Thursday, September 2, 2010

A Breakdown of Proxy Access

On August 25, 2010, the Securities and Exchange Commission voted 3-2 along party lines to allow proxy access. The new rule is historically significant since the SEC has considered investors’ right to proxy access for over three decades. While ultimately this reform was a victory for shareholder activists, it certainly does not offer a golden ticket for a successful dissident proxy campaign.

The new rule will allow shareholders to nominate directors on corporate proxy materials alongside management’s nominees. With the goal being to encourage long-term investment, the SEC will grant proxy access only to a shareholder – or multiple shareholders – who have owned 3% or more of a given company’s shares continuously for at least the past three years (note: companies under $75M in market cap are exempt for three years). Interestingly, “[s]hareholders will not be eligible to use the rule if they are holding the securities for the purpose of changing control of the company”. Additionally, shareholders eligible to use this new rule may nominate no more than one nominee, or what is 25% of the number of a company’s directors – which ever is greater. Submission of nominees must be prior to 120 days before the anniversary date of last year’s mailing of the company’s proxy statement. Other stipulations include the following: eligible investors will be entitled to include a 500 word supporting statement for their nominee(s), companies may seek a "no action letter" to permit the company to exclude the nominee(s); priority is given to the largest shareholder (or shareholder group) in the instance of multiple shareholders proposing more than 25% of the board; nominees must satisfy the eligibility requirements of federal and state laws, as well as objective independence standards of the national security exchange/association rules applicable to the company; investors cannot borrow shares to meet the 3% threshold, however, investors who lend shares may count it toward the threshold so long as they recall the stock before the election.

In defending itself against a possible lawsuit by the nation’s largest business lobby, The Chamber of Commerce, SEC Chairman Mary L. Schapiro argued that the Dodd-Frank Wall Street Reform and Consumer Protection Act granted the SEC the authority to address the issue of proxy access.

Andrew Shapiro of Lawndale Capital Management, an activist hedge fund investor who invests primarily in micro cap companies, complained that the new rule doesn’t go far enough. He argues that small company boards should not be exempted from the rule since their shareholders, “having already lost corporate governance protections from various other small company exemptions… are most in need of proxy access to offset the more prevalent dysfunction found in small company board’s governance”. Conversely, The Chamber of Commerce and other corporate representatives have complained that labor unions and pension funds would use proxy access to force their will on companies, thus damaging companies’ ability to realize otherwise sound business objectives. The Chamber of Commerce has argued that proxy access grants “special interests the ability to hold the board hostage on narrow issues at the expense of other shareholders” and “[s]pecial-interest politics have no place in the boardroom”. They have pledged to fight the rule tooth-and-nail.

However, without a Court injunction, proxy access will effect companies mailing proxy materials to shareholders as early as March 2011.  The implications are far reaching for both investors who want to use access and corporations who find themselves on the receiving end. This means that companies, Wachtell, Lipton, Rosen & Katz recommend, place a “heightened emphasis on investor relations and [have] more strategic and tactical thought being devoted to corporate governance issues”. Corporate boards will need to hold management to greater accountability than ever before, and focus more on issues like community and labor relations, social responsibility, executive compensation, ethical standards, etc. – which have been the subject of much criticism by labor unions and pension funds. On the other side, shareholders will need to seek “long-term value [in] their investment [in order] to manage the proxy access regime responsibly”.

Posted by David Schatz