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"A Consolation Prize Worth Keeping: An Analysis Of How The Amendments To Rule 14a-8 Intreract With Rule 14a-8 (i) (1)" by Stefan T. Akorli


A Consolation Prize Worth Keeping: An Analysis of How the Amendments to Rule 14a-8 Interact with Rule 14a-8(i)(1)
by Stefan T. Akorli

On September 6, 2011, Securities and Exchange Commission (SEC) Chairman Mary Schapiro announced that the Commission would not appeal Business Roundtable v. Sec. Exch. Comm'n, the decision that vacated the Commission's adopted Rule 14a-11. See 647 F.3d 1144 (D.C. Cir. July 22, 2011). That Rule would have required corporations to include their shareholders' board of director nominees in the corporation's proxy materials (meaning the corporation's proxy appointment forms and its proxy statement). See Press Release, U.S. Sec. Exch. Comm'n, Statement by SEC Chairman Mary L. Schapiro on Proxy Access Litigation (Sept. 6, 2011) (available at http://www.sec.gov/news/ press/2011/2011-179.html). The Chairman went on to announce that on September 13, 2011, adopted amendments to Rule 14a-8 would take effect. The Chairman explained that amendments to Rule 14a-8 would allow shareholders to do, on a corporation-by-corporation basis, what vacated Rule 14a-11 would have done for all corporations. Thus, the Chairman encouraged shareholders to look at the amendments to Rule 14a-8 as a consolation prize worth keeping.

It will become clear that shareholders of New York corporations should think twice about viewing the amendments this way: New York corporations might be able to exclude, by way of Rule 14a-8(i)(1), proposals for a by-law that (assuming shareholders' approval) would require the corporation to include shareholders' board of director nominees in the corporation's proxy materials. Using the arguments and counterarguments that a New York corporation seeking to exclude such a proposal and those that a shareholder seeking to include it might make regarding the applicability of Rule 14a-8(i)(1), one will see whether the amendments to 14a-8 are capable of providing, in the words of the Chairman describing the sought-after effect of vacated Rule 14a-11, "a meaningful opportunity for shareholders to exercise their right to nominate directors at their companies." Id.

(A brief detour for background information may be helpful to appreciate the possible impact of the 14a-8 amendments. While shareholders theoretically vote for and elect directors at the corporation's annual meeting, virtually no shareholders attend that meeting. Almost all shareholders vote by proxy. Before 14a-8's amendments, only the CEO-supported candidates' names appeared on the corporation-distributed proxy materials. Shareholders wanting to nominate directors generally had to make and distribute their own proxy materials, that is, engage in a complex and very expensive process. As a result of the complexity and cost, shareholders generally had no alternative to either voting for the CEO-supported candidates or not voting at all. See generally Lisa Fairfax, Government Governance and the Need to Reconcile Government Regulation with Board Fiduciary Duties, 95 MINN. L. REV. 1692, 1710 (2011); see generally ROBERT W. HAMILTON & RICHARD D. FREER, THE LAW OF CORPORATIONS IN A NUTSHELL 85-86 (6th ed. 2011).)

Amended Rule 14a-8 provides that a corporation must include a shareholder's proposal in the corporation's proxy materials unless one of the Rule's exceptions applies. 17 C.F.R. § 240.14a-8 (2011). Rule 14a-8(i)(1) provides an exception: a corporation may exclude a shareholder proposal from the corporation's proxy materials when "the proposal is not a proper subject for action by shareholders under the laws of the jurisdiction of the company's organization." Id.

A New York corporation seeking to exclude the shareholder's proposal might argue: the proper subject for shareholder action does not include management of the corporation--and the shareholder's proposal (assuming shareholders' approval) would manage the corporation. New York Business Corporation Law (NYBCL) §701 provides that "the business of a corporation shall be managed under the direction of its board of directors." N.Y. BUS. CORP. LAW § 701 (McKinney 2011). For the purposes of NYBCL §701, "Management means control, superintendence or guidance." Vogel v. Lewis, 268 N.Y.S.2d 237, 240 (N.Y. App. Div. 1966), aff'd 224 N.E.2d 738 (N.Y. 1967). The by-law that would result from the shareholder's proposal (assuming shareholder approval) would guide and control the corporation because the corporation would no longer be allowed to exclude shareholders from putting their board nominees in the corporation's proxy materials. Thus, it seems that the amendments to 14a-8 would not prevent the corporation from excluding the shareholder's proposal.

