On October 4, 2010, the Securities and Exchange Commission announced a delay in the effectiveness of its recently adopted proxy access rules, scheduled to take effect on November 15, 2010. The new proxy rules, which apply to all U.S. companies filing SEC reports under the Exchange Act, were designed to give large shareholders (i.e., 3% of the outstanding stock held for at least three years) the right to include their own board nominees in a company’s proxy materials. This would give the shareholders a broader choice of candidates for the Board of Directors, not just those nominated by the incumbent directors (who typically nominate themselves). To quote from the SEC release of August 25, 2010 announcing the new rules (SEC Release Nos. 33-9136; 34-62764; IC-29384; File No. S7-10-09): “Without the ability to effectively utilize the proxy process, shareholder nominees do not have a realistic prospect of being elected because most, if not all, shareholders return their proxy cards in advance of the shareholder meeting and thus, in essence, cast their votes before the meeting at which they may nominate directors. Recognizing that this failure of the proxy process to facilitate shareholder nomination rights has a practical effect on the right to elect directors, the new rules will enable the proxy process to more closely approximate the conditions of the shareholder meeting.” A related amendment to the proxy rules would require companies to include in their proxy statements shareholder proposals to amend the company’s governing documents to provide even more liberal procedures for proxy access.
The SEC’s announcement of a delay in the effectiveness of the new rules was a response to a lawsuit filed by the Business Roundtable and the Chamber of Commerce of the United States of America (Business Roundtable, et al. v. SEC, No. 10-1305 (D.C. Cir., filed Sept. 29, 2010)). These business groups seek to overturn the new proxy rules on the grounds that they are “arbitrary and capricious” and, in addition, that the SEC failed to properly assess the costs of proxy access or the effects on “efficiency, competition and capital formation,” as required by law.
As a result of the SEC announcement delaying effectiveness, the new proxy rules are not likely to affect the 2011 proxy season. The lawsuit will probably not be resolved for at least six months. Prior to the suspension of effectiveness, the new rules had applied to any companies that had mailed proxy materials for their previous annual meeting after March 13, 2010.
We predict that the SEC will prevail in the lawsuit and the new rules will become effective again sometime in late Spring 2011. The court will undoubtedly take notice of the fact that in the recently enacted Dodd-Frank Act, the Congress confirmed the SEC’s authority to require inclusion of shareholder nominees for director in company proxy materials. (Dodd-Frank Act §§ 971(a) and (b)). In addition, the SEC followed an elaborate rule making-process that began in June 2009. Many comments were submitted in response to the proposed rules and those comments are discussed in the adopting SEC Release of August 25th, which is 451 pages long.
We also predict that after the new proxy rules again become effective, they will have a profound effect on corporate governance at many SEC reporting companies.