Verizon, the Commission, and Rule 14a-8

Two weeks ago, Verizon shareholders approved a “say on pay” provision (the finally tally was only completed late last week).  The provision requests but does not require an advisory vote on executive compensation.  As the Verizon proxy statement provides:   

• RESOLVED, the shareholders of Verizon hereby request that the Board adopt a policy that includes, as a voting item in the proxy statement for each annual meeting, an advisory resolution, proposed by Verizon’s management, to approve the compensation of the named executive officers (“NEOs”), set forth in the proxy statement’s Summary Compensation Table (the “SCT”), and the accompanying narrative disclosure of material factors provided to understand the SCT. The policy should specify appropriate disclosures to ensure shareholders fully understand the vote is advisory and will not abrogate any employment agreement.

In other words, management can decide whether to hold the advisory vote.  Once the advisory vote is held, management can choose to disregard the results of the vote.  Why would shareholders propose such a meek requirement?  One reason might be to garner support.  Perhaps more shareholders will vote for a proposal if it lacks teeth. 

But another possible reason is that they had no choice.  The proposal was inserted into Verizon's proxy statement under Rule 14a-8, the shareholder proposal rule.  The Rule provides that proposals may be excluded if they are "[i]mproper under state law"  (Rule 14a-8(i)(1)) or would "violate" state law. Rule 14a-8(i)(2).  These exclusions rarely involves matters that are patently illegal.  Instead, they come up most often in the context of shareholder proposals that allegedly intrude into the day to day authority of the board of directors.  As the Commission has noted:

• In this regard, it is the Commission's understanding that the laws of most states do not, for the most part, explicitly indicate those matters which are proper for security holders to act upon, but instead provide only that "the business and affairs of every corporation organized under this law shall be managed by its board of directors," or words to that effect. Under such a statute, the board may be considered to have exclusive discretion in corporate matters, absent a specific provision to the contrary in the statute itself, or the corporation's charter or by-laws. Accordingly, proposals by security holders that mandate or direct the board to take certain action may constitute an unlawful intrusion on the board's discretionary authority under the typical statute.

Exchange Act Release No. 12598 (July 7, 1976).  Thus, to the extent that the company can attach an opinion opining that the proposal improperly intrudes into the business affairs of the board, the Commission will often allow for its exclusion.  This is true even though the issue may be in dispute.

Take for example the shareholder proposal submitted earlier this year to General Motors.  The proposal called called for a bylaw requiring each director to "oversee, evaluate and advise one of the following functional groups regarding corporate operations."  General Motors attached a letter from a Delaware law firm opining that the bylaw violated Section 141(a) of the Delaware Corporation law "because the Bylaws rather than the Certificate of Incorporation would modify the oversight duties of the Board by assigning to the directors additional, discrete responsibilities of the Board in managing the business and affairs of the Company."  In other words, duties of directors could not be set out in bylaws.  

This is not always a clear issue.  See Bebchuk v. CA, Inc., 902 A.2d 737, 743 (Del. Ch. 2006)  ("Furthermore, the question of whether a bylaw unduly restricts the ability of a board of directors to exercise its fiduciary duties can only be examined in the context of an enacted bylaw that is said to actually threaten the board's ability to discharge its obligations to the corporation and its stockholders.").  Moreover, Section 109 specifically allows shareholders to adopt bylaws that "contain any provision, not inconsistent with law or with the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees."  8 Del. C. § 109.  In other words, they can regulate the powers of directors in the bylaws, so long as they do not conflict with the charter or statute. 

To duck this issue, the Commission has attached a note to Rule 14a-8(i)(1) indicating that proposals "not considered proper under state law if they would be binding on the company" will generally be proper if they are cast as "recommendations or requests that the board of directors take specified action. . . "  In other words, shareholders often must phrase proposals as a recommendation rather than a requirement in order to avoid having them be excluded from management's proxy statement.  As recommendations, management is free to ignore them.

Thus, shareholders are forced into a Hobson's choice:  Either make the proposal a recommendation that can be ignored or have it be excluded from management's proxy statement.  The latter effectively denies shareholders the right to make the proposal in its entirety since the alternative requires a separate solicitation, something that is, in most instances, prohibitively expensive.  

In my article on the role of the Commission in the governance process, rule number one is to do no harm, that is, to not make the corporate governance process worse.  In this case, forcing shareholders to opt for recommendations rather than binding obligations that may be legal under state law is making the process worse.  It is because of issues such as this that the House of Representatives passed HR 1257, which would mandate advisory votes by shareholders on executive compensation. 

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