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Proxy Access Rule Vacated

July 22, 2011

 

On July 22, 2011, the U.S. Court of Appeals for the District of Columbia Circuit ruled the U.S. Securities and Exchange Commission “was arbitrary and capricious” in promulgating Rule 14a-11 under the Securities Exchange Act of 1934 and vacated the rule. The decision to vacate Rule 14a-11, which would have mandated a “proxy access” process for U.S. public companies, creates significant uncertainty as to the future of federally-mandated proxy access and the ability of shareholders to seek to implement proxy access at public companies.

Background

On December 14, 2009, the Commission proposed significant revisions to the federal proxy rules that would require public companies to include shareholder director nominees in their proxy materials, including new Rule 14a-11 and amendments to Rule 14a-8 (relating to shareholder proposals required to be included in a company’s proxy materials). On August 25, 2010, the Commission adopted the following proxy access rules, the first of which was struck down by the Court of Appeals today:

  • New Rule 14a-11. Under Rule 14a-11, a shareholder or group of shareholders who has held 3% of a company’s outstanding stock for three years would be able to nominate directors to the company’s board and have their nominees included in the company’s proxy materials, subject to certain eligibility and notice requirements as well as the requirements of the company’s governing documents or applicable state law.
  • Amendments to Rule 14a-8. Under amended Rule 14a-8(i)(8), a shareholder would be able to submit a proposal for inclusion in a company’s proxy materials that relates to the right of shareholders to nominate directors or other disclosure or procedural matters concerning that nomination right (including the creation of a company-specific “proxy access” process), so long as the proposal does not conflict with applicable law.

These rules were scheduled to become effective November 15, 2010 and apply to the proxy materials of any public company that mailed its proxy materials for its last annual meeting after March 15, 2010.

Industry Groups Seek Judicial Review

On September 29, 2010, the Business Roundtable and the Chamber of Commerce of the United States of America (the “Petitioners”) sought review and a stay of effectiveness of Rule 14a-11. Fearing unnecessary costs and regulatory uncertainty if the Petitioners’ suit was still pending when the proxy access rules became effective, the Commission issued a stay of both proxy access rules on October 4, 2010.

The Petitioners alleged that Rule 14a-11 was arbitrary and capricious in violation of the Administrative Procedure Act and that the Commission had failed to assess the Rule’s effect on efficiency, competition, and capital formation, as required by law. In particular, the Petitioners expressed the view that Rule 14a-11 would result in high costs and adverse consequences for companies while contradicting existing state law, undermining shareholders’ ability to shape proxy access on a company-by-company basis, and violating the First Amendment by forcing companies to carry and fund election speech by special interest candidates.

The Court of Appeals Vacates Rule 14a-11 for Violating the Administrative Procedures Act

In a particularly strongly-worded decision issued today, the Court of Appeals vacated Rule 14a-11. In its decision, the Court stated:

"We agree with the petitioners and hold the Commission acted arbitrarily and capriciously for having failed once again — as it did most recently in American Equity Investment Life Insurance Company v. SEC, 613 F.3d 166, 167–68 (D.C. Cir. 2010), and before that in Chamber of Commerce, 412 F.3d at 136 — 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. For these and other reasons, its decision to apply the rule to investment companies was also arbitrary."

In addition to vacating Rule 14a-11, the decision provides an extensive discussion of the process that is necessary for the Commission to satisfy the Administrative Procedures Act and its obligation under the federal securities laws to consider efficiency, competition, and capital formation in its adoption of new rules.

Possible Next Steps Regarding Proxy Access and Shareholder Proposals

The Commission must now determine whether to appeal the decision of the Court of Appeals, re-propose a proxy access rule, or determine not to go forward with a Commission-mandated proxy access process. Should the Commission determine to undertake new rulemaking or appeal the decision, the amount of time necessary to complete either process makes it extremely unlikely that there would be a Commission-mandated proxy access process in place for the 2011-2012 proxy season. Regardless of its determination regarding Rule 14a-11, the Commission may choose to take action to permit “private ordering” of proxy access at public companies by lifting its stay of the amendments to Rule 14a-8(i)(8). Such an action would clear the way for eligible shareholders to submit proposals for inclusion in a company’s proxy materials that seek to create a proxy access process at that company. In this regard, Meredith Cross, Director of the Commission's Division of Corporation Finance issued the following statement:

"We are disappointed by today's decision striking down a rule that made it easier for shareholders to nominate a candidate to a company's board of directors. We are considering our options going forward. We note that our rule allowing shareholders to submit proposals for proxy access at their companies, which we adopted at the same time, is unaffected by the court's decision."

Should the Commission lift its stay of the amendments to Rule 14a-8(i)(8), public companies will need to prepare to address these types of shareholder proposals in the coming proxy season. 

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For questions regarding this alert or the proxy access rules, please contact the authors or your O’Melveny & Myers advisor.