Shareholder Access, the SEC and Corporate Governance: The 5% Threshold (Part 2 1/2)

We are discussing the proposal made by the Securities and Exchange Commission that would amend Rule 14a-8(i)(8) to clarify that proposals may not be excluded that would sometimes require management to include shareholder nominees in the company’s proxy statement (“access proposal”).  The proposal is contained in Exchange Act Release No. 56160 (July 27, 2007).  This Blog has already written extensively about the alternative proposal made by the Commission that would deny shareholders access for this purpose and has submitted to the Commission a comment letter on the non-access proposal.

More specifically, we are discussing the restriction in the proposal that would limit the shareholders eligible to make access proposals to those with 5% or more of the voting shares of the company.  We noted that the restriction effectively amounts preemption of state law by imposing a uniform federal standard for certain types of bylaws.  In addition, the threshold is excessive, making these proposals all but impossible to make in many large public companies.  There are other reasons, however, why this is a bad idea. 

C. Bad Precedent

The imposition of a share ownership threshold for a particular type of proposals sets a very bad precedent. The rule currently contains only uniform ownership requirements that apply to all shareholders and are di minimus in amount. The access proposal would impose a unique ownership threshold that depends upon the type of proposal at issue. The Commission has in the past considered higher ownership thresholds that would apply to all proposals. See Exchange Act Release No. 19135 (Oct. 14, 1982).  Moreover, the Commission has considered using higher ownership thresholds to override a company’s right to delete proposals under some of the exclusions in Rule 14a-8. See Exchange Act Release No. 39093 (Sept. 19, 1997).  Applying a higher threshold to a specific proposal (not even a specific type of proposal) is quite different from these earlier approaches.  It would set a precedent for other types of proposals, encouraging the addition of unique ownership thresholds depending upon the content of the proposal, adding an additional layer of complexity to an already complex rule.

Despite the substantial departure in the traditional approach under Rule 14a-8, the Release never adequately explains why a unique threshold is necessary here but not for other types of proposals that have the same potential impact. Perhaps the Commission was concerned about an increase in the number of election contests that could result from access proposals. As discussed later, this is an overstated concern. Moreover, other types of proposals raise the same potential concern. Proposals seeking the adoption of cumulative voting, the nomination of multiple candidates for each position on the board, or the reimbursement for proxy expenses, all potentially raise the risk of an increase in the number of election contests. Yet the staff has declined to allow such proposals to be excluded under Rule 14a-8, apparently without concern about the need for a unique ownership threshold by the proposing shareholders.

D. Access Proposals and the Practice to Date

There has been some experience with access proposals. The actual practice belies the need for a high ownership threshold.  In the aftermath of the Second Circuit’s decision in AFSCME, there have been only four proposals made by shareholders, with two failing, one passing, and one being withdrawn (Seneca Capital apparently submitted a proposal to Reliant Energy but ultimately withdrew it). Two additional companies, Apria Healthcare and Comverse, voluntarily adopted access bylaws. The case of Apria Healthcare is instructive. The provision was adopted in 2003. It allowed 5% shareholders to make up to two nominations for inclusion in the company’s proxy statement. Although three annual meetings have since come and gone, no shareholder nominees have been included in the proxy statement.

In other words, very few access proposals have actually been made, all contained reasonable standards, and only one was adopted. Two have been put in place voluntarily but so have apparently not been used. This hardly seems to be an outpouring that will destabilize the carefully crafted proxy rules and requires provisions in Rule 14a-8 designed to severely limit the number of access proposals.

E. Possible Revision

We acknowledge the concerns expressed by Chairman Cox at the open meeting held on July 25. He noted that “changes to the existing system, even changes that everyone agrees are improvements, should be measured and incremental to ensure that first we do no harm.”

In considering a possible incremental approach, we recommend that the Commission substantially lower the ownership threshold for access proposals. The Commission should then build into the rule a stair step reduction in the percentage, with the ownership requirement falling each year until becoming identical to the existing ownership threshold for all proposals. The gradual process will provide time for companies and shareholders to get used to the new regime and to accumulate more data.

Conclusion:

The use of a unique threshold in the rule is a fundamental shift in the traditional approach taken by Rule 14a-8. The change is being done in an ad hoc, hurried fashion. The change needs to be considered more systematically and in a less controversial setting.  Alternatively, it ought to be put in place with a phased reduction, gradually reducing the necessary percentage over time, giving all parties time to become comfortable with access proposals.