September 14, 2006
Court Affirms Shareowner Right to File Resolutions on Proxy Access for Nominating Directors
by Bill Baue
The decision, which simply upholds existing rules that SEC practice had departed from, fills the
void left when the SEC proposed then abandoned a rule on proxy access for nominating directors.
Last week, seismic tremors significantly shifted the landscape of shareholder access to the proxy
for nominating directors, an issue that has calcified in the three years since the Securities and
Exchange Commission (SEC) proposed a rule then let it languish
unadopted. First, the Second Circuit Court
of Appeals issued its decision on American
Federation of State, County, and Municipal Employees Pension Plan v. American International
Group, denying AIG the right to exclude AFSCME's shareholder proposal seeking proxy
access to nominate directors. Two days later, SEC Chair Chris Cox directed the Division of Corporation Finance to draft a
rule to standardize nationwide application of the "town meeting rule"--14a-8(i)(8)--which guides SEC staff in
issuing no-action letters on election-related shareholder resolutions.
"This is the
fundamental issue in all of corporate governance and the defining character of the Exchange
Act--what rights do shareholders have to nominate and elect board members who reflect their
interests?" said Rich Ferlauto, director of pension and benefit policy at AFSCME. "Do shareholders
only have a right to disclosure, or do they have the right, under the Exchange Act and state laws,
to actually engage in an election that's run fairly and on an equal basis where shareholders really
have an opportunity to communicate with other owners on who the leadership of the company should
"In some ways, this decision can help bring a democratization of elections that
hasn't been there up until this point, and make capitalism more consistent with democracy," Mr.
Ferlauto told SocialFunds.com.
The SEC intends to present its proposal at an October 18
open meeting, leaving time for public commentary before a final proposal and rulemaking in time for
the 2007 proxy season. This announcement seems to emanate from the department of redundancy
department, as the SEC already expended significant resources on a rulemaking proposal on the issue
of shareholder access to the proxy for nominating directors, only to allow it to die on the vine.
"The statement last week didn't mention re-visitation of the 2003 proposal," John Nester,
SEC director of public affairs, told SocialFunds.com. He pointed out that the Corporation Finance
Division has yet to draft the recommendation, so it is not known what it will or will not include.
"The proposal in 2003 outlined a process by which shareholders could get greater access to company
elections; 14a-8 is not the same thing."
Well, yes and no. The rule in question does not
specifically concern shareholder access to the proxy for nominating directors, but the context in
which this rule amendment is being considered certainly does concern this issue, as the SEC
announcement makes explicit.
In the ruling, Circuit Judge Richard Wesley admonishes the
SEC for this same kind of willful separation of evident connections. The judge notes that the SEC
interpreted the town meeting rule one way from 1976 until 1990 (consistent with AFSCME's
interpretation), and then another way on an ad hoc basis thereafter (consistent with AIG's
interpretation), without giving reasons for the change. Furthermore, the amicus brief the SEC
filed for this case explaining its position elided this inconsistency, a fact that does not escape
the judge's notice.
"The amicus brief is curiously silent on any Division action prior to
1990 and characterizes the intermittent post-1990 no-action letters which continued to apply the
pre-1990 position as mere 'mistake[s],'" Judge Wesley states. "While we by no means wish to imply
that the Commission or the Division cannot correct analytical errors following a refinement in
their thinking, we have a difficult time accepting the SEC's characterization of a policy that the
Division consistently applied for sixteen years as nothing more than a 'mistake.'"
AFSCME's argument hinged on a single word: "an." The town meeting rule allows exclusion if the
resolution "relates to an election," not "elections," suggesting the rule was
intended to allow exclusion of resolutions meddling in specific contests, but not those addressing
election reform more generally. The ruling upheld this argument, requiring the SEC to apply this
standard from now on.
"This essentially creates a right of proxy access on a
company-by-company basis--now shareholder-nominated candidates could appear next to
director-nominated candidates on a corporate ballot if, and this is a very important if,
shareholders pass a binding bylaw amendment at a particular company," Mr. Ferlauto of AFSCME told
SocialFunds.com. "This would balance the power between shareholders, who have large burdens to
overcome to run independent nominees, and directors or nominating committees, who have the power of
the purse, if you will, and control over the proxy card when they're running candidates."
In a footnote, Judge Wesley notes the irony that the existing mechanism for filing resolutions
seeking proxy access for nominating directors upheld by the court is less restrictive than the 2003
proposal, which stipulates shareowners must hold over one percent of a company's stock. In other
words, the mere $2,000 threshold of share-ownership required for filing resolutions under the
standard process upheld in the court's decision makes it much easier to gain shareowner access to
the proxy for nominating directors than through the 2003 proposal.
"We and other
institutional shareholders are prepared to move ahead and use shareholder resolutions to create
proxy access at companies that are deserving--we're not going to wait for the SEC one way or the
other," said Mr. Ferlauto. "We would welcome the SEC revisiting the proposed rule that's
languished on the table for three years, but it's not necessary in order to enforce on a national
basis the decision of the Second Circuit, since that is where securities issues are litigated and
its decisions traditionally become the precedent nationally."