However, the shareholder might argue that NYBCL §701 does not state that only the board may manage the corporation. The shareholder might show that management decisions are not solely the province of the board by pointing out that, according to NYBCL §715(g), "[corporate] officers . . . shall have such authority and perform such duties in the management of the corporation as may be provided in the by-laws or . . . by the board." N.Y. BUS. CORP. LAW § 715 (McKinney 2011); See generally ROBERT W. HAMILTON & RICHARD D. FREER, THE LAW OF CORPORATIONS IN A NUTSHELL 83 (6th ed. 2011) ("Modern boards of large [public] companies are less about managing and more about overseeing. The actual management is done by officers").

The shareholder might also argue that NYBCL §601 states that "by-laws may be adopted, amended or repealed by a majority of the votes cast by the shares . . . ." N.Y. BUS. CORP. LAW § 601 (McKinney 2011), and that the by-laws, by their very nature, manage the corporation. See Storer v. Ripley, 139 N.Y.S.2d 786, 795 (N.Y. Sup. Ct. 1955), aff'd, 142 N.Y.S.2d 269 (N.Y. App. Div. 1955), judgment modified, 132 N.E.2d 87 (N.Y. 1956) (describing bylaws as "laws for the regulation of the business of the corporation."). Thus, shareholder proposals that would (assuming shareholders' approval) manage the corporation are not clearly impermissible.

Still, if there is not a limit on the extent to which by-laws may restrict NYBCL §701's decree that the board shall manage the corporation, then that decree might become meaningless. The extent to which shareholders may propose by-laws that (assuming shareholders' approval) manage the corporation is unclear; regarding New York Corporations' law, the following words of Professor Lawrence A. Hamermesh ring true:

[A]ttempts by stockholders to adopt by-laws limiting or influencing director authority inevitably offend the notion of management by the board of directors. However, neither the courts, the legislators, [nor] the SEC . . . have clearly articulated the means of resolving this conflict and determining whether a stockholder-adopted by-law provision that constrains director managerial authority is legally effective. CA, Inc. v. AFSCME Employees Pension Plan, 953 A.2d 227, 232 n.8 (Del.2008) (quoting Lawrence A. Hamermesh, Corporate Democracy and Stockholder-Adopted By-Laws: Taking Back the Street?, 73 TUL. L. REV. 409, 416 (1998)).

On public policy grounds, a New York court might might sensibly decide whether the corporation may exclude the shareholder's proposal. There are strong arguments for the shareholder and for the corporation regarding what decision would lead to a better outcome for New York citizens and corporations. For instance, the corporation might argue that a ruling compelling it to include shareholders' nominees will lead to undesirable results, including "the risk of an influx of special interest directors; the disruption and diversion of [corporate] resources that would accompany annual election contests; the risk of balkanized and dysfunctional boards; [and] the risk of deterring the most skilled men and women from serving on public company boards." Letter from Business Roundtable to Elizabeth M. Murphy, Secretary, U.S. Securities and Exchange Commission, SEC File No. S7‐10‐09 (Aug. 17, 2011).

The shareholder, on the other hand, might argue that, if the court does not allow the proposal, then shareholders wanting to nominate a candidate for the board must begin an expensive and complex proxy fight, which is neither practical nor prudent for most shareholders. See Lisa Fairfax, Government Governance and the Need to Reconcile Government Regulation with Board Fiduciary Duties, 95 MINN. L. REV. 1692, 1710 (2011) ("Evidence suggests that the costs and other logistical hurdles associated with waging a proxy contest makes it prohibitive for all but a small percentage of shareholders."). The shareholder might also argue that now is the time to remove impediments to competitive board elections, considering that the recent recession resulted from poor leadership by boards of directors. See Susanne Craig & Peter Lattman, Companies May Fail, but Directors Are in Demand, N.Y. TIMES, Sept. 14, 2010, http://dealbook. nytimes.com/ 2010/09/14/companies-may-fail-but-directors-are-in-demand/ ("a dramatic failure of corporate governance . . . was a central issue of the crisis," according to Chairman of the Financial Crisis Inquiry Commission). The shareholder might point out that the poor leadership was a predictable result of a flaw in board elections.

