25 July 2011
On July 22, 2011, the U.S. Court of Appeals for the District of Columbia Circuit vacated Rule 14a-11, the Securities and Exchange Commission’s proxy access rule. Rule 14a-11 provided a means for shareholders to use a company management’s proxy statement and form of proxy to nominate directors and solicit votes for their election if certain conditions were met.1 The proxy access rule was scheduled to go into effect on November 15, 2010, but the SEC stayed the effectiveness of the rule after the Business Roundtable and the Chamber of Commerce of the United States petitioned the court for a review of the rule.
The court decided this case under the Administrative Procedure Act, which gives the court the power to set aside an action by a regulatory agency that is “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” The court agreed with the Business Roundtable and the Chamber of Commerce that the SEC “relied upon insufficient empirical data when it concluded that Rule 14a-11 will improve board performance and increase shareholder value by facilitating the election of dissident shareholder nominees.” For example, the court noted that the SEC’s prediction that directors might not oppose nominees “had no basis beyond mere speculation.”
The court asserted that the SEC had ducked “serious evaluation of the costs that could be imposed upon companies from use of the rule by shareholders representing special interests, particularly union and government pension funds.” The court also found that, in weighing the rule’s costs and benefits, the SEC “arbitrarily ignored the effect of the final rule upon the total number of election contests” and that the SEC’s discussion of the frequency of nominations under its proxy access rule was internally inconsistent. The court held that the SEC was “arbitrary and capricious in promulgating Rule 14a-11” and therefore vacated the rule.
Additionally, in its opinion, the court emphasized that because the proxy access rule is arbitrary and capricious on its face, “it is assuredly invalid as applied specifically to investment companies.” The court noted concerns of investment companies that were left unaddressed by the SEC, such as greater costs from disrupting unitary and cluster board structures and a lack of a net benefit from applying the proxy access rule to investment companies.
Because the court made its decision under the Administrative Procedure Act, the court did not address the First Amendment challenge to the rule raised by the plaintiffs.
The SEC now needs to decide if it will pursue further court action on its existing rule, establish a better administrative record to satisfy the Administrative Procedure Act deficiencies and/or draft a new proxy access rule. Given all the regulatory action on the SEC's schedule, it is possible that proxy access may not be implemented in time for the 2012 proxy season.
Meredith Cross, Director of the Division of Corporation Finance, has indicated that the SEC will be reviewing its options going forward. She noted that the SEC’s amendment to Rule 14a-8, which allows shareholders to submit proposals rather than director nominations for proxy access at their companies, and which the SEC adopted at the same time as Rule 14a-11, is unaffected by the court's decision. The SEC had stayed the application of its Rule 14a-8 changes pending the outcome of this court case. From Ms. Cross’s statement, it is not clear whether the SEC’s stay of the Rule 14a-8 amendments is still in effect or, if the stay has been lifted, when such amendments to Rule 14a-8 will become effective. Presumably the SEC will clarify its position on its Rule 14a-8 amendments shortly.
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