Shareholder Access and the Uneconomic Economic Analysis: Business Roundtable v. SEC (Part 8)

The court also found the SEC’s analysis deficient because it did not discuss the use of access authority by “[s]hareholders with Special Interests.”  In effect, the SEC was supposed to discuss the use of access by unions to induce concessions outside of the shareholder context, specifically with respect to wage negotiations with public companies.  Specifically, the Commission was faulted for failing to respond: 

• to comments arguing that investors with a special interest, such as unions and state and local governments whose interests in jobs may well be greater than their interest in share value, can be expected to pursue self-interested objectives rather than the goal of maximizing shareholder value, and will likely cause companies to incur costs even when their nominee is unlikely to be elected.

The SEC received at least 600 letters.  It is not required to discuss every letter or every point, only those necessary to make a rational decision with respect to the rule under consideration. 

The contention that unions will use shareholder access to induce wage concessions has no significant empirical support.  It is true that those opposing shareholder access have worried that this will occur but there is no meaningful evidence that in fact it has occurred.   

This can be seen from the opinion of the DC Circuit.  While the court noted that commentators had raised this issue, the only authority cited (beyond the letter making the comment) was a quote from a single law review article written by a Chancellor in the Delaware Chancery court.   The quote did not relate to access but was a statement demonstrating that different shareholders had different potential interests.  In other words, the opinion contains not one actual example of unions using corporate governance authority as a mechanism to advance wage negotiations. 

But there is a far greater problem with the court’s requirement than the entirely speculative nature of the “cost.”  The court is presupposing that unions (and to a lesser extent public pension plans) will violate their fiduciary obligations to their pension plan beneficiaries.  The assumption is that unions will use the threat of access not to act in the best interests of their beneficiaries but to benefit union members to obtain wage concessions. 

Presumably this means that at least sometimes unions are expected to forego access when it is in the best interests of beneficiaries in order to benefit its membership.  In other words, the court faulted the SEC for not assuming that unions would violate the law and assessing the costs associated with the violation.  

The court cited no authority for the proposition that an agency, in adopting a rule, must assess speculative costs that depend upon a violation of the law.  To describe the SEC as irrational for not having done so is a legal principle too far. 

For more thoughts on the court's opinion in Business Roundtable, see Shareholder Access and Uneconomic Economic Analysis: Business Roundtable v. SEC.  Primary materials on the case, including the relevant briefs, can be found at the DU Corporate Governance web site.

Shareholder Access and the Uneconomic Economic Analysis: Business Roundtable v. SEC (Part 7)

The court in Business Roundtable also faulted the Commission for relying "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.”  

In drawing the conclusion, the court made it sound as if the SEC looked at only two sets of studies, those showing that the presence of dissident directors harmed firms and those showing that their presence benefited them.  The court then characterized the SEC’s approach as unprincipled.  The negative studies were “entirely” discounted while the SEC relied “exclusively and heavily” upon the positive studies, despite the presence of methodological flaws.  See Id.  (“Indeed, the Commission ‘recognize[d] the limitations of the Cernich (2009) study,’ and noted ‘its long-term findings on shareholder value creation are difficult to interpret.’"). 

This does not accurately capture the discussion of the data contained in the SEC’s release.  First, the Commission was up front about the division in the evidence.  Id.  (“The comments reflect the sharp divide on the question of whether facilitating shareholders' ability to exercise their rights to nominate and elect directors would lead to the benefit of improved board and company performance.”).  

Second, the Commission did not rely “exclusively” on the positive studies.  The Commission relied on numerous studies that showed that that “facilitating shareholders' rights and voice may result in better company performance.” 

Third, with respect to a study on hybrid boards that showed positive performance, the Commission noted the methodological limitations and characterized its value not as definitive but as “relevant.”   Moreover, the Commission pointed to other studies that supported the conclusions.  See Id. at n. 922 (“Other commenters adduce evidence that boards with a minority of dissident directors produce positive changes in corporate governance structures and strategy and result in increased shareholder value measured in both absolute returns and relative to peers.”). 

Finally, as to "entirely" discounting the negative studies, the Commission mentioned at least seven studies by name (see n. 926) and discussed the reasons why the conclusions were not sufficient to change its views with respect to access.

In other words, the Commission considered both sides of the argument, looked at both sets of studies, analyzed the data and came up with a reasoned conclusion.  While it is clear that some disagree with the analysis, the legal standard is irrationality.  The analysis employed by the Commission is not even remotely close to that standard. 

For more thoughts on the court's opinion in Business Roundtable, see Shareholder Access and Uneconomic Economic Analysis: Business Roundtable v. SEC.  Primary materials on the case, including the relevant briefs, can be found at the DU Corporate Governance web site.

Shareholder Access and the Uneconomic Economic Analysis: Business Roundtable v. SEC (Part 6)

The court suggested that the board had an obligation to resist access candidates.  The presumption was that the board's nominees were superior and, as a result, the board had a substantive obligation to resist inferior nominees.

The point is an interesting one that would ultimately backfire on most boards.  The duty suggests that if shareholders submit nominees who are superior to the board's nominees, the board has a fiduciary obligation to support the shareholder nominees.   

While as a practical matter, the board will always take the position that its candidates are superior, there are likely to be instances when this will be objectively untrue.  Boards can include actors or sports figures or family members.  It would not be particularly difficult for shareholders to nominate candidates that are more qualified than some of these nominees. 

The analysis in Business Roundtable suggests that the board had a fiduciary obligation to resist the inferior nominee.  To the extent shareholders submit the superior nominee, the board's decision to favor its own candidate would, under the DC Circuit's view, violate the board's fiduciary obligations.  This looks like a roadmap for challenges to the board whenever this occurs. 

For more thoughts on the court's opinion in Business Roundtable, see Shareholder Access and Uneconomic Economic Analysis: Business Roundtable v. SEC.  Primary materials on the case, including the relevant briefs, can be found at the DU Corporate Governance web site.

Shareholder Access and the Uneconomic Economic Analysis: Business Roundtable v. SEC (Part 5)

We noted that the DC Circuit found fault with the SEC's conclusion that the board would not always resist an access challenge.  The court did so by characterizing the board's fiduciary obligations as substantive.  In fact, the duty of care is process driven.  As long as the process is proper, the board can decide to resist or not resist an access challenge.

In incorrectly characterizing the board's fiduciary obligations, the court relied upon a letter submitted by American Bar Association Committee on Federal Regulation of Securities.  See Letter from Jeffrey W. Rubin, Chair, Comm. on Fed. Regulation of Secs., Am. Bar Ass'n, to SEC 35 (August 31, 2009), available at http://www.sec.gov/comments/s7-10-09/s71009-456.pdf (ABA Letter).  The letter stated that in some cases, the board would be "compelled by its fiduciary duties" to resist access candidates.  

In reaching this conclusion, however, the ABA letter made a surprising assertion.  The board's fiduciary obligations with respect to access candidates was the same as when the board confronted a proxy contest.  As the letter noted:  “we believe that the process will be the same as that which is experienced with traditional proxy contests, because the board’s fiduciary duties in each case will be the same.”

