This year, the hot topic in corporate governance is the rise of proxy access. Even as we speak, groups of activist investors are forcing companies to change the way they nominate and elect board members and are thereby poised to work a sea change in corporate governance. This article will define proxy access, discuss the regulatory status of proxy access proposals, and evaluate the proxy revolution’s likely affect on American companies.
What are Proxy Access Proposals?
In years past, companies have typically nominated their own candidates for seats on their boards of directors. But recently there have been signs of change, as activist shareholders at numerous companies have submitted ‘proxy access proposals.’ Those proposals aim to change company bylaws so as to provide shareholders with ‘proxy access’—i.e., the ability to directly nominate candidates for corporate board seats. Such measures usually limit the nomination right to shareholders that have owned or will own at least three percent of a company’s outstanding shares, for a period of three years.
Widespread proxy access would give pension funds, unions, and other institutional investors greater influence over the direction of U.S. companies. Pundits disagree as to whether that is a desirable development. Proponents of proxy access view direct nomination of board members as a way to effectuate more democratic and responsive corporate governance. Critics, however, are concerned that proxy access mechanisms might be used by special interests to pursue personal agendas and short-term profit, at the expense of long-term value creation.
How is Proxy Access Regulated?
The Dodd-Frank Act of 2010 provided the SEC with authority to create proxy access rules, in order to allow specified shareholders to directly nominate candidates for board seats. The SEC responded quickly and adopted a rule that would grant proxy access to investors holding at least three percent of outstanding shares for three years. But in 2011, the D.C. Circuit vacated that rule. Activist investors were thus left to fight for proxy access company by company, by offering and passing their own proxy access proposals.
Free from the SEC’s mandate, companies stymied proxy access proposals by refusing to present them to shareholders. In doing so, most made use of an SEC provision—Rule 14a-8—which permits companies to exclude a variety of shareholder proposals from their proxy materials, including any measure in direct conflict with one of the company’s own proposals to be submitted at the same shareholder meeting. Companies routinely blocked proxy access proposals with Rule 14a-8, by offering conflicting measures, and then—as required by law—submitting their intent to do so to the SEC. In most cases, the SEC would respond with “no-action” letters approving the move. Those letters were seen to provide companies with legal cover in the event that shareholders attempted to force the proposals through in court.
But in January 2015, the SEC abandoned the practice of issuing ‘no-action’ letters. The SEC withdrew one such letter it had given Whole Foods Markets, made a surprise announcement that a full review of the process had been initiated, and declared that it would not consider no-action requests under Rule 14a-8 in 2015. That decision has produced uncertainty as to the legitimacy of what had been a standard practice, and raised questions about the likelihood and merits of proxy access litigation. Today, all parties are eagerly awaiting the 3rd Circuit’s review of Trinity Wall Street v. Wal-Mart Stores, Inc., in which the District of Delaware required Wal-Mart to include a shareholder proposal in its proxy materials that the company had attempted to exclude under Rule 14a-8. The outcome of that case will cast a long shadow over future litigation, and until it is decided a great deal of uncertainty will continue to attach to proxy disputes.
The Future of Proxy Access
In recent weeks 14 companies—including corporate giants General Electric and Citigroup—have agreed to support proxy access proposals. Today, a powerful bloc of investors is pressing more than 100 other large companies to accept similar measures. Given these developments, many influential investors have argued that—regulatory uncertainty notwithstanding—proxy access is “no longer a question of ‘if’ as much as it is ‘when.’”
But while the proxy access revolution is unlikely to reverse course, there is disagreement as to the import of the coming change. While some believe that widespread proxy access presages a new era of investor activism, others cite estimates that “activists would rarely use access—and only in cases where companies have bigger problems on their hands.” As of yet it is unclear which prediction will prove accurate, because the territory is practically uncharted. What is clear is that going forward, investors will have greater influence over corporate boards at many companies. What remains to be seen is how they will use it.