The SEC, Rule 14a-8, and Shareholder Approval of the Auditor: Time for a Change in Administrative Policy (and Let 1000 Private Ordering Proposals Bloom) (Part 5)

Where does this position leave shareholders?

It is likely the case that the position was approved by the Commission in a back handed way in 2005.  When companies or shareholders appeal a ruling in a no action letter, the practice is to circulate a memorandum to the Commission suggesting that the body deny the appeal.  Where the Commission agrees with the position taken by the staff, the appeal will usually (but not always) be denied.  There are, however, exceptions.  For example, in the infamous no action letter, Cracker Barrell, the Commission accepted an appeal and affirmed the staff's ruling. Thus, the shift in the position with respect to shareholder approval of the auditor likely reflected the position of the Commission.

The position seems wrong on the law.  Transamerica confirmed that there was nothing “ordinary” about the practice.  Although hired by the company (the audit committee in the case of listed companies), the auditor nonetheless has a critical role in acting as a gatekeeper on behalf of shareholders.  Unlike most other types of consultants, therefore, shareholders have an interest in the identity and independence of the outside auditor.  This has long been true and long been recognized.   This is demonstrated by the fact that most large public companies submit auditors to shareholders.  Likewise, the case is strong that shareholder approval is a matter of public importance.  Indeed, the Treasury Report back in 2008 recommended that shareholder approval be made mandatory for listed companies. 

The only real argument suggesting otherwise is the decision by Congress in SOX to assign to the audit committee of listed companies the right to select the outside accounting firm.  But as the staff has recognized in other contexts, shareholder ratification neither involves the selection of the auditor nor results in the veto of the appointment.  The vote, therefore, is largely advisory.       

This was something noted by the Commission in the implementation of the audit committee requirements contained in SOX.  Rule 10A-3 provided that audit committee approval did not restrict or interfere with “any requirement or ability under a listed issuer's governing law or documents or other home country legal or listing provisions that requires or permits shareholders to ultimately vote on, approve or ratify" the independent auditor.  The language was added after commentators asked the Commission to clarify that the rule did not to specifically restrict or interfere with shareholder ratification.

It is a bit of an irony that congressional intrusion into the selection process in an effort to ensure greater auditor independence is the primary argument used to avoid shareholder approval of auditors, something also designed to ensure independence.

In short, the only issue with shareholder approval of auditors is whether the right should be required.  Seeking the authority through Rule 14a-8 is an attempt to head off a mandatory requirement through private ordering.  Yet by allowing the proposals to be excluded, the Commission is essentially leaving little choice except for a mandatory rule.  Congress could do so or it could be implemented by the exchanges.

The approach also shows the weaknesses associated with the "ordinary business" exclusion under Rule 14a-8.  Overburdened with requests, most coming in a narrow band of time, the staff has little opportunity to provide detailed analysis, even when a position shifts significantly. 

For another, the "ordinary business" exclusion is unmoored from state law and a matter of staff discretion.  Yet the staff is not an expert in the "ordinary business" of a corporation or an expert in matters of social importance.  As a result, interpretation under the "ordinary business" exclusion often shifts, depriving of market participants of certainty.

There are suggestions for reform set out in the paper listed below.  They are for another day.  In the short term, the staff needs to reverse its position on shareholder approval of auditors and allow private ordering to flourish.

The topic is developed more fully in Essay: The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors.



Comments

[Herrick Lidstone]

Jay:

Interesting series of posts, but I am not sure that they have practical importance. Because of amendments to NYSE Rule 452, brokers are no longer permitted to vote without direction from their client even in uncontested election of directors. Thus, unless companies also include a provision to vote for retention of auditors in their proxy, some may not be assured of even having a quorum present.

I think that you have seen in 2010, and will continue to see more proxies including auditor selection (non-binding, of course) to ensure that companies do obtain the broker vote for quorum purposes (which is permitted under NYSE Rule 452).

If the proxy only includes election of directors and say-on-pay and the brokers do not have direction from their client, they will submit nothing for the establishment of a quorum.