This is, however, a questionable assumption.  Proxy contests and access challenges raise very different concerns.  Those engaging in a proxy contest are likely to be short term investors who believe they have a significant chance of defeating management's slate.  Often they seek to take control by electing a majority of directors to the board. 

They seek control because proxy contests are often motivated by a desire to change the direction of the company.  To accomplish this change, insurgents will frequently expend considerable resources.  As the adopting release for Rule 14a-11 noted:   

• According to a study of proxy contests conducted during 2003, 2004, and 2005, the average cost of aproxy contest to a soliciting shareholder was $ 368,000. The costs included those associated with proxy advisors and solicitors, processing fees, legal fees, public relations, advertising, and printing and mailing of proxy materials.

Perhaps unsurprisingly, insurgents frequently win the contests.  In 2008, there were 50 proxy contests, with shareholders winning about half of them.

Those shareholders submitting nominees under the SEC's access rule pose very different concerns.  For one thing, they cannot be short term investors.  For another, they cannot seek control but are limited to no more than 25% of the positions on the board.  Finally, as the SEC noted, these investors will be far less likely to incur the expenses typically associated with a proxy contest. 

In considering the response to an access challenge, management does not have to worry that a defeat will result in the implementation of a damaging vision of the company.  Moreover, boards could easily decide that the access nominees are as qualified as those nominated by the board and allow shareholders to decide on board composition.   Finally, they could decide that management's candidates are superior but, given the low level of expenditures by the nominating shareholders, there was little chance the access candidates would actually win.

In all of these circumstances, the board could decide not to resist an access challenge.  In short, unlike a proxy contest, resistance by the board was not compelled by its fiduciary obligations.  In other words, the SEC's conclusion that sometimes the board might resist access and sometimes it might not is eminantly consistent with the fiduciary obliation of the board.  

For more thoughts on the court's opinion in Business Roundtable, see Shareholder Access and Uneconomic Economic Analysis: Business Roundtable v. SEC.  Primary materials on the case, including the relevant briefs, can be found at the DU Corporate Governance web site.

Shareholder Access and the Uneconomic Economic Analysis: Business Roundtable v. SEC (Part 4)

One of the concerns raised by the court was the SEC's failure to adequately assess the costs associated with the rule.  In doing so, however, the court relied upon a mistaken view of the board's fiduciary obligations. 

As part of the cost analysis, the Commission examined the likelihood that the board would expend resources to resist access nominees.  The SEC conceded that boards would often resist.   

• “as a practical matter, it can reasonably be expected that the boards of some companies likely would oppose the election of shareholder director nominees.  If the incumbent board members incur large expenditures to defeat shareholder director nominees, those expenditures will represent a cost to the company and, indirectly, all shareholders. It is also possible that some shareholders may perceive the use of corporate funds to oppose the election of nominees submitted by shareholders as having a negative effect on the value of their investments.”

But the Commission then went on to note that these costs would be limited by two factors.  First, the board was not required by its fiduciary obligations to expend such amounts.   As a result: 

• “the costs for companies may be less to the extent that directors determine not to expend such resources to oppose the election of the shareholder director nominees and simply include the shareholder director nominees and the related disclosure in the company's proxy materials.”  

In other words, companies would often resist access nominees but not always.   

The court found fault with this analysis.  The court concluded that the “Commission's prediction directors might choose not to oppose shareholder nominees had no basis beyond mere speculation.”  Instead, the court suggested that the board had a duty to resist.  Thus, it would only not do so where “it believes the cost of opposition would exceed the cost to the company of the board's preferred candidate losing the election, discounted by the probability of that happening”. 

As support for this duty to resist, the court cited a letter from the American Bar Association Committee on Federal Regulation of Securities.  In the letter, the Committed stated that:   

• If the [shareholder] nominee is determined [by the board] not to be as appropriate a candidate as those to be nominated by the board's independent nominating committee ..., then the board will be compelled by its fiduciary duty to make an appropriate effort to oppose the nominee, as boards now do in traditional proxy contests.
  

Letter from Jeffrey W. Rubin, Chair, Comm. on Fed. Regulation of Secs., Am. Bar Ass'n, to SEC 35 (August 31, 2009), available at http://www.sec.gov/comments/s7-10-09/s71009-456.pdf.

There are two significant problems with the court's analysis. First, the approach ignores the process nature of the duty of care.  See Brehm v. Eisner, 746 A.2d 244, 264 (Del. 2000) (“As for the plaintiffs' contention that the directors failed to exercise "substantive due care," we should note that such a concept is foreign to the business judgment rule. Courts do not measure, weigh or quantify directors' judgments. We do not even decide if they are reasonable in this context.  Due care in the decision making context is process due care only.”).  

In other words, the board can decide to resist or not resist access candidates and the decision will be upheld if the process is proper. The SEC does not need to justify, under a process standard, the possibility that the board may decide not to resist. 

But there is another problem with the court's analysis.  Even if the duty of care could be said to include a substantive component, it does not mandate, as the court seems to suggest, a presumption that the board must resist access challenges.   

For more thoughts on the court's opinion in Business Roundtable, see Shareholder Access and Uneconomic Economic Analysis: Business Roundtable v. SEC.  Primary materials on the case, including the relevant briefs, can be found at the DU Corporate Governance web site.

Shareholder Access and the Uneconomic Economic Analysis: Business Roundtable v. SEC (Part 3)

Before we look at the decision by the DC Circuit, we need to first ask whether the Business Roundtable had standing to raise the issues presented in the case. 

The Business Roundtable challenged the SEC for failing to adequately conduct the “economic” analysis of the rule.  The court described the SEC as having a “unique obligation” to analyze the impact of a rule on "efficiency, competition, and capital formation."  See 15 U.S.C. §§ 78c(f), 78w(a)(2).   Indeed, this was the basis for the court's ultimate decision to invalidate the rule.  See Business Roundtable (failure of SEC to "’apprise itself—and hence the public and the Congress—of the economic consequences of a proposed regulation’ makes promulgation of the rule arbitrary and capricious and not in accordance with law.”). 

But in fact, the legislative history to Section 3(f) indicates that the economic analysis required by Section 3(f) was designed to assist Congress not the private sector.  Congress adopted Section 3(f) in 1996.  Pub. L. No. 104-290, § 106(a), 110 Stat. 3416, 3424) (codified at 15 U.S.C. § 77b(b)).   In requiring the economic analysis, Congress noted that it did not override the SEC’s “foremost obligation” to protect investors.  See  H. Rep. 104-622, 104^th Cong., 2^nd Sess., at 39 (June 17, 1996) (“The new section makes clear that matters relating to efficiency, competition, and capital formation are only part of the public interest determination, which also includes, among other things, consideration of the protection of investors.  For 62 years, the foremost mission of the Commission has been investor protection, and this section does not alter the Commission’s mission.”). 

