GUEST CONTRIBUTOR POST: Frederick H. Alexander is a member of the Corporate Counseling Group of Morris, Nichols, Arsht & Tunnell LLP, which specializes in providing advice on corporate governance and transactions. He is also chair of the Council of the Corporation Law Section of the Delaware State Bar Association and co-chair of the General Review Task Force of the ABA Committee on Corporate Laws. This post is exclusive to The Conference Board Governance Center.
By Frederick H. Alexander
The final proxy access rules (the “Rules”) adopted by the SEC on Aug. 25 culminate a long struggle over whether stockholders should have a right to include their own nominees in the annual proxy statement of a public company. Federal law now gives stockholders a right to require a publicly traded company to include stockholder nominees in its proxy materials for up to 25 percent of the directors. The Rules also provide “access to greater access” by allowing stockholders to put proposals into a corporation’s proxy materials that call for an even more liberal proxy access regime than the Rules themselves contemplate.
This entry will focus on a few state law implications of the new rules from the vantage point of a Delaware corporate law practitioner, rather than the policy debate or the intricate workings of the Rules, which have already been the subject of a number of excellent law firm memos.
Proxy Access Does Not Mean The End of State Corporate Law. Many practitioners and academics have asserted that a federal mandate of proxy access is a significant step in the federalization of all of corporate law. If true, this would be disturbing: the current system, under which state corporate law generally governs the relationship among stockholders, directors and management, has been remarkably successful over the course of our country’s history. However, the alarm raised as to the federalization of corporate law at this point is somewhat overstated. As the Rules make clear, procedures governing the actual nomination and qualification of directors will continue to be governed by state law: only the right of those nominees to appear in a corporation’s proxy material is affected.
While the significance of the change should not in any way be minimized, the core of the law surrounding director elections will continue to be governed by state law. Directors must still be properly qualified under state law. They must be elected pursuant to the rules set forth in the Company’s charter and bylaws, and any dispute as to their proper election will be governed by state law and generally subject to resolution in state courts. Pure corporate issues, such as fiduciary duties, will remain largely a subject of state law. Rather than federalization, the true risk, as discussed at the end of this entry, is that the viewpoint taken by the SEC, along with other developments, may tip corporate governance into a new paradigm with significant long-term consequences.
Future Limits on Nominations and Elections. A more interesting state/federal question is whether the Rules will encourage developments in state law that limit the opportunity for stockholders to nominate candidates. The SEC Release (the “Release”) describing the Rules works from the baseline premise that all U.S. jurisdictions permit all voting stockholders to nominate candidates for election. The right to nominate candidates is, in fact, a fundamental aspect of the corporate franchise. The Release is very clear that the only purpose of the Rules is to aid stockholders in exercising this state law right. Thus, to the extent that Rule 14a‑11 (or more liberal proxy access rules adopted under the access to greater access provisions) creates an atmosphere of constant confrontation, corporations may seek to reasonably restrict or govern the exercise of the state law nomination right that is prerequisite to the federal access right.
This development may take several forms. First, corporations facing an increase in annual election contests may adopt charter and bylaw provisions that limit the nomination right. (One related question that the Release does not expressly address is whether the SEC intended to pre‑empt advance notice provisions that require more information from a nominating stockholder than do the Rules themselves, although nothing in the Rules suggests such pre-emption.) Additionally, if the effect of the Rules is to force corporations to spend large amounts of time and effort on annual election contests, the concept of holding meetings on a less than annual basis may be re‑examined.
Qualification and Other Bylaws. The Release states that nominees may be included in a proxy statement even if they do not satisfy the qualification requirements set forth in a company’s charter or bylaws. Nevertheless, directors who do not satisfy a corporation’s qualifications may not be seated under state corporate law. Corporations may want to review their bylaws to ensure that their qualification provisions are adequate, given the limited role of board nominating committees in the access process.
A System of Confrontation. Finally, I want to highlight two details of the Rule and discuss how they reflect a policy choice that suggests a flawed concept of corporate governance. First, the details: in calculating whether access nominees comprise 25 percent of the board (which is the permitted number of access nominees), only stockholder nominees proposed in a public confrontation are included. For example, a nominee proposed by a stockholder and accepted by a board nominating committee prior to the time that stockholder publicly announces the nomination (through an SEC filing), does not count towards the 25 percent threshold. In other words, it is the SEC’s policy that only a nomination including a public confrontation between a stockholder and the board counts as an access nominee. On a similar note, if an access nominee is elected to the board, and then renominated at the next election by the board (rather than by stockholders), the nominee will no longer count towards the threshold, even though the nominee became a director through the stockholder access process.
These counting rules appear to flow from a policy of promoting confrontation between stockholders and the board, and not just stockholder participation in the nomination process. This combative approach implies a theory of corporate governance that is out of step with state corporate law, under which directors are considered fiduciaries whose role is to govern the corporate enterprise for the benefit of its stockholders. At its best, access should be viewed as a mechanism to allow stockholders to bring the board in line with this expectation, and any stockholder-proposed director should satisfy the goal of a rational access process.
The counting rules outlined above, however, appear to work from a different premise: they assume that there is a zero-sum relationship between stockholders and directors. Any candidate agreed to by the board (at least without a public confrontation), is viewed as not being an authentic “stockholder access” candidate: any nominee approved by the directors is deemed the enemy of the stockholders. If the Rules help to tip corporate governance into a new paradigm, where stockholders and directors are viewed as permanent opponents in a struggle for power, rather than partners in a quest for value, then there will indeed have been a federal incursion into corporate law, and that incursion is likely to detract significantly from the value of the public corporation as a vehicle for raising and investing capital.