The Road to Proxy Access

The Road to Proxy Access ... If the stockholder is to regard himself as a continuing part-owner of the business in which he has placed his money, he must be ready at times to act like a true owner and to make the decisions associated with ownership. If he wants his interests fully protected he must be willing to do something of his own to protect them. This requires a moderate amount of initiative and judgment. Benjamin Graham and David Dodd, Securities Valuation, 1934 On April 14, 2003, the Securities and Exchange Commission (SEC) announced it would consider possible changes to proxy regulations “to improve corporate democracy.” The SEC would examine “procedures for the election of corporate directors,” and issue a report after consulting with “pension funds, shareholder advocacy groups, business and legal communities.” The resulting dialogue focused on “proxy access” — the idea that shareowners should be allowed to place their own board nominations on the proxies distributed by management, much as they are already allowed to place their own proposals on those proxies. New rules were expected to be in place by the 2004 proxy season. Eight years and three attempts later, we are still waiting. Last year, the SEC got as far as adopting: Rule 14a-11, which would require a minimum level of proxy access under specified circumstances. Amendments to Rule 14a-8, which would allow shareowners to submit access proposals company-by-company. The US Court of Appeals for the DC Circuit found the SEC "was arbitrary and capricious" in promulgating Rule 14a-11. The SEC has until September 9, 2011, to appeal the decision. Left standing, the decision could make it difficult to defend many Dodd-Frank Act rulemakings, since the three-judge panel took a very strict approach to the agency's analysis of costs and benefits. Changes to Rule 14a-8(i)(8) were not challenged but remain stayed by the SEC because related disclosure amendments were “entangled with” Rule 14a-11 changes. The Council of Institutional Investors urged the SEC to appeal the decision and to retain the stay of Rule 14a-8 “while the Commission considers the procedural issues raised by the Court.” Proxy access itself has wide support. The question is how it should be enabled — state-by-state, and within that, company-by-company using Rule 14a-8, or by a broad federal mandate, such as Rule 14a-11. Critical Years 1977-2011 In 1977 the SEC held a number of hearings to address corporate scandals. At that time, the Business Roundtable (BRT) recommended amendments to Rule 14a-8 that would allow shareowner bylaw proposals to provide for shareowner nominees to appear on company proxies. The BRT memo noted that such amendments … would do no more than allow the establishment of machinery to enable shareholders to exercise rights acknowledged to exist under state law. Soon, we saw several “private ordering” proposals. In 1980 Unicare Services included a proposal to allow any three shareowners to nominate and place candidates on the proxy. Shareowners at Mobil proposed a “reasonable number,” while those at Union Oil proposed a threshold of “500 or more shareholders” to place nominees on corporate proxies. One company argued that placing a minimum threshold on access would discriminate “in favor of large stockholders and to the detriment of small stockholders,” violating equal treatment principles. The California Public Employees’ Retirement System (CalPERS) participated in the movement, submitting a proposal in 1988 but withdrawing it when Texaco agreed to include their nominee. From 1942 to 1987 shareowner proposals under Rule 14a-8 were mostly viewed as ineffective. Prior to 1987, only two proposals had ever been approved. That year a proposal by Lewis Gilbert to allow shareowners to ratify the choice of auditors won a majority vote at Chock Full of O’Nuts Corporation and in 1988 Richard Foley’s proposal to redeem a poison pill won a majority vote at the Santa Fe Southern Pacific Corporation. In 1990, without public discussion or a rule change, the SEC began issuing a series of no-action letters on access proposals. The SEC’s about-face may have been prompted by fear that “private ordering,” through shareowners proposals, was about to begin in earnest. Tensions over this giant leap backward rose until AFSCME v AIG (2006). That case involved a 2004 bylaw proposal submitted by the American Federation of State, County & Municipal Employees (AFSCME) to the American International Group (AIG) requiring that specified nominees be included in the proxy.  AIG excluded the proposal after receiving a no action letter from the SEC and AFSCME filed suit.   