In other words, the SEC was required to produce the relevant economic analysis but it did not control whether the rule was or was not necessary to protect investors.  Instead, Congress commanded the use of the analysis so that it could intervene and overturn agency rules where necessary.  See H. Rep. 104-622, 104^th Cong., 2^nd Sess., at 39 (June 17, 1996) ("Such analysis will be necessary to the Congress in connection with the Congress' review of major rules pursuant to the terms of the Small Business Regulatory Enforcement Fairness Act of 1996."). 

The required analysis was, therefore, designed to benefit Congress, not the private sector.  Because the legislative history indicates that Congress intended to benefit Congress and not the private sector, Business Roundtable does not fall within the “zone of interest” protected by the statute.  See Thompson v. N. Am. Stainless, LP, 131 S. Ct. 863 (2011) (“We have held that this language establishes a regime under which a plaintiff may not sue unless he ‘falls within the “zone of interest” sought to be protected by the statutory provision whose violation forms the legal basis for his complaint.’  We have described the ‘zone of interests’ test as denying a right of review ‘if the plaintiff's interests are so marginally related to or inconsistent with the purposes implicit in the statute that it cannot reasonably be assumed that Congress intended to permit the suit.’”). 

Business Roundtable, it would seem, does not have standing to challenge errors in the analysis under Section 3(f). 

For more thoughts on the court's opinion in Business Roundtable, see Shareholder Access and Uneconomic Economic Analysis: Business Roundtable v. SEC.  Primary materials on the case, including the relevant briefs, can be found at the DU Corporate Governance web site.

Paredes, at 725 (“McKinsey & Company recently surveyed 150 directors who serve on the boards of more than 300 public companies. ²⁰⁹ The study reported that approximately 56% of the directors polled said that they only "moderately" know what is going on at the companies where they serve, while 14% of the directors polled responded "partially" when asked to what degree they really know what is going on at their companies. Of the directors McKinsey & Company surveyed, 76% said that the CEO "largely" "controls and shapes what directors learn about the company."

http://www.kslaw.com/imageserver/KSPublic/library/publication/2011articles/8-11LDNViewPoints.pdf (“Only 21% of the directors McKinsey surveyed felt they had a thorough understanding of their company’s current strategy, which leaves plenty of room for the lead director to help.  

http://www.kslaw.com/imageserver/KSPublic/library/publication/2011articles/8-11LDNViewPoints.pdf (“Many members said that their primary source of information regarding global corporate strategy comes from management.

Shareholder Access and the Uneconomic Economic Analysis: Business Roundtable v. SEC (Part 2)

In considering the wisdom of access, there are strong arguments on both sides.  In the end, access is a policy decision and one that has been thoroughly vetted by commentators and the Commission.

The DC Circuit's job in all of this is not to substitute its views on the wisdom of the policy but to largely determine whether the SEC used proper process in making the decision.  The standard for review -- arbitrary and capricious -- provides an agency considerable room.  The agency need not be perfect; it can even be sloppy.  What it can't be is irrational.

In examining the decision in Business Roundtable, the decision contains a dearth of law to support the panel's decision that the Commission acted in an arbitrary manner.  See Section 706 of the APA.  The arbitrary and capricious standard is probably the most litigated issue in administrative law.  A quick search through the Supreme Court file of Lexis-Nexis showed that there were 294 cases using the phrase “arbitrary and capricious.”  A search through the appellate court file came up with almost 3000 references to arbitrary and capricious in just the last ten years.  In short, there is plenty of law on the applicable standard.

DC Circuit cited almost none of it.  The opinion contained only one cite to a Supreme Court decision.  It referenced Motor Vehicle Mfrs. Ass'n v. State Farm, 463 US 29 (1983) for the broad proposition that an agency must have "examine[d] the relevant data and articulate[d] a satisfactory explanation for its action including a rational connection between the facts found and the choices made."  In other words, it stands for the proposition that an agency cannot act in an irrational manner in adopting a rule. 

A reading of the case itself does not help the court's analysis in Business Roundtable. As Justice Rehnquist put it in his concurring opinion, this was not a case involving the failure to adequately explain a study or reconcile purported inconsistencies in 73 pages of analysis.  It was a case where the agency "gave no explanation at all." 

The remaining authority used by the DC Circuit?  Of the thousands of opinions on the subject they relied on three DC appellate cases:  Chamber of Commerce v. SEC, 412 F.3d 133 (DC Cir. 2005); Pub. Citizen v. Fed. Motor Carrier Safety Admin., 374 F.3d 1209 (DC Cir. 2004); and American Equity Investment Life Insurance Co. v. SEC, 613 F.3d 166 (DC Cir. 2010).  The three decisions have two things in common.  They all involve the SEC and they were all written by judges on the panel in Business Roundtable. 

Judge Ginsburg wrote Chamber of Commerce, Judge Sentelle wrote American Equity (with Judge Ginsburg on the panel) and Public Citizen.  In other words, they found no judicial authority for their opinion in Business Roundtable beyond their own opinions. 

Moreover, the primary decision relied upon by the panel -- Chamber of Commerce -- does not really support its analysis.  First, Chamber of Commerce contains a detailed review of the law and includes about 20 citations to other decisions.  Second, it declined to accept arguments that entailed a second guessing of the SEC's analysis of data submitted during the comment process.  See Id.  ("Although a more detailed discussion of the study might have been useful, the Commission made clear enough the limitations of the study, and we have no cause to disturb its ultimate judgment that the study was 'unpersuasive evidence.'"). 

The court invalidated the rule not because the economic analysis could have been better but because the economic analysis was entirely absent.  The SEC in the rule under consideration in Chamber of Commerce had proposed three methods of conforming to the new requirements but entirely omitted any discussion of the costs of the different methods.  See Id. ("That particular difficulty may mean the Commission can determine only the range within which a fund's cost of compliance will fall, depending upon how it responds to the condition but, as the Chamber contends, it does not excuse the Commission from its statutory obligation to determine as best it can the economic implications of the rule it has proposed.").

Business Roundtable uses a very different analysis as we will discuss.  It did fault the SEC for not adequately discussing the limitations of various studies.  Nor did it find a complete absence of costs but instead found that the SEC's 73 page assessment was not thorough enough.  In doing so, the court chided the SEC for failing to assess costs that largely presupposed a breach of fiduciary obligations. 

To find the Commission irrational in this case, given the sweeping nature of the court's analysis, one would expect to find greater reliance on judicial precedent than what occurred in the opinion. 

Primary materials on the case, including the relevant briefs, can be found at the DU Corporate Governance web site. For more thoughts on the court's opinion in Business Roundtable, see Shareholder Access and Uneconomic Economic Analysis: Business Roundtable v. SEC.

Shareholder Access and the Uneconomic Economic Analysis: Business Roundtable v. SEC (Part 1)

We plan to provide a series of posts that examines the court's analysis in Business Roundtable v. SEC, the DC Circuit case that struck down Rule 14a-11, the shareholder access rule.

