benefits of the proxy access rule for shareholders outweigh its costs to companies. (A standard that is puzzlingly irrelevant to most other securities laws, but whatevs.) And it's going to be tough for them to prove that - because the Business Roundtable can commission lots of studies showing the costs, and on the other side there's probably not that much empirical evidence that letting union pensions bluster about benefits in corporate proxies helps shareholders.

Where there is tons of evidence is that value-focused activist investing can create positive returns (e.g. this, this). And there's a real case that making it easier for the Icahns and Ackmans of the world to replace incompetent boards would actually be good for other shareholders.

Since Rule 14a-11 doesn't do that, the D.C. Circuit is probably right that it fails the cost-benefit test. But while corporations would hate a much stronger proxy access rule that actually let activists do some damage, such a rule could potentially have real and quantifiable benefits to shareholders. It won't happen, but we'd love to see what the court would do if the SEC came back with a rule like that.

Investors Lose Power for Ousting Directors [WSJ]

Business Roundtable v. SEC


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