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Bracewell in the News

Regulators Pushing Corporate Governance Rule Changes


September 24, 2009

In May the U.S. Securities and Exchange Commission proposed two changes to its existing proxy rules that would make it easier for shareholders to get their candidates considered for positions on boards of directors. The proposal, from which the SEC hopes to develop a final rule in November, marks the SEC's third attempt in the last six years to increase proxy access for shareholders.

And it may be the best chance yet to get the rule adopted, given the public mood toward corporations.

The SEC is not alone in moving quickly on corporate governance changes. Regulators ranging from the state of Delaware to Congress to the New York Stock Exchange all have taken the financial crisis and resulting recession and used them to put forth long-discussed changes in the way corporate boards do business.

"You have so many proposals, and the time periods continue to get shorter," said John Brantley, a partner in the corporate department at Bracewell & Giuliani LLP. "More and more is asked of people faster and faster, and it's a challenge for companies to keep up."

The NYSE changed its rules for brokers' voting rights. Congress is considering various iterations of mandatory say-on-pay provisions. And the state of Delaware, home to more than 60 percent of Fortune 500 companies, instituted its own rules at the beginning of August that implement much of what the SEC has proposed, but in an enabling, not mandatory, statute.

SEC Lights the Spark

By far, the proposals that have drawn the most heat are the two rule changes proposed by the SEC. One affects New Exchange Act Rule 14a-11 and would bar companies from stopping shareholders from including their board nominee in the company's proxy materials unless the shareholders were barred from doing so under existing state law or the company's bylaws.

The proposed change also sets stock ownership limits that a shareholder would have to reach in order to place a nominee into the proxy materials.

Investors would be able to combine their stakes in order to meet those thresholds, and a shareholder would have to hold the securities for at least a year before making a nomination and sign a statement saying he intends to hold the securities through the annual meeting at which the vote is taken.

A second proposed rule change, to Rule 14a-8(i)(a), says shareholders could require corporations to include shareholder proposals to amend their bylaws so they do not conflict with SEC rules.

"I believe that the most effective means of providing accountability - in a way that is both cost-effective and timely - is to ensure that shareholders have a meaningful opportunity to effectuate the rights that they already have under state law to nominate directors," SEC Chairwoman Mary L. Schapiro said at an open meeting of the agency, during which the proposed change was announced.

But it's not necessarily the proposed changes themselves that have corporations and the lawyers who represent them up in arms, several attorneys told Law360. It's that the changes would be mandatory.

"I think this may be an overreaction in terms of trying to impose this on corporations rather than allowing corporations to decide this for themselves," said Sanjay Shirodkar of DLA Piper and a former SEC attorney.

Delaware as Role Model?

Shirodkar and others pointed to the rules that took effect in Delaware on Aug. 1 as a model for more workable proxy access policies.

In April the Delaware Legislature passed two new statutes to its General Corporation Law. Section 112 would allow corporations to include shareholder nominees to boards of directors on proxy materials and establish their own guidelines. Section 113 would allow corporations to set up processes to reimburse shareholder groups successful in getting their director nominees elected.

The key to the Delaware rules, according to Edward P. Welch of Skadden Arps Slate Meagher & Flom LLP, is that they are enabling statutes. Companies don't have to set up increased proxy access if the shareholders don't want it, he said, and they can establish their own standards rather than the fixed standards of the SEC proposal.

"I have a hard time figuring out what's wrong with an enabling statute that says, 'do it your way,'" Welch said.

Indeed, Troy A. Paredes, a Republican SEC commissioner, opposed the commission's proposal on proxy access precisely because of its mandatory nature. He pointed to the evolution of corporate elections, with more than 50 percent of Fortune 100 companies moving over to majority voting for directors from plurality voting in recent years without any mandatory statutes.

"The virtue of private ordering is that it does not force all corporations into the same governance box," Paredes said in a speech to the U.S. Chamber of Commerce in late June.

"Instead, it fosters the value of allowing a company to tailor its internal affairs," he said. "In yielding to the unique circumstances of different companies, enabling corporate law expects firms to follow different paths to achieving best results for the enterprise."

Backers of the SEC approach, however, do see a problem with using an enabling statute versus imposing mandatory rules on corporations.

"I see that position as a clever way of opposing proxy access without coming right out and saying it," said Cornish F. Hitchcock of the Hitchcock Law Firm and outside counsel to the Council of Institutional Investors, which has applauded the proposed SEC rule change.

Hitchcock said the Delaware changes were a preemptive strike against the SEC, meant to give companies the chance to argue that they were putting their own proxy access rules in place without any mandatory federal rules.

Vineeta Anand, chief research analyst in the AFL-CIO's Office of Investment, called the new Delaware rules a "sham." She noted that the Delaware rules involve a two-step process for getting shareholder candidates on the ballot and a potentially high barrier to entry before a shareholder can get their candidates on the proxy ballot.

Already some law firms are advising corporations to set a threshold of 5 percent stockholdings before shareholders can get their candidates on the ballot, Hitchcock said.

"It is very difficult for shareholders to come up with such a large percentage of holdings," Anand added.

Still, Welch said, the SEC should wait and see how things go in Delaware before imposing rules on corporations.

"Corporation law has historically been the focus of the states," he said. "And this is a change, and the question is, before we get too radical, why not let 112 and 113 play out for a year, maybe two."

Anand had a different take. Under the Securities Exchange Act of 1934, she said, companies are required to have shareholder proposals on their proxy forms, subject to a list of conditions.

"They cannot withhold information from shareholders," she said. "They're required to have that in their proxies."

The SEC says it wants to have the new rules finalized in November and implemented for the 2010 proxy season.

Others Get in on the Act

Meanwhile, while institutional investors and corporations tussle over the future of proxy access, other regulatory bodies have been busy changing the rules for corporate governance. In July the SEC approved a change to NYSE Rule 452 that prevents its member brokers from exercising discretionary voting in all director elections.

According to Brantley of Bracewell & Giuliani, the elimination brokers' abilities to vote on behalf of their clients in board elections could make it significantly more difficult to reach a quorum in director elections. The rule will decrease the voice of retail investors in director elections as well and increase the power of institutional investors.

"More time and money is going to have to be devoted to get these people to vote," Brantley said.

And on its last day in session at the end of July, the House of Representatives voted to pass a bill requiring nonbinding say-on-pay shareholder votes and preventing directors on a company's compensation committees from having financial ties to the company or its other directors.

President Barack Obama has advanced say-on-pay in his broader financial regulatory reform package, and similar measures are moving through the Senate.

John Finley, a partner with Simpson Thacher & Bartlett LLP, said say-on-pay provisions already were becoming a part of corporate culture.

"There were say-on-pay proposals being pushed and being adopted prior to the financial crisis," he said. "It was a bit in its infancy, but it was moving along."