Before we get into the heart of the opinion, though, we should provide some background.  This is the third attempt at access in the new millennium.  See Security Holder Director Nominations,  Exchange Act Release No. 48626 (Oct. 14, 2003); Shareholder Proposals, Exchange Act Release No. 56160 (July 27, 2007). 

The rule has been nothing but controversial.  The versions circulated in 2003 generated 13,000 or so comments. In connection with the most recent effort, at least 600 comments, many lengthy, were submitted.  The Commission considered all of this information in taking action with respect to the access rule.  See Exchange Act Release No. 62764 (August 25, 2010) (“the final rules include features from the proposals on this topic in 2003 and 2007, and reflect much of what we learned through the public comment that the Commission has received concerning this topic over the past seven years.”). 

Congress to some degree also participated in access.  After concerns were raised about the SEC's authority to adopt an access rule, Congress included in Dodd-Frank a provision that gave very broad rulemaking with respect to an access rule.  See Section 971 of Dodd-Frank.  An access rule could be adopted "under such terms and conditions as the Commission determines are in the interests of shareholders and for the protection of investors."  Last minute efforts from the Senate to restrict access to 5% shareholders and imposed a two year holding period were defeated. 

The human costs in adopting the rule were also significant.  According to the chairman of the SEC, the staff put in 21,000 hours on the rule, an amount of time equal to $2.2 million. The final release also included a lengthy cost-benefit analysis for the rule.  The analysis consisted of 73 pages in the release (26 pages in the Federal Register) and almost 40,000 words.  The staff’s analysis was long and thorough. 

It is with this background that we examine the analysis used by the DC Circuit in striking down Rule 14a-11, the shareholder access rule. 

Primary materials on the case, including the relevant briefs, can be found at the DU Corporate Governance web site. For more thoughts on the court's opinion in Business Roundtable, see Shareholder Access and Uneconomic Economic Analysis: Business Roundtable v. SEC.

Business Roundtable v. SEC: The Necessary Course to Understand the Decision

We are planning a series of posts on the DC Circuit's decision in Business Roundtable v. SEC, the case that struck down Rule 14a-11. Before doing so, however, we note the following comment by JW Verret at Truth on the Market.

He has suggested that those faulting the economic analysis used by the court ought to take a course in policy analysis.  As he writes:

• I think they could profit from a course in policy analysis.  The legislative history of the securities laws makes clear that the objective is a purely economic one, to stabilize markets, prevent fraud, and maximize economic growth.  The 33′ and 34′ Acts were a response to the stock market crash of 1929 after all.  Cost-benefit analysis is a tough fit in areas where nebulous ideas like justice or equity are at issue (though it is still quite informative) but where as here the underlying objectives are purely economic it is the only legitimate mode of analysis.  It is hard to demonstrate net benefits from new rules, that’s true.  But does that mean we shouldn’t even ask the question?  I suspect their hostility to cost-benefit analysis is actually grounded in their belief that independent agencies are useful tools to accomplish a progressive agenda, including empowering labor unions, promoting climate change regulation, fair trade, affirmative action, and a variety of other liberal causes.  Putting these issues in the hands of independent agencies politicizes the SEC, undermining its credibility and hindering the SEC’s job of promoting the efficient function of American capital markets.

There are several comments to be made about this approach.  First, the post mistakenly assumes that the issue in the case was cost-benefit analysis.  In fact, the primary authority used by the court in Business Roundtable was the SEC's obligation to analyze the effects of a rule on competition, efficiency and capital raising.  See Section 3(f), 15 USC 78c(f).

Second, the comment that cost-benefit analysis "is the only legitimate mode of analysis" reflects JW Verrett's "policy" perspective but it does not reflect the law.  In adopting Section 3(f), Congress had this to say:

• “The new section makes clear that matters relating to efficiency, competition, and capital formation are only part of the public interest determination, which also includes, among other things, consideration of the protection of investors.  For 62 years, the foremost mission of the Commission has been investor protection, and this section does not alter the Commission’s mission.” 

H. Rep. 104-622, 104^th Cong., 2^nd Sess., at 39 (June 17, 1996).  See also Section 3(f) in 1996, Pub. L. No. 104-290, § 106(a), 110 Stat. 3416, 3424).  In other words, the efficiency analysis was only one step required of the Commission.  Congress left open the possibility that the goals of investor protection could sometimes override the results of the economic analysis.

Finally, criticism of Business Roundtable is not criticism of cost-benefit analysis per se.  It is criticism of the particular requirements imposed by the court on the SEC.  As we will show in later posts, the court required the SEC to assess costs that are unproven to exist, required the SEC to assume that pension plans will violate their fiduciary obligations and then assess the costs of those violations, and imposed on the SEC a definition of fiduciary obligations that do not comport with the requirements of state law. 

Perhaps JW Verrett could use a course in administrative law.  For more thoughts on the court's opinion in Business Roundtable, see Shareholder Access and Uneconomic Economic Analysis: Business Roundtable v. SEC.

Shareholder Protection Act of 2011: Preemption, Prevention and Protection (The Consequences of the Legislation)

We are discussing the Shareholder Protection Act of 2011. So if this Act passes in its present form, what will be the consequences? 

In some respects, the consequences will be modest.  Certainly, they will require companies wanting to make campaign contributions to act proactively and submit the matter to shareholders for approval.  The increase in activism notwithstanding, shareholders still tend to approve what management asks.

On the other hand, there is reason to believe that the adoption of the provision will sharply reduce campaign contributions by public companies.  First, submitting the matter to shareholders will generate considerable publicity, much of it bad.  Companies will sometimes forego contributions rather than submit to a public pillorying. 

The likelihood of this occurring will be enhanced by language in the Act that provides a safe harbor for investment managers who decide to divest because of disagreement over political expenditures.  As the provision states:

• (f) Safe Harbor for Certain Divestment Decisions- Notwithstanding any other provision of Federal or State law, if an institutional investment manager makes the disclosures required under subsection (e), no person may bring any civil, criminal, or administrative action against the institutional investment manager, or any employee, officer, or director thereof, based solely upon a decision of the investment manager to divest from, or not to invest in, securities of an issuer due to an expenditure for political activities made by the issuer.'

In other words, those unhappy with the campaign contributions can disinvest without risk.  Shareholders of mutual funds could, therefore, put pressure on the advisors to do exactly that. 

Similarly, the SEC is instructed to conduct an "annual assessment of compliance" with these provisions and and submit a report to Congress.  At the same time, the GAO is instructed to "periodically evaluate and report to Congress on the effectiveness of the oversight by the Securities and Exchange Commission of the reporting and disclosure requirements".  In other words, Congress will receive reports on the provision.  Boards may not want to see their company's name on a report that suggests a clear political preference. 

Second, companies will sometimes forego seeking shareholder approval because of the risk of liability.  For listed companies, boards will have to approve specific expenditures of more than $50,000.  As a result, they will be "authorizing" the payments.  The Act provides that those improperly authorizing payments will be liable for treble damages. 