The flaw is that the corporation's chief executive officer (CEO) effectively handpicks the board of directors. See Lisa Fairfax, Government Governance and the Need to Reconcile Government Regulation with Board Fiduciary Duties, 95 MINN. L. REV. 1692, 1710 (2011); see also ROBERT W. HAMILTON & RICHARD D. FREER, THE LAW OF CORPORATIONS IN A NUTSHELL 85 (6th ed. 2011). Considering the CEO's role in picking directors and that directors value their membership, one might expect directors to acquiesce to the CEO. See Rakesh Khurana & Katharina Pick, The Social Nature of Boards, 70 BROOK. L. REV. 1259, 1278 (2005) ("[board] members have positive feelings toward their [board] and value the interpersonal rewards they get from membership"). Reports from the boardroom indicate that directors do just that. Professors Ronald Gilson and Reiner Kraakman observed that "[b]oard meetings are dominated by a management ethos of forced collegiality and agreement." Kelli A. Alces, Beyond the Board of Directors, 46 WAKE FOREST L. REV. 783, 799 (2011) (quoting Ronald J. Gilson & Reinier Kraakman, Reinventing the Outside Director: An Agenda for Institutional Investors, 43 STAN. L. REV. 863, 889 (1991)). Similarly, Professor James Fanto observed that "there is tremendous group pressure to go along with any proposal from the CEO that is echoed by the firm's professional advisers, even if a particular board member has different views about the proposal." James Fanto, Whistleblowing and the Public Director: Countering Corporate Inner Circles, 83 OR. L. REV. 435, 460 (2004). This power relationship does not bode well for the kind of board management or supervision of the CEO that entails, among other things, working long hours to understand, investigate, and ask tough questions about the CEO's business decisions. See Tamar Frankel, Corporate Boards of Directors: Advisors or Supervisors? 77 U. CIN. L. REV. 501, 510 (2008) ("As long as the CEOs . . . choose the proposed list of Board members on which shareholders are invited to vote, the Boards are not likely to become more [than minimally] supervisory").

If shareholders are able to nominate directors in the corporation's proxy materials, directors who hope to be reelected will probably acquiesce to the CEO less and supervise her more than they otherwise would. But see id. at 511 (highlighting the dangers of too much supervision); but see also Kelli A. Alces, Beyond the Board of Directors, 46 WAKE FOREST L. REV. 783, 792 (2011) ("[Directors] rely on . . . officers for the information they use to monitor. If the employee tells her employer why she is doing a great job and gives the employer the information needed to assess . . . , the boss cannot really make an independent judgment"). Tempering acquiescence and increasing supervision would likely help prevent egregiously bad business decisions like those that made failures out of many Wall Street corporations in recent years. See generally Shawn Tully, Wall Street's Money Machine Breaks Down, FORTUNE (Nov. 12, 2007), http://money.cnn.com/magazines/fortune/ fortune_archive/2007/11/26/101232838/ ("Investors are justly aghast that Wall Street ignored the obvious pitfalls.").

Neither New York statutes nor case law clearly indicates whether a shareholder may make a proposal that (assuming shareholders' approval) would allow shareholders to put their board nominees in the corporation's proxy materials. Nevertheless, because of public policy considerations -- specifically, because the shareholder's proposal would probably reduce the risk of egregiously bad business decisions and, hence, reduce the risk of another recession -- New York courts should allow the proposal. New York courts should help make the amendments to Rule 14a-8 a consolation prize worth keeping.

Stefan T. Akorli is a rising 3L at Washington University School of Law, where he is a member of Washington University's Kemper Art Museum student council. He has worked at Ghana's High Court (Commercial Division), in Accra, Ghana, and he counts entrepreneurship, golf, and Mandarin among his interests.

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This page contains a single entry from the blog posted on May 15, 2012 12:51 PM.

The previous post in this blog was "Alternative Dispute Resolution: How The Growth Of This Practice Has Led To A Drop In Litigation" by Francesca Altema.

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