On July 22, 2011 the D.C. Circuit struck down an SEC regulation (Rule 14(a)-11) that would have required publicly traded companies to allow qualified shareholders to propose nominations in Board of Directors (BOD) elections. The court held that the SEC failed to perform a required cost/benefit analysis of the new provision, as mandated under Section 3(f) of the Exchange Act and Section 2(c) of the Investment Company Act of 1940. Consequently, Rule 14(a)-11 was declared invalid and unenforceable.
Before the SEC proposed the final version of 14(a)-11, Delaware preemptively proposed and implemented its own law regarding shareholder nominations for BOD elections: DGCL 112. A critical difference between the Delaware law and the SEC proposal is that DGCL 112 does not require that Delaware corporations allow qualified shareholders to nominate candidates in BOD elections, but rather provides that qualified shareholders can be given the authority to nominate candidates if such a provision is adopted in the company’s bylaws. Additionally, Section 112 does not make shareholder nominations of BOD members the default rule, as the procedure must be proactively adopted in the bylaws. Rule 14(a)-11 would have made it mandatory for all publicly traded companies to allow qualified shareholders to nominate candidates in BOD elections (and would have superseded DGCL 112, but for being struck down).
The SEC has stated that it will not appeal the D.C. Circuit’s decision, and many believe the SEC will not attempt to propose and pass the same regulation again in the future, given the current political environment as well as the numerous other commitments the SEC must devote its time and energy towards. The Business Roundtable, who brought the lawsuit against the SEC that was ultimately successful, applauded the D.C. Circuit’s decision as a necessary reinforcement of the culture of regulatory restraint embodied by provisions such as Section 3(f) of the Exchange Act and Section 2(c) of the Investment Company Act of 1940.
The elimination of Rule 14(a)-11 deprives shareholders of publicly traded corporations a significant means of combating Board entrenchment. Many scholars and market observers have spilled a great deal of ink discussing the conflict of interest that exists between the owners of the corporation (shareholders) and its directors and officers that manage the company. Many judicial decisions and doctrines have centered on this issue and provided shareholders with means of legal redress where self-dealing or dereliction of duties is most obvious. However one cannot help but look upon the death of 14(a)-11 as a major missed opportunity in corporate governance, a moment when shareholders could have gained a greater say in the management of companies without being entangled in the day-to-day affairs of the company. The looming risk of being contested in an election may have provided BOD members with a strong incentive to make decisions that would truly maximize shareholder value (such as authorizing dividends rather than share repurchases or corporate “empire building”). At the same time, perhaps the failure of 14(a)-11 was a blessing in disguise, as “democracy” is not always an efficient means to profit generation and rational ignorance could have resulted in deleterious turnover in BOD’s.
Once a significant number of companies make DGCL 112 elections, it may be possible to determine the effects that shareholder nominations in BOD elections have on corporate governance.
I think this was a good thing. The Court should have acted quicker.