It is time for the Securities and Exchange Commission to propose proxy access again.
Since the U.S. Court of Appeals for the District of Columbia Circuit in 2011 invalidated the proxy access rule the SEC adopted, neither the SEC nor anyone else has addressed the questions raised in the decision.
In the intervening years, proxy access has moved to the back burner of the agenda for both the SEC, which did not appeal the ruling, and those in the corporate governance community who had once championed proxy access.
However, evidence has piled up in support of proxy access in the U.S., calling into question whether it is time for the SEC to repropose the rule. The evidence includes:
- the equity markets like proxy access;
- proxy access increases board accountability;
- abuse by special interest groups difficult and highly unlikely; and
- the kind of ex-ante cost-benefit analysis the court asked for is nearly impossible.
The SEC's rule the court struck down would have given a shareowner or group of shareholders who held 3% of a company's shares for three years access to corporate proxy materials to place a limited number of nominees on the corporate proxy ballot.
In striking down the rule, the court stated that the SEC had failed to adequately assess the economic costs of the proposed rule.
Markets in the U.S. favor proxy access, as was shown in the aftermath of the court's decision.
A number of studies came about due to the passing of the rule in 2010 and the subsequent overturning, assessing the impact of the event on the value of a company. A majority of these studies showed that shares of companies that would have benefited from proxy access (those with poor-performing boards) generally gained when the markets were surprised by news that looked like proxy access was coming, and declined when the court shot down proxy access.
It is self-evident that proxy access would increase board accountability.
If shareowners have the ability to add their own members if they feel a board is performing poorly, boards are going to ensure that they serve the interests of shareowners. There is a current debate in the corporate governance world about what exactly the ideal level of turnover on corporate boards should be. Since the financial crisis, board turnover has slowed and boards have become more entrenched. An article last April in the Harvard Business Review, “How Much Board Turnover Is Best,” found that boards that replace board members at a greater rate — generally around one new board member a year on average — outperform their peers.
The argument that proxy access would be used for narrow reasons by special interest groups rings hollow.
In non-U.S. markets that have some form of proxy access, such a shareholder nomination process is rarely used. Further, getting a nominee on the corporate ballot is the easy part. The nominating party still needs to persuade other shareowners, more than 50%, that the nominee's ideas are better than those of the current board members. The proposed SEC rule would have allowed nominating shareowners to nominate board members who could at most represent only 25% of the board. This is hardly a recipe for revolution when you consider that the largest pension funds — the ones most likely to use proxy access given their long-term investment horizons — hardly ever own 3% of any company.
It is unlikely that corporate raiders or quick-buck activist investors will abuse proxy access. It wasn't made for them. Few corporate raiders will wait the three years required by the proposed SEC rule to gain only at maximum 25% of the board seats. They would typically prefer to run their own slate of directors in a full-fledged proxy contest, which is done outside corporate proxy materials, to quickly change company boards.
Finally, the kind of ex-ante or forecast in advance of the outcome cost-benefit analysis the court asked for was relatively impossible for the SEC to provide. The “commission inconsistently and opportunistically framed the costs and benefits of the rule, failed adequately to quantify the certain costs or to explain why those costs could not be quantified,” the ruling states.
Too few examples of proxy access usage exist to draw meaningful conclusions, and costs related to a full proxy contest in which an investor wishes to replace an entire board offer a poor analogue. It took the court striking down proxy access to provide a “surprise” to the market that enabled studies proving that market participants think proxy access is beneficial. However, passing laws and then striking them down to surprise the market and see how it reacts is a poor way to legislate and regulate.
The great promise of proxy access is that it will hardly ever be used. That may sound counterintuitive, but we can already see what a world with proxy access would look like in the U.S. market when we observe what has happened in recent years due to annual say-on-pay votes and majority voting for directors.
The threat of negative votes on say on pay — or non-binding shareholder voting on the pay of the CEO and other top executives — and majority voting on director elections — requiring nominees to achieve a majority of the shareholder vote to win election to the board — has driven companies and their boards to increasingly engage with institutional investors.
No matter the cause, increased engagement between investors and companies and their boards is a positive development. Such increased engagement has led to more dialogue about investor concerns and in recent years has led to record levels of resolution withdrawals, signaling greater bargaining and compromise between both parties. According to “Proxy Voting Analytics,“ a joint report released in September by the U.S. Conference Board and FactSet Research Systems Inc., shareowners withdrew about 12% of their annual shareholder meeting proposals in the 2014 proxy season. An earlier report from Institutional Shareholder Services Inc. showed that in 2012 and 2013, record levels of such withdrawals were more than 25% each year.
A proxy access rule in the U.S. is a tool that will increase board accountability, will encourage better performance at poorly governed companies and will drive more engagement between long-term shareowners and companies.
The structure of the rule itself and the need to gain 50% support for nominees will keep the rule from being hijacked by those with interests that are only narrow and short term.
Access to the corporate proxy is something taken for granted in most developed markets. The United States is an outlier by not allowing shareowners to place their nominees on the annual corporate proxy. That can change if the SEC again proposes proxy access.
Matt Orsagh is the New York-based director of capital markets policy, CFA Institute, Charlottesville, Va.