The court ruled the prohibition on shareowner elections contained in Rule 14a-8(i)(8) applied only to proposals "used to oppose solicitations dealing with an identified board seat in an upcoming election” (also known as contested elections). The SEC subsequently adopted a rule banning proposals aimed at prospective elections but in 2010 adopted both a widely discussed federal mandate in Rule 14a-11 and less discussed amendments to Rule 14a-8(i)(8) to allow access through private ordering. What does the future hold? My own personal past offers perspective. Turning Point on the Road to Democracy On a 1987 trip to China, I met my wife’s uncle who was touring universities advising a gradual approach towards democracy. He cautioned students about that “funny period” when Red Guards broke his arms, thinking engineers weren’t needed to design or build dams. Tiananmen Square protests followed in 1989; knowledge, freedom and democracy were again repressed. In May 2002, I addressed an Asian Development Bank conference in Shanghai. Corporate governance in a post-Enron America, I argued, required greater democracy both at the top, in the accountability of boards and CEOs, and at the bottom, in the form of increased ownership and participation by employees. America too, had its democratic challenges. I told participants, one of our most sorely needed reforms was proxy access. As a sociologist, I had learned how labeling and socialization “harden” the objectivity of socially constructed worlds. We begin to see our institutions and laws as fixed, even though they are of our own making. Now, after expressing the need for reform to an audience half way around the world, I knew I should be making more of an effort to bring about proxy access at home. Two months later, I drafted a petition with Les Greenberg, who was largely responsible for the first Internet proxy campaign (at Lubys Inc.). That August 1, 2002 petition argued, “entrenched managers and directors will only improve corporate governance when they can be held accountable, e.g., voted out of office and replaced with directors chosen by shareholders.” Our proposal was summed up in one sentence: The intended effect of the suggested modifications is that the solicitation of proxies for all nominees for Director positions, who meet the other legal requirements, be required to be included in the Company’s proxy materials. Upon learning of our petition, a European investor told of his disappointment with how U.S. directors were elected. This is exactly how voting in communist countries worked. Everyone could vote, but there was just no choice of candidates. The point was not how to be elected, but how to get on the election list. With this system no changes were possible, so there was no motivation to improve the governance. According to the Council for Institutional Investors, our petition “re-energized” the “debate over shareholder access to management proxy cards to nominate directors and raise other issues.” Indeed, shortly thereafter, the SEC proposed a rule that began the current journey toward proxy access. Getting Proxy Access Right While the intervening years have seen modest improvements in corporate governance, proxy access is still needed. The first clause of the Magna Carta guaranteed “freedom of elections” to clerical offices of the English church to prevent the king from making appointments and siphoning off church revenues. Proxy access could have a similar impact on the governance of corporations. In most cases troubled companies have already lost substantial value by the time they face a contested board election. Costs for contests involving changes in control are generally estimated to range from two to four percent of firm value. Defensive measures often destroy more value. Takeovers and transitions back to profitability are expensive. There may also be heavy transaction costs to employees as well as communities. In contrast, the cost of proxy driven board transitions have run considerably below one percent, according to Patrick McGurn of Institutional Shareholder Services. In civil society, democratic transitions have long been recognized as preferable to war. Competition for board positions has traditionally stimulated share value. Firms with stronger shareowner rights have higher firm value, higher profits, higher sales growth, lower capital expenditures and fewer corporate acquisitions. Investors who bought firms with the strongest rights and sold those with the weakest rights would have earned abnormal returns of 8.5 percent per year, according to a widely cited study by Paul Gompers and Andrew Metrick.   Jill E. Fisch, a professor at the University of Pennsylvania Law School. recently wrote a paper, The Destructive Ambiguity of Federal Proxy Access. After examining the seventy-year history of efforts to obtain proxy access and offering a searing critique of SEC efforts, Fisch reaches a similar conclusion to our 2002 petition: The SEC should amend Regulation 14A to require the issuer to disclose, in its proxy statement, all properly-nominated director candidates… provide comparable disclosure in the proxy statement for all director candidates… require the issuer’s proxy card to give shareholders the opportunity to vote for any of the candidates included in the proxy statement… retain the recently adopted amendments to the election exclusion under Rule 14a-8 authorizing the inclusion of shareholder proposals concerning the process by which directors are selected. One of the