Moreover, the payments themselves may be a violation of fiduciary obligations, irrespective of the treble damages provision.  The shareholder law suit against News Corp apparently alleges, among other things, that the company imrpoperly made a "$1,250,000 contribution to the Republican Governor’s Association last year."  Rather than confront these risks, it will be easier to avoid having the authority in the first instance. 

To the extent that this Act is adopted, therefore, campaign contributions will likely fall, state law will be preempted yet again, and the role of the SEC in the governance process will be expanded. 

Shareholder Protection Act of 2011: Preemption, Prevention and Protection (Altering the Standards for Fiduciary Duties of the Board)

The Shareholder Protection Act of 2011 goes beyond director and shareholder approval.  By requiring shareholder approval in the proxy statement and by requiring disclosure of expenditures for the prior year in the annual report, the Act effectively triggers the application of the antifraud provisions.  To the extent companies do not accurately reveal the purpose of the payments on a going forward basis and the actual use of the payments (the latter will provide a check on the former), they may be liable.

The Act, however, went well beyond triggering the antifraud provisions.  For the first time in the federal securities laws, it would create a treble damage provision.  Moreover, the provision would likely apply on a strict liability basis. 

The Act provides that expenditures made in violation of the shareholder approval requirement will be "considered a breach of a fiduciary duty of the officers and directors who authorized the expenditures for political activities."  Liability will joint and several and equal three times the amount of the expenditure. In other words, authorization is the only element of the claim.  The provision imposes personal liability.  Moreover, it apparently does so on a strict liability basis.  Authorizing officers and directors will be liable even if they do not know about the provision or were otherwise unaware of the shareholder approval requirement.

Moreover, violations are more likely to occur than one might think.  Certainly, the authorization of political expenditures in the absence of shareholder approval will result in exposure.  But the provision is broader than that.  It applies the treble damages provision to any person who authorizes payments that are not "of the nature of those proposed by the issuer".  So those authorizing contributions will need to make sure that they are consistent with what shareholders actually approved.  This will not always be clear.  

Moreover, by defining the claim as a breach of fiduciary duty, boards will potentially be at risk for a derivative suit to the extent they fail to enforce the provision.  Once unauthorized campaign contributions are exposed, boards may find themselves in the unsavory position of having to bring actions against (or collecting treble damages from) authorizing officers or being sued for the failure to do so.  Similarly, boards may find themselves liable to the extent they delegated authority to officers.  Depending upon the terms of the delegation, it may fit the definition of "authorization." 

While Congress has been very willing to preempt state law in recent years, most of the changes have been with respect to process (other than, perhaps, assigning substantive authority to committees).  Congress for the most part has not tampered with fiduciary duty standards.  They have remained within the purview of state law.  Yet this proposal would alter that balance.  It would result in Congress defining fiduciary duty standards and the extent of liability as a result of violations. 

Shareholder Protection Act of 2011: Preemption, Prevention and Protection (Approval by the Board)

The Shareholder Protection Act of 2011 seeks to regulate campaign contributions by public companies.  It would require shareholder approval of the amount available for these contributions.  

The Act, however, goes well beyond the requirement of shareholder approval.  It also requires board approval of the contributions in certain cases. Proposed Section 16A of the Exchange Act (15 USC 78p-1) provides that listed companies must have in place a bylaw that "expressly provide[s] for a vote of the board" on any expenditure for political activities in excess of $50,000 (including amounts in excess of $50,000 in a "particular election").  Moreover, the votes must be made public within 48 hours "including in a clear and conspicuous location on the Web site of the issuer." 

This provision promises to be far more intrusive than other federal efforts with respect to approval requirements imposed on the board.  While Congress has mandated other approval requirements, they have for the most part been limited to committees.  Thus, SOX required audit committee approval of the independent accounting firm.  This provision applies to the entire board, which presumably means it cannot be delegated to an officer or board committee. 

The provision effectively preempts state law.  The board would effectively be required to approve expenditures that for large public companies are extraordinarily small in amount.  Moreover, by using a bylaw to accomplish this task, it suggests that shareholders can adopt bylaws that mandate board approval for other types of expenditures.  If so, this would substantially expand shareholder authority and give more teeth to proposals under Rule 14a-8.  

This provision would only apply to listed companies.  As such, it is more narrow than the provision requiring shareholder approval of the total amount of campaign contributions.  Nonetheless, the provision may well affect the behavior of smaller public companies.  Many, particularly those anticipating an exchange listing, may well put the bylaw in place.  Moreover, because the shareholder approval process will be disclosed in the proxy statement, boards will have a hard time disclaiming knowledge of the campaign contributions.  To the extent shareholders bring actions over the contributions, the board may be at risk over the contributions even if not approved.  

Finally, the obligation to disclose board results within 48 hours will create headaches.  Fro one thing, it will provide some directors with an incentive to dissent.  Those not wanting to be publicly associated with the recipients of the contributions may decided to vote against the expenditures.  In addition, companies may feel compelled (or Congress/SEC may eventually want to require) to provide an explanation for the vote.  It will entail some discussion of the inner workings of the board and, potentially, be the basis for an antifraud suit if inaccurate.  

Shareholder Protection Act of 2011: Preemption, Prevention and Protection (Approval by Shareholders)

The Shareholder Protection Act of 2011 seeks to regulate political contributions by, among other things, imposing a requirement that shareholders approve the expenditures. 

With respect to shareholder approval, a new Section 14C of the Exchange Act would require shareholders of public companies to approve "total amount of expenditures for political activities proposed to be made by the issuer for the forthcoming fiscal year".  See Proposed Section 14C, 15 USC 78n-3.

There are several points to make about this putative requirement.  First, it preempts state law. State law does not require shareholder approval as a precondition for a corporate expenditure.  In effect, this provision would reduce the discretion of the board and provide a shareholder veto over the contributions. 

Second, it continues the expansion of the SEC's authority (and the involvement of the federal government) in the corporate governance area with respect to shareholder rights.  State law requires shareholder approval of mergers, sale of all/substantially all assets, and dissolutions.  Shareholders must also elect directors and approve amendments to the charter (excepting the creation of a new class of stock assuming the presence of a blank check stock provision).  That's it.  When Congress mandated say on pay in Dodd-Frank, it for the first time required all public companies to extend voting rights to their shareholders and gave the SEC the authority to oversee the process.  See Rule 14a-21, 17 CFR 240.14a-21. Political contributions would represent the second time the federal government mandated that certain matters be submitted to the shareholders of all public companies and the second time that the SEC was assigned responsibility for overseeing the process.  

Third, the provision goes well beyond say on pay.  It does not provide an "advisory vote" on the matter but instead gives shareholders subsantive authority to approve or disapprove the activity.  While the board has the authority to ignore a shareholder vote on say on pay, it would not be able to do the same with the vote required in this provision.  But for shareholder approval, the expenditures could not be made.

