Shareholder Access and Comments: Opponents of Access (Part 3)

Comment Letters in favor of proposed changes to Rule 14a-8 outlined in SEC Release No. 34-56161, the “non-access” proposal, represented a minority of the total submitted. These Comment Letters, although fewer in number, raised many arguments and included a 16-page Letter from the law firm Wachtell, Lipton, Rosen & Katz (“WLRK”) and a 38-page Letter from Business Roundtable, an association of CEO’s from many U.S. companies.  Some of the companies submitting comment letters in favor of the “non-access” proposal include: Allstate,Boeing,Chevron,FedEx,General Motors,Wells Fargo, andXerox.

This post addresses the letters in favor of the “non-access” proposal in general and the WLRK Letter in full, as it encompasses most of the arguments made by the other letters opposing shareholder access.

In general, Comment Letters in favor of “non-access” urge the SEC to keep its “longstanding” view about its role regarding corporate election of directors, which requires contested elections to comply with other proxy rules. Some argued that enforcement of the requirement would be an administrative burden and unreasonably tax SEC resources.  

An individual investor from Utah suggested that “[i]nvestors should have faith in the management of their investments, and if they don't they should not invest or, if invested, they should sell.” This Letter argues that there has always been a vehicle for election of directors through a “proxy fight.” This Letter goes on to say “[i]t is a bunch of hooey to think that some silly investors should be able to put their own candidates on the board on the company's dime.” In addition, this Letter suggests that if the SEC must make a threshold it should be raised to 35%. Finally, this Letter makes the following comparison: “[i]f Nero fiddled while Rome burned, we'll be the next example, playing with our governance structures while many of the former ‘3rd world’ countries eclipse us.”

WLRK writes its letter in support of SEC Release No. 34-56161, the “non-access” proposal and in opposition to SEC Release No. 34-56160, the “access” proposal. In general, WLRK believes that allowing shareholders access to a company’s proxy statement for director nominations would have significant consequences. WLRK’s Letter, found here, makes the following three overarching assertions in support of its position.

1) The attack on the “director-centric” model of corporate governance established by state corporate law is unfounded.

2) The Costs and Risks of the Access proposal substantially outweigh its benefits

3) Proponents of the Access proposal have shown no need for proxy access

Attack on Director-Centric Corporate Governance

According to WLRK, State and corporate law establishes a “director-centric” model of corporate governance that has done well for public companies and the economy throughout our country’s history. WLRK contends that “activists” seek to trade this model with a “shareholder-centric” model of corporate governance as part of a broad campaign that has been going on for the past several years. And under the “shareholder-centric” model, the constant threat of replacement by activists “with short-term agendas” would erode the authority granted to directors in public companies. WLRK argues that a “director-centric” model is essential, because a board must balance the interest of management, employees, creditors, shareholders, and others to maximize long-term success. WLRK asserts that under the “shareholder-centric” model, non-shareholder groups are given no consideration.

The supporters of the “shareholder-centric” model, according to WLRK, attack the “director-centric” model based on three unfounded propositions. First, directors are “agents,” who have no independent right except to implement the will of the shareholder “owners.” WLRK opposes this proposition by asserting that the primary reason behind the corporate structure is to make clear that shareholders are not active owners. In addition, because shareholders are insulated from liability and directors have the potential liability of a fiduciary to all shareholders, creditors, and employees, WLRK argues that directors are not agents and do not have a duty of obedience to shareholders.

Second, directorial power, beyond agency, serves no wealth-maximizing purpose. Unsurprisingly, WLRK disagrees with this proposition. WLRK contends that a system where directors have independent decision making power is superior to the system where the power is left to shareholders. This superiority lies in the fact that lenders, employees, management, and governments need the stability of a board of directors with ultimate decision making power opposed to an “ever-changing” group of shareholders, who may expropriate funds, by “paying large special dividends or cutting off capital investments” because they have an economic incentive to so.

Third, directors are apt to abuse their power by lining their own pockets. WLRK’s arguments against this proposition are two-fold. As an empirical matter, WLRK asserts, “very few independent directors are ever found, after judicial inquiry, to be derelict in either their duty of care or of loyalty.” WLRK maintains that moreover, even if there is a consensus about this problem, the rules of legal review should be adjusted rather than the scope of director’s power.

Costs and Risks of proposed amendments

WLRK asserts that the costs and risks of shareholder access outweigh any benefits. Specifically, in an election contest, a company must devote a substantial amount of time and resources to the contest. As a result, election contests are extremely distracting to a company’s board and divert their attention from running the business.

In addition, when an election contest is successful it threatens to create a “dysfunctional and balkanized board.” WLRK claims that special interest groups would be the group most likely seeking to nominate a director. To the degree that the special interest groups are successful, WLRK contends, “it will promote balkanization, factions and politicization of boards.”

Finally, increasing proxy contests, among other things, may deter the most qualified from agreeing to serve as directors. WLRK argues that shareholder access will exacerbate this problem, with which companies are currently struggling.

Lack of demonstrated need for enchanced proxy access

Although WLRK admits election contests “may serve a purpose as a last resort in extreme circumstances,” it argues that the proponents of the “access” proposal have not presented any need or benefit for encouraging more election contests. WLRK contends that recent reforms make the issue of additional shareholder access even less important.

WLRK claims the vast majority of companies today encourage shareholders to submit suggestions for director positions to the company’s nominating committee. In addition, shareholders may file their own proxy materials. While this does impose costs, WLRK asserts that the cost has been greatly reduced and some cost ensures that shareholders will treat it as a last resort. Lastly, WLRK argues that post Enron and Worldcom, there has been a massive regulatory response. Because of the new regulations, including SOX and the stock exchange rules, further regulation is unnecessary.

Whether or not these are the most compelling arguments, it looks as if non-access will carry the day.