major flaws in the SEC’s now vacated Rule 14a-11, according to the DC Court of Appeals panel, was its failure to fully analyze the cost of proxy access to companies. The Commission “did nothing to estimate and quantify the costs it expects companies to incur.” The Court cited comments from the Chamber of Commerce predicting that boards would incur substantial expenditures through: significant media and public relations efforts, advertising …, mass mailings, and other communication efforts, as well as the hiring of outside advisors and the expenditure of significant time and effort by the company’s employees. Yes, some companies will spend a fortune to keep their boards fully intact, like in 1991 when Sears budgeted $5.5 million over and above its normal proxy solicitation expenses to keep one board seat from Robert A. G. Monks. We have learned many lessons in the last twenty years. One is that half measures, such as changes to Schedule 14A in 2004, which requires disclosure of the disposition of recommended nominees from 5% shareowners or groups, make little difference. Any move forward should be based on four principles: a universal proxy, full access, low barriers to entry and full disclosure of costs. A universal proxy will increase the likelihood that no special interest, such as unions or entrenched managers, will “control” the board, since many shareowners will probably choose directors ala carte, rather than along “party” lines. An ironclad prohibition in Rule 14a-11 against its use to change control through ballot access was counter productive. Why have democracy if, by design, it can’t lead to fundamental change? Full access is needed to ensure changes in control can occur in a timely manner — before the value of the corporation erodes — and without the unnecessary expense of a solicited proxy contest. Elitist eligibility requirements, such as those contained in Rule 14a-11, which bar most individual and institutional investors, must go. Artificial barriers requiring a 3% holding for 3 years in order to place a nominee on the ballot are arbitrary and capricious, especially given the SEC’s longstanding requirement of $2,000 worth of shares held for one year to submit shareowner proposals under Rule 14a-8. To address concerns of the Chamber of Commerce and reduce the likelihood of excess spending, all candidates, including the board’s own nominees, should be required to file pre- and post-election estimates. There should be an accounting of all campaign expenditures, including in-kind contributions and those expended by corporations or other interested entities on behalf of candidates they support. Boards and management should support these principles. The more candidates appear on the ballot, the more likely it is that board nominated candidates will win, since opponents will be split — unless shareowners are forced to rally around specific nominees to deal with truly urgent situations demanding intervention. In such limited circumstances, routine access and increased shareowner dialogue will make needed transitions much less costly. Reflections on Freedom and Democracy Knowledge has surpassed machines and capital as the driving force behind the world economy. It has long been recognized that workers add value, especially if they own a stake in their company and are able to participate in meaningful decision-making. The same is true for shareowners. Social networking platforms will soon move shareowner forums well ahead of those envisioned by former SEC Chairman Christopher Cox to virtual deliberative bodies with consensus building mechanisms and the ability to transfer and compile unsolicited voting rights. The movement to more democratic forms of corporate governance by empowering owners is important not only for creating wealth; it cuts directly to our ability to maintain a free society. In the past, Americans balanced the power of big business with the countervailing force of unions and governments. Today, the power of unions has dwindled and prescriptive government regulation, while often necessary, is inefficient when compared to enforceable self-policing by boards and shareowners of their agents. Analytical argument and empirical research demonstrate the value of shifting from oligarchic corporate structures towards those that incorporate built-in systems of accountability. Corporations that embrace participatory democratic systems should be better equipped to create wealth, compete in global markets and solve the highly complex problems of the 3rd millennium by unleashing the wealth-generating capacity of “human capital,” which is based in the skills and knowledge not only of corporate managers but of boards, employees and shareowners alike. Since 1995, James McRitchie has published CorpGov.net, an online resource for news, commentary and transformation. As a business developer, board member and shareowner, he saw too much focus on symptoms, instead of fundamental norms and structures. He created CorpGov.net to help diversified long-term investors exercise their rights and responsibilities as owners.