Shareholder Protection Act of 2011: Preemption, Prevention and Protection (What Citizens United May Have Wrought)

The issue of corporate campaign contributions has returned.  Several sponsors have reintroduced the Shareholder Protection Act of 2011.   The bill is designed to deal with some of the problems arising out of the Supreme Court's decision in Citizens United. 

In striking down restrictions on campaign contributions by corporations, the Court all but invited a governance response.  As the opinion noted:

• Shareholder objections raised through the procedures of corporate democracy . . .  can be more effective today because modern technology makes disclosures rapid and informative.  A campaign finance system that pairs corporate independent expenditures with effective disclosure has not existed before today. . . . With the advent of the Internet, prompt disclosure of expenditures can provide shareholders and citizens with the information needed to hold corporations and elected officials accountable for their positions   and  supporters. Shareholders can determine whether their corporation’s political speech advances the  corporation’s interest in making profits, and citizens can see whether elected officials are “‘in the pocket’   of  so-called moneyed  interests.”  . . . The First Amendment protects political speech; and disclosure permits citizens and shareholders to react to the speech of corporate entities in a proper way.  This transparency enables the electorate to make informed decisions and give proper weight to different speakers and messages.

As we have already discussed, the Court's view reflects a serious misunderstanding of shareholder authority under state law.  As a result, any effort by shareholders to influence the political expenditure process will require a legislative response. 

In that regard, members of Congress have reintroduced Shareholder Protection Act of 2011 (a version was also submitted last year). The Act seeks to regulate the campaign contribution process through four forms of protection:  the requirement for shareholder approval of the expenditures, the requirement of board authorization for the expenditures, the requirement that the expenditures be disclosed, and the imposition of treble damages on officers and directors who are responsible for any violation. 

To the extent adopted, the provisions will, among other things, result in a sizable preemption of state (read Delaware) law.  As a corollary, it will significantly expand the role of the SEC in the corporate governance area, a trend already well underway.  We'll look at some of these issues in the next few posts. 

The DC Circuit and Delaying the Inevitable

What are the long term implications of this decision?  Not  much.

In some respects, the DC Circuit's decision in Business Roundtable v. SEC is a grave disappointment.  The SEC has the authority to adopt an access rule, that was confirmed in Dodd-Frank. The rule was carefully crafted and vetted over a year long process.

The panel, however, didn't like the rule and imposed an almost impossible burden on the SEC.  It wasn't enough, for example, for the SEC to conclude that access could benefit boards and point to some studies making that point.  Instead, the Agency had to rely on the right studies.  The opinion criticized those used by the SEC but did not do the same with respect to those on the other side.  In other words, it is clear that the court agreed with one side but not the other.  One way or another that panel was going to strike down the rule.

That the DC Circuit would issue a political decision is no real surprise.  The circuit is full of judges who likely were too controversial for their home state senators to nominate.  Without senators in Congress, DC has no politicians who can object to the White House nominees.  As a result, the White House has a free hand and can more easily appoint controversial idealogues.  Moreover, the DC Circuit is often a stepping stone for the US Supreme Court.  Judges who want to be Justices can more easily attract the attention of the White House through their decisions. 

What the case shows is how far behind the courts are with respect to the evolution of the corporate governance process.  Two of the judges on the panel were appointed by President Reagan at the height of the law and economics movement.  That was the hey day of deregulation and the view that the market can resolve all issues.  The shallowness of that philosophy was brought home in the most recent recession.  But it is clear that this panel views interference in the management prerogative with disfavor and does not need much excuse to overturn it.

In one respect, the opinion did those favoring governance a favor.  Access is the most controversial rulemaking endeavor by the SEC in years, perhaps in the history of the Agency.  It represents the beginning of a paradigm shift in relations between directors and shareholders.  Access will force on management the obligation to consult with and talk to shareholders more often. 

Issuers are, however, unified in their opposition to the rule and the consequences of the rule.  With the Obama administration criticized as excessively anti-business, the DC Circuit has taken the issue off the table for the 2012 elections.  When the SEC returns with a new proposal, as it certainly will, the rule will likely go into effect after the elections.  The SEC will therefore have greater flexibility in determining the standards for access.  Thus some of the more onerous restrictions (the three year holding period for example) can more easily be jettisoned.  And, while the DC Circuit will get another crack at the rule, membership on the court is likely to shift in a more moderate direction.  

Access is an inevitability.  It is not because of ideology.  It arises out of the interests of shareholders.  As problems such as executive compensation remain intractable, shareholders will rely less on the "imperial CEO" model of governance and insist on greater participation.  While this can occur through incremental increases in authority (say on pay for example), the real solution is the right to nominate directors.  In fact, as the example of Britain has shown, it will be the threat of access that will cause boards to focus more often on the interests of shareholders rather than the actual use of the authority which, no matter what the DC Circuit thinks, is not likely to occur often.   

Given the importance of this authority and the more than half century of waiting by shareholders, a little more delay, in the greater scheme of things, won't really matter, particularly if the ultimate rule is more favorable to shareholders, which is likely to be the case.  Each time access has been shelved, the results have favored shareholders.  The initial efforts were for an access bylaw.  When that didn't happen, the SEC proposed a direct access right.  When that was delayed, Congress was prevailed upon to clarify the SEC's rulemaking authority in the area.  The same will likely occur here.  The ultimate rule will likely favor shareholders more than the current version.

The DC Circuit decision is, as we noted, a disappointment but it has not stopped access.  It has ony delayed the invevitable. 

Business Roundtable v. SEC: The Short Term Strategy

The SEC should appeal this decision.  At a minimum, it should seek en banc review by the entire circuit.  There are nine active judges on the circuit.  It would require five judges to vote in favor.  See DC Circuit Rule 35. En Banc Determination.  The SEC would be unlikely to get the five votes since the three on the panel opinion in Business Roundtable v. SEC would be unlikely to favor review of their decision by the entire circuit.  In other words, the SEC would have to get something approaching unanimity from the other judges on the court.  Nonetheless, if en banc review is denied, the SEC lost nothing in seeking review.

The risk, of course, is that the court will take the case and affirm and issue a decision that is entitled to greater weight than the panel opinion.  That is not likely.  The entire circuit is not likely to buy off on all of the reasoning contained in the panel opinion.  Forcing the SEC to choose among studies or analyze the impact of the rule on unions will probably not receive majority support (and, at a minimum, will likely spur a loud dissent).  To the extent the SEC loses but the reasoning is narrowed, the agency wins for two reasons.

First, it eases what the agency must do when it reconsiders access.  Right now, the standards set out in the panel opinion are open ended and impossible to meet on any objective basis.  There will always be other studies that the SEC did not arguably consider or other costs that were not adequately weighed, particularly for a requirement that has never gone into effect.  With no actual empirical evidence one way or another, the economic analysis will always involve some degree of conjecture and the conjecture can always be disputed.

