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The article below was published in Agenda, a Financial Times private subscription service for corporate directors, and is presented with permission.


Agenda, August 30, 2010 article


The week's news from other boardrooms




Article published on August 30, 2010

Reactions were mixed to the SEC’s approval last week of a proxy access rule, capping years of contentious debate over the issue.

Although on principle corporate directors and executives might not be thrilled with the new SEC mandate, they also might not have much cause for concern, at least not those at larger companies.

By a vote of 3 to 2, the SEC approved final rules that allow shareholders with at least 3% holdings for three years to nominate their own director candidates on the company ballot to replace up to 25% of the board.

For larger companies, the final rule is more corporate-friendly than the proposal, which had called for 1% holdings for one year at companies with a market capitalization over $700 million. For smaller companies with a market cap under $75 million, the holding requirement under the proposal was 5%. While the final rule is tougher on smaller companies, it provides for a three-year exemption period to weigh the impact of the proxy access rules on larger companies.

“Three years is definitely good for a public company — not as good as not adopting the rule at all, but the longer the better,” says Patrick Quick, a partner at Foley & Lardner.

Shareholder advocates had mixed reactions to the rule. While they were largely disappointed with the 3%-for-three-years restriction, they were happy to even be granted proxy access at all.

It will be challenging for activist investors such as public pension funds to meet the threshold requirement, explains Amy Borrus, deputy director at the Council of Institutional Investors. However, she says she doesn’t think it will be impossible.

Ricardo Duran, a spokesman at Calstrs, says that while it will be difficult to meet the 3% holding for three years in the large-cap segment of its portfolio, “Calstrs officials feel that it can be achieved.”

In an Aug. 12 letter to the SEC, several state pension funds illustrate the difficulties of meeting the 3% threshold, particularly with large-cap companies. The funds claim it would take 20 of the largest public pension funds that have stock in Goldman Sachs Group to hold in aggregate 2.88% of the company’s securities. What’s more, Calpers has released prior data showing the 10 largest public pension funds together hold less than a 2.5% stake at Bank of America, Microsoft, IBM and Exxon Mobil.

Lawyers say that because public pension funds are less likely to have the requisite holdings at large-cap companies, smaller and midsize companies are more likely to be targets of proxy access. Companies with a market cap under $75 million have a three-year reprieve from the new rules. SEC Chairman Mary Schapiro said changes to proxy access could be made in that time period depending on how the new rules play out at larger companies.

While hedge funds aren’t likely to meet the long-term holding requirements the proxy access rule requires, another type of investor that might be likely to use proxy access could be a disgruntled former executive who still holds a large amount of company stock, says Sanjay Shirodkar, of counsel at DLA Piper and former special counsel with the SEC. That scenario is also more likely to occur at smaller companies, he says.

Another possible, though perhaps unlikely, scenario is if a shareholder files a proxy access proposal that calls for an even less restrictive form of proxy access at a company. Last week, the SEC also voted to allow these types of proposals. However, a majority of shareholders would have to approve such a proposal and it would most likely be non-binding on the company.

Shareholders of companies that mailed their proxy statements for their last annual meeting no earlier than Feb. 20, 2010, will be eligible to submit director nominees for 2011 meetings. Shareholders that intend to submit a director nominee must provide the company with a 120-day advance notice from the anniversary of the company’s prior-year mailing of the proxy statement.

Legal Challenges Coming?

The SEC held off on determining a final proxy access rule until the Dodd-Frank financial reform bill passed, which gave the commission authority to draft federal rules governing director elections. Some legal scholars view this as a states’ right. Commissioner Kathleen Casey, who voted against the proxy access rule, said today that even though Congress gave the SEC authority, she thinks a legal battle is likely.

“I believe the rule is so fundamentally and fatally flawed that it will have difficulty facing judicial scrutiny,” Casey said.

Commissioner Elisse Walter countered by saying in her remarks, “I for one never doubted our authority… but I am quite pleased Congress clarified [it].”

The U.S. Chamber of Commerce is considering taking legal action against the new proxy access rule, says Tom Quaadman, vice president for the business group’s capital markets center. While Chamber officials believe Dodd-Frank protects the SEC on the state-versus-federal issue, the business group is considering challenging the new regulation on the grounds that the agency acted in an arbitrary and capricious manner when drafting the rules. The SEC doesn’t appear to have taken into account the opinion of the business community or other outside voices that were against a proxy access rule, says Quaadman.

The chamber has sued the SEC before and won. Shirodkar, the attorney at DLA Piper, says the case would probably go to the D.C. circuit court, which is known for sometimes deciding against the SEC. For instance, earlier this month, the D.C. circuit sent the SEC’s order approving the NYSE Arca ArcaBook fees rule back to the agency for further consideration because the SEC did not sufficiently explain the basis of its approval and did not support its conclusion with adequate evidence.


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