Second, if the en banc court takes the case and narrows the reasoning, it will better frame the issue for the US Supreme Court.  Judge Ginsburg made a point in the panel opinion of citing two other cases where the SEC has been reversed in recent years for failing to adequately develop the record (with both opinions written by members of the panel in Business Roundtable v. SEC).  Rather than show the SEC's incompetence, as was the purpose of the citations, they illustrate how much the DC Circuit has routinely invaded the administrative function and substituted its views for that of the agency. 

The Supreme Court has dealt with this sort of thing before.  In Vermont Yankee, the Court put a stop to efforts by the DC Circuit to rewrite the process rule in the APA.  In Chevron, the Court objected to appellate courts substituting their views for that of the agency.

This is no guarantee that the SEC would win in the Supreme Court.  But by doing nothing, the agency allows the DC Circuit to impose more and more onerous standards on the rulemaking process, particularly on rules designed to alter the corporate governance process.   

Business Roundtable v. SEC: Judicial Substitution of Its View for that of the Agency

In striking down the shareholder access rule, the court in Business Roundtable v. SEC ostensibly had to determine whether the SEC's position was arbitrary.  In other words, the court was not allowed to substitute its view for that of the agency.  See FCC v. Fox TV Stations, Inc., 129 S. Ct. 1800 (2009) ("We have made clear, however, that 'a court is not to substitute its judgment for that of the agency,' ibid., and should 'uphold a decision of less than ideal clarity if the agency's path may reasonably be discerned,'"). 

Nor can the court require perfection.  Instead, the court can generally strike down an agency decision only if "irrational."  See Allentown Mack Sales & Serv. v. NLRB, 522 U.S. 359, 364 (1998) ("While the Board's adoption of a unitary standard for polling, RM elections, and withdrawals of recognition is in some respects a puzzling policy, we do not find it so irrational as to be "arbitrary [or] capricious" within the meaning of the Administrative Procedure Act"). 

The DC Circuit, in this case, did not apply a standard of irrationality.  Instead, it in fact substituted its judgment for that of the SEC.  This can be seen from the reasoning (the court favoring one set of studies over another, for example), but also from the lack of authority in the opinion.  From pages 7 until 21, when the court actually examined the economic analysis used by the SEC, the opinion cited only two cases. 

One of the cases was a Supreme Court case cited for a general proposition.  The only other case citation was a pair of references to Chamber of Commerce v. SEC, 412 F.3d 133 (DC Cir. 2005).  Judge Ginsburg wrote that opinion and in it struck down an SEC rule adopted under the Investment Company Act of 1940.  In other words, Judge Ginsburg, for much of the legal analysis, could only cite himself as case authority for the positions taken in the decision. 

We will discuss the short term implications of this opinion in the next post.

The Politics of the DC Circuit: Business Roundtable v. SEC

The opinion from the DC Circuit finally came out and as suggested in the oral argument the three judge panel (a particularly bad draw for the SEC) struck down shareholder access.  The opinion is here.  The court concluded that the SEC had acted in an arbitrary and capricious fashion by not considering all of the economic consequences of the rule.

Given that the adopting release had something like 50 pages on the economic consequences, the court had to strain to come up with an example of arbitrary behavior by the Commission.  The court for example noted that the SEC had concluded that sometimes management would not resist access candidates and, as a result, would not incur significant costs.  The court viewed this as an arbitrary conclusion.  As the opinion noted:

• We agree with the petitioners that the Commission’s prediction directors might choose not to oppose shareholder nominees had no basis beyond mere speculation. Although it is possible that a board, consistent with its fiduciary duties, might forgo expending resources to oppose a shareholder nominee — for example, if it believes the cost of opposition would exceed the cost to the company of the board’s preferred candidate losing the election, discounted by the probability of that happening — the Commission has presented no evidence that such forbearance is ever seen in practice.

There was no evidence because there have yet to be access candidates since, aside from a few companies, the right does not exist.  The only support for the proposition that the SEC was wrong was a quote from a comment letter submitted by the ABA.  According to the letter:

• If the [shareholder] nominee is determined [by the board] not to be as appropriate a candidate as those to be nominated by the board’s independent nominating committee ..., then the board will be compelled by its fiduciary duty to make an appropriate effort to oppose the nominee,

As we have noted, the board could easily determine that its candidate and the shareholder's candidate were equally qualified.  More importantly, even if opposing the shareholder's candidate, that is not the same thing as saying the board must expend a material amount of funds to defeat the candidate.  As we have noted: 

• even if the board opposes access nominees, it does not mean that it will expend funds opposing them.  A board may size up the situation and realize that the access candidates have little or no chance of winning.  In those circumstances it would arguably violate the board's fiduciary duties to expend funds to oppose the nominees. 

In other words, the court's argument is very weak.  It has no real authority.  The analysis reflects less a view on the law and more a use of the law to invalidate a rule that the panel does not like. 

Citizens United and the Limits of Shareholder Approval

Since the famous (or infamous) case of Citizens United, concern has been expressed over corporate contributions to political campaigns.  An early attempt to address the concerns focused on the idea that shareholders would be asked to approve campaign contributions.  The issue is now beginning to surface in the shareholder proposal area under Rule 14a-8. 

Shareholders at Home Depot have submitted a proposal calling on the Company to submit its policies regarding political contributions to shareholders for an advisory vote.  The staff of the SEC issued a no action letter declining to allow the Company to exclude the proposal.  We have included the text of the proposal below. 

The proposal demonstrates a central flaw in the Supreme Court's analysis in Citizens United.  In effect, the majority on the Supreme Court held that the issue of campaign contributions was a matter between directors and shareholders.  As the Court stated:

• With the advent of the Internet, prompt disclosure of expenditures can provide shareholders and citizens with the information needed to hold corporations and elected officials accountable for their positions and supporters. Shareholders can determine whether their corporation's political speech advances the corporation's interest in making profits, and citizens can see whether elected officials are "'in the pocket' of so-called moneyed interests."  The First Amendment protects political speech; and disclosure permits citizens and shareholders to react to the speech of corporate entities in a proper way. This transparency enables the electorate to make informed decisions and give proper weight to different speakers and messages.

The Court made it seem like broad dissemination of information about campaign contributions was sufficient.  Apparently this was because shareholders could, with the disclosure, effect the company's practices with respect to the contributions.  In fact, this is probably not the case.  As CA v. AFSME shows, the Delaware courts are highly protective of board discretion and willing to strike down almost any effort by shareholders to tie the hands of directors.  As a result, a proposal calling for mandatory limits on campaign contributions would likely be invalidated under state law. 

The shareholder proposals submitted to Home Depot illustrates this in practice.  Like most shareholder proposals designed to change board behavior, the proposal is precatory. It merely "recommends" that the board take certain action.  The use of a precatory proposal may in part be strategic.  Some shareholders are more likely to support it if it is not binding.  But precatory proposals are also necessary because, otherwise, the SEC may allow the company to delete the proposal under Rule 14a-8 as falling within the "ordinary business" of the corporation (this exclusion is discussed in The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors). 

The precatory nature of the proposal is significant.  Foremost, management can, for the most part, just ignore it.  Moreover, the proposal submitted to Home Depot merely recommends an advisory vote on the company's policies.  To the extent management implements the proposal, it can ignore the annual results.    

This is not to say that shareholder decisions are irrelevant.  In some cases, they will influence the board.  The reaction will depend upon the particular company and the particular board.  But it will be the board's decision, not shareholders.  In other words, the Supreme Court seemed to think that shareholders had the power to compel changes in political contributions once disclosure occurred.  On this point, however, those Justices were mistaken.  There is currently no meaningful mechanism for shareholders to change corporate practices with respect to campaign contributions.     

The proxy statement for Home Depot with this proposal is here.  The meeting will be held on June 2.  The company by the way noted that it already had a policy in place, that it made contributions public, and that it viewed an annual advisory vote as not something that "would provide shareholders with any more meaningful information than is already available."

Resolved: Shareholders recommend that the Board of Directors adopt a policy under which the proxy statement for each annual meeting will contain a proposal describing:

• the company's policies on electioneering contributions, any specific expenditures for electioneering communications known to be anticipated during the forthcoming fiscal year, the total amount ofsuch anticipated expenditures, a list of electioneering expenditures made in the prior fiscal year, and

• providing an advisory shareholder vote on those policies and future plans.

Supporting' Statement: Proponents recommend that the annual proposal also contain management's analysis of potential issues of congruen'cy with stated company values or policy, and risks to our company's brand, reputation, or shareholder value. "Expenditures for electioneering communications" means spending directly, or through a third party, at any time during the year, on printed, internet or broadcast communications, which are reasonably susceptible to interpretation as in support of or opposition to a specific candidate.

Shareholder Advisory Vote on Electioneering Contributions

Whereas, the Supreme Court ruling in Citizens United v. Federal Election Commission (Citizens United) interpreted the First Amendment right of freedom of speech to include certain corporate political expenditures involving "electioneering communications," and striking down elements of
the previously well-established McCain-Feingold law;

Whereas Citizens United is viewed by some as having eroded a wall that has stood for a century between corporations and electoral politics (e.g., New York Times editorial, "The Court's Blow to Democracl on January 21, 2010);

Whereas, the Shareholders' Protection Act (H.R.4790) pending iIi Congress in response to Citizens United would amend the Securities Exchange Act of 1934 to require ineach public company's annual proxy statement a description of the specific nature of any expenditures for political activities proposed by the issuer for the forthcoming fiscal year not previously approved, to the extent known to the issuer, and including the total amount of such proposed expenditures, and providing for a separate shareholder vote to authorize such proposed expenditures;

Whereas, in July 2010 Target Corporation donated $150,000 to the political group Minnesota Forward, which was followed by a major national controversy with demonstrations, petitions, threatened boycotts and considerable negative publiCity;

Whereas, Home Depot founder and retired CEO Bernie Marcus voiced his opinion in the Wall Street Journal ("Bad Labor Law Is a Path to Economic Ruin" 08/26/08) that companies should use corporate, and thus shareholder, resources for political means;

Whereas, proponents believe The Home Depot should establish policies that minimize risk to the firm's reputation and brand through possible future missteps in corporate, electioneering;

Whereas, The Home Depot has a firm nondiscrimination policy which states, "The Company prohibits discrimination or harassment on account of race, color, sex (gender), age, religion, national origin, sexual orientation, gender identity of expression, disability, protected veteran status, or any other basis prohibited under'applicable law." Furthermore, Home Depot has a complete Values Guide which emphasizes our commitment to "creating shareholder value,"
"respect[ing] all people," and to "understand the impact of our decisions accept responsibility for our actions;"

Resolved: Shareholders recommend that the Board of Directors adopt a policy under which the proxy statement for each annual meeting will contain a proposal describIng:

• the company's policies on electioneering contributions, any specific expenditures for electioneering communications known to be anticipated during the forthcoming fiscal year, the total amount ofsuch anticipated expenditures, a list of electioneering expenditures made in the prior fiscal year, and

• providing an advisory shareholder vote on those policies and future plans.

Supporting' Statement: Proponents recommend that the annual proposal also contain management's analysis of potential issues of congruen'cy with stated company values or policy, and risks to our company's brand, reputation, or shareholder value. "Expenditures for electioneering communications" means spending directly, or through a third party, at any time during the year, on printed, internet or broadcast communications, which are reasonably susceptible to interpretation as in support of or opposition to a specific candidate.

Inroads into the Chimera of Demand Refusal in Delaware: Louisiana Municipal Police v. Morgan Stanley (Part 3)

We are discussing Louisiana Municipal Police v. Morgan Stanley, an inspection rights case.  In deciding cases, VC Laster often brings to his opinions reasoning that reflect his longstanding experience with practice in Delaware.  In this case, it seems as if he wants to send a message to counsel that "demand refusal" cases in his court will be treated differently.  On this issue, it is worth quoting the opinion at length:

• The question of whether a corporation should sue its directors and senior officers puts directors in a difficult position where they are subject to potentially subtle influences and pressures.  Basic notions of accountability require that stockholders be able to use Section 220 to evaluate whether the demand-refusal decision was made in good faith, after a reasonable investigation, “or whether the Board had some different, ulterior motivation.” Axcelis, 1 A.3d at 291.  It is only if the directors refuse the litigation demand, as typically happens, that the subsequent litigation paths diverge.  By contrast, a decision to refuse a litigation demand is reviewed under the business judgment rule, which forces a plaintiff to overcome the rule’s powerful presumptions before a court will examine the merits of the directors’ decision. See Levine v. Smith, 591 A.2d 194, 212 (Del. 1991). The highly deferential standard for reviewing a demand-refusal decision makes it critical that an accountability mechanism exist in the form of a limited right to information under Section 220.

Demand refusal letters, in his court, will have to have some real substance.  As he states:

• Morgan Stanley cannot rely on the Demand Refusal Letter to foreclose LAMPERS’s right to use Section 220. The letter describes the Board’s process, but it does not provide any substantive insight into the Board’s decision. In form, the Demand Refusal Letter is longer than the peremptory refusal found insufficient in Grimes II. In substance, the two letters are identical. A board cannot defeat the use of Section 220 that the Delaware Supreme Court contemplated in Grimes I, Scattered, and Spiegel by sending a self-serving letter describing process sans content. Such an approach would render nugatory the right to use Section 220 to investigate demand refusal.

This doesn't mean that, ultimately, shareholders will have an easy time challenging the demand refusal decision.

• LAMPERS recognizes that the deference afforded to the Board’s decision means it faces long odds in showing that the refusal was wrongful. Whether the Board in fact acted wrongfully is not currently at issue. Rather, the question is whether LAMPERS’s purpose for inspection is proper. It is.

But companies will now know that the demand refusal process will be subject to shareholder inspection.  With that in mind, it is likely to become more rigorous.  There may even be an instance when the committee decides to authorize the action.  This is the right approach and right outcome.